Company vs. Sole Trader: Which is the Best Business Entity for You?

Pros and Cons of Being a Sole Trader 

A sole trader, also known as a sole proprietorship, is the simplest and most common type of business structure. About 60% of Australian businesses are sole traders. As a sole trader, you're responsible for all aspects of your business, from decision-making to financial management. 

The advantages of being a sole trader include: 

• Easy and inexpensive to set up 
• Complete control and autonomy over the business 
• Lower accounting and compliance costs 
• Personal tax rates apply, which can be beneficial if your business has low profits 

The disadvantages of being a sole trader include:  

• Unlimited liability, which means that personal assets can be used to settle business debts 
• Limited access to capital as you can't issue shares to outside investors to put money into your business
• Limited ability to expand the business 
• Lack of separation between personal and business assets 

Before deciding to become a sole trader, it's important to consider the nature of your business and the level of risk involved. If you have a low-risk business or your business is a side hustle you want to maintain complete control over, being a sole trader may be the best choice. However, registering a company may be a better option if your business involves higher risk or you plan to expand your business by taking on debt. This is because you will not be liable for the business's losses or debts. 

Pros and Cons of Registering a Company 

A company is a separate legal entity from its owners, and its operations are managed by a board of directors appointed by shareholders. Registering a company involves more legal and compliance requirements than being a sole trader. Still, it is more tax effective if your business generates a lot of profit and offers greater protection for personal assets and potential for business growth.

The advantages of registering a company include the following: 

• Limited liability, which protects personal assets 
• Easier access to capital as you can issue new shares to investors
• Potential for growth and expansion 
• Separation of personal and business assets 
• More tax effective if you generate large profits

The disadvantages of registering a company include the following:  

• Higher start-up costs and ongoing compliance costs 
• More complex legal and tax requirements 
• Less control over decision-making

A company is a better option for high-risk businesses that need to raise money, or those with significant growth potential, while a sole trader structure may be sufficient for low-risk businesses.

Pros and Cons of Registering a Partnership

A partnership is a business structure where two or more individuals own and operate a business together. Partnerships can be a general partnership or a limited partnership, which provides limited liability protection to specific partners. 

Advantages of a partnership include: 

• Shared decision-making and workload 
• More access to capital and resources 
• Lower compliance costs compared to a company 

Disadvantages of a partnership include:  

• Unlimited liability for partners 
• Shared profits and losses 
• Difficulty in resolving disputes between partners.
  

Pros and Cons of Registering a Trust 

A trust is a legal structure where a trustee holds property or assets for the benefit of beneficiaries. Trusts can be used for various purposes, including asset protection, tax, and estate planning. 

Advantages of a trust include: 

• Asset protection and tax benefits 
• Flexibility in distributing income and assets 
• Greater control over the use of assets 

Disadvantages of a trust include:  

• Complex legal and tax requirements 
• Higher costs for setting up and maintaining the trust 
• Limited access to capital 

Partnerships and trusts can be suitable for businesses with multiple owners or those that require special tax or asset protection considerations. It's important to seek professional advice before choosing a business structure that best suits your needs.

Choosing the Right Business Structure 

Choosing the right business structure for your company is a critical decision affecting your business operations, taxes, and legal liability. When making this decision, consider the following factors: 

1. Business risk: How much risk is involved in your business? A company or trust structure may offer more protection for personal assets if you have a high-risk business. 
2. Tax implications: How will your business be taxed? Sole traders pay personal income tax rates, while companies pay a lower corporate tax rate which benefits businesses generating larger profits.
3. Compliance requirements: What are the legal and compliance requirements for your chosen business structure? Companies and trusts generally have more requirements than sole traders or partnerships. 
4. Ownership and control: How much power do you want over your business? Sole traders and partnerships offer complete control, while companies involve a board of directors and shareholders. 
5. Future plans: What are your plans for the future of your business? A company or trust structure may be better suited if you plan to expand or raise capital. 

It's important to seek professional advice when choosing a business structure that best suits your needs. For instance, you can speak with a lawyer from a firm specialising in supporting small businesses, such as Sprintlaw, to help you understand each option's legal effects and make an informed decision. You can also seek advice from an accountant or business advisor to get a holistic understanding of each structure and which is best suited for your business.

Which structure is the most tax effective? 

In Australia, the business structure that is the most tax effective depends on the income and eligible deductions the business generates. Generally, companies are considered more tax-effective than sole traders because they are eligible for lower corporate tax rates, currently set at 30% for large companies and 25% for small businesses (under $50 million in turnover). 

On the other hand, sole traders are taxed at individual income tax rates, which can be as high as 45% for income over $180,000 per annum. Generally speaking, if you expect to generate a profit of over $100,000 a year from your business, having a company structure will be more tax effective. This is because, all things being equal, you will be taxed at 25% versus the marginal tax rate you will be taxed as a sole trader. 

Example: 

Here's an example of the tax implications for a company versus a sole trader in Australia if the business earns $140,000 per year.

For a company generating a $140,000 profit:

The company would be taxed at a corporate tax rate of 25% as it is considered a small business. Therefore, the tax payable for the company would be 25% x $140,000 = $35,000. 

For a sole trader generating a $140,000 profit:

As a sole trader, the $140,000 would be taxed at individual income tax rates:

• The first $18,200 of profit would be tax-free. 
• Profit between $18,201 and $45,000 would be taxed at 19%. 
• Profit between $45,001 and $120,000 would be taxed at 32.5%. 
• Profit between $120,001 and $180,000 would be taxed at 37%. 
  

Therefore, the tax payable for a sole trader earning $140,000 would be: 

$18,200 x 0% = $0 

($45,000 - $18,201) x 19% = $5,092 

($120,000 - $45,001) x 32.5% = $29,374 

($140,000 - $120,001) x 37% = $7,400 

Total tax payable = $41,866

As you can see from this example, the company would be taxed lower ($35,000) than a sole trader ($41,866) earning the same profit. However, it's important to note that this is just one example, and the tax implications can vary depending on individual circumstances. It's crucial to seek professional advice to determine the most tax-effective approach for your business. 

Business Structure Quiz

If you need more help deciding between a company or sole trader business structure, then take the Thriday business structure quiz. Based on your answers, the quiz will recommend the approach you could take.

Business Structure FAQs 

What is a business structure? 

A business structure is the legal form of a business that determines how it is organised and managed. Several business structures exist, including sole traders, companies, partnerships, and trusts.   

What is a sole trader? 

A sole trader is a business structure where one person owns and operates the business. The individual is personally liable for all aspects of the business, including debts and legal obligations. 

What is a company? 

A company is a legal entity that is separate from its owners. Shareholders own the company, and a board of directors manages its operations. Companies offer limited liability protection to their shareholders, meaning their personal assets are protected. 

What is a partnership? 

A partnership is a business structure where two or more people own and operate the business. Partnerships can be general or limited, and partners share the profits and losses of the business. 

What is a trust? 

A trust is a legal structure where a trustee holds assets or property for the benefit of beneficiaries. Trusts can be used for asset protection, tax, and estate planning. 

How do I choose the right business structure for my business? 

Choosing the right business structure depends on several factors, including the nature of your business, level of risk, tax implications, compliance requirements, ownership and control, and future plans. It's important to seek professional advice to make an informed decision. 

Can I change my business structure later? 

Yes, changing your business structure is possible later if it no longer suits your needs. However, this process can be complex and involve legal and financial implications. 

Choosing the right business structure is crucial for any entrepreneur starting a business. Several options are available, including sole trader, company, partnership, or trust, and each has advantages and disadvantages. 

As we've seen, the choice of business structure depends on various factors, such as your business goals, tax implications, liability, and flexibility. It's crucial to seek professional advice before making a final decision, as this can help you save time and money in the long run. 

Remember, the business structure you choose can significantly impact your business's success, so take the time to understand your options and choose the one that's best for your business. By making an informed decision, you'll be setting yourself up for success and avoiding potential legal and financial complications down the road.