How to choose the right structure for your business

So, you have an amazing idea and want to start a business. Congratulations! You’ve just passed the first – and sometimes the hardest – step to becoming a business owner. But the natural next question you might have is, ‘Which business structure is right for me?’

There are many options to choose from, with each affecting how your business will operate. However, the main types of business structures in Australia are sole trader, partnership, company, and trust. The first three are the most common options for small businesses and typically the easiest legal entities to form.

This guide hopes to give you a basic understanding of each option, stating the pros, cons, and definitions of the available business structures.

1. Sole Trader

A sole trader is a single person who is responsible for all aspects of their business. They make the decisions but are also legally responsible for debts and losses or when things go wrong.

Sole trader is the simplest business structure and is usually relatively cheap to set up. It requires fewer reporting requirements than other types and doesn’t require you to open a business bank account. The sole trader structure is also the simplest for tax purposes, as no other people are involved but you.

While being your own boss is certainly a benefit to many, this business structure does come with risk. You personally will take on all the responsibility, whether it be lodging your tax returns, keeping your financial records for five years, or dealing with losses.

Having your business under a sole trader structure will put everything on you – for better or worse. This is where sole trader insurance is crucial, as it is designed to protect you from various risks you may come up against.

One of the key types of business insurance cover for many sole traders is Public Liability insurance*. Public Liability insurance is designed to provide protection if a third party is injured or sustains property damage as a result of your negligent business activities. You may also consider other types of insurance, like Professional Indemnity* or Business Insurance*, depending on your occupation and the nature of your business.

Paying yourself as a sole trader is also important, especially regarding superannuation. While making super payments regularly is generally a good idea, you are not obligated to do so.

With adequate business insurance and a solid business plan, being a sole trader can be a positive business structure to build your business around.

2. Partnership

As its name suggests, a partnership is a business structure where two or more people distribute responsibilities. There are three types of partnerships you can enter, with each differing in how income and losses are distributed.

• General partnerships (GP) occur where all partners equally manage the business, and each has unlimited liability for the debts and obligations it may incur.
• Limited partnerships (LP) are made up of partners whose liability is limited to the money they’ve put into the business. Unlike GPs, limited partnerships are often passive partners and can be used for an injection of cash into your business.
• There are also incorporated limited partnerships (ILP) where partners can have limited responsibility for debts and losses so long as at least one general partner bears unlimited liability.

Partnerships are relatively simple to set up and have minimal reporting requirements. However, each partner must have a separate tax file number and they must apply for an Australian Business Number (ABN) together and use it for business dealings.

Something unique to partnerships is that each partner doesn’t pay income tax on the income earned. Rather, they pay tax on the net share of the income each receives.

There are varying laws across Australia for how partnership business structures operate, so be sure to check out the conditions of your state or territory.

3. Company

The third type of common business structure is company. Companies are different from partnerships or sole trader structures as they are separate legal entities that make it so the business itself can incur debt, sue, or be sued like a person can.

As a member of a company or a shareholder, you are not liable for its debts. However, if you are a director of the company, you can be found personally responsible if you are in breach of your legal obligations.

Companies also require a tax return lodged every year with the ATO, as well as an annual review, which usually costs a fee.

The setup of a company is a lot more complicated and expensive, and it’s usually suited to those expecting a highly variable return from their business. This is often the case for businesses that operate at a loss in the plan for future profits.

4. Trust

The fourth type of business structure in Australia is a trust. With a trust, a trustee (either an individual or a company) carries out business on behalf of the trust’s beneficiaries or members.

Trusts are typically not used by small businesses for a few reasons. They are expensive and complex to set up and require yearly admin tasks to meet legal requirements. It can be difficult to make changes or dissolve a trust once it is established.

Becoming the trustee company or individual is a large responsibility. The trustee is considered the owner of the business and is also responsible for its debts and losses.

Key differences between sole trader, partnership, company and trust

Here’s a quick breakdown of key differences between sole trader, partnership, and company business structures:

There are many other differences between these legal structures. An accountant, solicitor, or business advisor can help you understand each legal structure and determine which is right for your small business.

How to choose a business structure

When deciding on a structure for your new business, you may want to seek the advice of a professional, like an accountant or a business advisor, who will take the time to understand your business and advise on the best structure for you.

However, it may help to take a few things into consideration as you weigh your options, like:

• Who owns your company – Just you, or you and others?
• How much responsibility you have in the business – Do you make decisions by yourself or share the responsibility with others?
• Your potential personal liability – Are you prepared to shoulder business debts and losses?
• How much you pay in tax – A more complex business structure could be better suited to businesses that expect to pay higher taxes.

The legal structure of a business can change throughout the life of the business. While sole trader may make sense when you’re starting out, it may make sense to re-register as a company in the future. Again, a business professional can help you navigate your options as your business grows.

The bottom line

The ideal business structure for your small business usually depends on your specific set of circumstances. While there are many advantages and disadvantages for you to consider, evaluating what business structure works best for your situation will sharpen your business knowledge on important subjects – such as business insurance and tax practices – for years to come.

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