Choosing a business structure isn’t as complex as you may think. Learn here which one is best for you
Get a coffee and sit down with us for a minute or two.
Before we get into some of the details, have a think about your business. Fast forward a couple of years – where will your business be? What will it look like?
Will you need to employ staff or keep it as a home business? Do you want to expand overseas, or will you need capital to grow?
Great, now keep the answers to these questions in the back of your mind as you learn about each of the business structures.
What do you mean exactly, by business structure?
In a nutshell, the business structure you choose in the end will outline how your business will legally conduct its day-to-day operations.
The business structure type will be bound by certain laws as it conducts its business, the specific taxes it will have to pay, and it will affect what happens when the business cannot pay its debts.
Each business structure has different obligations it is responsible for as well, but we’ll get into these as we discuss each of the business structure types you can choose from.
Does it matter?
Yes. This is an important step for your business as the structure will impact on your tax, personal liabilities, asset protection, legal costs, clients, operational risk and reporting obligations.
The two main considerations for business structure
There are rules which may limit your choice in business structure.
They are based on two main considerations that decide the business structure type –
- The number of owners in the business and
- If the business will hold and control any assets for the benefit of others. By assets we mean, estate, property, or business.
What are the business structure types?
Let’s jump in and help you to choose your business structure
1. Sole trader ABN holder
What is a sole trader? This is the simplest structure for a self-employed person who owns and runs their business as an individual. It gives you full control and responsibility for any issues.
Advantages of a sole trader
- Less expensive to run
- You can run the business under a trading name. It doesn’t have to be under your name
- You have complete control over the management and future of the business
- It has the least amount of paperwork for the business structures
- Profits are taxed at the owner’s personal income tax rate
- Closing or selling the business is easy, the owner keeps all the after-tax gains
- You have more privacy as you do not need to disclose your profits to the public
Disadvantages of a sole trader
You are fully responsible for all your business debts. They will be paid from your personal assets such as your home, vehicles, or savings.
- Tax is paid at the owner’s marginal tax rate which may be higher than the company tax rate.
- There are few tax concessions available for a sole trader
- There are limits to business expansion.
Choosing between ABN sole trader or company registration? We have an article for you!
2. Partnership Business Structure
What is a partnership? A partnership is where 2 or more people operate a business as co-owners and share income. All co-owners act on behalf of each other in the business.
It is like a sole trader and follows a simple registration process.
However, we highly recommend when choosing a partnership business structure by creating an agreement between all parties that covers business details, roles of the partners, operational outline, and expectations so all partners are clear from the outset.
Advantages of a partnership
- It is simple and cost-effective to set up.
- A smart way to combine resources and the individual expertise of people.
- You can use a trading name for the business
- It is easy to operate
- Profits and losses are shared between the partners, according to their share of the business
- You have more privacy as you do not need to disclose your profits to the public
- Your business can grow – it is relatively easy to transfer from a partnership into a company down the track.
Disadvantages of a partnership
- All partners are personally responsible for business debts, including debts incurred by the other partners.
- All partners can participate in the running of the partnership unless you have agreed otherwise.
- All profits must be shared between the partners.
- The partnership itself does not pay tax. Tax is charged at the personal rate of each partner. As your business earnings increase, so too does your tax rate.
- It can be difficult to add or remove partners from the partnership. Ownership to someone outside the partnership cannot be done without the other partners’ permission.
- Personal differences and disagreements between the partners may hinder the business.
3. Company Structure
What is a company? A company is its own legal entity, separating the personal responsibility of its shareholders and directors.
A Proprietary Limited company or Pty Ltd, can be started by a minimum of 1 director and 1 shareholder, but you can have more directors and shareholders.. Each shareholder may own an equal portion of the shares (for example, one share each), or any other portion the shareholders agree in the company through an initial share offering.
Most incorporated companies in Australia have shareholders, company directors and managers who are typically the same two or three people.
Advantages of a company structure
- All legal arrangements are in the company’s name, not in the name of directors and managers.
- The tax rate for a company is less than the highest rate for individuals.
- In most cases, shareholders are not liable to pay company debts, they can only lose the value of their shares.
- When the company’s profits are distributed to shareholders, the shareholders can receive a tax offset for any tax the company has paid. This can lead to a refund if your marginal rate is lower than the company rate.
- Continuity of management and ownership in death or disability is maintained as company shares can be transferred.
Disadvantages of a company structure
- A company is more regulated than other business structures.
- It is more costly to establish and run a company and the rules are more complex.
- If the directors fail to meet their legal obligations, they may be personally accountable for the company’s debts.
- The company’s profits distributed to shareholders are taxable. This can lead to a tax debt if the shareholder’s marginal rate is higher than the company tax rate, although the shareholder may receive a tax offset for any tax the company has paid.
- Suppliers and lenders are hesitant to lend money or enter into contracts with Pty Ltd companies unless directors or shareholders provide personal guarantees.
What is a trust? A trust is not a legal entity. It is a relationship where a trustee (an individual or a company) carries on business for the benefit of other people (these are the beneficiaries).
This business structure is potentially the most complex business structure, so stay with us here.
There are 2 main ways to utilise this structure:
- Trading trust – this is where the business is run through a trust and the trustee is responsible for the business operations.
- Family trust, otherwise known as a discretionary trust – this is where assets, such as shares in a family business or rental properties, are held in trust for the benefit of you and your family. The trust is not responsible for the operations of the company but will receive distributions of profits that can be distributed to your family as you see fit.
The trustee can either be a company or one or more individuals.
Advantages of a trust
- A trust provides protection of assets as well as limits the liability in relation to the business.
- A trust separates the control of an asset from the owner of the asset. This may be useful for protecting the income or assets of a young person or family unit
- Trusts offer flexible tax obligations as income and capital gains can be spread among the beneficiaries
- The beneficiaries of a trust are not responsible for the trust’s debts
- Beneficiaries pay tax on trust income at their own marginal rats
Disadvantages of a trust
- A trust is more costly to set-up
- Its complex legal structure requires the services of a solicitor or accountant to set up and maintain
- The trustee has a strict obligation to hold and manage the property for the exclusive benefit of the beneficiaries
- The operation of the business is restricted to the terms outlined in the trust deed
- Trusts have broad regulations they must comply with, so may be difficult for a business owner to maintain
- Trusts cannot distribute losses, only profits
- Profits earned may increase tax rates
- A trust cannot retain profits to be used later to expand the business. It is subject to penalty rates of tax if it does
- Investors may not want to invest in a trust
What if I choose the wrong business structure type?
It’s OK, you can always change your business structure as your company develops and grows. There may be paperwork and costs involved but it can be done!
Remember, circumstances change all the time, so it may be hard to predict the future.
Talk to the professionals at Sleek for further clarification on choosing the right business structure for your business. We’ll help you outline and outweigh the pros and cons of each structure to find the one that fits the best!