by Shaun McGowanIf you’re about to launch your own business, you have some pretty big decisions ahead of you.
One of the first is:
How are you are going to structure your business?
The answer will depend on a lot of factors – including:
I know it can all seem pretty overwhelming – but in this article I’ll guide you through your options and all the things you need to think about to help you decide which is the best structure for your business.
First things first, though.
At this point, you’re probably thinking:
“How many business structures can there possibly be? How many options do I actually have?”
Let’s go over that first.
What business structures exist in Australia?
Generally speaking, you have four options.
These are:
1. Sole trader |
2. Partnership |
3. Company |
4. Trust |
I’ll take a quick look at the pros and cons of each, and give you a general outline of the way they function.
Sole Trader
A sole trader the simplest of the four structures. This is because, well, you don’t usually have to work with anyone else. You may be planning to have your spouse or partner work alongside you, but that still keeps the model simple because I assume the two of you will have the same goals.
A sole trader business is the quickest and easiest to set up. What’s more, it’s the most affordable option and the one that gives you the most control and flexibility over the way your business is run – all of which explains why it’s the most popular choice in the country.
As a sole trader you’ll have the least amount of business administration and reporting to worry about, too – and, because you don’t have employees, you won’t have the hassle of paying salaries, super contributions or workers’ compensation
All of this sounds good, right?
But there is also a downside to choosing a sole trader business structure:
If you run up any business debts, you’ll be held fully responsible. This means that your personal assets – even your home – could be at risk if your business runs into trouble.
So, how do I register for a sole trader business model?
Good question!
Registering as a sole trader is a very simple process. You’ll need to start by applying for an Australian Business Number, which you can do right here.
You’ll also need to register your business name, which will cost you $34 AUD for a year or $75 AUD for three years. You can come up with a catchy business name, or you can even use your own. You can’t use a name that’s already in use, though, so you’ll need to check that the name you want hasn’t already been taken.
You may want think about trademarking your business name, too, if you want to protect full rights to it.
To make the setup process even quicker you can apply your ABN and register your business name at the same time.
Partnership
A partnership is exactly what it sounds like – two or more people working together to start and maintain a business.
You’ll need to agree what each member of your partnership will contribute to the business (i.e. time, money and expertise) – and what responsibilities you will each have. You will share the profits and losses of the business, and each of you will be equally responsible for the business as a whole.
That means that, much like a sole trader, you and any other members will be personally liable for any debts your business incurs. So if one of your partners doesn’t hold up their end of the deal, you’ll have to cover them.
What does this mean for you?
Basically, it means that before you do anything, you really need to have a written document in place outlining everything you’ve agreed, and setting out how you’ll resolve any conflicts. You’ll also need to consider what will happen if you dissolve the partnership.
In short, you need to be absolutely clear on your rights and responsibilities, and make sure that your partner knows theirs.
No matter how amazing and trustworthy your business partner is (and you wouldn’t be going into business with them if they weren’t, right?), it still doesn’t hurt to have a written agreement to fall back on, just in case something goes wrong down the track.
I know we all like to think we handle conflict in the most positive way possible, but business can get messy. Why not make sure it's easy to clean up?
How do I register my partnership?
Just like with a sole trader, you can register here, using your names or a business name. While a partnership is relatively easy to dissolve, this legal structure is more difficult to change.
Company
What sets a company apart from a sole trader or partnership is that it is a separate legal entity. The owners of the company will be shareholders, and those shareholders may or may not also be the directors of the company.
If you choose this option, it will limit your legal liability (because the company itself can be sued, rather than you personally). BUT you can still be held liable as a director if you are responsible for any kind of negligence or abuse committed by the company.
There are two main types of company in Australia: proprietary company (PTY Ltd) and public company (Ltd).
A proprietary companyA proprietary company cannot have more than fifty shareholders who are not employees, and can’t be listed on the stock exchange. |
A public companyA public company can have more than 50 non-employee shareholders, and you have the option to list it on the stock exchange. |
The company structure does have some definite advantages over sole trading or partnership:
It’s usually easier for a company to raise large amounts of capital.
- It’s usually easier for a company to raise large amounts of capital.
- Australian companies with an annual turnover of less than $25 million pay tax at just 27.5% – which is a lower rate than you might pay as an individual (depending on your income).
All of this may sound pretty good – but there are also some downsides (aren’t there always?):
- Companies have higher start-up costs than sole traders or partnerships.
- The ongoing admin is more onerous as the accountability and reporting obligations for companies are much stricter than for sole traders or partnerships.
- You’ll have answer to the company’s shareholders, and any other directors will also have a say in the decision-making process, so you may have less control over your business than you would as a sole trader.
How do I register my company?
You can register your business as a proprietary or public company (under the Corporations Act 2001) through ASIC. It is more difficult and time-consuming to set up than either a sole trader business or a partnership – and while it’s not difficult to dissolve a company, you will find it very difficult to change the company’s legal structure at a later stage.
Trust
Trusts are a completely different type of business structure, with a very specific purpose.
Unlike a company, a trust is not a separate legal entity. As with a sole trading or partnership, if you set up a trust and act as Trustee you’ll have control over how the business is run, and you will be personally liable for any debts the trust incurs.
That means that, much like a sole trader, you and any other members will be personally liable for any debts your business incurs. So if one of your partners doesn’t hold up their end of the deal, you’ll have to cover them.
However, unlike sole trading, a partnership or a company, you as the Trustee won’t receive any income from the business. You’ll be managing the business on behalf of the beneficiaries, who will usually be members of your family.
Yep, basically a trust is a legal arrangement that lets you set up and run a business on behalf of a third party. The rules are complex – as a Trustee you will have a lot of legal and financial administration to take care of, and the tax rules can be complicated too. So you really should get professional advice on whether this structure is the right choice for your business – and if so, how to set it up and make sure you’re keeping on top of all the requirements.
How do I register a trust?
If you do decide that a trust is the right structure for your business, you’ll need to set it up with a formal deed. I’m afraid the process can be quite expensive, and once you have a legal trust deed in place you won’t be able to change or revoke it easily.
Like I said:
Get advice before you lock yourself into using a trust to structure your business.
Do you need a business loan?
See if you qualifyHow do I know what business structure is right for me?
Okay, so now you know a little bit about each business structure, are you clear on which one is right for you?
“Well, maybe…” you might be thinking, “but what exactly do I need to consider?”
Let me help you with that.
Here’s an overview of the main things you need to think about when deciding how to structure your business.
Legal liability
As a business owner, I’m pretty sure you’d like to take the least risky option. After all, when it comes to personal legal liability, the lower, the better, right?
As a sole trader you’ll be pretty much directly in the line of fire – if your business gets into financial difficulty (or, for example, someone sues you for negligence), you could lose all your personal assets as well as your livelihood.
But as a sole trader, you have complete control over the business, so you can make decisions based on your own individual risk appetite. With a partnership, the risk is shared, but so is the responsibility – and if the partnership isn’t successful, you could have to pick up the slack for your business partners.
With a company you have a layer of protection – if the business fails, your personal assets won’t be on the line unless you’ve given a personal guarantee for any business loans.
BUT as a director you will still be responsible for the company’s actions, so you could still be personally sued if one of your customers files a negligence claim against your company. What’s more – if you own a company you’ll have a lot more rules to comply with, so there are a lot more things that can go wrong!
I know it’s a scary thought, so here’s a quick word to the wise:
Whichever structure you decide on, make sure you have personal liability or professional indemnity insurance in place!
Tax
The way you structure your business can have a massive impact on how you pay tax – and more importantly, how much you pay.
Each of our structures has different tax rules, so you definitely need to get clear on this before you make any decisions. Here’s a quick overview of how you’ll pay tax on each structure:
How do I pay tax as a sole trader?
The ATO will treat any money you earn as a sole trader as part of your personal income. You can list all your business expenses as deductions in your return, and you’ll end up paying tax at the standard personal income tax rate based on how much you earn in total.
You may have to pay your tax in PAYG instalments throughout the year.
How do I pay tax as part of a partnership?
As well as filing your individual tax return you’ll also need to file an annual partnership tax return. Again, you can claim deductions for any business-related expenses.
Okay, so how do my partner and I figure out who pays what?
The partnership tax return will show the total net income of the partnership, and also how you have distributed the profits (or losses) between you.
You will then each declare your share in your personal tax return, and as with a sole trading business you’ll pay tax at the personal tax rate based on your total income.
That means that you and your partners could end up paying different amounts of tax, even if you receive the same income from the business. (Say, for example, that you have other income from another business, rent or investments, you may fall into a higher tax bracket than your partner).
How will my company pay tax?
If you set up a company to run your business, the profits will be totally separate from your personal income. Instead, the company will pay tax at the base rate of 27.5%. It may also qualify for tax concessions, offsets or rebates which could bring down the amount of tax it has to pay, so be sure to check if your business qualifies (your accountant will help with that).
If you draw any income from the business in the form of a salary or dividends you will then need to declare that in your personal tax return.
How will my trust pay tax?
In some circumstances, trusts don’t have to pay tax at all.
“Wait!”, you may be thinking. “I might not need to pay any taxes? Is that true?”
Okay, let me be more specific.
Whether or not your trust will have to pay tax will depend on a lot of things, including the type of trust you set up, who the beneficiaries are and how you distribute the income.
You’ll still need to report any income on a trust, as well as all deductions, and file a tax return every year.
Trust tax rules are pretty complex, so you’ll definitely need to check it all out through the Australian Tax Office, as well as getting guidance from your own independent financial advisor.
Capital and costs
Capital is another important consideration when you’re deciding on your business structure.
As a sole trader or partnerships you’ll probably have to put up all the capital yourselves, unless you can raise start-up capital through crowdfunding.
If you’re planning to look for external investors (angels or venture capitalists) you can expect your investors to want shares in the business, which means you’ll need to set up a company. And if you’re hoping to go big and list your business on the stock exchange someday, you’ll need to set it up as a public company.
Well, that’s where cost comes in.
Companies cost much more to establish and maintain than a sole trader or partnership business. That’s one of the reasons you might need more capital in the first place! If yours is a simple, low-cost business model – or if you plan to finance your business through debt rather than capital – then setting it up as a company could just make everything more complicated than it needs to be.
How much control do you want to have?
‘Too many cooks’ and all that…
As soon as you ask people to invest in your business, or join your company board, or even work with you in partnership, you lose some control over how you run your business.
If total control is what you’re after, sole trading is the easiest way to get it.
But even the Bill Gates, Steve Jobs and Richard Bransons of this world know that they have strengths and weaknesses. Sharing the business decisions with others who have skills you don’t have can make all the difference.
In the end it comes down to why you’re setting up this business. If you just want to use your skills to earn income, and need an ABN to be able to do it, then you’ll probably want to keep it simple.
If you’re planning to build a global business empire and list it on the stock exchange, you’ll need a public company – and you may well decide that giving up some control in exchange for expertise (and capital) is a winning business move!
Australian business structure comparison
| Structure | Count (2017 ABS) | Setup Costs | Complexity | Personal Asset Protection | Tax Calculation & Rate |
|---|---|---|---|---|---|
| Sole Trader | ~ 575,000 | Low | Simple | No | Standard personal income tax |
| Partnership | ~ 250,000 | Moderate | Simple | No | Standard personal income tax |
| Company | ~ 825,000 | High | Complex | Yes | 27.5% |
| Trust | ~ 650,000 | High | Complex | Yes | Depends on structure and number of beneficiaries |
Conclusion
There’s a whole lot to think about when deciding on your business structure. You can’t decide based on just one factor, like how much tax you’ll pay or how much control you’ll have.
The fact is that each structure is designed for a different type of business, and they all have pros and cons. The right structure for you will depend on your personal preferences, your long term goals, how much of your own money you’re prepared to invest, and how much risk you are prepared to take.
It’s definitely something you want to get right from the start, so the best advice I can give you is: take advice!
Give them a call and don’t be afraid to ask a lot of questions!
Nothing beats word-of-mouth, of course, so once you’ve chatted to the reps, get in touch with the people in your network and ask their opinion.
What business structure do you think is right for you? How did you come to this conclusion?
Let us know in the comments below.
