Choosing a business structure is, well, tricky business. If you are thinking of starting a business, you should first weigh up the pros and cons of each business structure to figure out which one best suits your needs. This is an important step that shouldn’t be overlooked because it affects many aspects of your business such as tax, liability, capital, management and costs.
The three main business structures in Australia are: sole trader, partnership, and company. This article highlights the main features of each structure to help you compare and select which is best for your business.
A sole trader is where generally only one person funds and owns the business. Most new businesses are set up as sole traders, mainly due to the fact that it is the simplest structure and the least expensive in terms of set up costs. Sole traders face very few legal and tax formalities. The rules regarding keeping records, auditing and filing of financial information are very relaxed compared to companies.
The main disadvantage is that you face unlimited liability. As a sole trader, there is no separation between the assets and liabilities of the business and your own, so you are personally liable for all aspects of the business. This means that your creditors are entitled to seize and sell your personal assets if your business goes bankrupt!
A partnership involves a number of people (up to 20) joining forces to carry on a business together. Control or management of the business is shared, and income is often received jointly. Partnerships are governed by the Partnership Act 1958, but like sole traders, there are very few restrictions to setting up a partnership. A big advantage of a partnership is that by pooling resources together, you have more capital. Also, with many partners, you are able to bring several skill sets to the business.
There are two major disadvantages of a partnership structure. First, partners face joint and several liability. This means that each partner is fully liable to third parties despite any agreement between the partners. Second, if a partner makes a business mistake, every partner will face the brunt of it. For example, one partner could sign a disastrous contract without your knowledge or consent. As a result, your personal assets could be at risk, even if you weren’t personally at fault!
A company is a separate legal entity from its owners. It has the same rights as a natural person: it can incur debt, sue and be sued. The main disadvantages of setting up a company are that it is the most complex structure, with high set-up costs and administrative costs. They are also subject to many more onerous legal and tax formalities than other business structures. For example, companies must be registered with ASIC, and they are subject to the legal obligations contained within the Corporations Act 2001.
The major advantage of registering a company is that the company’s owners (i.e. shareholders) can limit their personal liability and are generally not liable for the debts of the company. This gives shareholders peace of mind knowing that their personal assets are safe from creditors if the company goes belly up!
Good news – You’re not locked in!
Choosing a business structure can be a difficult task as there are so many factors to weigh up. Also, you might find that the business structure best for your business today, may not be best in the future as your business grows and changes. But don’t worry, the good news is that you can change your business structure at any time! You are not locked in to one business structure for the life of your business, so be sure to monitor how your business structure performs over time so you can determine if and when to make the switch.
About the author
With over 20 years’ legal and business experience, Katherine Hawes is the founder and principle solicitor of Aquarius Lawyers. She previously wrote How to protect your IP when you have an online business for Dynamic Business.