Choosing a Business Structure – Structuring to Be a Small Business

One of the most important steps in setting up a business in Australia is determining your business structure. There are four main types of business structures in Australia: sole trader, partnership, company, and trust.

The business structure you choose will determine the following:

• Tax responsibility
• Level of liability for your business or its products or services
• Administrative costs
• Legal procedures and requirements for registration
• Whether you can bring partners on board and the type of partnerships
• Decision-making process
• Room for growth

To help you determine which structure is most suitable for a small business entity, this article will discuss the four business structures, their features, pros, and cons.

The 4 Business Structures in Australia

Sole Trader

The sole trader, also often referred to as a sole proprietor, is the simplest business structure in Australia. Most small businesses in Australia are registered as sole traders.

Pros

A sole proprietorship is easy and cheap to set up as a small business entity. You operate the business under your name. You are the main decision-maker in the business. As such, this business model offers great flexibility. You can change its structure, sell, or dissolve it as you deem appropriate without the need to consult with anyone else.

You retain all the profits made in the business. Profits from sole trader small businesses are considered personal income. Therefore, personal income tax applies.

Cons

The burden of raising capital for the business lies fully on the business owner. This can limit your ability to expand and sustain the operational costs.

The main disadvantage of a sole trader business is unlimited liability. This means that the owner bears any risks or debts associated with the business. For instance, if the business has incurred any debt in its operations, the creditors can confiscate your personal property to secure the amount owed.

Partnership

A partnership is the most ideal business structure for two or more people coming together to carry out business in the long run.

Pros

It is relatively easy and cheap to set up. You share the burden of raising capital with your partners, which can help with business expansion.

Cons

The business owners have unlimited liability. Therefore, it is important that you carefully choose your partners. This is because all partners have equal liability for each other’s actions. You should have a partnership agreement that stipulates how the business will be operated and each partner’s responsibility.

Ideally, each partner should have equal ownership and control of the business. Decision-making should be done in consultation with all partners, including decisions on the small business entities day-to-day running and critical decisions on whether to change the structure of the business, resolve, or resell it.

Company

A company structure is best suited if you’re looking to grow and scale your business significantly. It is also the right model for high-risk businesses.

Companies are regulated by the Corporations Act, which stipulates their statutory and constitutional obligations. During registration, a company must submit a company constitution and shareholders agreement. The constitution provides the terms and procedures for dissolving or selling the company.

Pros

A company is considered a legal entity. It offers its owners limited liability. This means that in case the company has incurred debt in its operation, individual shareholders are only liable up to the amount of the unpaid shares.

Companies have structured management. The shareholders have a primary responsibility to raise the capital required to set up or grow the business. They also have a responsibility to hire a management team that oversees the day-to-day running decision-making of the business.

The management’s main responsibility is to ensure the sustainability and profitability of the business. The roles and responsibilities of the management are clearly defined in the corporate structure of the company. The shareholders have the ultimate power to fire and hire the company’s management.

Cons

It is more complex and expensive to set up. In regard to taxation, companies should be 30% of the income in tax. Therefore, companies should keep the financial records up to date and submit their annual tax and file their tax returns to the ASIC, which attracts additional operational costs.

Trust

The business owner in this business structure serves as a trustee for individuals or corporates. The trustee’s main job is to distribute profits to the beneficiaries as provided for in the trust deed.

The tax responsibility of a trust is determined by whether the trust was set up as a sole trader, partnership, or company. If set up as a sole trader and partnership, then the trustee is liable for any debts. On the other hand, if it is set up as a company, the trustee and shareholders have limited liability.

When setting up, you require a unit holder’s agreement in the case of a unit trust and a shareholder’s agreement if serving as a corporate trustee. The trustee makes decisions concerning investment strategies, while the appointer is the ultimate controller of income distribution to beneficiaries.

Cons

A trust is more complicated and expensive to set up. It is not ideal to set up your business as a trust if you require to keep business profits. In Australia, trusts are required to distribute any income or profit; otherwise, it is subjected to a 49% marginal tax rate. Beneficiaries are required to pay a personal income tax on their share of the trust income.

Conclusion

Choose the right business structure for your small business on your preferred decision-making mechanism, long-term vision for the business, whether or not you are partnering with other people, and method of raising capital.

Once you have decided on the right structure, choose a business name, and register your business. For all business structures, you will need to provide a registered business name, an Australian Business Number (ABN), and a Tax File Number (TFN).

It is important that you choose the right business structure from the start, as changing a business structure can be quite expensive and cumbersome.