When starting a business, there are a number of important decisions to be made. One of the very first things to consider is how to structure your business. How you decide to model your business will determine much of how the business will grow and how you will maintain it moving forward. Finding the right structure is imperative to the success of the business and there are risks and benefits to each different type of structure. All small businesses face unique challenges and specifically tailored legal advice is the best way to ensure you choose the best path.
Key Questions in Deciding on Business Structure
When determining how you want to structure your business, you should carefully consider which will best reflect your future goals and have the most long term benefits. Each structure has different costs, both upfront and ongoing, which will affect how beneficial the structure will be for your particular situation.
Some of the most important things to consider when selecting a business structure are:
- What type of business you are going to run
- The risk profile of your business
- Potential growth; is the structure realistic for the type, size, and growth of business?
- Involvement of others
- How you want to make decisions going forward
- Cost of startup/registration and maintenance
- Difficulty of set up; what documents will you need?
- Liability; different structures help with asset protection and personal liability
- Profit scheme
- Malleability of business structure and ease of potential dissolution
- Tax advantages/disadvantages
Four Common Business Structures
Sole Trader/Sole Proprietorship: Most of Australian small businesses use this structure. This is the simplest business structure available, is easy to set up, and reasonably cost effective. A sole trader manages and operates their business under their own name and is legally responsible for every aspect of the business (unlimited liability), though they can still hire others to work for them. This type of business structure might be best for contractors, traders, entertainers, home businesses, and small businesses.
The advantages to this business structure are the relatively low costs, ease of structure change, and fewer regulations. The disadvantage are the ‘unlimited liability’ involved and more limited growth potential.
Partnership: A partnership involves an association of two or more people who are both jointly and severally legally responsible for all aspects of the business. Partnerships are relatively easy to set up and are cost effective. However, it is extremely important to carefully choose your partner as you will equally share liability for their actions. In this structure, a partnership agreement will be in place to outline how the partnership will operate.
The advantaged to this business structure are the ease and low cost of set-up and dissolution. The disadvantages include the higher level of liability involved and the shared decision making.
Company Structure: A company is a separate legal entity, and is the best type of structure for a growing business. Because a company is its own legal entity, individual shareholders are not liable for all debts and liabilities incurred by the company, but only up to the amount unpaid on their shares (usually zero). Similarly, the directions of the company are protected from debts and liability of the company with some exceptions. This feature makes a company structure suitable for high-risk businesses and start-ups.
The advantages of this business structure include the limited liability, the tax benefits, and potential for growth. The disadvantages include the high cost of starting and maintaining a company and lack of control in decision-making.
Trust: A trust is simply an entity that holds property/income for the benefit of others. In a business structured with a trust, there will be an individual or corporate trustee who controls the trust and distributes assets to the trusts beneficiaries. An individual trustee is personally liable for the trusts debts, but corporate trustees are normally protected by limited liability.
The advantages to this business structure are the limited liability and the ease of raising capital. The disadvantages however, are the expense and difficulty of set up and dissolution and lack of decision-making control.
Each business structure is affected by taxes differently, an important factor to consider when first setting your business up. Partnerships, companies, and trusts receive tax benefits whereas the sole trader structure does not. However, the profits earned by a sole trader are considered personal income for tax purposes while the profits earned by companies are taxed and need to maintain meticulous records.
The best way to ensure the success of your business is to seek legal advice from a professional trained in such issues. Together, you and your attorney can formulate the best plan to set your business up for success.