A beginner’s guide to business structures

One of the final things that need to be done before pressing go on a new business idea is structuring the company properly. Getting business structures right is crucial to any new starter, and here are some things to keep in mind when setting it all up.

Starting up a new business comes along with a long list of administrative tasks that need to be completed before the eager founder can push the pedal to the metal and take the plunge on their new venture.

This list of pre-launch tasks includes things like finding the right business partner, validating the business concept properly and choosing a business name. The further down you go, the less ‘exciting’ the task is, but they all play an integral role in forming a business with strong foundations.

READ: How to register your business for the first-time business owner

Setting up the corporate structure is one of those tasks that appear right down the bottom of any pre-launch to-do list, and as disinterested as the founder might be in going through the process, getting it right in the beginning is crucial to the quality of those structural foundations.

Key takeaways:

• Business structure basics: sole trader, company or trust?
• Business structures impact the way your business is taxed, as well as its legal responsibilities
• Don’t forget GST!

Moving from a sole trader to a business entity

Sometimes, the business founder might start their new venture as a part time gig, or as a ‘side hustle’ which they take on to supplement their income. When this happens, they often opt to run their business as a sole trader.

In short, a sole trader means that the person themselves becomes a business entity. This structure treats all of your income, regardless of where it comes from, as personal income.

READ: Key differences between sole trader and company

Becoming a sole trader requires for the person to apply (don’t worry, it’s free) for an ABN, and once approved, list the ABN on their invoices.

Given that such a structure treats all income in the same way, as a sole trader, any business income gets taxed at your personal income tax rate which can climb as a high as 47 percent.

Eventually, there comes a point where the business needs to transition from a sole trader entity to a business entity. The practical differences are that (as a small business,) the company tax rate is 27.5 percent, and it is kept completely separate from any other income.

Also, while running a business as a sole trader is free, there are annual accounting fees associated with running things out of a separate business entity.

To get an idea as to when the optimal time to transition from sole trader to an actual business entity would be, I reached out to Remco Marcelis, founder of an accounting firm called Standard Ledger.

Given that Standard Ledger specialises in accounting services for startups and early stage businesses, Marcelis had plenty to share about corporate structures for such businesses.

According to Marcelis, the question of when to move from sole trader to business entity is often mistaken as a purely a “tax question” when the reality is that there are several other important factors to consider.

Marcelis explained that the once either (or both) of the following two circumstances arise, the time to have a serious conversation about corporate structures has arrived:

1. “There are risks of being sued, beyond what’s ‘just’ covered by insurance;
2. You have reached the point of having created something of value and need a company to hold that in.”

Marcelis also pointed out that for tech businesses, accessing the R&D Tax Incentive and equity investment are also reasons to start considering the transition from sole trader to a business entity.

“For startups looking to access the R&D Tax Incentive or investment, having a business entity is just non-negotiable.

When you’re just consulting you can keep going a long time as a sole trader (and it in fact makes it easier to claim home office costs etc) but, especially if you’re working with a partner to build something (eg software, brand name etc) you want to jointly own and share that. Another turning point comes when you’re looking to hire employees.

Two common corporate structure mistakes

In his experience dealing with countless small business owners, Marcelis told The Pulse that there were two overarching mistakes that these business owners tend to make when setting up their corporate structure:

1. Mixing business with pleasure

Marcelis warned business owners against “not truly separating personal from business” and “running them out of the same bank accounts”. According to Marcelis, not creating those separations can have truly detrimental impacts on the business, as it makes it very difficult to “stay on top of what’s going” in the business.

As a suggestion, Marcelis encouraged small business owners to setup separate account for personal and business transactions.

2. Living in denial of inevitable obligations

Another very common mistake that Marcelis pointed out was that small business owners can turn a blind eye to future financial obligations.

“Small business owners can mistakenly live in a false economy of not staying aware of future GST, PAYG and tax obligations. As long as you’re paying attention to it then it won’t catch you by surprise.”

Marcelis said that a great way of staying ahead of the curve with this one is to set up completely separate bank accounts to set the money of those future obligations aside.

Trust or company?

Aside from running a business as a sole trader or actual business entity, companies can also be structured as trusts.

Without getting into too much detail about the way trusts typically work, Marcelis flagged that there’s a theory that when families go into business together (for example; husband and wife, mother and daughter, and so on) that if they operate their business out of as trust, it will be “easier to distribute dividends” than it would be if the business was being run out of a company.

Marcelis disagreed with this theory, saying it was a misconception, and in the event that founders choose to structure their companies as such, they’re opening themselves up to some “potential legal liabilities”.

Register for GST from day one

When it comes to GST (goods and services tax) in Australia, the law only requires companies to register once their income reaches $75 thousand or more.

Generally speaking, once a company registers for GST, they are required to start charging their customers an additional 10 percent to cover those taxes.

While the common practice among early stage business is to wait until they reach the $75,000 income threshold before registering, Marcelis encouraged startups to do things a little differently and register right from the beginning.

“We recommend registering from day one because it allows you to claim back the GST on anything that the company spends.

“Many pre-revenue startups are spending thousands on product development and they can claim GST back on that spend.

“Claiming this GST back can also be done retrospectively.”

The most common reason as to why people avoid doing this is because of the extra administrative work that it requires. But, Marcelis believed that “doing the admin yourself” or “paying a bookkeeper” is worthwhile if it means you can get your hands on some of that cash.

If you do decide to register for GST, Marcelis also recommended going through the return on quarterly basis, rather than annually.

“Sorting your GST out quarterly allows you to better manage your business affairs and to get the cash back quicker.”

Knowing when to transition from sole trader to business entity, staying away from the common structural pitfalls that founders tend to make and registering for GST early are just a few ways to ensure that your early stage business will be built to last.

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