Choosing the right business structure is a significant decision when initially setting up your business. Sure, you can change your business structure later, but this will involve administrative burdens and tax implications. Hence, it is critical to think carefully about the best structure for your business and its unique circumstances. 

There are four common business structures to choose from:

• sole trader;
• partnership; 
• company; or
• trust.

This article explores each business structure in detail to help you with your decision. 

Sole Trader

A sole trader is an individual running a business. Due to its simple structure, ease of set up and minimal operational costs, it is a common business structure for individuals looking to start a business for the first time.

When operating as a sole trader, you and your business are considered to be one single entity. You become legally responsible for all elements of your business, including making decisions relating to the operation and management of your business. Likewise, should your business run into trouble, you will become personally liable for all debts of your business.  

Notably, this business structure is ideal:

• if you plan to operate a business on your own;
• due to ease of set up and operational costs; and
• due to its simple tax structure and minimal reporting requirements.

Considerations for a Sole Trader

Operating as a sole trader may be tempting when you are initially turning your small business idea into a reality. However, note it is difficult to grow as a sole trader. Lenders like angel investors or venture capital firms are typically interested in startups with high potential for growth. Indeed, their primary focus is on generating a return on their investment, which may result in having equity or control over your business. Unfortunately, your sole trader business is not particularly tempting for investors, making it difficult to secure funds and grow within this structure. 

Additionally, the fact that you, as a sole trader, have unlimited liability means that all of your personal assets are at risk if things turn south. So, if your business runs into financial trouble, creditors may attempt to seize your personal assets, like your car or house. 

Finally, as a sole trader, you cannot split business profits or losses with other individuals, including your relatives or family. Therefore, you will be personally liable to pay tax on all the income from your business.

Partnership

Another type of business structure is a partnership. A partnership is an association of two or more individuals (or businesses) that come together to conduct business. Like a sole trader structure, partners are jointly responsible for the debts of the business. As such, it is crucial to consider who you enter into a partnership with, as all partners are equally liable for the other partners’ actions. 

A partnership should have a partnership agreement in place, which sets out how the partnership operates.

Indeed, a partnership may be worth considering if:

• you have like-minded partners who you can trust;
• your potential partners can bring value to the business; and
• you wish to share profits and losses amongst partners.

Considerations for a Partnership

Before forming a partnership, ensure you understand the principle of joint and several liability. Joint liability is where two or more people promise to do the same thing. In a partnership, where you and your partner enter into contracts with third parties, you are both responsible for completing your ‘joint’ promise. Suppose you and your partner agree to pay $100 for a third party to create your business’ website, and all partners fail to fulfil this promise. Accordingly, a third party can sue either one or both partners for the full amount. 

Notably, several liability may exist, and you can explicitly state these details in your partnership agreement. Several liability is where two or more people make separate agreements with another party. Using the example above, you promise to pay $50 and your partner promises to pay $50 to a third party. So, when one partner fulfils their obligation, it does not discharge another partner’s obligation to fulfil their promise. 

Another consideration is your potential taxable income. In a partnership, each partner pays tax on their share of the partnership profit at their individual tax rate. While this makes the tax structure relatively simple, it is not ideal if you predict your business will make a significant profit. Therefore, it may be suitable to consider a different business structure, such as a company. 

Company

A company is the most ideal business structure if you are looking to grow and scale your business. As mentioned, investors are more willing to invest in companies who show promise of growth. A company’s ability to issue shares, raise capital and expand business makes this structure most attractive for startup businesses. 

Unlike a sole trader or partnership, a company is its own legal entity, granting you with limited liability. Accordingly, suppose your company runs into trouble with third parties, like suppliers. In this case, those third parties will engage with the company as a separate legal entity, and your personal assets remain safe and untouchable. This limited liability makes the company structure suitable for high-risk businesses. 

Ultimately, a company is very suitable if:

• you have large plans for growth; and
• you want to minimise your personal liability.

Considerations for a Company

When operating as a company, you will need to understand and abide by all of your corporate governance obligations. Importantly, directors are responsible for ensuring their company complies the Corporations Act. Some of the most important responsibilities are:

• maintaining up-to-date financial records;
• ensuring good governance (e.g. ensuring proper decision making);
• notifying ASIC of certain company changes; and
• paying ASIC’s fees.

There are also director duties to keep in mind. The key directors’ duties are to: 

• ensure the company complies with all legal obligations;
• act in good faith in the best interests of the company and avoid conflicts with personal interests;
• prevent the company from trading while insolvent; and
• be careful and diligent when running the company, amongst others. 

A director who breaches their duties may find themselves facing a hefty fine, being criminally liable orfacing jail time. 

Another consideration is drafting and implementing a company constitution and a shareholders agreement. A company constitution is a legal document that will govern your company’s management, especially between the company’s directors and its shareholders. Likewise, a shareholders agreement outlines the rights and responsibilities of shareholders, and how the company will:

• issue shares;
• pay dividends; and
• resolve internal conflicts.

Ultimately, there are many legal documents and obligations under corporate law that you will need to follow. Ensure you take these into consideration before forming your company.

Trusts

A trust is a type of relationship where one party manages property for another party’s benefit. A trust is generally governed by a trust deed, detailing the objectives, terms, and rules for creating and managing a trust. Likewise, it is possible to own and run a business through a trust. This structure is an excellent way to safeguard particular assets and take advantage of tax benefits.

Considerations for a Trust

Consider the two different types of trusts before deciding to run your business through a trust.

It is more common for sole traders or members of the same family to run their business through a discretionary trust. In this structure, the trustee has the flexibility and discretion to manage the trust’s assets. They can choose which beneficiaries will receive distributions and to what extent (if any). Discretionary trusts are commonly used to distribute a family’s assets or to conduct a family business. Accordingly, they are also known as ‘family trusts.’

However, if you are looking to enter business with two or more people, perhaps not from the same family, a unit trust may be more ideal. Here, trust income and assets are divided into defined units, giving each unitholder entitlements to receive their fair (and proportionate) share of business profits. So, at the end of each financial year, a trust must distribute its income to unitholders (limited to the proportion of units they hold). Indeed, this proportionate amount is fixed with no room for discretion. 

Key Takeaways

There are four common business structures to choose from: a sole trader, partnership, company or trust. Indeed, the taxes you pay, your personal liability and your ability to expand and attract funding all depend on the structure you choose. Hence, it is critical that you carefully consider which structure is most suitable for the type of business you are planning to run. 

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