How To Choose A Business Structure

Before you can start your business you have to decide on your business structure. 

Your business structure will determine: 

• Your responsibilities as a business owner
• How (and if) your assets are protected
• Tax liabilities
• Potential personal liability
• Ongoing costs
• Required paperwork 

Your business structure will be based on: 

• The type of business you run
• The initial size of the business
• Your personal circumstances
• Plans for Business Growth

You can always change your business structure if you find that your circumstances change or your business grows unexpectedly. Especially if you begin as a sole trader. 

So don’t worry, you’re not stuck! 

You may want to discuss your planned business structure with a legal, business, or financial advisor before starting your business. 

Although there are a variety of business structures available in Australia, we’ll only be exploring the first 4 in detail. 

• Sole Trader – A single person running a business on their own.
• Partnership – Several people (or entities) running a business together not as a company. 
• Company – A separate legal entity. Provides more protection than the two above. 
• Trust – A legal entity that holds income or property for the benefit of others. 
• Co-operative – A business organization with at least 5 members that is owned by its members.
• Incorporated association – Usually for charitable, recreational, or cultural purposes. 

Below is a table exploring the four major business structures and the pros and cons of each.

We’ll explore each structure in more detail after the table. 

Business Structures	Sole Trader	Partnership	Company	Trust
Easy to set up?	Yes	Yes	No	No
Expensive?	No	No	Yes	Yes
Do I retain control?	Yes	No	No	No
Complex reporting requirements?	No	No	Yes	Yes
Personal assets at threat with business debt?	Yes	Yes	Not as likely	Not as likely
Do I retain all profits from the business?	Yes	No	No	No
Employ staff?	Yes	Yes	Yes	Yes
Do I pay myself a super, workers comp, etc.?	No	No	Yes (if employed by the company)	Yes (if employed by the company)
Easy to change legal structure?	Yes	No	No	No
Can I plan tax through income splitting and similar?	No	Yes	Yes	Yes
Easy to raise capital?	No	Yes	Yes	Yes
Easy to exit or dissolve?	Yes	Yes	Yes	No

 

Sole Trader

A sole trader is the easiest and simplest form of business structure to create. 

It’s inexpensive to set up. 

You are legally responsible for all aspects of your business. 

You’ll make all of the decisions about your business like employing people. 

Pros:

• Simple to set up.
• Easy to operate.
• Complete control over business decisions and assets.
• Few reporting requirements.
• Use your individual tax file number to file tax.
• Any business losses can be offset against other income such as investments.
• Not considered an employee of your business, so you don’t owe payroll tax, workers’ comp, or superannuation.
• Easy to change the business structure.
• Do not need to register a business name if you use your own name.

Cons:

• You are 100% liable if things go wrong, which means your personal assets are at risk including all assets jointly owned.
• Can’t do much tax planning so you’re personally liable to pay tax on all business income.

Other Considerations: 

• You’ll be taxed as an individual. But you’ll need to register for goods and services tax (GST) if your income is more than $75,000 from your business.
• You are not covered by workers’ compensation if you hurt yourself at work which can result in loss of income and still owing your business expenses.

 

Partnership

A partnership is a business structure involving 2 or more people with the goal of making a profit. 

A general partnership is the most common type of partnership entered into and involves all partners participating in the day-to-day management of the business. 

Pros:

• Easy to set up.
• Few reporting requirements.
• Shared management and control with partners.
• Your share of the business tax losses may be offset against other personal income.
• Easy to dissolve.
• Workers’ compensation and super contributions not required for partners as partners are not employees.
• Easier to obtain financing as there are multiple partners assets and income involved.

Cons:

• Partners are legally liable for all debts and there is no protection of personal assets.
• Possible disputes over administrative control, business direction, and profit-sharing.
• Changes in ownership can be difficult and requires the establishment of a new partnership.
• If your partner can’t afford their share of a business debt, you will be held liable.
• You are held liable for half of the debt that your partner incurs for the business, even if it’s incurred without your knowledge.

Other Considerations:

• You should have a “partnership agreement” before beginning that outlines each partners roles, responsibilities, financial contribution, and dispute resolution.
• The “partnership agreement” outlines the tax liability for each partner if profits and losses are not distributed equally.
• Each partner pays tax on their share of the partnership income.

 

Company

A company is a legal entity that is separate from its owners. That way, if the company is in debt, sued, or sues someone else, the company’s shareholders can limit their personal liability. 

A company is a more complex business structure and has higher reporting obligations and set up costs. 

A company can either be private or a public entity. 

There must be at least one director in a company. The director is responsible for managing the business activities of the company. 

A Company Must:

• Be incorporated under the Corporations Act 2001.
• Be registered with the Australian Securities and Investment Commission (ASIC).

Pros:

• Limited liability for owners/ shareholders.
• Can raise capital.
• Can carry forward business losses to offset profits in the future.
• Easy to change ownership.
• Profits can be reinvested in the company or paid as dividends to the shareholders.
• Business structure is well understood and accepted.

Cons:

• High set-up and maintenance costs.
• Reporting requirements are complex.
• Can’t distribute losses to shareholders.
• You do not have complete control.
• There’s no “tax-free threshold” and tax is paid on every dollar earned.

Other Considerations:

• Company tax requirements are different from those of the other business structures and income tax is owed on profits at the company tax rate (see more about tax obligations here).
• Officers and directors of the company must legally specify how they perform their duties and manage company affairs according to the Corporations Act 2001.

 

Trust

A trust is not a separate legal entity. It is a business structure where a “trustee” does business on behalf of the trust’s members. 

Trustees can be a company or an individual. 

Trustees are legally liable for debts of the trust. 

Trusts are set up via a trust deed. 

There are two types of trusts: discretionary or unit trusts. 

• Discretionary trusts are where the trustee has the discretion to distribute funds to the beneficiaries as they see fit.
• Unit trusts divide the trust into units and distribution is established by how many units are held by each member.

Pros:

• Reduced liability if the trustee is a corporation.
• Assets are protected.
• Flexibility in the distribution of assets and income.

Cons:

• Can be expensive and complex.
• Difficult to dissolve.
• Difficult to make changes, especially where children are involved.
• Profits retained to reinvest will incur tax penalty rates.
• Can only distribute profits, not losses.

Other Considerations:

• The trust is not liable to pay tax, instead, tax is assessed to the beneficiaries or trustee who receive the trust income.
• Trustee must apply for a tax file number and file an annual trust return.