How to choose the right business structure
When starting a new business, it’s tempting to dive into things so you can start making money as soon as possible. But don’t get ahead of yourself: there are still a lot of tasks to take care of.
You need to know how to choose a business structure that'll be best for your future company. Let’s take a look at what this entails.
Why is it important to choose the right business structure?
Choosing a business structure isn't just a formality and it’s not something to be taken lightly. The business structure you choose will have an impact on your:
Personal liabilities and protections
Applicable tax laws
Administrative and legal requirements
There’s also the matter of complexity and your ability to manage your company. Each business structure offers a different balance of the above factors.
Some business structures are more complex, but offer more legal protections and tax-related benefits. Others are simpler to manage, but offer limited protection to owners.
Some are more flexible and made for change, while others are designed for longevity. And, while most business structures are conducive to continuous growth, others are meant for more temporary or small-scale ventures.
Choosing the right business structure is crucial because it'll allow you to accomplish your business goals in the most productive way, and with minimal risk.
Types of business structures
There are many different types of business structures in Australia to choose from. Let’s take a look at the key aspects of each.
A sole tradership is owned and controlled by a single individual.
From an administrative perspective, sole traderships are the easiest type of business to form and manage. With minimal fees and reporting requirements, owners can focus on actually running their business.
Sole traders are personally liable for all financial aspects of their business, including:
In cases where the sole trader is unable to pay the company’s debts, their personal property and assets may be in legal jeopardy. The owner may also be held legally responsible in cases where the law was broken during business operations.
A sole tradership is a good option for fledgling entrepreneurs with a solid business plan. But the personal responsibilities and liabilities involved can eventually hold your business back.
A company is a legal business entity separate from any of its owners or directors.
A company owner is an individual who owns shares of the company, while a director controls certain aspects of the business operations. The income generated by the business belongs to the business, with shareholders determining how to reinvest or distribute profits.
Along with the complexities of ownership and management, parties must also adhere to additional laws and regulations. For example, owners must comply with the Corporations Act of 2001, while directors must maintain a director identification number at all times.
Companies must keep accurate and up-to-date financial records and must notify the Australian Securities and Investments Commission when making changes to their business operations.
While Australia’s full company tax rate is 30%, companies may be required to pay additional taxes, such as goods and service tax, pay as you go withholding and payroll tax. Business income doesn't, however, factor into personal tax records.
Owners and shareholders also have no legal liability for the company’s debts, losses or legal troubles. Should a company go bankrupt or be sued, its owner’s personal assets and property would be protected.
(That said, directors can be held personally liable for losses sustained by the company due to negligence on their part.)
Sole traders often convert their business into companies to limit their personal liabilities, as well as to employ staff and expand their operations.
Read this next: Sole traders vs companies: What are the key differences?
Business partnerships are formed when two or more individuals enter into an agreement to split ownership of an organisation.
In a partnership, profits and losses are split between all owners according to their contractual agreement. Each partner pays taxes based on the share of income they receive from the partnership. The company will pay taxes on business income generated.
Partnership contracts dictate the type of partnership formed:
General partnership (GP): Each partner is equally responsible for business operations and assumes unlimited liability as an owner.
Limited partnership (LP): Limited partnerships involve passive investors and/or silent partners whose liability is limited to the amount they’ve invested in the business.
Incorporated limited partnership (ILP): In an ILP, at least one partner must assume unlimited liability for business operations. All other partners — silent or active — may assume limited liability.
A trust is a limited liability business structure in which a trustee — either an individual or a company — operates a business on behalf of a beneficiary.
The goal of forming a trust is to generate income for the beneficiary. Trusts, then, are typically formed as investments by a separate entity, either for themselves or another party.
Depending on the agreement, trustees may have some control over the company’s financial decisions, such as the distribution of business profits. However, trustees must always operate within the terms of the agreement and must always act in the interest of protecting the beneficiary’s assets.
(Note that these contractual agreements aren't easily changed after the fact. As these contracts are typically complex, the Australian government suggests you consult with an accountant or attorney when forming a trust.)
As well as strict contractual guidelines, trusts must comply with specific regulations and will need to complete additional paperwork to maintain compliance.
While forming a trust may become a possibility as you grow your business, chances are this won’t be your first option for getting started.
A co-operative, or co-op, is a member-owned, limited-liability company consisting of five or more members and at least three directors.
Co-ops are usually formed to achieve a common goal. Typically, co-ops focus not just on achieving business success, but also on serving their community in some way.
Co-ops operate democratically, allowing all members to have an equal say in business decisions. This structure gives individual members a sense of autonomy, while also keeping them focused on the organisation’s goals.
When registering as a co-op, there are two types to choose from:
Distributing co-operatives / for-profit co-ops can distribute some or all profits to share-holding members. Share capital must be used to fund distributing co-operatives, with optional member subscription fees applicable.
Non-distributing co-operatives / not-for-profit co-ops must reinvest all profits back into the business. Funding sources for nonprofits include member subscriptions, grant funding, and — to a restricted degree — share capital.
Joint ventures are created when two or more parties — individuals, organisations, or a combination of both — agree to pool resources for a specific project or initiative.
Joint ventures are designed to be temporary. Unlike other business entities, joint ventures are intended to dissolve after the stated goal has been achieved.
A joint venture operates as a separate entity from all parties’ other business ventures. While joint ventures can be incorporated to limit liability, there’s no legal mandate to do so. Typically, a joint venture agreement will contain the following information and stipulations:
Structure and rules of governance
Obligations of each party
Division of profit and loss
Intellectual property ownership
Processes for resolving disputes
Terms for nullifying the agreement
Indigenous business owners can incorporate their business via the Office of Registrar of Indigenous Corporations.
Indigenous corporations are nearly identical to incorporated companies but come with a few additional perks. For one, Indigenous companies may be exempt from registration fees and certain administrative tasks. Moreover, Indigenous owners are provided resources to help navigate the incorporation process (and to help keep business moving in the right direction).
Changing your business structure
Over time, you may need to change the structure of your business. Typically, this involves sole traderships becoming partnerships, or sole traderships/partnerships becoming full-fledged companies.
There are many reasons to change your business structure, including:
The need to bring on a business partner
Internal restructuring to improve human capital management
To expand business operations
To limit liability and separate your personal and business assets
To achieve more affordable tax rates
Changing your business structure can also improve your reputation within your industry, which can potentially lead to investment opportunities and other possibilities for your company.
Sole trader to company
The process of changing from sole tradership to a company involves three key steps:
1. Company registration: Register your company name and apply for an Australian Business Number and Australian Company Number. If bringing on a partner, you’ll also need to create a partnership agreement.
2. Transfer assets: Any licences, trademarks, or intellectual property owned by your sole tradership must be transferred to your new company.
3. Cancel former accounts and IDs: Typically, your sole trader ABN will need to be cancelled before you begin doing business under your new company name.
Partnership to company
A company cannot be formed directly from a partnership. Instead, the partnership must first be legally dissolved. All stakeholders would then form a separate company following the steps listed above.
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