Choosing a business structure is one of the most significant decisions that a business owner will make. Your business structure will go on to define your business activity in a number of important ways, including your legal liability and the way that you’re taxed. 

In this guide, I’ll break down the 4 most common structures you can choose from and compare some pros and cons.

First – what is a business structure?

A business structure defines the way your business is run and operated. It’s the framework you establish your business against, and it will guide the way your business grows going forward. You can change your structure later, but it’s not always simple.

Plenty of important things will depend on the business structure that you choose. This includes the way you are taxed, your legal responsibilities, the way you can distribute your income and the rules & regulations your business needs to comply with. It’s a big decision. 

The four main types of business structures.

There are four common types of business structures to choose from – Sole Traders, Partnerships, Companies and Trusts. Each has its pros and cons, and different structures will suit different kinds of businesses and different stages of business growth. Let’s get into these structures in more detail:

1. Sole Traders are the sole proprietors of their business. As an individual, they’re legally liable for every aspect of their business, and they’re taxed as an individual as well.
   
   This is an easy and low-cost structure, but it’s also risky and it makes growth difficult. It’s best used to get rolling quickly when you have a good idea.
   
2. Partnerships are similar to sole trading in that they are low-cost to set up and run, but legally risky and not ideal for growth. In a partnership, you and 1 or more partners are jointly responsible for your business and your (unlimited) legal liabilities.
   
   You share business debts and distribute business income between yourselves, and you’re taxed as individuals on your distributed profits. It’s good for pooling resources.
   
3. Companies are their own separate legal entities. If the company incurs a debt, you as an individual are not liable. The company’s profits are taxed at the fixed corporate rate, and companies are not necessarily owned by the person who runs them.
   
   All of this makes companies the ideal structure for medium and larger businesses. Companies have more regulatory and compliance requirements but are great for long-term growth.
   
4. A Trust is a separate legal entity you can run your business through. A trust is controlled by an individual or corporate trustee, who has legal liability for the business
   
   The trustee distributes profits to the beneficiaries of the trust according to the terms of the trust deed. This structure is great for distributing the profits from your business in a flexible way, but it can potentially become confusing or unwieldy in a trading business.

1. More about Sole Traders

This is the simplest and most popular type of business structure in Australia. Most small businesses operate as Sole Traders. All you need to get started is an ABN, which is free, and your reporting and admin requirements are typically minimal.

A Sole Trader manages and operates their business as an individual. There is no distinction between you and your business as a legal entity, and you’re legally liable for every aspect of your business. There’s also no division between your business assets and your personal assets, and you’re taxed on your income as an individual. 

The Ups and Downs of Sole Trading

Sole Trading has a few key advantages but some big catches too. Here are the biggest advantages of Sole Trading:

• It’s super cheap & easy to set up and run your business as a sole trader. There’s a lack of confusing regulations or corporate fees, meaning you can get started quickly

• Being taxed as an individual is also less confusing for those who aren’t that financially literate. You just fill out the business schedule on your personal tax return.
  
• Plus, on the lower income brackets, you’ll generally pay less tax at the individual rate than if you were being taxed as a company
  
• As an individual, you can take total control and cut down on bureaucracy.
  

These are all great reasons to start sole trading. However, this structure also comes with some heavy risks attached. Here are the key disadvantages of a sole trader structure:

• Your legal liability as an individual means if you get sued, your personal assets (like your house and car) are at risk and you potentially could lose everything.  It’s a good idea to get professional insurance to mitigate at least some of this risk. 

• The other downside of sole trading is that, past a certain point, it’s not tax-effective for growth. As your individual income from the business grows, you will start being taxed at a higher tax rate than the fixed corporate rate paid by trusts or companies.
  
• Finally, managing everything about your business will also become more complex as it grows, increasing your exposure to serious financial risks. 

Can Sole Traders employ staff?

Yes, which may surprise you given sole trading’s association with freelancers and contractors. Sole traders can still employ staff to help run their business. You can’t employ yourself, however – you’re the business owner, and your profits aren’t a wage.

Many brick-and-mortar businesses like cafes or retail stores will get started quickly using sole trader structures, then steadily take on more employees as they grow.  However, we wouldn’t really recommend sticking with this strategy forever.  Businesses with an eye on growth should take advice on incorporating as a company when the time is right – usually around 6-12 months.

Overall, I think Sole Trading is great for getting started quickly, but it can become a big obstacle later on. Want to read more about transitioning out of this structure? Check out my guide to the Sole Trader Blues here.

2. More about Partnerships

Partnerships are similar to Sole Trader structures in that they’re simple, low cost and easy to set up. The big difference is that under a partnership, you and at least one other person share responsibility for the business. 

Your business is still not a separate legal entity from yourselves, and you still have unlimited legal liability as individuals. Generally, these structures are great for when two people come together with a good idea and the shared skills & resources to make it happen. 

How do taxes and profits work in a partnership? 

Whilst partnerships must file annual tax returns, it is not taxed as a separate business entity. Instead, each partner pays tax on their share of the net income of the partnership. This means that you must file both an individual and a partnership tax return.

This can create an advantageous situation if the business makes a loss. Losses in a partnership are distributed annually amongst the partners, just like the profits. This means that partners can deduct losses from the business partnership on their individual tax returns.

The Ins and Outs of Partnerships

The benefits of this structure are generally very similar to sole trading. Here are the advantages of partnerships:

• Cheap and easy to set up, with low maintenance costs and a relaxed regulatory environment.
  
• Excellent for pooling your skills and resources with somebody else to get your business idea off the ground quickly.

Most of the issues with partnerships stem from the fact that you’re sharing responsibility and control with someone else. Here are the disadvantages of partnerships:

• Just in case unlimited legal liability wasn’t enough to keep you up at night, someone who is in a partnership is also legally liable for the actions of their business partner.
  
• A personal fallout between partners can cause big trouble and quickly create a legal or financial headache. Always make sure to get an ironclad agreement in writing at the beginning of a partnership!
  
•  We’ve found that these risks are generally magnified if one partner has more assets than the other. The person with more invested is always carrying more risk.

Partnerships are great for pooling your resources and getting started without much of a cost, but you need to take the risks seriously. Check out my deep dive look at partnerships if you want to know more!

The three types of Partnerships

There are three types of partnerships out there, so it helps to know the difference between them. These are suited to different situations, and choosing the right one can help mitigate potential conflict. Here are the three types of partnerships in Australia:

• General Partnerships are the most common. Management responsibilities, liability, and profits are divided among all partners as per their established agreement.
  
• In a Limited Partnership, each partner’s input and liability are based on the percentage of their investment in the business. It’s best suited to short-term agreements.
  
• A Joint Venture is essentially a short-term general partnership, with an agreed start and end date.

3. More about Companies

Incorporating as a company establishes your business as its own separate legal entity. This limits your personal legal liability to the value of your shares. Your business may take on debt, but your personal assets are generally protected.

A company is owned by the shareholders, who appoint a director to manage operations. You can choose to be the sole shareholder, or more commonly, your company will have multiple shareholders. You can also appoint yourself as a company director if you wish, though it’s not always recommended.

The Advantages of a Company

Companies are a more complex structure than partnerships or sole traders. This means there’s more to consider when you’re weighing up the pros and cons. Here are the key advantages of incorporating as a company:

• Companies are very tax-effective. In Australia, businesses earning under $50 million a year enjoy a discounted tax rate of 25%, with larger companies paying 30% (2021-22 rates). Compared to the highest individual tax rate of 45%, it’s clear why companies are a more tax effective structure for higher-earning businesses
  
• Company structures are great for retention of capital. Investors and institutional lenders generally prefer dealing with companies because of the stricter regulatory environment. This makes it an ideal business structure if you plan to raise money through external investment or debt financing.
  
• Another benefit of companies is that you can retain and reinvest your profits directly back into the business, thus reducing your overall taxable amount at the end of the year. You can also carry any losses forward and offset them against your business profits the following year. 

The Disadvantages of a Company

For all of the above reasons, a company is a great structure for most businesses that have gotten off the ground successfully and are starting to mature. However, there are some cons to this structure too. Here are the disadvantages of a Company:

• Companies have a much stricter regulatory environment. Registering and incorporating is just the tip of the iceberg; companies will have a lot of ongoing compliance and reporting work to do, all governed by ASIC (The Australian Securities and Investments Commission).
  
• All of this makes companies expensive to set up, and it may prove too complex to manage on your own. It’s generally a good idea to enlist the help of a business advisor when you’re setting up and maintaining this structure.
  
• Companies do not allow you to flexibly distribute profits outside of your organisation. If you’re keen to share your business success with your family or with others, you may do better with a trust instead. Check out my in-depth article on choosing between companies and trusts here. 

4. More about Trusts

Trusts are another business structure that’s popular with complex businesses and complex families – most of the farms in Australia are owned by trusts.

 Family groups and family-owned SMEs use trusts because they allow you to distribute business income to family members while still protecting your assets from legal liability. They’re fantastic for passing on wealth from generation to generation.

Trusts have been around a long time, so they can be a bit complicated to wrap your head around. Essentially, a trust is controlled by an appointed trustee who has legal liability for your business. The trustee distributes profits to the beneficiaries of the trust according to the terms of the trust deed. We recommend always using a corporate trustee instead of an individual.

All income must be distributed out of a trust, and the recipients pay tax on the income at an individual rate. This obviously has some big pros and cons – let’s get into them now.

Advantages and Disadvantages of a Trust.

Here are the biggest advantages of using a trust:

• The biggest advantage of this structure is that it makes sharing your profits and assets easy, especially with your family. With a legal lifespan of 80 years, trusts are designed with intergenerational wealth transfer in mind.
  
• Trusts are good for effectively distributing gains, like the windfall from selling a large property. If you’re currently at the stage where you’re mostly focused on investing and growing your existing wealth, this is a good time to consider a trust structure
  
• The way profits are distributed allows you to really micromanage minimising your tax. By effectively distributing income to those in lower tax brackets, like your young adult children, businesses can often end up paying less tax than they would on the fixed corporate rate.
  
• Trusts are great for protecting your assets. Holding significant assets like your house in a trust adds a layer of added protection from personal legal liability.

As you can see, there are a lot of great advantages to choosing a trust structure, especially around flexibly distributing your gains. However, it’s certainly not suited to every business model. Here are the disadvantages of a trust structure:

• You shouldn’t run a trading business out of a trust, or a business that’s still rapidly growing. Having to distribute all business income out of the business makes reinvesting profits difficult, and potential tax-effectiveness can be easily cancelled out by added administrative costs. Any income that’s not distributed will be taxed at 49%.
  
• Compliance with trust regulations can be a bit of a burden, especially if your business is a bit more complex. Just like with a company structure, we always recommend getting professional financial advice on setting up and maintaining your trust
  
• The trustee has full legal liability for the assets held in your trust, so you must choose wisely. If you can’t find a corporate trustee that you can depend on, or you’re considering an individual trustee, you might not be in the best position to set up a trust.
  
• Family trusts are also called ‘discretionary trusts’  because the amounts distributed can be changed at the trustee’s discretion. Sudden or unexpected changes to distributed amounts can potentially exacerbate any existing family tensions.

Trusts are one of the most advantageous business structures out there when they’re used in the right circumstances. To find out more, check out my article about how a family trust can complement your business structure. 

Family Trusts vs. Unit Trusts

One last thing you should understand about this particular business structure is that there are two different kinds of trusts out there – Family Trusts and Unit Trusts. Here’s the key difference:

• A Family Trust, often called a Discretionary Trust, gives the trustee discretion over how much capital is distributed to each beneficiary. The trustee can pay one beneficiary 70%, one 20%, and one 10%. Depending on the trustee’s discretion, this could change each time there’s a distribution.
  
• A Unit Trust divides the trust’s capital into fixed parts, called units. Capital is distributed to the beneficiaries in proportion to the units that they hold, similar to how shares function for shareholders. If you have 30% of the units, you’ll receive 30% of the profits. These proportions generally remain fixed throughout each distribution.

Most trusts in Australia are family trusts. Generally, a unit trust will be used for a joint venture between two business structures. For instance, two different family trusts may come together to buy a factory, and they will own that factory through a unit trust. 

Comparing the 4 Business Structures

If you’ve made it this far, you’ve now got a pretty good understanding of the 4 business structures available for you to choose from. 

It’s certainly a lot of info to take in, so we’ve put together a quick chart you can look at to quickly compare the pros and cons of these different structures:

Business Structure	Sole Trader	Partnership	Company	Trust
Cheap to set up and run	Yes	Yes	No	No
Easy to set up	Yes	Yes	Yes	Yes
Ongoing compliance costs	Low	Low	High	High
Tax effective in the long term	No	No	Yes	Yes
Unlimited legal liability	Yes	Yes	No	No
Good for raising capital	No	No	Yes	No
Distribute Gains Flexibly	Yes	Yes	No	Yes
Good for Growth	No	No	Yes	Yes
Easy to Pass On or Sell	No	No	Yes	Yes

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This has been our comprehensive guide on Business Structures. Hopefully, you’re now armed with a much better understanding of sole traders, partnerships, companies and trusts. It will help you make the right choice when you’re choosing a structure for your business.

However, it’s definitely a lot to take in. The good news is that you don’t have to work it out all on your own – a quick 5-minute call with one of our talented business advisors will have you sorted out in no time.  Get in touch today!

The information in this article is of a general nature. It does not take your specific needs or circumstances into consideration. You should look at your own financial position, objectives and requirements and seek financial advice before making any financial decisions.