Disclosure: This article is not intended to replace in any way professional accounting advice
When it comes to moving beyond ideas phase to actually ‘starting’ your startup, one of the first decisions you need to make is what structure your business will be. There are different tax and legal implications which flow from the structure you choose, so it’s really important to take the time to work out the structure which is right for you.
There are four main structures which you can choose from; Sole Trader, Partnership, Company and Trust.
A sole trader means just that – it’s all about you when it comes to business ownership and control. There is no separation of your own personal assets from the business assets, and no separation of business income from personal income from a tax perspective. Unlike a company, when working in your sole trader business, you are not considered an employee and therefore the 9.25% compulsory superannuation obligations do not apply.
One of the key advantages of a sole trader is that it is relatively easy and cheap to set up. Apart from registering the business name with ASIC, there are no regulatory-body set-up fees for a sole trader business (unlike a company where you are required to pay establishment fees or a Trust which you need to pay stamp duty in most states). It also has minimal reporting requirements.
Its main disadvantage is unlimited liability. What this means is that as there is no separation of your personal assets from your business assets – if your business fails and you canât pay creditors, then your own personal assets (such as your home, car etc) could be at risk. Also, for startups looking to bring on investors it is very difficult to raise additional capital as a sole trader.
A common misconception is that a partnership must have 2 partners. A partnership can have anywhere from 2 to 20 partners. Whilst a partnership is a separate legal entity for tax purposes, together the partners share all the business assets and liabilities. A partnership completes it’s own tax return, however tax is paid in the partner’s personal tax return from their share of partnership profits.
Given a partnership has more than one owner, an obvious advantage is that there is more access to capital and skill-sets given more owners. Also, just like a sole trader, it is relatively easy and cheap to set up.
Generally when there is a change in partners, there is no continuity of the business which presents a key disadvantage. Also, each partner is jointly responsible for the debts of the partnership. This means that you will be responsible for debts one of your partners incurs in the partnership, even if you did not cause it. A word of warning here – make sure everything is documented up front. The best of friendships can be tested when in business together, so make sure you and your partners are clear on each others roles and responsibilities.
With a company, compliance starts to get a bit trickier and more expensive. Owners of a company are called its shareholders, and ‘directors’ are those responsible for the decision making and management of the company. You can be the sole-director and sole-shareholder of your startup – there are no regulations preventing this.
An advantage of a company is that it is often easier to access capital than other structures. Ownership of the company can be transferred through the sale of shares, which also makes it a much easier structure to bring investors on board with. Also, there is limited liability (unlike a sole trader or partnership), which means that a company is treated as a separate legal entity to you.
With a company structure comes additional reporting requirements which are more complex and costly. A company must be registered with ASIC, and pay fees to ASIC for incorporation as well as an ongoing Annual ASIC Review Fee . Also, the costs of tax compliance for companies is generally higher and the costs to wind up a company can be quite expensive. Some advice when setting up a company is always to have a shareholders agreement in place.
A trust is quite complex in detail, especially compared to the other structures. I recommend that if considering a trust structure, you chat with your accountant or lawyer first.
In summary, with a trust there are two key ongoing relationships; the trustee and the beneficiaries. The trustee operates the trust (similar to the role of a director in a company) for the benefit of its beneficiaries (similar to the role of a shareholder in a company).
The advantages of a trust are twofold – asset protection and from a tax perspective, there can be flexibility in the distribution of income to beneficiaries. The disadvantages, however is that there are lots of regulations and responsibilities the trustee needs to be on top of and it is expensive to set-up and maintain.
Whilst long, this article only briefly touches on some of the issues surrounding the different structures. It’s important to discuss your structure with an expert. If you make the wrong call for your business situation, it could cost you so much more later on…
Note: This article is covered in more detail in our Nudge Startups Tools of the Trade: Guide to Finance Basics available for download through Shoe String via this link
Emma Petroulas is Client Happiness Director at Nudge Accounting. She also lectures in Small Business at the University of Technology, Sydney (UTS).