Company or Unit Trust to Trade Equity Options

Originally Posted by DaveL

Hi All,
My very first post, and so would appreciate your kind assistance.

With a good friend, I am looking at setting up either a Company or a Trust to initially trade Equity Options on the US Markets. We have prepared a detailed Business Plan and are currently finalising the Option Trading Strategies we will use. In the near future we will open an account and commence trading. We have both studied and traded markets for many years and fully understand the risks of options trading and strategies to manage those risks. We believe we each have complementary strengths in the market which we can leverage into a genuine market "edge" to ensure consistent long-term profits.

Usual caution about mixing friends and money applies. But the good thing is you're going into it cautiously and not outlaying much cash to start with.

Given there's only 2 of you and you're investing an equal amount, who makes the decisions? What if there's a deadlock? Whatever structure you decide on must have a mechanism to break decision paralysis. Perhaps for investment decisions the rule could be unanimous or no investment, but that won't work for issues such as early exits. Maybe it's toss of the coin?

I recommend you both sit down and map out on paper what the "rules" should be to regulate this joint business venture. To establish it, to run it and most importantly to end it.

We intend to only put in about $5K each initially (perhaps plus entity set up costs). The intention would be to build our trading capital from profits and compound them to the greatest extent possible. Once the performance milestones in our business plan are met (which confirms the merit of our strategies) we may add more funds. I do have a family trust already set up and am considering the family trust would own my initial shares in a Company or units in the Trust if that proves, on balance the best structure. That should give you flexibility and asset protection.

So the question is what would be the better entity to use - a company or a unit trust? Would appreciate your views please on the merits of each and then on balance, what you may feel is the "better" alternative (and also your reasons for that conclusion).

Companies are able to retain profits after paying tax @ 30%. Trusts must distribute the net taxable income each financial year or be taxed at the top marginal rate (i.e. 46.5%). It's harder to get money out of companies as it must be dividended out or loaned out. But loans can be deemed to be dividends in some circumstances. Talk to your accountant. In essence there's just a tax deferral with a company, but that may let you wait to dividend $ out in a year where the taxable income of one of the beneficiaries of your DT is low.

Remember companies do not get access to the general 50% CGT discount for assets held for > 12 months whereas trusts (as pass through structures) can do. BUT I suspect (and your accountant should confirm) your profits will be on revenue rather than capital account, so this point may be academic.

Also, query whether you'll want to use some debt funding? In that case perhaps upstream should include a hybrid discretionary trust.

Some other considerations we want to address are:

the ability to allow money (initial funds plus profits) to grow in that entity or alternatively, to have a strategy to roll profits back into the entity if that is necessary; Suggests a company with your shares owned by your DT. But you can always just notionally roll $ back into UT (after it's been included in taxable income of whomever your DT distributes it to). I.e. you both end up with a loan account with the trust and no money actually leaves.

the ability and flexibility to get money (profits) out of the entity when we choose to, as either dividends or distributions; Suggests a unit trust (but note comments above about timing).

taxation implications, including eventually having the entity pay many of the costs associated with our trading activities (such as charges for internet access, market data, trading software, educational activities, etc.) and taxation implications of trust distributions vs. (hopefully fully franked) dividends; Either structure can pay your costs first.

ability to pay ourselves a salary at some future time (that is, we may eventually be employees of this new entity as well as and share / unit holders in it); Either approach will work. You'll get taxed on your salary as usual.

set up costs and ongoing "running costs" of the entity; and
any other aspects you feel may be important considerations in deciding which entity is the best option. Even if you go with a UT, the trustee should be a company, not the pair of you. This of course adds to the cost.

Ideally, whatever entity type we choose will be able to meet our needs into the foreseeable future as our trading capital (and therefore profits) grows.

We will of course seek professional assistance to set up a structure and the reason for this post is to seek as many views as possible to gain the greatest understanding so that we become "informed".

Thanks very much for your help.

Asset protection will be better with a company, but really the risks are fairly limited. Presumably the option broker will have only limited recourse security from the entity you use.

DavidL