Choosing the right structure for your business will significantly affect its legal and operational risk, asset protection, tax obligations, legal costs and clientele. There are four common business structures to choose from:
- sole trader;
- company; or
You can change structures to accommodate your business’s growth, but changing legal structures can often be very complex. Therefore, it is essential to think carefully when choosing the right structure for your business to ensure it best reflects your future goals.
Types of Different Business Structures
Sole Trader is the simplest of the available business structures. As a sole trader, you manage and operate the business under your name. Such structure is cheap and easy to set up. However, it is not very flexible and will not accommodate a growing business. The sole trader structure is most suitable for contractors, tradies, entertainers, home businesses, online stores, websites and most small businesses. The majority of small business owners in Australia are sole traders.
A partnership is an association of two or more people who carry on business as a partnership. Setting up a partnership structure is simple and relatively cost-effective. However, there are several disadvantages to the structure. Like a sole trader structure, partners are jointly responsible for the debts of the business. Therefore, it is crucial to consider who you enter into a partnership with, as all partners are equally liable for the other partners’ actions. A partnership should have a partnership agreement in place, which sets out how the partnership operates.
A company structure is ideal when you are looking to grow and scale your business. A company is its own legal entity. Therefore, individual shareholders are only liable for debts or liabilities that the company incurs up to the amount unpaid on their shares (which is commonly zero). This limited liability makes the company structure suitable for high-risk businesses. The ability to raise capital and grow via the issue of shares makes the company structure the most suitable for startup businesses. The Corporations Act regulates companies who must abide by their statutory obligations and Constitution or Replaceable Rules. If your company has more than one shareholder, you should have a shareholders agreement in place.
You can use a trust to run a business. A trust will have an individual or corporate trustee who controls the trust. It is their job to distribute profits to the beneficiaries of the trust, per the trust deed. If a trust has an individual trustee, the trustee will be personally liable for the trust’s debts. On the other hand, if a trust has a corporate trustee, its shareholders receive protection by the company’s limited liability. A trust is not suitable if you require profits left in the business to help its scale, as a trust must distribute any income, or it will be taxed at the top marginal tax rate of 49%. Additionally, a trust may also require a unitholders agreement (if it is a unit trust) and a shareholders agreement (if it has a corporate trustee).
Deciding on a Business Structure
When starting a business one of the first things you should consider is which structure will have the best long-term benefits and reflect your future goals. You will need to think carefully about:
- the type of business you are going to run;
- its risk profile;
- plans for growth;
- the involvement of others; and
- how to come to decisions.
Each structure has different upfront and ongoing costs. A sole trader is the cheapest to establish. Alternatively, more complicated structures, such as a trust with corporate trustees, incur higher legal set up costs and government fees.
The way that tax affects the different business structures will also factor into your decision. The profits made by sole trader businesses are considered personal income and are taxed as such. Companies pay 30% tax on their income but must keep financial records up to date and lodge annual tax returns and reports to ASIC. Using a trust structure may allow you to plan your tax, by streaming distributions to beneficiaries on lower tax rates.
|Business Structure||Sole Trader||Partnership||Company||Trust|
|Expensive to register||No||No||Yes||Yes|
|Difficult to set up||No||No||Yes||Yes|
|Complete control over decision-making||Yes||No||No||No|
|Easy to raise capital||No||Yes||Yes||Yes|
|Easy to dissolve or sell||Yes||Yes||Yes||No|
|Can I retain all profits made?||Yes||No||No||No|
|Can I change structures easily?||Yes||No||No||No|
Ownership vs Control
Additionally, it is essential to consider how each structure is controlled and owned. It is best practice to engage a lawyer to ensure the documents governing each structure are appropriately executed to affect control and ownership distribution amongst the parties. Consequently, choosing the right business structure will allow you to manage the level of ownership and control you desire.
Sole traders wholly own their business and operate in their own capacity. Hence, both ownership and control personally resides with them.
The default position for partnerships is that there is a unity of ownership and control; however, the partnership agreement’s provisions can break this. It is crucial to consider how your partnership agreement will divide ownership and control between yourself and your partner(s).
There is a defined separation between the company’s owners (shareholders) and its management (directors) in a corporate structure. Management can consist of owners, but this is not a requirement. While the management controls the business’s day-to-day decision-making, the owners (shareholders) have the ultimate power to appoint and remove directors from the board. The company constitution typically governs this process; also the Shareholder’s Agreement (if the company has one).
A trust structure is defined by the relationship between the beneficial owners (beneficiaries) and the legal owner (trustee). Whilst it is the trustee (legal owner) who makes the decisions concerning distribution amounts and investment strategies following the terms of the trust deed, the ultimate control of the trust resides with the appointer who has the power to replace the existing trustee with a new one.
How Can LegalVision Help Me?
LegalVision tailors legal advice for businesses and individuals, and can assist you when choosing the right structure for your business and preparing the relevant paperwork to ensure you’re off to a good start. If you have any questions or need legal advice, contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.