Sole Trader vs Company vs Trust: What Works Best?

One of the most important decisions that you will ever make for your small business is choosing the right business structure. You will find yourself asking: which structure is best? But the real question you should be asking is: which structure is best for me? Because the truth is, there is no one size fits all answer.

This blog post will go through the three most common structures: sole trader, company and trust. We will give a brief description of what they are, the pros and cons of each, and what kind of businesses they are best suited for.

Sole Trader

A sole trader structure is the simplest option. You and the business are legally the same entity, you operate under your own ABN and report business income through your personal tax return.

Benefits:

• Minimal startup costs, making it the cheapest option.
• Simple to set up – all you need is an ABN (and a registered business name if you are not trading under your own legal name). There are no additional legal headaches.
• You have full control over business decisions, meaning there are no internal governance disputes between co-owners or directors.
• You lodge business income as part of your individual tax return, allowing you to utilize personal tax-free thresholds and offset business losses against any other personal income (such as salary).

Risks:

• You are personally liable for all business debts. If your business is sued or incurs debt, then your personal assets like your home and bank accounts are at risk.
• If your business is earning high profits, you miss out on the flat tax rates that are accessible to corporate structures.
• Challenges with growth and investments, since sole traders may lack the formal governance structure and perceived credibility that investors and lenders often associate with a registered company.
• Without a built-in team and management structure, it can be difficult to maintain a healthy work-life balance.

A sole trader structure is best for someone who is testing out a business idea or operating on a very small scale. Most first-time business owners opt to be a sole trader. It is intended for people who want to avoid complex reporting and setup requirements. It works well for businesses who do not need a lot of upfront capital, such as freelancers, tradespeople, independent contractors and small franchises.

Company

A company is a separate legal entity that is registered with the Australian Securities and Investments Commission (ASIC).

Benefits:

• Limited personal liability, meaning better asset protection. Shareholders are typically only liable for the amount that they invested in their shares. However, directors may still face personal liability in certain circumstances, such as insolvent trading or where personal guarantees have been provided.
• The business will outlive its founders. Unlike sole traders, companies can continue their daily operations if ownership changes or if shareholders leave.
• High potential for long-term growth as it is easier to sell shares and attract investment.

Risks:

• Higher setup costs and complexity. Companies require formal legal documents, strict compliance with industry regulations and ongoing admin costs.
• Loss of privacy. Key corporate details (such as director names and registered addresses) are publicly available through ASIC, and certain companies are required to lodge financial reports that can be accessed by the public.
• Higher risk of disputes. Within day-to-day operations, there can often be conflict between the goals of company directors and shareholders.
• There are three annual obligations companies have to ASIC each year: pay the annual review fee, verify and update company details and pass a solvency resolution.

A company structure is best for businesses with ambitious goals, multiple directors and stable finances. A company is appealing for professionals who have a higher exposure to liability because it comes with significant personal asset protection. It is also ideal for those who wish to grow their business by increasing capital and expanding their client base. Creating and managing a company is a complex matter, but the right lawyer can help you through it.

Trust

A trust is less like a business structure and more like a financial backbone for your business. A trust is a fiduciary relationship where a trustee (an individual or a company) is appointed to hold and manage business assets and operations for the benefit of designated beneficiaries.

Benefits:

• Offers high tax flexibility, as trustees can distribute income to beneficiaries with the lowest marginal tax rates.
• Allows for smooth transitions of wealth and business control without triggering immediate ownership transfer issues.
• Greater Assets and financial records are generally private, as trusts are not required to register with ASIC. Trust assets may also be shielded from personal liability and third-party creditors in certain circumstances.

Risks:

• Trusts come with high setup costs and ongoing administrative costs.
• Inability to retain profits. In a discretionary trust, any income not distributed to beneficiaries by the end of the financial year may be taxed at the highest marginal rate.
• If family breakdown occurs, it is difficult to dissolve or alter an existing trust structure. Certain variations to the terms of the trust may trigger capital gains tax and stamp duty consequences.

Trust structures are popular amongst family-owned businesses because they offer high asset protection and succession planning opportunities. A trust is also beneficial for a business holding assets of significant value because it strategically minimises tax through income splitting.

So How do You Choose?

Obviously, seeking legal advice is the best way to ensure that you are making the right decision for your circumstances. When you do so, you need to carefully evaluate the following legal and operational factors, and decide which ones are the most important to you.

• Liability Protection: how much personal risk are you willing to take?
• Tax Implications: which structure offers the best tax advantages for your situation?
• Funding Needs: will you need investors or loans?
• Administrative Burden: how much paperwork and compliance are you prepared to handle?
• Future Goals: Do you plan to expand, sell or pass on the business to someone else?

Choosing the right business structure the first time is important because changing your structure later can be a complex and costly process. If you have any questions about which business structure is right for you, please do not hesitate to contact us at Signus Legal. We are here to help.

DISCLAIMER: This article is for informational purposes only and does not constitute legal advice.