How to choose the right business structure for you

Starting a business is exciting! You get to be your own boss, sell your products or services, and make your mark on the world. There's no limit to what you can achieve. However, before you start trading, the government requires you to choose a business structure.

Related: How to write a business plan

What are the different business structures?

There are four types of business structures in Australia, each one governed by different laws and tax responsibilities. The organizational structures for a company are:

Sole trader
Partnership
Company
Trust

Let’s look at how the Australian Government defines each type, as well as the advantages and disadvantages of each one.

Sole trader

You're an individual and the sole owner of the business, but you can employ staff. You're responsible for all decisions and losses in your business and you report the business income in your personal tax return.

Advantages of the sole trader structure

You have full control of your business and finances.
You use your individual tax file number for your tax returns.
Costs are low to set up and run.
Reporting requirements are far less than any other business structure.

Disadvantages of the sole trader structure

Your personal assets are at risk if anyone tries to recover a business debt.
You have a personal liability to pay tax on all business income.
You can't offer shares to raise funds for your business, so you'll need to seek financing from traditional lenders such as banks.
You're taxed at a higher rate as an individual compared to a company.

The sole trader structure is the easiest to set up, but the word “sole” in the name can mislead people into thinking they always need to work alone.

Jane Tweedy, founder and lead trainer of FAQ Business Training and a Business Connect advisor has heard it before.

"There is a common misconception that a sole trader cannot employ others and must become a company to do so. This is not the case," she says. “Sole traders have no restrictions on employing others, and like any other structure those employees are subject to PAYG withholding tax, super and workers compensation."

There's no need to go the company structure route and experience its complexities if the sole trader structure will suit your needs.

Partnership

You and your partners carry on a business together and share income, losses and control of the business. The partnership can employ staff (the partners in the partnership are not considered employees).

Advantages of the partnership structure

It's low-cost to set up and run.
You and your partners share control and management of the business.
Each partner reports his or her share of the business income via an individual tax return.
Has greater borrowing capacity than sole trader.

Disadvantages of the partnership structure

Each partner is personally liable for the actions and debts of the other partners.
A new partnership needs to be established whenever a partner leaves.
Potential for friction and disagreements is high with each partner having an equal say.

Partnerships are governed by the laws of your state or territory. Some State Partnership Acts were determined as early as 1891.

Find out more about your state or territory's Partnership Act.

Company

A company is a separate legal entity from you. It has at least one shareholder (owner) and one director (who runs the business). Income and losses belong to the company. Companies can employ staff.

Advantages of the company structure

It's a legal entity, meaning legal requirements are in the company's name and not the individual owners’ names.
Ownership can be easily transferred in the case of disability or death of key people.
Tax rates are lower for companies than for individuals.
Shareholders can provide access to greater capital for growth.

Business Structure Woman Filling Beer Mug from Tap

Disadvantages of the company structure

Can be expensive to establish and maintain.
Has complex reporting requirements.
Needs its own tax file number with a tax return submitted each year.
Profits shared with shareholders are taxable.
There’s a learning curve required to comply with regulations of the Corporations Act 2001.

If you've chosen the sole trader structure and feel limited by the options available for raising funds, moving to the company structure will be beneficial.

"A common change is moving from a sole trader, often entered into as a low-cost test of their business idea, into the separate legal entity of a company,” Jane says. “However, there are rules regarding the ownership structure and directors, or it would be deemed a new business. Seek advice before moving structures, as there are strict requirements."

Trust

Your business or businesslike activity is managed by a trustee for the benefit of others (known as the beneficiaries). A trustee is responsible for dealing with the trust, including lodging returns, distributing income or losses to the beneficiaries, and overseeing the payment of debts.

Advantages of establishing a trust

In relation to the business, it provides asset protection and limited liability.
Offers tax flexibility.
Beneficiaries are not generally liable for trust debts.
A company can be a trustee, limiting asset liability.

Disadvantages of a trust

Setup is expensive, as a formal deed is required.
There are annual administrative tasks required.
The trust is obligated to exclusively benefit the beneficiaries.
Tax penalties apply if the trust retains profits for its own use.

Jane says that she's recently seen a change where people are moving away from complicated and expensive trust structures to simpler company structures.

Making a decision about business structure

Deciding on the legal structure for your company will depend on what you have in mind for your business and future growth.

The sole trader structure mentioned by Jane as a “low-cost test” of your business can be an excellent place to start. It's perfect for a freelancer looking to work from home, where the equipment startup costs are low.
A partnership structure is perfect for joint owners (up to 20) and is governed by the laws in your state or territory. A new partnership agreement is required whenever there's a change in partners. There's a risk of disagreements, with each partner having equal say in the business's direction. But the startup costs are low, and it doesn't have the reporting requirements of the company structure.
The company structure offers greater advantages when it comes to raising funds for expansion and growth due to the offering of shares. This structure is perfect for setting up a café or other business where premises and equipment leasing is required. As a separate legal entity, it provides some protection against creditors claiming directors' personal assets to settle debts if the business fails. But it has higher administrative costs due to reporting requirements.
The trust structure is not one to be entered lightly due to the high costs of set-up and operation. There's also the requirements that the trust strictly adheres to the formal trust deed that's required as part of the set-up.

This comparison chart can help you see how the advantages and disadvantages stack up.

Hop to it!

Take advantage of government offerings to determine the best organisational structure for your business. You can also access the planning templates to give your business its best start. And if you just want to talk to someone, the site will connect you to business advisers like Jane Tweedy who will counsel you on the best path for your business. Good luck!