Sole trader, partnership and companies are some of the business structures available in Australia. When it comes to starting a small business, choosing the right business structure is one of the first decisions an entrepreneur must make. In this article, we will understand what is a sole trader, a partnership and a company, their advantages and disadvantages – and how to choose the right one for your business.
Choosing the right business structure
There are more than two million small businesses in Australia accounting for 97 percent of all Australian businesses according to the Australian Bureau of Statistics (ABS), all of which are made up of several different types of structures.
If you have decided to take your idea, skill, product to the next level, the first step is to work out which business structure you should choose for your business and why.
There are a few options available:
- sole trader
They are vastly different in many ways, from how they relate to your work, to licenses you may need, to your personal liability and to your tax and legal obligations.
For many people, the simplest solution is to start operating as a sole trader. There are a range of advantages and disadvantages of running a business in this way that should be considered before you get started. The good thing is that you can change the business structure pretty much at any time during the life of your business.
Let’s have a look at some key points for each option.
Partnership business: advantages and disadvantages
Partnership business is usually made up of 2 or more (up to 20) people responsible for the running of the business.
Decision making and financial investment are often shared, potentially lessening some of the workload and risk, but compromises may have to be made to keep all partners happy.
Pros of a partnership
- Up to 20 business partners
- Partners share knowledge and skills, and get tasks done faster and achieve more together than if they worked alone
- Costs are split among partners, with less financial burden on one person
- Partnership setup requires less paperwork
- Partnership agreement is more simple than the paperwork for other business structures
- No additional business tax forms
- Each partner is responsible for their own superannuation
Cons of a partnership
- Requires a separate TFN
- You cannot act independently and make decisions on your own
- Potential disagreements with your partner/s
- You have to share profits with others
- A partnership is not a separate legal entity from you and the other partners. All partners are legally and financially responsible for the business. Debt collectors can come after your personal money.
- You’re taxed individually
Company: advantages and disadvantages
In Australia, approximately 20,000 new companies are registered each month. The most common company type is a Pty Ltd (proprietary limited company). Unlike a sole trader or partnership structured businesses, a business with a company structure is a separate legal entity. This means it has its own legal rights, and personal liability is limited.
Pros of a company
- It is a separate legal entity, with reduced personal responsibility for any business debts and liabilities
- Easier to attract investors, customers and suppliers
- implies that the business operates on a larger and more serious scale
- more tax efficient, with a flat corporate tax rate of 27.5%, regardless of its profits (check the latest details on the Australian Taxation Office (ATO) website)
- Shareholders Agreements provide significant protection against company disputes
- protection from personal liability
- Easy to pass on or sell ownership
Cons of a company
- More complex and costly to start, set up, administer and manage
- Higher levels of paperwork and compliance
- Registering a company imposes serious responsibilities on directors. A director who breaches their duties may need to pay a fine or find themselves criminally liable and face jail time.
- The company must register for GST if your turnover is over $75,000 a year and has to pay the annual review fee (close to $300) to ASIC.
Trust: advantages and disadvantages
Trusts, unlike companies, are not separate legal entities.
Running your business through a trust involves a trustee. The trustee of the trust is the legal entity who owns the assets and enters into contracts on the trust’s behalf. Trustee is responsible for:
- owning and operating the business’ assets;
- distributing the business’ income; and
- complying with the trust deed’s obligations.
Pros of operating as Trust
- Income can be distributed with the lowest marginal tax rates
- The trust’s beneficiaries pay tax on income they receive at their own marginal rate
- The trustee can distribute income at their discretion
- The trust model provides more privacy than a company
- The beneficiaries do not own the trust assets, so there is some protection from a beneficiary’s third party creditors
Cons of operating as Trust
- Much more expensive and complex to establish and maintain than other structures
- Cumbersome to operate on a daily business
- Hard to dissolve or alter, may result in various additional costs
- More difficult to borrow funds based on the intricacies of loan structures
- The trust deed limits a trustee’s powers
- You cannot distribute losses (only profits). Therefore, any profits earned will incur increased tax rates.
- Trustees can be personally liable for the trust’s debts, unless indemnified or a company structure
Sole trader: advantages and disadvantages
Registering as a sole trader is a great option for people wanting to start a small business. It’s the simplest and cheapest business structure to set up, with very few obligations, unlike other business structures.
It is free to establish and has limited ongoing compliance (i.e. accounting/tax) costs associated with it. You don’t need to do separate company tax returns because you can include all your business expenses and outgoings in your personal tax return. This structure still allows you to employ other people to help you run the business.
You can always roll your sole trader business up into a company or other structure when the time comes
Pros of a sole trader
- Simple to set up and operate – you are the business
- Gives you full control of your assets and business decisions – you are the boss
- Requires fewer reporting requirements and is generally a low-cost structure
- You can use your tax file number (TFN) to lodge tax returns
- Doesn’t require a separate business bank account, although this is recommended to make it easier to keep track of your business income and expenses
- business structure is simple and inexpensive to set up and run
- Little ongoing paperwork
- No need to register a business name – you can use your own
- you keep all the profits
- you can use your tax file number (TFN) to lodge tax returns
- any losses incurred by your business can be offset against other income earned
- relatively easy to change your business structure if you want to expand or stop operating
Cons of a sole trader
- you are on your own, and all the responsibility for making day-to-day business decisions is yours
- there’s no legal distinction between private and business assets – so you are responsible for all the debts
- Doesn’t allow you to split business profits or losses made with family members
- You’re taxed as a single person
- Investors take you less seriously – harder to raise capital
- Retaining high-calibre employees can be difficult
- It can be hard to take holidays
- You’ll need to pay yourself, usually out of a distribution of the business profits
- You are responsible for your own superannuation
What about the business name?
When it comes to business name, as a sole trader you have 2 options:
- Use your own name to start your side hustle or business. This is the simplest and quickest way to get started. If you use your own personal name for your business, then there is no need to set up and register a business name.
- If you don’t wish to trade under your own name, you’ll need to apply for a business name.
To register your business name, first check if it’s available by checking the National Business Names Index and if you wish to trade online it’s a good idea to check that a suitable domain name/address is also available. You can apply for a business name through the Australian Securities & Investments Commission (ASIC). Follow the link to register a business name with ASIC, which will allow you to trade under a name other than your own. This is not expensive and is really useful if you’re trying to build a brand that stands separately from yourself.
The business name you choose for your sole trader business has no legal entity status and does not give you ownership of that name or legal protection of it. If you wish to legally protect your business name and stop other businesses from using it, you’ll need to trademark it.
How do I set myself up as a sole trader?
- First you need to register ABN (Australian Business Number)
The ABN is a unique 11 digit number that identifies your business or organisation to the government and community.
In order to operate as a Sole Trader you must have an Australian Business Number (ABN). In fact, every business in Australia, whether you are a sole trader or a company, needs to have an ABN in order to trade. It’s extremely simple, and free if you do it yourself, process and will only take around 30 minutes to complete online. All you need to have is your Tax File Number (TFN) and personal details ready, and you’ll be able to register for an ABN in no time on the Australian Business Register site. Once done, you will be able to use this number for all your business dealings.
- Next, you need to set up separate business bank accounts (optional)
Ideally you should keep your personal and business accounts separate. You can set up a bank account to handle all of your business income and expenses. In addition to that, you can have an online savings account that you use to set aside funds to pay your tax and Business Activity Statements (BAS) when the time comes.
- Tax stuff to know
If you’re going to earn more than $75,000 in a year you need to register for GST which you can apply for within the ABN application form. Businesses are responsible for collecting GST on behalf of the ATO.
Being registered means you’ll be adding 10% GST on to your invoices that you’ll then hand over to the ATO. It also means you will get GST refunded by ATO when you incur costs for your business that include GST.
If you are registered and collect GST, you will likely need to lodge a quarterly Business Activity Statement (BAS) that summarises the GST collected and paid for that quarter so you know what to pay to the ATO. You can easily do this yourself or get a bookkeeper to handle this for you.
Sole Traders pay tax with their individual Tax File Number (TFN). Annual tax returns are very similar to employee tax returns, with some extra sections specific to sole traders. There are no special tax rates for sole traders. As a sole trader you are required to pay the same tax as an individual taxpayer, at personal income tax rates.
Currently there are more than 1.4 million sole traders in Australia accounting for more than 60 per cent of all Australian businesses.
Before you set off on your small business journey we recommend having a good think about what you want to achieve. As a rule of thumb, if your intention is to simply work for yourself, then a sole trader structure may be adequate.
If on the other hand you are looking at employing several people and working on larger projects, especially where you need to take on larger liabilities, then a company structure may be more appropriate. Whichever way you choose – good luck, and don’t forget to keep your profile updated to get discovered and recommended to opportunities on ZippyCrowd!