As a small business owner, it’s normal to do deals with people you already know and trust. You might buy stock from a friend’s business, lease a workspace from a related company, or pay a family member to help with bookkeeping.
There’s nothing wrong with that. But when the other party is “connected” to you (for example, a director, shareholder, relative, related entity, or a close business associate), it becomes especially important that the deal is structured on arm’s length terms.
In plain English, an arm’s length transaction is one that looks and feels like a deal between strangers in the open market. When your arrangements are genuinely at arm’s length, you’re far less likely to run into disputes, governance issues, or unnecessary regulatory attention.
This guide breaks down what arm’s length means in practical terms, where it matters most for small businesses in Australia, and how you can document your deals properly so you can keep building with confidence.
What Does “Arm’s Length” Mean In Business?
In business, “arm’s length” generally describes a transaction where the parties act independently, in their own interests, and the terms are consistent with market norms.
It’s commonly used when:
- you’re dealing with a related party (for example, a family member, a director, or a related company); or
- there’s a risk the deal could be seen as “mates rates”, overly generous, or designed to shift value in a way that wouldn’t happen in a normal commercial negotiation.
Why Arm’s Length Deals Matter For Small Businesses
Keeping your transactions on arm’s length terms is more than a “nice to have”. It helps protect you in very practical ways:
- Cleaner business records: Your financials make sense to your accountant, investors, and lenders.
- Lower dispute risk: If something goes wrong later, you can point to clear terms and market reasoning.
- Better governance: Directors and owners can show they acted in the company’s best interests.
- Stronger compliance position: Many legal and regulatory frameworks (including tax and corporate governance rules) look closely at related-party arrangements and whether they are commercial.
Even if you’re operating informally right now, building a habit of documenting related-party arrangements on arm’s length terms is one of the simplest ways to create a scalable, saleable business.
When Do You Need To Think About Arm’s Length Transactions?
You’ll usually need to think about arm’s length terms when you’re doing a deal with anyone who is not truly independent from you.
Here are common examples for Australian small businesses.
A very common scenario is leasing premises from a director, a family member, or another entity you control. This can be completely legitimate, but it should be on market-like terms.
Key things to check:
- Is the rent comparable to similar properties in the area?
- Are outgoings and repair obligations allocated in a normal way?
- Is the lease term and renewal structure commercially reasonable?
- Is there a clear written agreement?
Even where the relationship is friendly, a proper Commercial Tenancy Agreement helps show the arrangement is on arm’s length terms and prevents misunderstandings later.
If you run multiple entities (for example, an operating company and a related holding entity), you might invoice between them for management services, equipment hire, IP licences, staff secondments, or stock.
These arrangements should still look like normal business dealings. That typically means:
- services are clearly defined (what is actually being provided);
- pricing is justifiable (how did you decide the fee);
- invoices are issued and paid in a consistent, business-like way.
Often, a tailored Service Agreement is the simplest way to document scope, fees, and expectations so the arrangement is clearly on arm’s length terms.
3. Paying Family Members Or Hiring “Someone You Know”
Many small businesses start out with support from family. You might pay your partner to do admin, your sibling to manage social media, or your parent to help in-store.
To keep that on arm’s length terms:
- pay rates should be reasonable for the role;
- duties should be clear (so payment matches actual work);
- the arrangement should be documented like any other hire.
Even for early-stage businesses, a written Employment Contract (or contractor agreement, if that’s the correct engagement model) helps you treat the relationship professionally and reduce risk.
4. Loans Between You And The Business
Another scenario that often needs an arm’s length lens is money moving between the business and owners or directors.
For example, you might:
- loan money to the business to cover cash flow;
- take money out and treat it as a loan to you;
- have a related entity provide funding or guarantees.
The issue is not that these are “not allowed” - it’s that the terms should be clear and commercially sensible (interest, repayment timing, security, and what happens if repayment doesn’t occur).
In many cases, documenting it with a proper Loan Agreement helps demonstrate the arrangement is on arm’s length terms and avoids later disputes about whether it was a gift, a dividend, wages, or something else. (Note: related-party loans can also raise tax issues in Australia, such as Division 7A for private companies, so it’s a good idea to get tax advice as well.)
5. Selling A Business Or Bringing In A New Investor
When you sell your business (or part of it), the buyer and their advisors will often look closely at related-party arrangements. If your business rents a premises from a director, relies on a founder-owned brand name, or has informal deals with related entities, that can raise red flags.
Cleaning up and documenting these arrangements early helps your business look more “investment ready” and can make a sale process far smoother.
How To Make Sure A Deal Is Truly “Arm’s Length” (Practical Checklist)
So how do you actually structure an arm’s length transaction?
There isn’t one single legal test that fits every situation, but in practice, you want your deal to be defensible if a third party ever reviewed it (an auditor, investor, regulator, or even a judge in a dispute). Where tax outcomes matter, what counts as “arm’s length” can also depend on the specific tax rules that apply (for example, transfer pricing concepts for cross-border dealings or Division 7A for certain private company payments/loans), so you should also speak to your accountant or tax adviser about your situation.
Step 1: Confirm Who The “Connected” Parties Are
Start by being honest about the relationship. Ask:
- Is the other party a relative, friend, director, shareholder, or employee?
- Is it a company or trust you control (or that controls you)?
- Would an outsider say the relationship could influence the deal?
If the answer is yes, treat it as a related-party arrangement and make sure the terms are arm’s length.
Step 2: Benchmark The Terms Against The Market
You don’t need a 40-page valuation report for every agreement, but you should have some objective basis for your pricing and terms.
Depending on the transaction type, this might include:
- quotes from other suppliers or contractors;
- comparable market rates (for rent, wages, consulting fees);
- historical pricing you’ve paid to independent parties;
- a note from your accountant or broker explaining why the price is reasonable.
What matters is that you can show the deal wasn’t just made up without reference to what an independent party would accept.
Step 3: Document The Deal Like You Would With A Stranger
This is where many small businesses get caught out. You might have a perfectly reasonable arrangement, but if it’s not written down, it can be hard to prove later.
Good arm’s length documentation often includes:
- a written contract (even if it’s short);
- clear scope (what is being provided and what isn’t);
- fees/pricing and payment terms;
- term, renewal, and termination rights;
- who carries what risk (insurance, liability, repairs, defects, delays).
If you’re working with a co-founder or co-owner, it can also help to align on decision-making and related-party approvals through a Shareholders Agreement, particularly where one owner is transacting with the business.
Step 4: Manage Conflicts Of Interest (Especially For Companies)
If your business is run through a company, directors have duties to act in the company’s best interests. Related-party dealings can create a conflict between personal interests and company interests.
Practically, that means you should consider:
- declaring the conflict (for example, at a directors’ meeting);
- having non-interested decision-makers approve the deal where possible (and checking what your constitution and any shareholders agreement requires);
- recording the reasons the deal is fair and on arm’s length terms.
A solid governance foundation, including an up-to-date Company Constitution, can make these processes clearer as your business grows.
Step 5: Keep Evidence And Keep It Consistent
Consistency is a big part of showing an arrangement is arm’s length. If you say the rent is market rate, but it’s paid sporadically, waived for months, or altered informally without a paper trail, it starts to look less commercial.
A few habits that help:
- issue invoices on schedule;
- pay invoices on schedule (or document any deferrals);
- avoid mixing personal and business spending;
- record variations in writing (even an email confirming updated terms).
Common Arm’s Length Mistakes (And How To Avoid Them)
Most arm’s length issues we see don’t come from bad intentions. They come from small businesses moving quickly, relying on trust, and not documenting changes as they go.
Here are a few common pitfalls to watch out for.
“We’ll Sort It Out Later” Agreements
If you start trading before the paperwork is signed, you can end up arguing later about what was agreed - especially if money is tight or the relationship breaks down.
Even a short written agreement upfront is usually better than a perfect agreement later.
Mates Rates Without A Commercial Rationale
Discounts aren’t inherently a problem. The issue is where the price is so far from market that it looks like value is being shifted for non-business reasons (and in some cases, it can also have tax consequences).
If you do offer a discount to a related party, document why. For example, maybe they’re paying in advance, committing to a longer term, or doing bundled work.
Unclear Deliverables (Especially For Management Or Consulting Fees)
Related entities often invoice “management fees” without clear deliverables. That can look vague and hard to justify.
To strengthen the arm’s length nature of the transaction, describe what’s actually being provided (for example, HR support, bookkeeping, marketing coordination, or IT maintenance) and how the fee is calculated.
If the business relies on a brand name, software, content, or designs owned by a founder or another entity, it’s worth documenting permission and terms.
An IP licence arrangement can be particularly important if you later sell the business, bring on investors, or have a founder exit.
What Legal Documents Help Support Arm’s Length Transactions?
Having the right documents in place is one of the most practical ways to show your arrangements are genuinely on arm’s length terms. It also makes day-to-day operations smoother, because everyone knows what’s expected.
Depending on your situation, the following documents are commonly used:
- Service Agreement: sets out the scope of services, payment terms, timing, and liability (useful for contractor work, management services, marketing, IT support, and related-party services).
- Commercial Lease / Tenancy Agreement: documents rent, outgoings, repairs, term and renewal (especially where premises are owned by a related party).
- Employment Contract: clarifies duties, pay, and expectations when you hire staff (including family members) and helps support compliant, business-like arrangements.
- Loan Agreement: records interest, repayments, defaults, and any security for money lent between owners/directors/related entities and the business. (Note: get tax advice on related-party loans, including potential Division 7A implications for private companies.)
- Shareholders Agreement: sets rules for decision-making, exits, and how conflicts and related-party dealings are handled between owners.
- Company Constitution: supports governance processes for approvals and decision-making (particularly useful as your company grows and decisions get more formal).
If your business collects customer information (even something as simple as email addresses for marketing), you should also think about privacy compliance as part of your overall risk management. A Privacy Policy won’t “make” a transaction arm’s length, but it can help show your business is set up in a defensible and professional way.
Key Takeaways
- Arm’s length transactions are deals that look and operate like a normal market transaction between independent parties, even if you’re dealing with someone connected to you.
- Small businesses often face arm’s length issues when renting property from related parties, paying family members, invoicing between related entities, or making loans to/from owners and directors.
- A practical way to test an arm’s length arrangement is to ask: would you accept these same terms with a stranger, and could you justify them with market evidence?
- Clear documentation (service agreements, leases, employment contracts, and loan agreements) helps reduce disputes and makes your business easier to run, fund, and potentially sell.
- For companies, managing conflicts of interest and recording approvals can be just as important as getting the price right (and you should also get accounting/tax advice where related-party dealings affect tax outcomes).
If you’d like help documenting related-party arrangements and putting the right contracts in place, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.
