Are you starting a business and are wondering what type of business structure to use? The answer is not as simple as picking the one that gives you the best tax breaks. There are other factors like management and personal liability to consider too.
While it’s possible, and sometimes will be necessary, to change your legal structure as your business grows, changes, or simply just evolves, it’s important to make sure you are using the right business structure right from the start. Unnecessarily changing your legal structure will involve some extra time and effort on top of the cost associated with the registration.
In this article, we’ll take a look at the four common types of business structures: sole proprietorship, partnership, company and trust. We’ll also take a look at the advantages and disadvantages of each business structure.
1. Sole Trader Business Structure
This is the simplest business structure from a management perspective, but it’s also the riskiest in terms of personal liability. A sole trader is an unincorporated business that is owned and run by one person.
Sole trader setup is also the easiest and inexpensive option. To set up this kind of business structure you will need an Australian business number (ABN), business name registration, and /or trademark registration.
Advantages of sole trading
- It’s inexpensive, simple to set up, and easy to manage which means less paperwork for you.
- You practically own all your business assets and profits generated, which means you get to keep everything your business makes.
- Unlike publicly traded companies, your business’s financial information is not available to the public.
- Lastly, because you’re the sole owner, that means you have complete control over your business and the direction it takes.
Disadvantages of sole trading
- You are personally liable for any business debts and liabilities. This means that if the business goes bankrupt, you will have to pay back all the debts from your own personal assets.
- Secondly, because you’re not a separate entity from your business, you’ll be liable to pay taxes at your marginal tax rate instead of a lower corporate tax rate.
- There are few tax concessions for sole traders compared to other business structures.
- Lastly, while this legal structure may be ideal when you’re starting out, it can create limitations when the time to grow and expand arrives.
As you can see, this type of business structure is ideal if you’re planning to run a business by yourself and don’t want the extra hassle, but it’s less than ideal if you plan on expanding your business in the future.
2. Partnership Business Structure
A partnership is similar to a sole trader’s business structure in a lot of ways including tax-related issues and personal liability implications. Partnerships are not separate legal entities, which means all partners are personally liable for the debts and taxes of the business.
Partnerships are a popular business structure because they allow for more than two or more people to come together and form a business.
Here are the advantages and disadvantages of partnerships:
Advantages of Partnerships
- While not as easier to set up and manage as a sole trader, partnerships are still a lot easier and inexpensive to set up and manage than companies. All partners have equal rights to manage their business.
- With more people offering expertise and resources, the better the chances of growth and profitability.
- Unlike companies, partnerships don’t have to file financial statements with ASIC or publicly disclose their earnings.
- As specified in the partnership agreement, profit and losses are shared as per the agreement which makes it easier for tax liability and profit-sharing.
Disadvantages of partnerships
- As mentioned, partnerships are not separate legal entities from their owners, meaning third-party creditors can go after the personal assets of their partners as well as the business.
- Similar to sole traders, everyone in the partnership will be taxed at a marginal tax rate instead of the lower corporate tax rate.
- This business entity structure also limits expansion, however, it’s fairly easy to switch to a company structure when the time is right.
- Personal differences and disagreements among partners can also hamper the smooth running of the business.
The success and failure of a partnership can come down to how well the partners work together as a team. And thus it is important that a partnership agreement is drawn up specifying the roles and responsibilities of each partner to avoid any ambiguity and future disputes.
3. Company Business Structure
A company is a separate legal entity from its shareholders and directors. This means that the company is liable for its own debts and can sue or be sued by others. In Australia, there are two types of structure you can set up:
- Proprietary limited or private company. This means the company cannot raise money from the general public by issuing shares.
- Public company. A public company can have an unlimited number of shareholders and also raise capital by issuing shares.
Some conditions must be met when setting up a company:
- A company must be registered under the Australian Corporations Law.
- Australian business number (ABN), business name registration and trademark registration
- Keep valid and accurate financial records
- And comply with all obligations under Corporations Act 2001.
Here are the advantages and disadvantages of partnerships:
- While shareholders can lose the value of their shares, they are not personally liable for the debts of the company.
- There is no limit on the number of shareholders, making it fairly easy to raise large capital for business growth.
- The corporate tax rate is a lot more favorable than personal tax rates that sole traders and partnerships may be liable for.
- The amount of paperwork required can be onerous. All financial documents have to be filed by the director with ASIC every year.
- The cost of setting up a company can be expensive compared to setting up other structures like sole traders and partnerships and trusts.
- Profits distributed to company shareholders are subject to dividend tax.
Setting up a company structure can be a complex undertaking. At Tax Delivery & Accounting solution, we help both start-ups and small businesses with company registration and trust formations.
4. Trust Business Structure
A trust is a legal entity that can be used for business and investment purposes. The trustee (either an individual(s) or a company) is responsible for managing the trust and holding the assets on behalf of the beneficiaries.
There are two types of trusts in Australia:
- Fixed trust: is a trust where the assets and income are distributed at fixed rates.
- Discretionary trust: this type of trust does not specify how trust funds will be distributed. The trustee decides how much each beneficiary gets.
Advantages of a Trust Business Structure
- A trust can provide asset protection for the beneficiaries from personal creditors.
- Similar to shareholders, beneficiaries of a trust are not liable for the debts of the trust.
- A greater level of flexibility when it comes to taxes.
Disadvantages of a Trust Business Structure
- Setting up a trust can be costly and complex. Specialized accounting services are often needed to get this type of structure off the ground.
- Because of the complexity of the structure, there are ongoing legal and financial obligations to be fulfilled.
- A trust cannot keep the profit for growth like a company can. All profits must be distributed to the beneficiaries.
- A trust deed dictates how trust has to be managed and what assets can be invested in.
We Can Help with Your Business Structure Registration
Whether you need to set up a discretionary trust or register a limited liability partnership, Tax Delivery & Accounting Solutions can help you get started.
Our company registration and trust formation services include the following complimentary features:
- Company Registration – This includes 2 copies of company constitution and all minutes and registers required corporate law, company reigstered with ASIC, including ACN and corporate key.
- Discretionary Trust Formation – Trust Register including 2 copies of trust deed and all minutes as required by applicable government regulations. Australian Business Number (ABN) and Tax File Number (TFN) as issued by the Australian Taxation Office (ATO).
- Register a Limited Liability Partnership – Preparation and lodgement of rgistration forms. Partnership certificate and business name registration. Australian Business Number (ABN) and Tax File Number (TFN) as issued by the Australian Taxation Office (ATO).
We believe in client-to-business trust and believe in long-term relationships that benefit both parties through excellent communication and the experienced backbone of our accounting business. We love assisting both start-ups and small businesses to grow, maintain and sustain their company in Australia. Contact us today to find out how we can help you.