Starting or Buying a Business? 4 Types of Business Structures

by Vanessa Lovie 27th of August, 2021

4 Types of Business Structures

If you are looking to start a business, the initial decision on the type of business structure you go with, will be based on a number of factors such as; capital, number of people involved in a business, cost of operations, legal requirements, licenses, tax obligations etc. Whilst you can change your business structure down the track, such as transitioning from a partnership to a company, it's important to take note of the differences when starting a business.

If you are in the process of buying a business, it's important to know the difference between the structures as it may affect how the business sale is negotiated and sale is processed.

Understanding the four types of business structures in Australia

1. Sole trader

This form of business structure is best suited to an individual who wants to run their own business. Whilst is it possible to hire employees as a sole-trader, many choose to operate this style of business as 'owner-operators' and then sell products or accept work from clients.

Sole traders are the most popular form of business structure in Australia as it is one of simplest ways of starting a business. Moreover, the costs associated with starting a sole trade business are minimal making it the least expensive among all the types of business structures.

This type of structure is best suited to start-up businesses that don't anticipate a high turnover or risk involved in running their business.

While this form of business structure might be the easiest, it does have unlimited liability, meaning your personal assets are at risk if anything goes wrong. A sole trader uses their ABN and Tax File Number to operate the business and as such are responsible for any debts occurred. The owner also has to declare all profits as part of their personal income which is why people often transition into a partnership or company once the business starts to earn a decent income as it can change the owners tax obligations.

If you are buying a business that is established as a sole trader, you need to ask yourself, if the clients will stay once the original owner has left the business. If the businesses income and reputation are tied closely to the business owner, the ability to sell and obtain an optimum price may be affected.

2. Partnership

A partnership business is another form of structure whereby two or more people are involved in the ownership of the business. They decide to share aspects of the business such as capital, profit, tax obligations, skills, expertise, clients etc. The share of the profit can be divided between the owners.

Like a sole trader, the legal requirements and taxes for a partnership are minimal. The main difference between the structures is how many people can own the business.

There needs to be a clear agreement between the owners as to how the business will operate and what each partner will put into the business and receive. To ensure the smooth operation of the partnership this agreement between partners is extremely important to avoid any disagreements or misunderstandings.

Similar to a Sole-Trader there is unlimited liability, meaning all the owners personal assets are at risk. So you need to have full trust with your partner in business as you may be responsible for their mistakes as well.

If you are looking to buy a partnership, similar questions are to be raised like with sole-traders. That is, will the business remain profitable once the owner (or partners) have left the business.

3. A Company

A company is essentially a separate legal entity from its owners meaning that the liability of the company is limited to the business itself and does not extend to its owners, who in this case are shareholders of the company. This means if the business fails, and the company can’t pay all its debts, the shareholders will not be personally liable for those debts.

The company is run by directors, who also tend to be shareholders. The directors of a company may be found responsible for errors that are unlawful or negligent and as a result, may become personally liable. So whilst a company does have limited liability, there are some loopholes, that owners need to be aware of.

As a separate entity with its own ABN, ACN and TFN a company can do more than a sole trader and partnership. A company has a right to sue and can be sued, it can own property, it can hold profit, it can be listed as a private or public company and go on the stock exchange and much more.

Whilst a company is more expensive to establish and is liable for other expenses such as Company Tax, it does have limited liability which offers business owners more protection. A company has to abide by the Corporations Act 2001.

If you are looking to buy a company, you will need to consider the options available such as purchasing a certain percentage of shares, becoming a director, buying out aspects of the business etc. This is why it is important to always seek professional advice.

Starting or buying a company structure
Companies are separate entities, meaning they have limited liability and your personal assets are more protected.

4. Trust

A trust is a form of business structure that is different from all the other business structures because trust is managed by a trustee (can be a person or company) who manages the trust on behalf of the members or beneficiaries. There is a formal Trust Deed that outlines how the trust operates.

This type of structure is mostly used by families who want their relatives to be the beneficiaries of the trust but do not want them to manage the everyday operations of the trust. A trust may be of two types as well including discretionary trusts, where the trustee can decide about the distribution of funds among beneficiaries and unit trusts where beneficiaries each hold a number of trust units and therefore their share of profit is predetermined.

Trusts are complex to set up and you'll need time and the right skills to do it properly. It's best to see a qualified, licensed professional to help you understand what's involved and the registrations you'll need.

Whether your starting a business, looking to buy a business, or thinking about selling. Its important to understand the main types of business structures and how they may affect your decisions. Consulting with a professional accountant, solicitor or business broker will help you make a well informed decision.

Tags: buying acquisition small business entrepreneurs