Regardless of the industry you're in, the way you structure your business will have ramifications long into the future.
From the amount of tax you pay to the administrative load and your level of personal liability, the consequences of your decision can be serious; and they may have a profound influence on the success of your enterprise.
It's vital to fully understand your options and put the necessary consideration into the most suitable one for you and your business.
For most small businesses, there are four basic choices. Familiarise yourself with each of the four structures and then ask yourself the right questions in order to determine which structure is best for your business.
The four basic structures for a small business
- Sole trader
A sole trader business is where one person owns, operates, and manages the business. This is a structure used by tradespeople, shop-owners, consultants, and other small businesses with one main entity running it.
It is a common structure for small micro businesses. A sole trader is not considered a separate legal entity.
A partnership brings together two or more people who jointly own and manage the business - but not as a company.
Each party contributes funding, labour, and skills to the business, sharing in the income and liabilities according to pre-agreed ratios as detailed in a partnership agreement.
Trusts are legal relationships where a person or persons (the 'trustees') hold property or income on behalf of a beneficiary or group of beneficiaries.
Trusts are commonly used in family-run businesses. The benefits include tax minimisation strategies, as well as succession planning opportunities to ensure the future of the business.
Companies are a legal entity in their own right, separate from their owners. A different tax structure and administrative requirements apply.
NOTE: Other business structures exist, however, as a small business owner, these are the four most widely used options. Always seek specialist advice before making your final decision.
Which aspects of your business will your decision affect?
There are six main areas of your business that will be affected by your decision regarding business structure:
- Finances including tax liabilities, superannuation, workers' compensation, etc.
- Legal controls and constraints
- Administrative burden and costs
- Asset protection
- Personal liability for debts
- Your ability to raise funds
Note: you can change your business structure if your circumstances change but it still pays to opt for the most suitable structure from the start. Changing from sole trader to another structure is relatively simple but changing from a partnership, company, or trust is more complicated.
Which business structure is right for you?
In order to arrive at the most suitable structure for your business, carefully consider the following questions:
- What size of business are you creating?
If it's just you in the business for the foreseeable future, it's likely that sole trader status will be most favourable; but if you have rapid growth plans, forming a company may be more suitable.
As a sole trader, even though you are solely responsible for running the business, you can still hire employees.
You do not need to pay superannuation and workers compensation to yourself as a sole trader or partnership but if you form a company or trust and are employed by that entity, these payments are compulsory. There are different thresholds and coverage rules in different states, so you will need to seek expert advice for your unique situation. (ie. QLD does not cover directors, but NSW does).
- Can you handle a complicated set up procedure?
The simplest and cheapest form of business structure to register is sole trader or partnership. They are generally quick and easy to set up.
If it's just you in charge of operating the business, you may want to avoid the complexities involved in setting up a trust or company.
- How flexible do you need your business to be?
Sole traders enjoy greater flexibility of management and generally operate with fewer legal controls than companies, partnerships, or trusts.
However, they have less flexibility with tax affairs. There is no income-splitting option like there is with partnership, company and trust setups.
- Do you want to keep admin and reporting simple?
If you're considering setting up a trust or company, the administrative and reporting requirements are more cumbersome than with a simpler sole trader set up.
- Are you comfortable accepting full liability?
Sole traders retain all the profits from the business (unlike with a partnership, trust or company) but they are also liable for all debts. This can increase the pressures of running the business and even threaten your home and other personal assets.
Companies are more complicated and costlier to set up but your personal circumstances and preferences may mean you're more comfortable with not being solely responsible for debts incurred. Only the assets of the Company will be at risk, however it is possible for a director's personal assets to be at risk if they are found to have acted negligently.
- Will you need to raise capital?
As a company, trust, or partnership, it's relatively easy to raise capital. However, this becomes much more difficult as a sole trader, so you will generally have to rely on savings, home equity or family loans.
- Are you comfortable relinquishing some control?
As a sole trader, you have sole control over the decision-making. As a partnership, trust, or company, decision-making will need to be a shared responsibility. Are you comfortable with that?
Need specialist advice on structuring your new business? Contact one of our advisors and we'll be happy to talk through your options in plain English!