Whether starting a new business or contemplating changing your current business model, it is important to choose the right structure to enable the best management of your business. Various tax implications, costs, and personal risks and liabilities associated with each business model are important to consider when choosing how best to structure your business. You should be aware of the structures available to you and the strengths and weaknesses of each type so you can make an informed decision, but it is also important to talk to your accountant about the different structures, as they have a thorough knowledge of each and can help you make the right choice for your business.

 

 

 

 

 

 

 

 

Here in Australia, there are four main business structures to choose from, some with a few variations, which are:

Sole trader – an individual operating as the sole person legally responsible for all aspects of the business.

Partnership – an association of people or entities running a business together, but not as a company.

Trust – an entity that holds property or income for the benefit of others.

Company – a legal entity separate from its shareholders.

But how do you choose which is right for your business?

 

Choosing A Business Structure – The Pros and Cons

Sole Trader

It is easy and highly cost-effective to set up as a sole trader, and as the only person legally responsible for the business, you have all the control. This model can be highly effective for initial start-ups and microbusinesses during the first few years of operation. Sole traders will need to register for an Australian Business Number (ABN), and register their business name. Sole traders pay tax at the same rate as individual taxpayers, as the income earned from the business is treated as their own and they do not draw a wage from the business.

Pros

Cons

  • Low cost to set up and relatively easy
  • Owner has 100% control and keeps all profits
  • Fewer compliance and legal obligations
  • Owner has unlimited personal liability
  • If owner falls ill or is unable to work, profits cease
  • It can be difficult to raise finances to fund the business initially

Partnership

As the name suggests, in a partnership the business is owned by two or more partners with the income being divided between them. It is important to have a partnership agreement or contract that outlines any salaries, drawings, profit share, loan agreements, termination clauses, if new partners can be admitted, how books are kept and how disputes are settled and losses handled. The partnership will need an ABN and its own tax file number (TFN). A partner will pay tax on their share of the net partnership income.

Pros

Cons

  • Shares risk and responsibility between the partners
  • A wider skill set and broader management base
  • Raising finance can be easier with more partners
  • Each partner is personally liable for all debt incurred by the partnership, and if one partner has no funds, the other will be required to shoulder all the debt
  • Decision making and authority is divided among partners
  • Limits placed on size of partnership

Company

A company is a registered legal entity that is trading in its own right, that has shareholders who have invested time, money or both starting up the business. Any profits made are either reinvested in the company or shared among the shareholders in the form of dividends. A company also has directors who are appointed by the company to run it. Directors are often asked to give personal guarantee to secure any debts the company may have incurred. A company must be registered with the Australian Securities and Investment Commission (ASIC), which will issue an Australian Company Number (ACN). A company also needs its own ABN and TFN to lodge an annual income tax return.

Pros

Cons

  • Financial liability is limited to the company assets
  • Easier to raise finance for expansion
  • Ownership can be easily transferred
  • Must publicly disclose key information
  • Extra regulations around record keeping
  • Owners cannot offset losses against other income

Trust

A family trust, or discretionary trust, is like a company in many ways. A trust is commonly set up with a company acting as trustee. It is initially costlier to set up and it requires ongoing management, so you should check with your accountant and solicitor to explore if setting up a trust is right for you. A trust needs its own ABN and TFN in the trust’s name.

Pros

Cons

  • Limited personal liability
  • A trust offers more privacy than a company
  • Greater options and flexibility in income distribution
  • Initially costly to set up
  • More compliance and legal obligations
  • Powers of the trust are limited to the trust deed

 

Reasons To Restructure

There may also be times when your business needs to restructure. There are many good reasons to change business models; often to be more profitable, improve business processes or to adapt to the changing needs in the marketplace after significant business growth. Less extensive changes to the business structure could include changing ownership, adding partners or investors, or changing the legal set up and operational aspects of the business.

A common time to restructure is after a sole trader has experienced significant business growth and may wish to take on a partner to distribute the risk and responsibility, or even register a company to limit financial liability. Alternatively, a company may be too restrictive, and you wish to restructure into a trust to enable greater income distribution flexibility and more privacy.

Each business structure can incur significantly different tax obligations, so it is very important to be aware of the implications before making changes to your business structure. It is a good idea to chat to your accountant about changing business models, as they can help you decide which model would best fit your needs, and can help you set up your new business structure.

All entities also need to consider goods and services tax (GST) implications. An entity must register for GST if the projected turnover is $75,000 or above.

 

What to Consider When Restructuring

  1. Why are you changing your business structure; are you aligning structure with strategy?
  2. Do you have a business plan for your new structure, and have you ensured your business plan reflects the new structure, and outlines the goals and objectives of your business?
  3. Are you prepared to apply for a new business name, ABN, TFN, ACN or GST, and change all your branding to reflect your new business model?
  4. Have you looked over your partnership agreement, trust deed or corporate governance structure, or do you need to create one?
  5. What changes are there to your tax obligations and are you prepared to pay them?
  6. Do you know what assets, trademarks, or names you need to transfer to the new entity?

This article covers the basics of structuring or restructuring your business, but you should always talk to your accountant before making a decision. The key to success is having the right business structure so you save on tax, maximise your cashflow, and if something unexpected does go wrong, you have the peace of mind that assets are protected in the right business model for you.

As always, feel free to contact us to get any advice on choosing a structure for your business, as we are happy to help. Stone Accountants provides comprehensive business setup services; visit our Business Structure Setup page for more information.

 

Click the picture below to download our infographic outlining the strengths and weaknesses of the various business models described above.


 

 

 

 

Stone Financial Services Pty Ltd (ASIC No. 318837) ABN 24 125 161 435 is a Corporate Authorised Representative of Merit Wealth Pty Ltd ABN 89 125 557 002, Australian Financial Services Licence Number 409361

Joanne Hahnel (ASIC No. 313858) is a Limited Authorised Representative of Merit Wealth Pty Ltd ABN 89 125 557 002, Australian Financial Services Licence Number 409361

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