Considering Opening a Business? We Break Down the Five Most Common Business Structures!
The type of business structure you choose affects how your business will operate. Things to take into consideration when choosing your structure include means of tax efficiency, your flexibility to obtain capital, distribute income, asset protection, control and succession and personal liability.
What does each structure involve?
Individual (sole trader):
An individual or sole trader is an individual trading as themselves. This means that the proprietor is legally responsible for all aspects of the business, including all assets, liabilities, income and losses.
Partnership:
A partnership arises when at least two people, or incorporated entities, operate a business together. This is different from a company as the parties remain individually liable if the business incurs credit.
Discretionary Trust/ Family Trust:
A discretionary trust (also commonly known as a family trust) gives the trustee the power to allocate when and how much of the trust income and capital the various beneficiaries are to receive.
Unit Trust/ Fixed Trust:
Unit trusts (also commonly known as fixed trusts) see the beneficiary’s interest in the fund divided into segments of different value. These are called units. This fixed trust fund is held by the trustee and allocated dependent on the number and class of units owned by each unitholder.
Company:
A company is an entity that has a separate legal existence from its owners. The company’s legal status gives it the same rights as a natural person which means a company can incur debt, commence lawsuits and have lawsuits filed against it. Small business owners often use a type of company structure called a proprietary limited company, which has the words ‘Pty Ltd’ after the name. This type of company can’t sell its shares to the public and has limited liability. Further, a company structure means the directors may not be at risk of losing personal assets should the business become insolvent.
The following table compares the key components associated with the five main business structures:
In what situation would you use each structure:
Individual (sole trader):
Sole traders often chose to operate as themselves when originally establishing a small business. This is because they are one of the simplest and cheaper options in terms of choosing a structure. People often chose this option if they want to maintain full power and authority of the business.
You must be aware when picking this structure, you are likely to bet at risk of having your own personal assets liable should the business default on debts.
Partnership:
Partnerships are useful when you will be jointly in a business with other people. This type of structure is beneficial in appointing shared and individual duties dependent on experience. It is also an easier and relatively inexpensive option to set up. As a sole trader, the partners are directly liable for unpaid debts. This means that not only can the partners keep and allocate profit, but they will also be personally liable should any business debt remain unpaid. Like a sole trader, you may risk losing your personal assets through this structure in the event of unpaid debt.
Discretionary Trust/ Family Trust:
Trusts can be expensive not only when setting up but also in terms of ongoing costs. With that being said, the legal trustee is in charge of managing trust funds, meaning beneficiaries have no influence on their income. This means legal trustees can determine who can receive what amount. It is worth noting, a company can also be appointed as a legal trustee. Having a company as a trustee does provide some asset protection.
Discretionary trusts are often used for income splitting between married couples and families as they offer the flexibility to change the distributions. Other purposes include tax planning, estate planning, carrying on a business, asset protection and investment and land holdings.
Unit Trust/ Fixed Trust:
Unit trusts are a popular structure if going into business with other unrelated parties. This is a suitable option if you want all unitholders to receive a fixed interest in capital and income.
Company:
A company structure is often used either as a first point of call when opening a business or to expand a business after a significant amount of growth (particularly sole traders or partnerships). Companies can be more complex to set up than a sole trader or partnership and can be more costly in terms of additional reporting costs. The added benefit, however, is a lack of personal liability meaning directors will not risk the loss of personal assets should the venture not work out.
You must weigh up whether you would prefer the added compliance costs, stricter reporting and set tax rate on profit in order to be not personally liable for accrued business debt before choosing this structure.
It is important you consider what business structure will best satisfy the purpose of your business. Each structure requires different regulations and processes, therefore it is vital you are fully aware and understand all aspects of your intended structure before making a final decision.