There are countless decisions that one has to make when starting a business. However, there is one decision that is crucial in determining the future success of your business, and that is: what business structure is best to adopt?
It is important to note that there is no correct answer to this question. In fact, choosing the right business structure can often be confusing and complex. So we’re here to help break down the options.
Firstly, a sole proprietorship is the most common business structure. In fact, it is the most popular business structure across Australia, the UK and the US. With that being said, there are drawbacks to being a sole trader.
Key benefits of a sole proprietorship:
- Very simple and easy to form.
- Essentially full managerial control. This means that you will freely be able to make decisions regarding the direction of the business as you wish.
- Being your own boss means that there are fewer registration and legal fees associated with starting the business, such as hiring other employees or renting out office spaces.
Key limitations of a sole proprietorship:
- Being the only one in charge means that you are legally and financially responsible for, essentially, the whole business.
- Being the only employee may stagnate the cultural growth of the business.
- You will be limited in who you can share ideas and concerns with.
The nature of a partnership is very much in its name. Partnerships usually involve two or more people who share the profits and losses between them. With that being said, here are some pros and cons of establishing a partnership:
Key benefits of a partnership:
- Unlike a sole trader, there is a greater ability to share ideas and concerns.
- There is flexibility and ease in changing the business structure.
- More partners means more access to capital.
- Losses are spread among owners.
Key limitations of a partnership:
- More partners does not mean unlimited liability. The personal assets of the partners may still be at risk if the business runs into trouble.
- Greater potential for conflicts of opinions.
- Profits must be shared among owners.
- Legal costs, including those associated with partnership agreements.
A company is a separate legal entity, and has distinct rights from its shareholders, directors and employees. However, companies are extremely complicated and expensive to establish, and must also comply with legislation such as the Corporation Act 2001. Here are some benefits and limitations of a company business structure.
Key benefits of a company:
- Limited liability amongst shareholders, meaning that those managing the company are not personally liable for losses incurred by the business.
- Capital can be easily raised.
- As a director, you will have no personal responsibility for debt (provided the debts are not resultant of fraudulence or negligence).
Key limitations of a company:
- Strict compliance with various legislation.
- If a director fails to meet their legal obligations, they may be liable to penalties or imprisonment.
- Companies incur company tax.
- High establishment and compliance costs.
A trust is a business structure where an individual or company (trustee) carries particular assets on behalf of the trust’s members. Trusts fall into the same category as sole traders and partnerships, in that they are not separate legal entities. Furthermore, trusts can be characterised into two types: discretionary trust, and unit trusts.
A discretionary trust allows the trustee to operate at his or her discretion with regards to the distribution of profit and income to beneficiaries. On the other hand, a unit trust removes this discretion. This is because trusts are separated into fixed ‘units’ for the beneficiaries. This may seem quite complex, so here are some pros and cons of a each type of trust:
Key benefits of a Discretionary Trust:
- Resulting from the ability to freely distribute your income, you will be able to fall in a lower tax bracket.
- Assets are protecting against creditors.
Key benefits of a Unit Trust:
- Unit trusts do not need to pay tax.
- Assets are protecting against creditors.
Key limitations of a Discretionary Trust:
- There are onerous regulatory burdens to running discretionary trusts.
- Unlike partnerships where both profits and losses are spread across partners, only profits are distributed to beneficiaries. Ultimately, this leaves the entirety of the losses with the trustee.
- Company structures are more attractive to potential investors than trust structures.
Key limitations of a Unit Trust:
- Expensive and complex to establish
- Must distribute all profits and income to the beneficiaries at the end of each financial year.
- The trustee is the only decision maker and legal right holder over the unit trust. Therefore, beneficiaries may be opposed to losing control over their assets.
Please keep in mind, there is no golden rule to picking the best business structure. In fact, businesses constantly change from sole traders to partnerships, and from partnerships to companies.