Getting into business? Understand your structure

What we mean by structure

The structure is the vessel through which the business operates. Choosing it means deciding what that vessel exposes you to, how money reaches you, and how easily you can bring someone in or get yourself out.

It is worth a few minutes of your own attention because the consequences land on you personally, not on your adviser.

Sole trader

The simplest structure available. Being a sole trader means you are in business as yourself.

If John Smith decides to offer handyman services in his neighbourhood, he starts doing it as John Smith. He will need an Australian Business Number and will need to consider whether he must register for GST, but he can be operating in days.

The advantages are speed and simplicity. John is himself, he earns money, and he pays tax on it as personal income.

The disadvantage is substantial and it is the reason most people move on from this structure. If John repairs a set of stairs and someone later falls through them and sues, John is personally liable for the whole claim. If John owns a house, the house is exposed.

Partnership

Take a sole trader and add others and you generally have a partnership. In simple terms, a partnership is two or more people carrying on a business in common with a view to profit. In Queensland it is governed by the Partnership Act 1891 (Qld).

Law firms were traditionally required to use this model, which is why old television dramas feature firm names with four surnames in them.

The liability position is the same as a sole trader, with an additional feature that surprises people. Each partner is liable for all of the debts of the partnership, not a proportionate share. If your partner has no money, you do not have a 50 per cent liability to creditors. You have the whole of it.

The second risk is that you are bound by what your partners do. If Sue and John are partners and John commits the partnership to a poor deal, Sue is generally bound by it and, as above, fully liable for it. Choose partners accordingly.

Tax treatment is more involved than for a sole trader, so have a direct conversation with your accountant before you start.

Document it while everyone is getting along

Setting up a partnership can in theory be nearly as quick as being a sole trader. In practice you want a written partnership agreement, and the best time to negotiate one is while the relationship is good. Deal with at least:

• Who makes which decisions, and how decisions are made.
• How new partners are admitted, and by what process.
• What happens when one partner wants out and the other does not. Can one force the other to buy them out?
• How the partnership is valued.
• How disagreements are resolved.
• What happens if a partner brings the business into disrepute.

Our page on partnership agreements covers what a workable agreement contains.

A proprietary company

A company is among the most common structures, for one main reason. It provides a degree of protection against you being sued personally.

A company is a separate legal person. It is the company that carries on the business, so it is the company that gets sued when something goes wrong. That protection is not absolute, and it has been narrowing. Directors can be personally liable in a growing range of circumstances, including for unpaid superannuation and PAYG withholding, and for insolvent trading.

A company acts through its officers, which will probably be you as director. Its profits are either paid to shareholders, probably also you, or reinvested. That gives you flexibility about how and when you are paid, which can be used to advantage.

On the other side, being a director carries duties under the Corporations Act 2001 (Cth), including the duty to act with care and diligence, in good faith, and not to misuse your position or company information. There are annual compliance costs, ASIC obligations and a director identification number requirement.

If you are going into business with others, document the same issues as for a partnership, twice over. You need to deal with the directors and how the business operates, and separately with the shareholders, covering who comes in, who goes out, how shares are valued and who votes on what. See shareholders agreements.

Adding a trust

Trusts are harder to explain and this is a high level summary. Get specific accounting and legal advice before using one.

Unlike a company, a trust is not a person. It is best thought of as a relationship rather than a thing.

A trust exists where legal and beneficial ownership of property are split. The person who owns the property in name is the trustee, which can be an individual or a company. The people who get the benefit are the beneficiaries, who can also be individuals or companies.

A trust is usually used to direct money to where you want it to go in a tax effective way. It offers little benefit in terms of operational risk, and it often makes day to day administration harder.

A worked example

Sue and John go into business and incorporate SueJohn Pty Ltd. They are the directors. The shareholders are:

• Sue Pty Ltd as trustee for the Sue Family Trust; and
• John Pty Ltd as trustee for the John Family Trust.

Why? If SueJohn is profitable, it can pay dividends to its shareholders. Sue’s corporate trustee receives her share as shareholder, and the trust can then distribute to its beneficiaries, which might include Sue, her partner, adult children and charities she supports. The money ends up broadly where Sue wanted it, distributed across more than one taxpayer.

The cost is complexity. That example contains three companies and two trusts. Keeping track of which entity did what becomes genuinely difficult, and you will pay your accountant for multiple sets of books and multiple tax returns every year, permanently.

The questions to ask your advisers

When you are setting up, put these to your accountant and your lawyer together:

1. Am I personally at risk in this structure? If so, how, and what would trigger it?
2. How do I get paid? Is tax minimised this way? Can I distribute income to others if I want to?
3. How much more am I paying each year in accounting and ASIC compliance under this structure than under the alternative?
4. How easy is it to bring in an investor or a new partner, and what are the tax consequences of doing so?
5. If I exit the business later, can I do it tax effectively? Will buyers want a business in this form?
6. Are my insurance costs different under this structure? That one is often a question for your broker.
7. If I want to change structure later, for example from sole trader to company, how would that work and what would it cost?

A stitch in time

Getting the structure right at the start is worth the time it takes.

Your accountant may well have a preferred model they use often, and it may be exactly right for what you are doing. Asking the questions above tells you whether it is right for you specifically, or right in general.

This is one of the few areas where input from an accountant and a lawyer at the same time is genuinely more useful than either alone. Our page on setting up a business covers the legal side of the setup.