Sole Trader, Partnership, Trust or Company. What’s the right Australian business structure for you? This might be one of the most critical business decisions you make – so getting it right is important.
Whether you’re a first-time entrepreneur or a seasoned business owner, selecting the right structure for your business can be challenging. There are multiple options, all with different pros and cons. Far too many business owners just skip this important decision altogether, effectively merging their personal and business interests and leaving themselves at risk. If you’re serious about going into business, then you need to get serious about properly structuring it.
When choosing the right structure for your business, here are the 4 most important criteria to consider:
- Your personal liability exposure from your business products or services
- Whether you have (or plan to have) partners or investors in the business
- The administrative costs of setting up and maintaining your business structure
- The tax effectiveness of the structure
These are Legal123’s views of the pros and cons of different business structures – from a legal perspective. But before making a final decision, you should also check with your accountant – to understand the tax benefits of each structure for you.
What are my Business Structure options?
In Australia, there are generally 4 options for structuring your business.
Sole Trader: Being a Sole Trader is the simplest and least expensive option. Designed for business owners who are the sole proprietors of their companies, this structure doesn’t give you much protection if things go wrong. Your personal assets are unprotected from any claims arising from your business.
Pty Ltd Company: Incorporation (i.e. forming a Proprietary Limited Company) effectively makes your business a separate legal entity from you. This structure involves quite a bit of paperwork and can be expensive to maintain. But it offers your personal assets protection from liability and only your company assets are at risk in the event of any legal actions and company debts.
Partnership: Creating a Partnership allows you to go into business with multiple people and share income. Partnerships are easier and less expensive than Companies to set up. However, all partners together are personally responsible for business debts and actions against the Partnership. And each partner is individually liable for debts incurred by the other partners. This means you have unlimited liability, unlike a Company structure.
Trust: A Trust isn’t an organisation at all, but instead a legal structure to hold assets. For example, you might set up a Trust to hold your business assets, then appoint a Trustee to manage them. Commonly, the Trustee is a Company and the Trust provides asset protection and limits liability from operating the business. Trusts are very flexible for tax purposes. However, a Trust is a complex legal structure and establishing a Trust costs significantly more than a Sole Trader or Partnership.
That’s the summary. Now let’s look at each option in more detail.
As a Sole Trader your personal assets (e.g. your house) are at risk
When most people think of a small business owner, a Sole Trader immediately comes to mind. The Sole Trader structure is for individuals doing business on their own. This structure preserves your right to make all decisions about your business but clouds any distinction between your personal and business assets.
The costs of becoming a Sole Trader are minimal and the application process is relatively simple, compared to other business structures. Ongoing administration costs are also smaller. If all this sounds too good to be true, it just might be.
The ultimate downside of being a Sole Trader is that it places your personal assets at risk. Sole Traders are not fully separate legal entities from their owners, which means that if your business is sued, you could end up paying the costs from your personal assets. You’ll also be stuck personally with your business debts, including any tax obligations incurred.
In addition, being a Sole Trader doesn’t offer you any real tax benefits. All-in-all, this business setup is less than ideal. You can read more about the pros and cons here.
A Pty Ltd Company protects you from being personally liable
If you’re serious about starting and growing a successful business, then you really should consider a Pty Ltd Company. This is a legal entity that is separate from you personally. If things do go wrong, your business mistakes are unlikely to destroy your personal financial assets. But for this to work successfully, you must keep your personal assets separate from your business assets – separate personal and business bank accounts, family home in your name not the Company’s, etc.
If you incorporate as a Company, you’ll be a shareholder. You can be the sole shareholder or have multiple shareholders in your business. If you have multiple shareholders, they will usually have a vote on any major decisions in your business. The voting rights and how your business is managed will be set out in your Company Constitution – a standard document in most cases – and your Shareholder Agreement. The rules you must adhere to when managing your Company are set out in the Australian Corporations Act.
The primary drawback of using a Pty Ltd Company is that the ongoing costs are relatively high – and the formation costs can also be large. A less expensive option for incorporating your Pty Ltd Company (and you can do it easily online) is $660 through Incorporator.com.au (which includes the ASIC registration fee). Bear in mind, some accountants charge 2-3 times this amount – so choose wisely.
Then annually you’ll need to file a company tax return with the ATO and update your ASIC registration details. The costs of an accountant to prepare and submit your personal and company tax returns can run between $1,000 and $2,500, depending on the complexity of the return and whether your accountant is located in a major Australian city or regional town. But a Company structure does give you some ability to structure your earnings from the business in the most tax-effective way. In addition, you’ll need to pay the annual ASIC Review Fee, which was $243 in 2015.
You can read more about the pros and cons here.
With a Partnership you are liable for all partners’ actions and debts
If you have a business partner whom you trust and want to work with, a Partnership might seem like a good choice. For many Australian business owners, this approach works well. The costs of setting up a Partnership are relatively low, and this option for your business requires less maintenance and fewer administrative costs than a Pty Ltd Company. A Partnership also offers more financial reporting privacy, compared to a (Pty Ltd or Public) Company.
Generally speaking, a Partnership is limited to between 2 and 20 partners. However, there are exceptions laid out in the Australian Corporations Act. For example, a Partnership can consist of:
- 50 Actuaries, Medical Practitioners, Patent Attorneys or Stockbrokers
- 100 Architects, Pharmaceutical Chemists or Veterinary Surgeons
- 400 Legal Practitioners, and
- 1,000 Accountants!
A Partnership also allows you to pool your assets, which can make it easier to operate your business. For example, if you and your partner apply for a loan for office space, being able to pool your assets can make you (together) a more attractive loan candidate.
However, Partnerships offer little protection if things go wrong. You’ll be personally liable for your business debts, as well as any lawsuits from bad decisions your business made. Worse still, in the same way a Partnership allows you to merge your assets with your partner, you may also be liable for your partners’ debts. These risks can be mitigated with appropriate insurance cover or becoming a “limited” partner. For these reasons, we strongly advise anyone considering a Partnership to get professional advice and a very detailed understanding of your partners’ financial situation.
In addition, Partnerships do not offer any substantial tax benefits. Your Partnership doesn’t pay taxes directly. Instead, you and your partners must lodge annual tax returns and pay personal tax based on your share of the Partnership’s earnings. You can read more about the pros and cons here.
Trusts do not have the tax advantages they used to
Trusts are one of the oldest legal structures devised and have been used to handle everything from family inheritances to funding political activities. A Trust is simply an arrangement wherein an overseer, known as a Trustee, manages assets. If you entrust your business to a Trustee, it will act as a manager of the business, making decisions, disbursing funds and paying bills.
The Trust provides asset protection and limits liability from operating the business. Beneficiaries (owners) of a Trust are generally not liable for Trust debts, unlike Sole Traders and Partnerships. And the Trustee is normally incorporated as a Pty Ltd Company, to give the Trustee some protection from liability too.
The main benefit of operating a Trust is that it gives you flexibility in how income from the Trust is distributed. The Trust itself usually pays no tax but distributes its profits to the Beneficiaries each year. This gives you some tax planning flexibility (taking advantage of the different tax-free thresholds and personal tax rates of each Beneficiary) that the other business structures aren’t able to. However, because Trusts have historically been widely used for tax avoidance, the ATO has been cracking down on Trusts.
The setting up and administration of a Trust is very complex and costly. You’ll have to draw up a Deed of Trust, which requires the assistance of a lawyer. And if you want to expand your business, and retain profits to do so, you’ll be subject to penalty tax rates.
If you use the Trust option you’ll probably ALSO use a Corporate structure for the Trustee and/or Beneficiaries, which involves additional costs. You can read more about the pros and cons here.
Now, you need to Register your business
Once you’ve decided on the best structure for your business and chosen a business name, you need to Register your business and business name. And you need to do this with several different Australian regulators and organisations.
Irrespective of whether you’ve chosen to be a Sole Trader, Partnership, Trust or Pty Ltd Company, you will need a:
- Registered business name
- ABN (Australian Business Number)
- TFN (Tax File Number)
and will probably need to register for GST too. So there really are no differences between the various Australian business setup options here.
ASIC: First you need to sign up for an ASIC Connect account. You should have already searched the ASIC and IP Australia databases to make sure your business name has not previously been registered or trademarked. The ASIC registration fee is either $36 for one year or $84 for three years. When your application has been approved you’ll be given an ACN (Australian Company Number).
Australian Business Register: Next, you need to take your ACN and apply for an ABN (Australian Business Number). An ABN has become a very important unique identifier of your business (necessary for opening bank accounts, filing tax returns, including on invoices, etc.) and every Australian business needs one. At the same time you can register on this Australian Government website for your TFN (Tax File Number), PAYG (Pay As You Go) and GST. There are no registration fees for these registrations.
IP Australia: This step is often skipped by startup businesses, but is vital for protecting your business, brand name and intellectual property. Although you have registered your business name with ASIC, this does not mean that you have exclusive ownership of it. It can be used as a “trading as” name, “Pty Ltd” name or trademarked as a brand name. To prevent this, you need to register your business name (and logo and tagline) with IP Australia. The costs of doing this vary depending on the number of “product categories” you want to cover, but look to spend at least $500 to $700 for this extra protection.
Website Domain & Social Media: You also need to register your business online and these days that doesn’t just mean a website address. It includes all the major social media platforms too! You can register your “.com.au” and all derivative domains (e.g. .com, .org, .net, .mobi, .info, etc.) with a service like Netregistry. And use NameChk to check your business name is available on social media platforms like Facebook, Twitter, YouTube, etc. Registering on ALL these social media platforms isn’t absolutely necessary but at least have the majors covered off.
Regulatory Licences & Permits: Whether this step is required depends on your specific type of business. The Australian Business Licence and Information Service is like a one-stop-shop for finding out what Australian licences, permits, approvals, registrations, etc. your business needs to meet its compliance obligations. Make sure you check it out!
The table above summarises the pros and cons of the different Australian structures for your business. A tick is good, a cross is bad and a dash is neutral. Overall we believe the Pty Ltd Company structure is best for most Australian businesses.
You’re not wedded to a single structure for the life of your business. But if you change your structure it affects your taxes, liabilities, responsibilities, asset protection and ongoing costs. Similarly, you can change your business name, brand name, logo and business branding image at any time. However, the costs and risks of doing so also not insignificant.
So spend the time during the startup phase of your business to get the structure, business name and branding right. It will save you a lot of time and money down the road.
If you need help choosing the right business structure and registering your Australian business, then get in touch.