An essential part of starting or expanding a business is deciding the structure of the business. There are three main different business structures:
- sole trader;
- partnership; and
Each has their own advantages and disadvantages, so it’s important to choose the structure that fits best for your business.
1. Sole trader
A sole trader is an individual running a business.
- the simplest and cheapest business structure to establish;
- you have full control of your business;
- there are minimal reporting requirements; and
- does not require a separate business bank account.
- not a separate legal entity so you are liable for all debts and obligations of the business;
- has unlimited liability and all your personal assets are at risk if a debt or lability arises;
- earnings are taxed at your personal income tax rate; and
- doesn’t allow you to split business profits or losses made with family members.
A sole trader is the simplest form of business structure. As a sole trader you are legally responsible for all aspects of your business including any debts and losses and day-to-day business decisions. A sole trader business structure is the type of ownership that would best suit very small operations like tradesmen, or those based on the owner’s personal talents (i.e. a jewellery maker or clothes designer).
A partnership is a group or association of people who carry on a business together and each has unlimited liability for the debts and obligations the business may incur.
- relatively easy and inexpensive to set up;
- minimal reporting requirements;
- ensures the resources and expertise of a number of people are utilised; and
- simple to administer – profits and losses are shared between partners according to their share (as specified in the “partnership agreement”).
- not a separate legal entity so you and your partners are liable for all debts and obligations of the business;
- partners are jointly and severally liable for the debts and liabilities of the business. This means that each partner’s personal assets (e.g. family home) are at risk if a debt or lability arises;
- each partner’s earnings are taxed at their personal income tax rate; and
- each partner is personally liable to pay tax on all the income derived and you cannot split income of the business with family members.
A partnership is when two or more people operate a business as co-owners and share income. All partners act on behalf of each other in the business. Before entering into a partnership it is advisable to have a lawyer prepare a partnership agreement. This is important because personal liability is unlimited for each partner – i.e. you will be held liable for any shortfall if the business fails and a partner can’t afford to pay their share of any debts.
A company is a separate legal entity which can incur debts, sue or be sued. A company is run by its directors and owned by its shareholders. It is therefore important to enter into a “shareholders agreement” to govern the relationship between directors and shareholders.
- limited liability for shareholders;
- more attractive investment vehicle, so the business has wider access to working capital;
- the company tax rate is lower than the highest tax rate for individuals and income tax can be further minimised by introducing a discretionary trust; and
- easy to sell and pass on ownership.
- a more complex business structure to start and run;
- involves higher set up and running costs than other business structures, e.g. must be registered with the Australian Securities and Investments Commission (“ASIC”) and pay annual ASIC fees;
- directors have legal obligations under the Corporations Act 2001 (Cth); and
- cannot distribute losses to its shareholders.
Compared to other business structures, a company has higher set-up and administration costs. Companies also have additional reporting requirements. Although a company provides some asset protection, its directors can be legally liable for their actions and, sometimes, the debts of the company.
There are three commonly used business structures in Australia: sole trader, partnership and company. Each structure serves a different purpose and has its pros and cons. You’re not locked into any structure and you can change the structure as your business changes or expands.
To speak to a lawyer about choosing the right busines structure for your business, call Vault Legal today on 1300 002 212 or email us at firstname.lastname@example.org.
Key words: business structures, sole trader, partnership, company, partnership agreement and shareholders agreement.
Disclaimer: The content of this blog is intended to provide a general guide to the subject matter. This blog should not be relied upon as legal advice. Specialist advice should be sought about your specific circumstances.