Types of business structure
Your business structure can affect how much tax you pay, and how you're treated by the law. It’s worth considering the pros and cons before deciding on your legal setup.
Business structures and their effects
The main types of business structure are sole trader, partnership, and company. Your choice will affect your admin burden, tax, legal status, and your ability to raise money by selling shares.
If you don’t choose a business structure
If you don’t choose a structure when starting a business, you’ll be assumed to be a sole trader. That’s how a lot of people start out. However, it’s worth understanding what it means to be a sole trader, and getting your head around the other structures. Speak to a lawyer or accountant before making any changes.
What is a sole trader?
A sole trader is a single-owner business. It doesn’t have to be a single-worker business, so you can hire staff.
Advantages of a sole trader
It’s easy to set up as a sole trader and tax is simple. You just declare income on your personal tax return.
Disadvantages of a sole trader
A sole trader doesn’t have any special legal status, which means the owner is personally responsible for what the business does. If the business gets into debt or legal trouble, so does the owner. Your choice of insurance becomes very important.
What is a partnership?
A partnership is owned by two or more people. There are no rules about how it’s divided. One partner can own 99% of the business.
Advantages of a partnership
It’s easy to set up as a partnership, though it’s recommended you have an official letter that sets out the agreement between partners. Tax is simple too. You just declare your share of business income on your personal tax return.
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’s in a partnership agreement
A simple business partnership agreement should:
state the legal name of the partnership and say what you do
name the owners and show how many shares each has
appoint a primary business officer
say when and how income is distributed among the partners
include a process for resolving disputes
identify how bookkeeping and finances will be managed
outline how the partnership can be wrapped up (and how debts or profits would be distributed)
As you can imagine, even a simple business partnership agreement can get lengthy and complicated. Search the internet for examples or, better still, ask an accountant or lawyer to help.
What is a company?
A company is legally separate from its owner (or owners), which means 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 a lawyer can give you the lowdown. Companies pay a lower tax rate, which can be attractive – although you may be taxed again when you distribute that income to owners, so speak to a tax professional. You can also sell shares in your company to raise money.
Disadvantages of a company
It will cost you more to operate as a company than as a sole trader or partnership. There’s also more admin. You’ll need to know how the company will operate before you get started, and you’ll have to regularly submit paperwork to the Companies Office.
What about trusts?
While they’re not especially common, some types of businesses set up as trusts. They’re more complex than sole trader or partnership structures, but they may be useful for estate planning. Trusts tend to be used by businesses that own a lot of assets, such as farms. Speak to an accountant to see if they’re for you.
You can change your business structure
You’re not locked into one structure forever. A lot of businesses start out as sole traders or partnerships and grow into companies. You might change your business structure if you start getting bigger and doing more complex projects which carry a greater financial or legal risk for you.
Where do franchises fit?
If you buy into a franchise, you don’t automatically become part of their business. You form your own business and enter into a deal with the franchisor. You may be able to choose your own business structure, or the franchise agreement may require it to be set up in a specific way, such as a company.