Types of business structures: how to choose the right one for your business

What is a business structure?

By ‘business structure’, we’re talking about the legal structure of a business. The main types of business structures are sole trader, partnership, and company.

Choosing a business structure for your small business affects your admin burden, your business’s taxation, legal status, daily operations, and your personal liability.

Types of business structures

Here's a comparison of the different types of business ownership.

What is a sole trader?

A sole trader is a single-owner business. It doesn’t have to be a single-worker business, though, so you can hire staff.

Advantages of being a sole trader

It’s easy to set up as a sole trader and your tax obligations are simple – you just declare income on your personal tax return.

Disadvantages of being a sole trader

A sole trader doesn’t have any special legal status, so the owner is personally responsible for what the business does. If the business gets into debt or legal trouble, so does the owner, so you need insurance.

What is a partnership?

If you and at least one other person share ownership of your business, you’re in a partnership. There are no rules about how ownership is divided – one partner can own 99% of the business.

Advantages of a partnership

It’s easy to set up as a partnership, although you should have an official letter that sets out the agreement between partners. Your tax obligations are simple, too: you just declare your share of business income on your personal tax return or complete a partnership tax return form available from the Australian Taxation Office (ATO).

Disadvantages of a partnership

If the business gets into financial or legal strife, the partners do too. You could also get into difficulty if one of the other partners does something wrong.

What is a company?

A company is legally separate from its owner (or owners), so you’re less exposed to legal or financial issues. A company can be owned by one person or many.

Advantages of a company

You get some legal and financial protection if things go wrong – your accountant or lawyer can give you the lowdown. Companies also generally pay a lower tax rate.

Disadvantages of a company

It'll cost you more to operate as a company than as a sole trader or partnership, and there’s also more admin – for example, you’ll have to regularly submit paperwork to the Australian Securities and Investments Commission (ASIC). You'll also have to understand how the complexities of the company structure (such as ownership) affect how you make business decisions.

What is a trust?

Under this structure, a trustee manages the business for the sake of its beneficiaries, including by looking after the business’s income and losses.

Advantages of a trust

Trusts can be useful for estate and tax planning. They can be used to pass assets on to future generations and can be subject to a capital gains tax discount.

Disadvantages of a trust

They can be complicated and expensive to get up and running, then difficult to change once running – therefore not a very flexible business structure. It’s a good idea to get expert legal and accounting advice related to your circumstances before setting up a trust.

The risks of not choosing a business structure

If you don’t formally choose a structure for your business, you may face:

1. Unlimited personal liability: Your personal assets – such as your home or savings – could be seized to satisfy business debts or legal judgements. Here’s more about personal liability.
2. Tax implications: Your personal income and business income will be treated as the same, so you might pay more tax than you need to.
3. Difficulty raising capital: Potential investors and bank lenders might be discouraged if you don’t have a formal business structure.
4. Limited growth potential: Have visions of expanding? To make significantly higher sales? Your scope may be limited without the right business structure.

What happens if you don’t choose: default business structures

If you don’t choose a structure, your business will be considered a sole trader. This comes with unlimited personal liability for any business debts or obligations.

Choose the right business structure for your small business

Here are the things to think about when choosing between the various business entity types.

Understand your liability risks

Think about what it means to be responsible for your business’s debt. You need to balance the risk of personal responsibility with other factors. For example, while sole traders are exposed to more financial risk, a company comes with disadvantages like higher admin costs than a sole trader or partnership.

Consider your control and decision-making preferences

How many people will be running the business? Will you want to grow your leadership team and number of owners? For instance, when weighing up the benefits of a company vs a partnership, consider how you’d like to distribute power and responsibility.

Work out your funding needs

Even the smallest businesses need cash to get started. Companies can issue shares, making it easier to raise capital, while other business types (such as sole traders and partnerships) may struggle to secure large loans.

Plan for future growth

Flexibility is the key to meeting the evolving needs of your business. Maybe you’ll want to sell it one day? Maybe it’ll diversify or double in size? Your choice of structure must give you room to develop, so think about how different legal structures for businesses compare – for instance, companies let you transfer ownership and manage growth more easily.

Can you change your business structure?

Yes – you’re not locked into one structure. Many businesses start out as sole traders or partnerships and grow into companies. You might change your business structure if the business grows and you take on more complex projects with more financial or legal risk.

Simplify your business finances with Xero

Choosing the right entity for your business is just the start of building your company.

Xero software streamlines your financial admin so every step of the process is faster – whether it’s sending invoices, managing cash flow, or creating customised reports.

Automatic calculations always put the latest numbers at your fingertips, while Xero’s cloud-based platform means everything you need is in one secure, accessible place. Less admin means more time for the rest of your business. That’s why small businesses love Xero.