When starting a business there are so many decisions to make in a short period of time. One of the most important of those decisions is what legal structure you will use to run your business. As a business owner and manager, it is important that you give careful consideration to this question and choose a business structure that will help you achieve your goals. Business advisers, such as lawyers and accountants, can really assist in this early decision-making process by ensuring all crucial elements of your business are properly considered. Below we provide a brief summary and explanation of the different types of commonly used business structures.
The sole trader structure arises when a person operates a business under an Australian Business Number (ABN). It is considered simple, inexpensive and a common form of administration. This choice of business structure is most suitable for very small businesses as there are minimal setup and administration costs. As a sole trader, you can operate using your own name or under a different name, which must be registered under the Business Names Registration Act 2011 (Cth). As the only owner, you have total control and management over the business. The one significant downside of a sole trader structure is that the business owner is personally liable for all the debts and liabilities of the business (which is the main distinction between this structure and a company structure).
The most common form of business structure is the company. A company is an entity that is separate from its owners and directors (i.e. it can sue and be sued in its own name). On formation, shares in the company are issued to the owners and directors are appointed to manage the business. Companies are governed by the Corporation Act 2001 (Cth) and regulated by the Australian Securities and Investment Commission (ASIC).
Some of the criticisms of a company structure include:
- higher administration and set up cost;
- complex reporting requirements; and
- increased regulation under corporation’s law for the owner of the business.
One thing that many people forget to consider is that whilst the debts of the company can’t be enforced against business owners, certain liabilities (e.g. certain liabilities to the ATO and compulsory superannuation payments) if they remain unpaid may be enforced against directors personally. Directors also owe duties to the company, its shareholders, other directors and third parties, which may also result in personal liability if not upheld.
The partnership structure (considered a fading choice of business structure in recent times) is used when two or more people come together to form a business with a common purpose to make a profit. A partnership structure is generally inexpensive, simple to form and easier to dissolve than other business structures.
Upon the formation of the partnership, it is prudent to have a lawyer put together a partnership agreement that sets out, among other things, how income and/or losses will be shared between partners and how the business will be managed.
The key difference between a partnership and a company is that each partner is personally liable for the debts and liabilities of the partnership (remember that a company incurs all debts and liabilities in its own name) so that if a partnership is sued, each partner will be jointly liable for the claim. Each partner is also bound by the conduct of the other partners, so it is important to carefully consider who you enter into a partnership with.
A trust is a legal structure that is created where a person (a trustee) holds property, incurs liabilities and earns and distributes income for the good of one or more beneficiaries. The trust is created by way of execution of a ‘trust deed’, that specifies (inter alia):
- who the trustee will be (it can be an individual or a company);
- who the beneficiaries will be;
- who will have the power to appoint a trustee; and
- how the proceeds of the trust will be distributed.
Whilst a trust is a more complex structure, and there are various types of trusts to choose from, it can provide business owners (depending on the ambitions of the business) with significant tax minimisation benefits (particularly if the business is likely to incur Capital Gains Tax (CGT) in the course of their business operations).
Trusts are often used in conjunction with companies to achieve the benefits of both asset protection and income splitting. One criticism, however, is that once established, trusts are quite rigid to operate and changes to trust deed terms should only be made after careful consideration so as not to trigger tax consequences. The ongoing administration and set-up costs may also be expensive.
Choosing a business structure is just like setting the foundations of a home. The sturdier the structure, the higher it will rise. When setting up your business, ask yourself the following questions:
- Do you want to protect your personal assets from your business creditors;
- Do you have plans for expansion and will the costs of a more sophisticated structure benefit you in the future;
- Do you plan to bring on any business partners in the future or will there be a need for investment from a third party.
The answers to these questions will help determine which business structure you should adopt. If you are thinking of starting a new business contact us now.