Legal Structures: Set Up Your Business Correctly The First Time Around
Thinking of starting a new business in 2020?
Starting a new business can be a risky undertaking and choosing the correct legal structure is vital for your success. Whether you’re embarking on a new business adventure or planning to give your start-up idea a shot, it’s vital to start the way you want to continue. And hey, let’s be optimists. You’re preparing for success right? The key to mastering your new business is good preparation and setting up your structure correctly the first time around.
The most common types of legal business structures are Sole Traders, Partnerships, Companies, Unit Trusts and Discretionary Trust (also known as Family Trusts).
Each vary in size, setup, flexibility, taxation, and risk. So choose wisely!
1. Sole Trader
A Sole Trader is what some people call consulting or working on an ABN. A sole trader is extremely straightforward to establish. It is as simple as obtaining an ABN and any other specific industry registrations and away you go. It is also the cheapest form of business structure.
A sole trader is “on the line” for everything and assumes all of the risk. The risks attached to this structure are by far the biggest pitfall. Should anything go wrong, personal assets (such as your home) are completely exposed.
The typical types of business that would setup as a sole trader are very straightforward businesses. For instance, a tradesman that is subcontracting to one or two other businesses. Also, as a sole trader there is very little flexibility in terms of taxation. You are exposed to the top marginal tax rate if the business performs well.
2. Partnership
A partnership is typically used where 2 (or more) people wish to start a business or work in that business together. Quite straightforward to establish, a partnership simply requires an ABN and a partnership agreement (should the partners wish) and the structure is ready to start business.
The most frightening disadvantage associated with a partnership is the concept of joint and several liability. This means that each partner is responsible and bound by each and every decision that any partner of the business makes, even without their knowledge. If one partner makes a terrible decision and is not in a position to bear the consequences, 100% of that liability then rests with the other partners, making it one of the riskiest structures available.
Taxation benefits are quite limited as profits are split in proportion to the partners holding specified in the agreement (the partnership is not taxed in its own right).
3. Company
A Company is treated as a separate entity under the law for most issues. Establishing a company can be quite costly and there are ongoing costs with the corporate regulator (ASIC). Costs associated with taxation filings would also be more than what would be associated with simpler structures.
Businesses typically operating as a company are those who are looking to have a number of investors (either now or in the future) involved in the business and also those who are looking to limit risk. Limited liability is a major advantage associated with a company. As the business can be sued in its own right if it runs into trouble, the liability of any director is limited to that of the assets of the company (i.e. the business) rather than exposing personal assets, making it generally the safest structure available.
A company has a simple flat tax rate of 27.5% if running a small business, and 30% if running a larger business (or running as an investor).
4. Trust
Typically discretionary trusts are used by family businesses looking to ease the burden of income tax. The trustee is the entity that controls a trust, with the risk of a trust defined not by the fact that it is a trust, but by who the trustee is. Unfortunately, where the trustees of the trust are individuals, the risk attached is similar to that of a sole trader; personal assets can be exposed.
Discretionary trusts provide the ability to spread the load when it comes to taxation. They have the ability to distribute to many beneficiaries each year (subject to a number of rules) and can result in more favourable taxation position than other structures.
Our conclusion
Unfortunately there is no one correct structure for every business, and a mixture of structures is often required to offer security and flexibility for unique situations. Here at Cherry Black, our business consultants can talk you through all of the relevant issues and options to help you decide what structure is best for you and your business.