Have you ever wondered how someone can run a business independently compared to a CEO of a large corporation? They often perform similar tasks on different scales and within various organisational structures. Your business structure can influence how much tax you pay, how much admin you have, and how you’re treated legally.
Three primary business structures exist: sole trader, partnership, and company. There’s also the option to be under a trust or to work as a co-operative. Let’s examine why you need a business structure and these structures in more detail.
Why do you need a business structure?
A business structure is the foundation upon which your business operates. Factors such as size, type, and desired management style can all influence your choice. Your structure determines various aspects of your business, including:
- Ownership: Whether you’re considered an employee or the owner.
- Liability: Your personal exposure to business debts.
- Control: The level of authority you have.
- Costs: Ongoing expenses and paperwork.
- Licenses: The permits and permissions you need.
- Tax: The amount of tax you’ll pay.
It’s essential to analyse the business structure options to find the best fit for you and your business. If you don’t specify a structure when starting, you’ll automatically be considered a sole trader. Let’s take a closer look at the main business structure types.
What is a sole trader?
A sole trader is a business owned and operated by a single individual. You have complete control over the business but are also personally liable for its actions. While the administrative and tax burdens are relatively low, there’s no legal separation between you and the business.
Advantages of a sole trader include:
- Low startup costs
- Minimal tax obligations
- Simple setup
- No requirement for a separate bank account or complex administration, unlike the other structures, which all do.
Sole traders have one major disadvantage:
- Unlimited personal liability: You are personally responsible if the business faces debt or legal issues. It’s essential to have adequate insurance to mitigate these risks.
What is a partnership?
A partnership involves two or more individuals working together to run a business. Profits and losses are shared among the partners based on their agreed-upon ownership percentages. Partnerships are generally easy to establish and manage, with minimal administrative and tax burdens.
Advantages of a partnership include:
- Lower setup costs, only slightly higher than a sole trader but still manageable.
- Minimal tax and legal obligations
However, partnerships also have potential drawbacks:
- Lack of legal protection: There’s no separation between the partners’ personal and business assets. If the business faces financial difficulties, the partners may struggle personally.
- Potential for conflict: Disagreements among partners can lead to significant problems.
Partners must have a clear written agreement outlining their rights, responsibilities, and profit-sharing arrangements. This can help prevent misunderstandings and mitigate risks in a partnership business structure.
What is a company?
A company is a legal entity separate from its owners. Usually, the owner is a financial stakeholder who owns the company’s capital. A company structure differs because it provides an extra layer of protection against personal liability for business debts or legal issues. It also comes with increased administrative and tax burdens.
Advantages of a company include:
- Limited liability: Your personal assets are generally protected from business debts.
- Lower tax rates: Companies often enjoy lower tax rates than other business structures.
- Legal and financial protection: If the business faces legal or financial difficulties, you’re protected to some extent.
However, companies also have potential drawbacks:
- Increased costs: Operating a company typically involves higher costs than sole traders or partnerships.
- Administrative burdens: You must regularly submit paperwork to the Australian Securities and Investments Commission (ASIC).
- Complexity: Companies are generally more complex to set up and manage.
Companies are well-suited for businesses with complex operations, significant financial risks, or a need for enhanced legal protection.
What is a trust?
A trust is quite different from the other three structures, as there is no ‘one’ owner in a traditional sense. Instead, the assets of the trust are held by the trustee for the benefit of the beneficiaries. It’s a legal arrangement where the trustee has a fiduciary duty to act in the best interests of the beneficiaries, who have limited rights and control.
In this structure, a trustee is responsible for business operations, decisions, and debts or losses. Think of it like a safe deposit box. The trustee holds the key to the box, but they can’t use the contents for their own benefit. They must use the contents according to the terms of the trust agreement, which outlines the beneficiaries and how the assets should be managed.
But trusts still have drawbacks. They have high costs, significant tax obligations, and are very complex to set up. Usually, a company is a trustee, which can reduce liability.
What is a co-operative?
A co-operative is a type of business its members own, usually about five. It works to benefit its members by providing goods or services that they might need help to get. Co-operatives are different from other businesses because they share costs and operate based on principles like fairness, democracy, and helping the community.
There are two types:
- Distributing co-operatives: Can share any annual profits to members
- Non-distributing co-operatives: Can’t distribute any profits with members
Which business structure is best?
The best business structure for you depends on your goals, risk tolerance, administrative capabilities, and plans.
All structures have advantages and disadvantages. When deciding, consider factors like your industry, geographic location, and personal preferences. Consult a professional advisor for tailored advice and to ensure you choose the structure that best suits your business needs. Remember, you can change your business structure as your business grows and evolves.
Connect with a business community
Are you looking to connect with sole traders, partnerships, or small businesses? Here at Melbourne Connect Co-working, we have a flourishing community of creators and innovators starting their business journeys. If you want to be surrounded by their entrepreneurial mindsets and take advantage of flexible working options, we have a variety of ways you can.
We’ve got you covered, from easy-to-book podcast studios and communal kitchens to tech-filled meeting rooms. Learn more about our options here.