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How to Choose the Right Business Structure?

Alexis Walker1205 24-Jul-2019

The business structure that you decide to operate under will determine a great many things regarding the way in which you run your business. For instance, it will determine the ownership of the company, which may come to play when it comes to selling a business or sharing responsibility. Other than this, you get to determine the liability, which is incredibly important when things go wrong. In a lot of cases, you get to determine the authority, as well, seeing as how your business can have one or multiple owners. In a scenario where they disagree, it’s incredibly important to know who has the seniority. Then, there’s the issue of paying taxes. Different business structures pay taxes under different schemes.

In general, there are many different types of business structure but, for the sake of simplicity, we will focus this post on the major five that the majority of Australian entrepreneurs start as. These five are a sole proprietorship, general partnership, limited liability company, S corporation (S-corp) and C corporation (C-corp). Due to the importance of this decision, it’s vital that you figure out the right structure for your enterprise. Here are the very basics of what you need to know on this topic.

Sole proprietorship

The best thing about a sole proprietorship is the fact that, as an owner, you’ll be directly in charge of the decision making. This means that you have the full freedom to pursue your mission and vision. This also means that all the profits go to you, as well as any potential tax advantages. Other than this, sole proprietorships usually have low start-up costs and require minimal working capital to operate. Again, this is due to the fact that there is no profit sharing and you get to choose how much work capital to reinvest in your budget. Other than this, you get a lot of freedom from various regulations and getting the necessary paperwork is fairly simple.

There are, however, a lot of downsides, as well as a lot of reasons, which is why so many experts advise against running as a sole proprietorship. First of all, you have unlimited liability and, due to the fact that your private funds and your company funds are, more or less, one and the same, you risk your private assets, should your business operate on a loss. In the absence of the owner, there’s a major problem with business continuity. Not to mention that raising capital tends to be incredibly complex, as well.

General partnership

The next business structure worth discussing is a general partnership, which is basically an agreement between several parties to combine their resources in order to make profits. As you might have guessed, this leads to a lower start-up cost, due to the fact that each of the parties invests their share, instead of leaving the funding to be the responsibility of a single person. Sharing responsibilities is also a lot easier, mostly due to the fact that everyone gets their share of administrative tasks to handle. Ideally, people could even split these responsibilities according to their interests and aspirations. Regulations in this field are limited and there are numerous possible tax advantages to consider.

The problem, however, lies in divided authority, especially in 50-50 partnerships, which are surprisingly common. It’s also quite hard to find suitable business partners, mostly due to the fact that just because shares your interests, this doesn’t mean that they share your vision, as well. One of the biggest legal problems lies in the fact that by making an agreement with a third-party, one partner can legally bind the other without their prior approval. When it comes to the issue of liability, the situation is quite similar to that with a sole proprietorship.

Limited liability company (LLC)

It is generally regarded that a limited liability company has more benefits when compared to both sole proprietorships and general partnerships. However, during the startup stage, not all businesses are ready to become limited liability companies. Here, you get a limited liability, which legally protects your private assets from the worst-case scenario regarding your business. Other than this, you get flexible profit and loss, as well as operating flexibility. As far as ownership rules are concerned, you have the freedom of organizing this in any way you want with your partners. All in all, if you had to describe the concept of the LLC in two words, these words would be flexibility and safety.

The problems, however, are quite numerous, as well. First of all, you get to pay more taxes, as well as a dividend distribution tax. This issue, however, is best outsourced to top Australian accounting firms. Another issue that people may have a problem with is the fact that there’s a compulsory audit every financial year, which can turn into an administrative nightmare for all those who are not careful with their finances. Other than this, there’s also the additional cost of buying into a company, which should not be underestimated.

S corporation

The simplest way to describe the S corporation would be to say that there are two criterions that a business needs to fulfil to be classified as one. First, they need to have no more than 100 shareholders. Second, the business must have one class of stock. The way in which this work is fairly simple, the S company doesn’t pay an income tax and its profits are divided to their shareholders. These shareholders later must report the income or loss on their individual tax returns.

The benefit of this is the fact that there’s no double taxation, there’s no excessive compensation and there’s an option for tax-free withdrawal of equity. The disadvantages, nonetheless, are the fact that there is a stricter operational process and there are certain shareholder compensation requirements that the company might not be able to fulfil. One more disadvantage lies in the interaction of the S company with venture capitalists. Namely, in order to raise capital from them, this company would later have to be restructured and become a C corporation. Which leads us to our final structure type…

C corporation

A C corporation is the next stage of the S corporation. The way in which it works is by getting taxed once on a business level and then a second time on the individual level (like the S corporation). The benefits, however, is that there’s no limitation to the number of shareholders and there’s no limitation to the number of different stocks in use. Now, previously, we’ve mentioned that restructuring an S corporation to become a C corporation is possible, however, it’s probably for the best if you were to decide on this, early on.

One of the biggest advantages of running a C corporation is the fact that there’s an incredibly wide range of deductions available. In general, it’s also advised that the choice of whether to go as a C corporation depends on your industry. For instance, businesses in the retail industry (especially in traditional retail with the brick and mortar establishment and employees) might find a C-corp to be a great idea. On the other hand, businesses that deal with appreciating assets (like in the real estate industry) might find this model to be quite ineffective.

In conclusion

As you can see, the specific situation that you’re in may result in a scenario where your business needs to determine the structure in your stead. For instance, if you just can’t run a business on your own a sole proprietorship would be out of the question, etc. Nonetheless, in some scenarios, making the right choice may determine the success of your business.



Updated 20-Jan-2020
Alexis is a Sydney-based part-time lifestyle writer and a full-time mom of two. Her words carry the richness of her travelling and parenting adventures, offer advice and inspiration to those who desire to improve their lives. Outside of the office, she takes pleasure in spending precious time with her youngsters and absorbing the happiness they constantly radiate.

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