One of the most crucial yet overlooked decisions when starting a new business is its legal structure. This choice will have a significant influence on your operations—from how much tax you pay to your personal responsibility if a case is filed against you.
The right legal business structure can mean all the difference when it comes to the direction and success of your business, so it’s important to make an informed decision before choosing the ideal business model.
Here are a few things to keep in mind when making your decision.
What is A Business Legal Structure?
A business legal structure is a framework in which a business operates and defines the relationships between the owners, employees, and shareholders.
This includes things like the ownership hierarchy, profit distribution, as well as the degree of personal liability. This structure is recognized by the government and dictates how the business will be taxed.
7 Business Structures in Australia
In Australia, there are seven business structures that you can choose to register, each with its own set of characteristics and benefits.
They are as follows:
- Sole trader: A structure where a single individual is legally liable for the entire business operations.
- Company: A business structure that’s legally separate from an individual and comes with its own legal and tax obligations.
- Partnership: A structure composed of 2 or more individuals who share profit and loss.
- Trust: A structure where a trustee engages in business on behalf of beneficiaries or trust members.
- Joint venture: An agreement between 2 or more parties engaging in an ongoing short-term or long-term business project.
- Co-operative: A legal business entity with 5 or more members that perform business to fulfil the interests of its members. Each member has an equal say in the way the organisation is run.
- Indigenous corporation: A business entity run by indigenous business owners to serve the interests of Aboriginals and Torres Strait Islanders.
Each of these structures has its own set of rules, regulations, and tax implications.
What’s The Best Legal Structure For First-Time Business Owners?
If it’s your first time starting a business, then it’s often advantageous to opt for a sole trader legal structure. This structure entails the least amount of paperwork, making it fairly straightforward for any new entrepreneur to establish.
In this structure, the business revenue and losses will be reflected as personal income, and you won’t have to spend much on fees. Moreover, this legal structure is the least complicated when it comes to tax and dissolution, as you’ll only need to report business income and expenses on your personal tax return.
Most new business owners tend to pick a sole trader legal structure due to its straightforward nature. However, as your business gains more renown, it’s only natural for issues to arise alongside it. Business owners may be more at risk of having litigation filed against them, and this is troublesome for sole trade structures as these lawsuits can also seize personal assets.
Therefore, once your business starts to pick up traction, it might be more beneficial to switch to another business structure like a company or co-operative. But in most cases, a sole trader entity is highly preferred.
What Business Entity Protects Your Personal Assets?
If you’re starting a business that comes with a higher degree of risk, then you might want to consider a company or a limited liability partnership legal structure. This is because these business structures protect your personal assets if your business is sued.
Company Legal Structure
A company is a separate legal entity from its shareholders, meaning that the shareholders will not be held personally liable for the company’s debts and obligations.
This limits their financial risk if the business is unable to pay its debts. While the protection against personal bankruptcy is a huge boon, running this business entity also comes at a higher set-up cost, a more complex business structure, and a deep understanding of the Corporations Act 2001.
Partnership Legal Structure
There are three main types of partnerships:
- General partnerships
- Limited liability partnerships
- Incorporated limited partnerships
In a general partnership, all partners are equally liable for the debts and obligations of the business. This puts them at greater financial risk than if they were to operate as a company.
A limited liability partnership, on the other hand, shields partners from being held personally liable for the debts of the business. This means that partners are only financially responsible for their own actions and not those of the other partners.
An incorporated limited partnership is a structure wherein partners can possess limited liability on debts and obligations. However, there must be at least one general partner who will be held liable for the debts of the business. These partners are usually investors or venture capitalists.
Learn more about the difference between a limited or unlimited liability company with LegalVision NZ.
What’s The Best Legal Structure?
Your business’s legal structure will largely depend on your product offering, business objectives, and risk tolerance. If you’re starting a low-risk business, then it might be best to go with a sole proprietorship or general partnership.
But if you’re planning to run a full-fledged, macro business, then a company or limited liability partnership might be a more suitable legal structure.