No matter what stage of business you’re in, whether you’re starting out, growing, or reassessing, it’s imperative that you have the right business structure. It can help you minimise risk, reduce tax and increase profits.
In this article, we discuss the basics of business structures. It is recommended that you discuss these matters with your accountant and lawyer. This is so that you can make an informed decision about which business structure will suit your specific needs.
Sole trader arrangements are a low-cost option for people starting out in business, which appeals to many.
It is important, however, to remember that sole traders are responsible for everything that happens in their businesses. The sole proprietor is responsible for 100% of the business liabilities, which can be recovered from their personal assets.
Sole traders declare their business income (or loss) as part of their personal income tax return and are taxed at the same rate as an individual.
While a sole trader arrangement may be suitable at the start of your business journey, as you grow, take on more risk, or add other people to the business, you should then consider the other options available.
A partnership is a bit like a sole trader with more than one person. When starting out with 2 or more people, a partnership can be attractive due to the low costs of setting up.
A key thing to consider is that a partnership is not a separate legal entity. Generally, in a partnership, all partners will be equally responsible for the management and liabilities of the business. Usually, each partner will have unlimited personal liability for the debts and obligations of the business. If the partnership cannot meet its debts, creditors can seek to recover loss from the personal assets of one or more of the partners.
This may mean that if one partner has more assets, they will bear the responsibility for the partnership’s loss. If one partner has limited personal assets and another owns their home for example, a creditor may recover some or all their loss by requiring that one partner to sell their home.
It may seem like the last thing you want to do when starting a new business venture. However, it is prudent to consider what should happen if the partners want to part ways or are otherwise in dispute. While having a few heads in the business can be very beneficial, there is also the added risk that the partners may not be able to agree on issues. Having a partnership agreement prepared can set out the expectations of each partner, which will minimize the risk of a dispute (where parties are clear on their rights and responsibilities), assist with resolving a dispute, or make severing the partnership easier (if required).
Using a company structure can mean increased setup and ongoing costs, as well as more complex reporting requirements and administrative burdens.
A company is said to have a ‘corporate veil’, which means that the company is a separate entity from the individuals behind it. A key benefit of this, which makes it the most popular business structure, is protection for those running the business. A company structure seeks to balance the interests of those behind the business, by encouraging growth while shielding the individuals from risk (by limiting their liability for business affairs).
There are limited circumstances where those behind a business can have personal liability, and if you are setting up a company, particularly if you are to be a director, you should be aware of your duties and responsibilities. There are lots of helpful resources available to help you with this, as well as professional advisers.
It is easier to enter and exit a company, which makes selling or passing the business on, as well as bringing people in, simpler.
A key document for your company will be your constitution, which dictates how your company will be structured and operates. You should also consider whether a shareholder agreement is necessary where there are multiple shareholders.
The tax requirements for a company are different to those of other business structures. A company pays income tax on its income (or profits) at the company tax rate.
A trust structure can also be implemented within a business. A trustee is responsible for the trust’s income and losses and can be an individual or a company.
To maximise tax benefits, family businesses often use trusts to distribute income between members.
Your business is held in trust by a trustee for the benefit of other people (the beneficiaries).
Trusts can be complex and require an initial trust deed to establish them.
It is important to explore your options when setting up your business to find the right business structure for you. In the case of a sole trader or partnership, you may be limited by your structure over time, particularly if you experience significant growth. You will be able to maximise your business potential and minimize your risks if you have a team of trusted business advisers on your side.