You’ve decided to setup a business and you’re ready to think about how you are going to structure it OR perhaps, you’ve already taken that initiative and are well into the business lifecycle. Naturally, you’ll pick the easiest, simplest, cost effective structure which will lead you to becoming a sole trader. Come up with a business name (the hardest decision to date), jump online and register for an ABN. That was easy. Now its time to grow and scale the business of your dreams… right?
WRONG!
- Small Business Risk and Unlimited Liability
Business is a risky place. In fact according to Forbes, around 20% of small business don’t make it past the first year of trading and by year 5, only 50% are still around to tell a story. Thus, whilst starting out as a sole trader might seem like the easiest and right thing to do, we implore you to consider the risk involved.
As a sole trader, I want to introduce you to a small concept you face, which is called “unlimited liability”. What does this foreign accounting jargon mean? Put simply, the liability/risk/obligations of the business rest solely with you the individual and business owner. You are the business.
In case you aren’t already alerted enough about why “unlimited liability” is a massive risk to put you, your family and your business in, let me paint some scenarios for you.
- Any debt you incur in the business, is also incurred personally.
- The risk of an employee pursuing you in the business, is also a risk you take on personally.
- The risk of you defaulting your home loan, will affect the assets in your business.
- The risk of you being unable to pay your business creditors could put your family home at risk.
- The risk of you being sued by a customer puts your personal assets up for grabs
As accountants we want you to limit the risk you take going into an unknown environment, thus under very limited circumstances do we recommend you trade as a sole trader, largely because of the risk involved. Especially when there are other structures that can create “Limited liability” and separate yourself from the risk of business.
2. Tax Rates and tax planning
Ahhh Tax, the not so silent killer of small business. Don’t get us wrong. Tax is a good thing, in fact if you aren’t paying tax it only means 1 of 2 things.
- You’re either making no profit – that’s no good
- You’re doing something dodgy or illegal- yikes, that’s even worse!
However just because we have an obligation to pay tax, does not mean we should be paying more than our faire share. What do we mean by this you ask?
As a sole trader, you are treated as an individual for tax purposes and the business simply forms part of your overall tax return. Any profits go straight to you and there is no if, buts or maybes. Once your business profit is added with all your other sources of income (any other jobs, salary, wages, dividends, rental income) you pay tax at marginal rates. These start low…. As low as $0. However these quickly increase to a maximum of a whopping 49%!
If we compare this top marginal rate of 48% to other structures such as a company – 27.5% for SBE’s or 0% for a discretionary trust, there are some potential tax savings that we are missing out on.
Not only is the tax rate for a sole trader potentially very high, there is no chance of distributing profits to various entities. In a trust for example, the profits can often be distributed to members in a family group and could lead to a much different tax bill.
3. People don’t take you seriously
The third real consideration that should be weighed up, is the idea that when someone looks to use you as a supplier or service provider, they will often search around.
Business want to work with other business’ that have a solid reputation, track record and are trustworthy. In fact, some companies may just simply refuse to work with sole traders as they don’t feel confident in a sole traders ability to deliver. This is because most businesses’ with some sort of scale, operations and market share would have generally incorporated. Having a company structure in place helps formalise your business arrangement and looks “established” to your potential clientele.
Simply put, having that “pty ltd” could be the difference between getting a job or not. Thus depending on the lifetime value of your clients or work, it may be a small price to pay for quite a hefty return.
In summary, structuring your business is a complex task that requires serious expertise. Assuming that being a sole trader is just the easy, quick way to get started has serious potential of hurting your business in the long run.
At Advisory Corp Accountants, we offer a free review of your business structure and strategy.
After a conversation around your business, your current circumstances and your future goals, we will be able to point you in the right direction and ensure that you aren’t just a negative small business statistic.
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