How to structure your small business – and pay yourself

(Steadfast)


So you’ve got that burning desire to start your own business. You’ve honed your particular product or service down to a sure fire proposition, you’ve researched the market, identified the demand you’ll meet and it’s all systems go.

It’s an exciting time, but it’s also a time when you need to make decisions that could prove vitally important down the track: under what structure to run your business, and how you will pay yourself – whether you take a salary, drawings from income, or loans from the company.

“Getting it right from the outset can save you both headaches and money”

These may be less exciting decisions than your website, your marketing plan and establishing your new premises – but they’re absolutely critical decisions. Getting it right from the outset can save you both headaches and money.

Small business structures

There are four main structures to choose from: sole trader status, a partnership, a proprietary limited company, and a proprietary limited company as trustee for a trust (whether a discretionary trust or a unit trust).

Sole trader status – or multiple sole traders operating in partnership – is easiest to set up: all that you need is an Australian Business Number (ABN). You are taxed on the company’s net profit at your individual tax rate, and end-of-year accounting is simple: all you need to do is produce a business profit and loss (P&L) statement, and prepare a personal tax return based on the net profit.

A proprietary limited company requires a company name, Australian Company Number (ACN) and ABN. You are creating a legal entity, which has the privileges of limited liability in the case of litigation or bankruptcy, and the company tax rate, but it has obligations in terms of documentation, record-keeping and registration with the Australian Securities & Investments Commission (ASIC). The establishment and annual tax and compliance costs are higher than for sole trader status.

A proprietary limited company as trustee for a trust has the added layer – of both responsibility and cost – of establishing the trust and maintaining its accounts. At the end of each financial year, the trust is required to distribute all of the trust’s profits – they cannot be kept in the trust.

Asset protection is critical

The proprietary limited company-plus-trust structure is the least common, but the best, says business coach and mentor Dr. David Dugan, of Elite Enterprises. “Entrepreneurs not only want to succeed, they should also be thinking of protecting their business and their personal assets. But too many people stuff it up by not getting the structure right and the appropriate insurances in place from the start.”

“Too many people stuff it up by not getting the structure right and the appropriate insurances in place from the start”

Dugan says the company-plus-trust structure gives business proprietors the most flexibility and the most complete asset protection. “The downside of this structure, which is why people sometimes don’t want to do it, is that at the end of the year you have to distribute all of the profits in the trust, whereas in a company you can hold the profits in there.

Your company as part of your overall wealth

“Also, it costs a little bit more to get a company and a trust set up. But it gives you much more tax-effectiveness and flexibility in terms of your overall wealth creation strategy, which may have investments outside your business,” says Dugan.

“Not enough small business owners are thinking at the outset about protecting themselves and their assets, but they should be. That aspect alone makes sole trader status or a partnership a recipe for disaster,” he says.

How will you pay yourself?

Once you have decided on the structure you want, you then have to think about how you will be