An essential part of starting or expanding a business is deciding the structure of the business. There are three main different business structures:

1. sole trader;
2. partnership; and
3. company

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.

 

Advantages

• 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.

 

Disadvantages

• 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).

 

2. Partnership

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.

Advantages

• 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”).

 

Disadvantages

• 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.

 

3. Company

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.

Advantages

• 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.

 

Disadvantages

• 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.

 

Key Takeaway

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 info@vaultlegal.com.au.

 

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.