Is your business structure working against you?
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March 7, 2018
When starting a business, one of the most important decisions you will make is the type of legal structure that you select. This step is often underestimated (especially by small businesses and startups) in favour of more interesting new business tasks such as branding and retail setup… however, the structure that you select can either help you grow or hold you back.
Not only will your structural decision impact how much you pay in taxes, but it will also impact the paperwork, personal liability and your ability to raise funds.
When setting up your business, did you give structure the proper consideration that it deserves? If not, or if you’re unsure whether you selected the right structure for your needs, read on.
In choosing the right business structure for your needs, there are four crucial criteria to consider. These are:
- – Whether you plan to have or currently have partners and/or investors in the business;
- – The administrative costs of setting up and maintaining your business structure
- – The tax efficacy of your business structure; and
- – Your personal liability risk from your products and/or services.
In Australia, there are more than two million business made up of the four most common Australian business structures: Sole Trader, Company, Partnership and Trust.
To choose (or change) your business structure, you need to know the benefits vs. risks for each structure type. Let’s explore these now.
- Sole Trader
This is the simplest business structure. If you set up your business as a sole trader, you’ll be legally responsible for every aspect of the business and be accountable for all decisions (although you can hire people to help you make the best decisions). Many small business owners are sole trader.
The costs of being a sole trader are minimal, and the application process is a breeze compared to other business structures. In addition, ongoing administrative costs are also significantly smaller.
The big downside of sole tradership is that as the sole responsible individual, your personal assets are at risk. This is because sole traders are not fully separate legal entities… so if your business is ever sued, you could end up paying the costs out of your personal asset pool. As an individual, you’ll also be held liable for any business debts incurred, including tax obligations.
And as far as tax benefits go, there aren’t too many benefits to being a sole trader. You’re also responsible for your own superannuation.
| Benefits | Risks |
| Your TFN can be used to lodge tax returns | Being solely responsible can make it difficult to take holidays and breaks |
| Easy and inexpensive to set up, and relatively inexpensive to run | It can be significantly more difficult to apply for finance, especially if your business earnings aren’t stable |
| You have complete control | Your personal assets are at risk if things go wrong |
| You’re not required to register a business name, as you can use your own name | You’re solely responsible for liabilities such as employee claims or debts |
| It’s easy to change your business structure if you want to expand or downsize/cease operating | No real tax benefits |
- Partnership
In a partnership, a group of people (generally between two and 20 people, although there are exceptions made for certain industries) are responsible for running the business. Responsibilities of decision making and investment are shared (either evenly across the group or through a select number or group members taking certain responsibilities).
This lessens the burden of workload and distributes the risk. However, partnership businesses often find themselves having to make plenty of compromises to ensure to keep all partners happy.
Partnerships mean that each partner will pay tax on the share of net partnership income that they receive, and can offset their share of the losses incurred against any other income earned. Like a sole tradership, each partner is also responsible for their own superannuation.
Most partnerships are operated by partners who were close friends/colleagues previously, and have established a history of a solid working relationship together in other capacities. The partnership structure works very well for those whose values align very closely with their partners’ but, it’s also common to see partnerships in a state of disarray after conflicts arise from working so closely together.
If one or more partners seeks greater control than the others, things often go wrong… and if things do go wrong, a partnership offers little protection.
| Benefits | Risks |
| Partnerships are relatively inexpensive and simple to run | Disagreements amongst partners can often break out… the more partners include, the more disagreements there are likely to be |
| It can be easier to get finance with the assets of at least two people pooled together | Compromise is frequent to ensure that all partners’ needs are being satisfied and as a result, some partners will not feel truly satisfied or in control enough |
| There is relatively little ongoing paperwork or red tape | Each partner shares responsibility for all liabilities, regardless of how much of the partnership that they actually own |
| A partnership offers more financial reporting privacy compared with a company | No real tax benefits |
- Company
Company structures (such as Pty Ltd) have the benefit of lessening personal liability with the business classified as a separate legal entity from its owner/s.
All money earned through trade belongs to the company, not its owners, and business operations are owned by shareholders and controlled by directors.
If things do go wrong in business, your business mistakes are far less likely to impede on your personal assets… however, this is only the case if your personal assets are kept separate from your business assets.
If you incorporate as a company, you’ll be a shareholder – you can either be a sole shareholder or have multiple shareholders, and if you have multiple shareholders, they’ll be owed a vote on any major decisions made in your business. Most companies have a Company Constitution, which is a standard document that stipulate the voting rights and managerial processes that each shareholder will abide by. The roles you must adhere to when managing your company are also set out in the Australian Corporations Act.
| Benefits | Risks |
| Lessened personal responsibility for any business debts and liabilities | More complex to start and run… ongoing costs are relatively high and accounting can become complex |
| Tax deductions are available for directors’ wages and misc. salary costs | There are ongoing compliance costs and higher levels of compliance required, plus more paperwork |
| If you decide to move on, it’s easy to pass on ownership or sell the company | Personal assets can be on the line, if your company was set up improperly… it’s necessary to seek out expert help from the start |
| Shareholders tax can be reduced with franking credits (credits for the tax already paid by the company) | There’s no such thing as immediate full control where multiple stakeholders are involved and compromise is often necessary – this means that major decisions can take considerable time |
- Trust
A trust is an organisation, run by a trustee to benefit beneficiaries (beneficiaries must be listed). Trustees can either be an individual or a company, and the designated trustee becomes responsible for all debts and liabilities incurred.
Trust profits are distributed annually to beneficiaries, and beneficiaries pay tax individually. As long a trust distributes all profits, trusts typically will not pay tax.
Trusts require a formal trust deed to set out the operation terms. Trusts are one of the oldest legal structures and have been used to handle matters such as family inheritance, and the main benefit of operation is the flexibility in how trust income is distributed. The ATO now has strong policies and auditing processes of trusts to ensure that they’re not being used for tax avoidance.
| Benefits | Risks |
| The personal responsibility for any debts and liabilities is low, if the trustee is a company | Setting up and administration is very costly, and requires the help of an expert to draw up a Deed of Trust – and additionally, trusts generally have a lifespan of 99 years |
| There’s great flexibility in distributing profits to beneficiaries | If you wish to expand your business and retain the profits to do so, you’ll have to pay penalty tax rates |
| If you decide to move on, it’s easy to pass on ownership or sell the trust | Additional costs are incurred if you also use a corporate structure for the trustee or beneficiaries |
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Is your business structure working against you?
If you’ve set up your business structure and are now realising that it might be a good idea to restructure, don’t worry – you’re not married to a structure for the duration of your business!
However, restructuring isn’t something to take lightly and it’s important to do it right (to spare yourself worry, hassle and cost in the long run).
Not sure if your business structure is right for you, or want to restructure your business? Book a consultation with one of our experts today and let’s set up a time to talk. Assisting your bottom line is our bottom line.
This article is general information only. It does not give business, accounting, taxation, financial planning or other professional advice or service. It does not consider your specific situation, objectives or needs and if personal advice is required, a detailed analysis of your particular circumstances would need to be sought. Please see our Privacy and Disclaimers page for further information.
