When to move from sole trader to company?

Written on 26 October, 2018 by Bill Smith
Categories Small Business

Many businesses start as a team of one but as it starts to grow, you may find that ‘sole trader’ no longer describes your business. When you’re busy running the day to day of a business, it’s easy to neglect things like your company structure. When is it a good time to move from sole trader to company?

To help answer that question, here are a few points to consider as a business owner.

Varied tax rates

As any sole trader will know, the profit earned by their business will be included directly within their own personal income on their annual return, and therefore taxed at a marginal rate. Naturally, a sole trader’s tax bracket, payments and refunds will depend on the success (or lack of success) of business operations, as well as expenses, incentives and other financial elements of their life outside of ‘work’.

Companies, however, are recognised as a separate legal entity. Unlike individuals, they qualify for flat tax rates between 27.5-30%, depending on their annual turnover and amount of passive income. This is often less than many individual tax rates, which can go as high as 45% (alongside the additional Medicare levy).

We asked Katie Richards, CEO of Virtual Legal, to run the numbers and her findings indicate a range of $90,000 – $119,000 in assessable income (anything that is not exempt under income tax law) for sole traders before they start paying more tax than companies do. “This is before taking [into account] all of the deductions [and added obligations] from the company,” Katie added, so it is best to assess your individual position before making a transition. After all, there is still a tax-free threshold for individuals earning under $18,200, which does not apply to companies.

Companies attract better investment opportunities

Small businesses often have difficulty ramping up their operations without an injection of financial support from outside parties. If you are a sole trader looking to expand product lines, services, or even into multiple industries to challenge existing competitors, then you will undoubtedly encounter issues sourcing investment. Will you have to sacrifice part of your ownership? Will you have to change the way you like to operate? Sometimes you will have no choice. Investing in small business is frequently considered more hassle than it’s worth, and financiers can impose stringent conditions to ensure their return on investment (ROI) is protected.

“Investment is not possible as a sole trader,” says Katie, “because there is no way of showing what the investor owns, given there are no shares in you personally. At least with a company, they can buy a specific allocation or percentage of shares for a certain price.” By issuing shares, you can potentially receive a vast investment that will aid in growing your business.

Bigger is better when it comes to market perception  

The sole trader business structure comes at a cost: poor public perception. If you’re competing against multinationals, your sole trader business may always be seen to operate in the minor leagues.

“Being a company looks more sophisticated,” Katie advised us. “[It] is also better for passing on the business and getting partners involved.”

As mentioned above, businesses with aspirations of growing into vehicles that turnover staggering amounts in revenue will need plenty of investment to get off the ground. They will also have to do business with major players in order to remain sustainable or connect with the public and be placed on supplier lists. Unfortunately, everything boils back to ROI, and companies are automatically gifted with a perception of greater ‘scale’ over sole trader businesses.


Limited liability as you grow

Sole traders are accountable to fulfil any and all obligations entered into as a business. These could include security for loans, handling any law suits, or even simply losing the capital put forward to keep the business afloat. If, for whatever reason, your business finds itself without the means to meet financial liabilities, then you are potentially at risk of losing your personal income and possessions in order to satisfy what is required of you.

The appeal of operating a business via a company is that you create an entire separate legal entity. This means that, while you might be a director that ‘runs’ day-to-day operations, you will also have numerous shareholders who, as investors, technically ‘own’ the business. This dilutes the responsibilities of each individual owner and protects them from losing personal financial reserves or possessions to third parties.

The downside to transitioning

It might seem like transitioning from a sole trader into a company is upgrading into a desirable new business structure, but it is important to remember the benefits of running as a sole trader. Katie reminds us that, in transitioning to company status, you will have to “change your employment agreements, independent contractor agreements, supplier agreements, name on the electricity account, on the lease, on pretty much everything that the business owns or contracts to.”

To gather a better understanding of the position of your business, and whether it is a practicable strategy to transition from a sole trader into a company, it is advised you consult a finance professional.


Disclaimer: This information is general in nature and does not constitute financial or legal advice. In considering whether this information is appropriate for your needs, please seek professional advice from a financial advisor.



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