Choosing a Business Structure
You’ve had your brilliant idea, mapped out your business plan, and you’re almost ready to launch yourself into the world of entrepreneurship. But before money starts changing hands, give some thought as to your business structure, because this will determine how you operate, scale and deal with unforeseen events down the track.
There are three main options for business structures in Australia, each with their pros and cons. It’s a very good idea to talk to your accountant or financial advisor before settling on a structure, especially if your business is complex or anticipates serious expansion. A fourth possibility involves setting up a trust and is beyond the scope of this article.
1. Sole trader
This is the structure most beloved of people selling their time or labour on an individual basis. You use your personal tax file number (TFN), although you will need an Australian Business Number (ABN) in order to trade.
Pros – This is as simple as it gets. You don’t need to establish a separate business bank account unless you prefer to, although you do need to keep financial records for at least 5 years. You can change your business structure if you scale up in the future or cease running the business. And with some exceptions (always check with the Australian Taxation Office) you can claim any business losses against other streams of revenue, including salary if you also hold an employee position, or investment income. If you’re starting a business on the side, this structure is particularly ideal.
Cons – The lack of separation between you as a natural person and you as a business leaves you exposed to liability. If your business incurs a debt, your personal assets are up for grabs to creditors seeking to recover that debt. You also can’t split profits with family members, and you are personally liable for tax payable on the profits of the business.
This isn’t very different from a sole trader except that it allows you to combine your talents with others. Often used for family businesses, partnerships are cheap, easy to set up and allow an amount of flexibility in their operation.
Pros – There is minimal paperwork involved in setting up a partnership. Unlike sole traders, partnerships need their own TFN, but don’t always need an ABN unless they are carrying on an enterprise. Tax is paid by the various partners on the share of the partnership income each receives. It is popular with small family businesses as it allows the partnership to be constructed in a way that distributes more income to an individual on a lower tax bracket. You cannot, however, chop and change the distribution from year to year to minimise overall tax liabilities and you should have an agreement in place detailing the distribution before commencing trade.
Cons – A partnership does nothing to separate personal liability from the business. If the business incurs debts, or is sued for negligence, the partners are jointly and severally liable for any penalties incurred. That means that you’re vulnerable to the actions of your business partners, which may create a liability that rebounds onto you.
A company is a legal entity unto itself, which has its own rights and responsibilities. It may be private or publicly listed.
Pros – A company allows for limited liability to its directors. There are limitations to this protection that go well beyond the scope of this article, but in general, the company’s owners are not personally liable for the debts of the company. This allows for a greater level of risk taking and is a powerful incentive for a lot of business owners.
Cons – This is a complex structure with more onerous obligations and higher set up costs then the former two. A company must be registered with the Australian Securities and Investments Commission (ASIC) and requires you to understand and comply with the Corporations Act 2001. While directors aren’t personally liable for debts incurred by the company, they do have a range of director’s duties that require them to act honestly and in good faith, and which carry substantial penalties if not adhered to.
As should be evident, business structures don’t have to be complicated to set up, but the ramifications of choosing one can be significant. Always consult a licensed professional for advice before committing yourself to a business structure.
This article was written by Tanya Ashworth-Keppel on behalf of the Australian Institute of Business. All opinions are that of the writer and do not necessarily reflect the opinion of AIB. The following sources were used to compile this article: Australian Taxation Office.