Starting a business: choosing the right structure

The choice of business structure is an important decision to make at the outset of a business venture.  Below we consider the four main types of structures including sole trader, partnership, company and trust and the advantages and disadvantages of each.

When setting up a business structure, consideration should be given to factors such as how many people will be involved in the business, what the business will do, how much income is likely to be earned from the business and the intended growth of the business.

In making the choice as to which structure to use, the principal considerations include:

  1. Set-up and administration costs;
  2. Protection of the assets of the entity and the client;
  3. Flexibility in the structure and in distribution of the profit;
  4. Minimisation of tax; and
  5. Suitability to client’s desired exit strategy and/or succession plan.

SOLE TRADER

This is the simplest trading structure whereby the business has no separate legal existence from its owner. It is owned and run by one individual, who is fully responsible for all debts and liabilities of the business.

The principal is not an employee of the business and therefore compulsory employee superannuation contributions, payroll tax and workers compensation do not apply.

Advantage

Lower establishment costs and minimal legal and compliance requirements.

Disadvantage

Individual is personally liable for all financial obligations.

PARTNERSHIP

A partnership is ‘the relationship which exists between persons carrying on a business in common with a view to a profit’, so it takes two or more individuals to form a partnership.

All partners legally share profits, which can be in unequal shares and involve unequal risks and losses, according to the partnership contract.

Running costs include regular production of management accounts for partnership meetings. A partnership tax return is required as well as the partner’s individual returns.

Advantage

Partnerships are relatively inexpensive to form and operate.

Disadvantage

Partners are severally and jointly liable for the obligations of the partnership. There is also potential for dispute and loss of trust between the partners.

COMPANY

Unlike partnerships and sole traders, a company is a legal entity separate from its shareholder owners. There are four types of companies:

  1. a company limited by shares;
  2. a company limited by guarantee;
  3. a company with unlimited liability; and
  4. a no-liability company (for mining purposes).

The words “Pty Ltd” after a business name show that the business is a registered legal entity trading in its own right. A company is owned by shareholders and directors manage the company’s day to day business and affairs.

The shareholders of a company receive any company profits in the form of dividends.

Companies are governed by the Corporations Law and there are a number of duties and obligations for company directors. Primarily, directors have an obligation to act in the best interests of the company.

Companies incur incorporation expenses and often a shareholders’ agreement having similar ongoing account requirements. ASIC and other compliance regimes add further administrative costs and burdens.

Advantage

Shareholders can limit their personal liability and are not generally liable for the company debts. Instead, the financial liability of the company is limited to the company assets.

Disadvantage

Establishment of a company and ongoing administrative and compliance costs associated with the Corporations Law can be high.

TRUST 

A trust is a business structure whereby the trustee holds property, incurs liabilities, and earns and distributes income on behalf of the beneficiaries.

The trust deed normally provides for the trustee to be indemnified by the assets of the trust but not by the beneficiaries. The trustee’s powers are set out in the trust deed and in trustee legislation.  A trustee can be an individual or a company.

The most common types of trusts are:

  • fixed trusts,
  • unit trusts;
  • hybrid trusts; and
  • discretionary trusts

A formal deed is required to set up a trust and there are annual tasks for a trustee to undertake. Trusts without corporate trustees are relatively inexpensive to set-up and run, and with a corporate trustee it is necessary to add the cost of setting up a company.

Advantage

There is flexibility in income distribution and income can be streamed to low income tax beneficiaries to take advantage of their lower marginal tax rate. Assets can be protected through a properly drafted deed.

Disadvantage

Trusts can be costly to set up, particularly if there is a corporate trustee, and there are greater compliance and legal requirements associated with administering a trust.

Each business varies, and no business owners’ circumstances are the same. It is important that advice is sought from an accountant and a lawyer about the advantages and disadvantages of each structure to make sure that most beneficial structure is used, depending on the needs of the business.

If you or someone you know wants more information or needs help or advice, please contact us on (02) 8014 5885 or email info@nolanlawyers.com.au.

 

By |2018-10-29T14:12:04+10:00April 2nd, 2018|Uncategorized|