Your Business Structure

Your business structure is the next important decision you'll make once you've chosen creating a business as your first money vehicle.

Each country has its own laws concerning the various structures, and what follows applies specifically to Australia. But most countries offer similar business structures (such as companies and trusts) so this will give you a general overview of the choices.

You'll need the services of a professional accountant in any case if you decide to set up any structure other than that of a sole trader, so he or she will provide all the specific information pertaining to the laws of your own country.

The main business structures are as follows:

Sole Trader

You can set up a business in your own name, without co-owners or partners. The structure can be easily changed to a partnership or company if the situation later requires it.

Advantages:

It's a simple way to do business and there are no establishment costs.
You're in full control, dealing as an individual directly with all other parties.
You don't need to register a business name, unless using one other than your own name (John Smith & Company versus John Smith).
You're taxed as an individual, although you may have to pay provisional tax (which is your estimated annual or quarterly tax, payable in advance).
You don’t share the profits.
You aren't required to keep financial records.
You can operate with a minimum of government restrictions.
Sole traders have the best capital gains tax concessions.

Disadvantages:

You are personally liable for any damages incurred by the business and you have no asset protection.
You're limited by what you can personally contribute to the business in terms of capital, resources, skills, knowledge and borrowing capacity.
You pay tax at your personal tax rate, which can be 50% higher than the company tax rate.
There's no way to shelter income for tax purposes.
You're limited in terms of tax breaks, growth prospects, and in the ability to share the workload, risks and losses.
Customers and other businesses may not take you seriously.

Start-up Procedures:

Register a business name if you have added words to your full name.
In Australia, consider registering for GST.

Partnership

You can set up a partnership with one or more persons with a view to making a profit. Legally, a partnership agreement is valid for a minimum of one year.

A partnership is not a separate legal entity and the partners are taxed as individuals. Partnerships have their own tax file number and must lodge an annual tax return, even though they don't pay tax.

Advantages:

Like sole trading, a partnership is a simple way to do business and there are no establishment costs.
Partners share liability for damages and debts so the burden is less than a sole trader's.
Partners may have a wider range of capital, resources, skills, knowledge and borrowing capacity to contribute to the business than a sole trader.
Partnerships offer more tax breaks and growth prospects, as well as a greater ability to share the workload, risks and losses than a sole trader.
Not all partners need be active in the business.
Partnerships have no legal accounting or recording requirements.
Capital gains tax concessions are available to the individual partners.

Disadvantages:

Partners pay their portion of the partnership's tax at their personal tax rates, which may be substantially higher than the company tax rate.
There's no way to shelter income for tax purposes.
Partnerships have unlimited liability and each partner can be sued individually and jointly for the partnership liability.
Each partner has joint and individual liability for debts and losses incurred by himself OR any of the other partners.

Start-up Procedures:

Each partner should sign a full, specific and unambiguous partnership agreement, setting out terms regarding shares, assets, profits, liability, termination and disputes. If this is not done, state legislation determines the rights and duties of the partners.
Register a business name if the partnership has added words to the full names of the partners.

Private Company or Corporation

A company is a separate entity, both legally and for tax purposes, and can enter into agreements in its own name. It's composed of shareholders and officers and managed by directors who are company employees. An individual can be the sole director and the sole shareholder of a company if they so choose.

A company has specific reporting and accounting requirements set by the Tax Office, and must pay taxes on its earnings. It can own property, enter into contracts, take legal actions against others and be held legally liable for its own actions.

Advantages:

While shareholders own the company, the liability of each shareholder is limited to the amount paid to the company for the total shares purchased.
Shareholders receive profits through dividends, which include a tax credit if they are 'fully franked' (i.e., the company has paid tax on the profits).
Companies pay tax at a fixed rate (lower than the individual rate) and taxes may be minimized by legal means.
Companies can hire skilled management.
Companies offer more retirement plan opportunities for directors.

Disadvantages:

Companies are more complex and expensive to set up and terminate.
Companies are more strictly regulated and monitored by government regulatory and tax bodies.
Directors can be held personally liable for damages incurred by the company if the director has behaved irresponsibly or fraudulently.

The Role of a Company Director:

A company director must act honestly, with diligence and in the company’s best interest, without making improper use of their position, especially with regard to inside information.
A director must ensure that accounting records are kept and tax obligations are met.
A director enters into agreements on behalf of the company.
A director can be held accountable for negligence or breaking company law or the company’s constitution.
A director may be sued by shareholders or outside parties.

Set-up Procedure:

Reserve a company name with the requisite government body (ASIC in Australia).
Lodge the prescribed documents with the requisite government body, including the company’s constitution.

Trusts

A trust is not a separate entity by law, although it must lodge its own annual tax return. It is operated by a trustee, who makes decisions on behalf of the beneficiaries. Any profits made by the trust must be distributed annually to the beneficiaries, who then pay tax at their individual rates on what they receive.

There are several types of trusts:

Family or discretionary trusts
The trustee has discretion with regard to the way he or she distributes income and capital to the beneficiaries.
Unit trusts
The trustee distributes the income and capital according to the number of units each beneficiary holds in the trust.
Hybrid trusts
These are a combination of discretionary and unit trusts.
Testamentary trusts
This type of trust is created by a will and comes into effect when the person who created the trust dies.

A business can trade as a trust.

Advantages:

The business can distribute income to the beneficiary with the lowest tax threshold.
If the trustee is sued, the assets in the trust are separate and protected.
There is a higher degree of protection if the trustee is a company, with a single director.
Trusts continue for 80 years or until they are dissolved.

Disadvantages:

You must set up a company and/or trust through an accountant or lawyer, so there are costs involved. Trust deeds must be prepared by a lawyer, but an accountant can organize the process.
Trusts are more complex to operate than sole trading or partnerships.
Like a company director, trustees have obligations and responsibilities.

Combination Structures

Many people use a combination of structures to run their businesses, with an eye to protecting assets as well as minimizing taxes. Robert G. Allen, in his book Multiple Streams of Income, offers an excellent example of this in the chapter on Financial Fortress Strategies. Find an accountant or lawyer in your area who specializes in creating this kind of structure and get some professional advice on what will work best for you.