So you’ve got your great idea, you’ve done your research and you’re ready to take the next step, where do you start?
Well, in our professional opinion we suggest you give some time to consider what business structure you should implement because it will cost you time and money if you get this wrong. Not to say it can’t be changed in the future and in some cases starting simple and upgrading later may be best. But let’s explore some options – there is not a one size fits all model, there are many considerations so please talk to us before you jump in.
There are some not negotiable tasks you need to have undertaken before you decide which structure you begin with – business plan and forecast, market research to see if there is a demand for your service or product, due diligence.
The simplest structure is that of the Sole Trader, you are the only owner, you call all of the shots and generally do all of the work in the start-up phase. The upside of this structure is you have lots of flexibility when it comes to spending your hard-earned money. The start-up costs are minimal and you can use your own Tax File Number to lodge your tax returns.
The downside is you cannot share your income with any other family member, you pay all the tax on income earned and if something should go wrong, your personal assets are exposed.
Next in your choices is the Partnership, where you join forces with a family member, or someone else and run your venture together. As with the Sole Trader, this is relatively easy to set up with a few more ‘add ons’. A partnership agreement would be highly recommended outlining your roles and responsibilities, a separate Tax File Number would be required. The partnership itself does not pay tax, the profits would be shared according to the partnership agreement and this would be included in Partners individual returns. You do still need to prepare a separate partnership tax return but there’s fewer restrictions on how you withdraw funds.
Like the Sole Trader, you cannot share any income outside of the partnership, and each partner should be responsible for their own superannuation Set up costs would be higher than that of a sole trader but you could do much of them yourself.
Now let’s look at a Company Structure and why you would want to consider this option from the beginning. This structure would be seen as over the top for some startups but in some cases getting a structure suitable for the long term is better from day 1. This option should be given serious consideration if you have personal assets such as a family home, investments etc. A company, in the eyes of the law, is seen as a separate entity and can be sued (worst case scenario). By operating in a company as a separate legal entity the exposure of any assets in your own name are limited.
The company does require more funds to start up – and it comes with lots of roles and responsibilities (check out our blog on Directors responsibilities for guidance there) . The benefits are a lower tax rate, asset protection to a certain degree and it has the same rights as a ‘natural’ person.
The downside of operating a company is the initial cost to set up plus the annual compliance costs are more expensive but the biggest issue, in my opinion, is getting money out of your business. It is not as simple as going to the ATM to withdraw money – every withdrawal comes with a tax and super implication. There needs to be more structure in place to manage any income and expenses earned. You will need to pay ASIC every year and Directors responsibilities are taken very seriously.
The last structure to be considered would be a trust. There are three types of trusts, we’ll discuss the most common form, the Discretionary trust or Family trust but be aware there are also unit trusts and hybrid trusts. Every trust requires a Trustee to make all of the decisions on behalf of the beneficiaries (generally family members).
The pros of this choice are the ability to share income for tax effectiveness and asset protection. The downside is that it is the most expensive to set up and annual costs can be higher especially if you choose to have a company in place to act as Trustee (the Director of this company would make the decisions on behalf of the Trust). Like the company set up, this is a good choice if you have lots of personal assets to start with.
As you can see from the above, there are lots of choices available and it really depends on your personal situation.
Okay, so let’s ponder this scenario: You start your business as a sole trader. Your business takes off and before you know it, you’ve got a very successful venture growing. Your profit exceeds $100,000 one year meaning your marginal tax rate being paid is now above 39% for every dollar earned above $90,000. It is no longer tax-effective compared with the tax payable if you operate from a company therefore its time to upgrade. You’ve got the money to make the change but here is the clincher – you have to start all over again. Everything needs to change, and I mean everything. You could even have to pay stamp duty to the government on any goodwill established in the formative years. It is a process, new bank accounts, systems, contracts, leases, new employment contracts and super accounts to set up- this is a timely and costly exercise. Had you started out with a company from day 1 you could have saved yourself all this time and cost to change.
I hope the above has helped give you some insight into selecting a business structure however I would also like to suggest you talk to us before you make a decision. Together we can guide you on the best way forward.