The Pros and Cons of A Sole Trader Versus Company

April 25, 2022

When starting a business in Australia, there are a few things to consider. The first is what type of business you want to start, and often the choice is between a sole trader or a company.

To understand the differences between a sole trader versus a company in Australia, it’s very important to understand how and why the different business structures exist, because this means you will have true and lasting knowledge of the differences, and more importantly why they are different, for the rest of your life.

Most accountants and lawyers do not understand or think about this, and they only know the differences because they rote learned them at University or through experience as a junior, but once you understand the brief history and how different business types developed, it’s very easy to truly understand the difference between a sole trader versus a company without having to memorise all the details.

The Easy Way to Understand Sole Trader Versus Company

It’s easy to start investigating sole trader and company business types and get lost in the sentences like “a sole trader is a person who is the same entity as the business, and a company is a separate legal entity”, and not really understand what that means, and even end up more confused.

This is because no one explains the history of business and how the different types of business structures came to be, either because they learned the hard way and don’t know themselves (i.e. they learned by rote), or they learned why the different business types exist but don’t pass the knowledge on – but it’s the key to truly understanding the differences.

I know it’s the era of skim reading, but the whole of this article is essential to understanding the difference between a sole trader versus a company, and when you do, I promise you will never lose the knowledge of the difference between different business entity types.

So, please read on, because the extra five minutes of reading the following information will cause you to understand the differences – forever.

Read it all – you can do it!

Sole Trader Was All There Was

When business enterprises first started to appear, there was no such thing as a company, there was only the sole trader.

If a person sold (or traded back then) a good, or service, the person was the business. For example, if John Smith sold or traded salt, the business was John Smith. If John Smith needed to pay tax, he paid it on any income he earned selling or trading salt or any other income from other sources.

If John Smith sold or traded salt that was fake, John Smith could get into trouble personally. If John Smith got into financial trouble selling and trading salt, John Smith could lose his personal assets and possessions.

This is because John Smith is the business, and there is no other way a business could be.

This was the most common way a business was structured until recent human history and didn’t start to rapidly change until the industrial revolution.

It was not that long ago, that Peter Jones was the local bootmaker, and there was no Nike.

Sole Trader

Peter, the Bootmaker

This is the meaning of sole trader. You are the business and the business is you. Anything the business does, good or bad, is you and you are directly liable.

How and Why Do Companies Exist?

Along the way in history, a notion developed that there could be a business that was owned by people, but it was a ‘thing’ on its own separate from the people that owned it, and it could even have its own separate name. This might seem obvious now because separate business and brand names are everywhere, but it was revolutionary at the time.

In our example, let’s pretend John Smith and his cousin Pia Smith started mining salt, employing some people to dig it up and deliver it, and they called the business JP Salt.

JP Salt is its own “thing” that is owned equally by John and Pia Smith, e.g. they both “share” 50/50 ownership of JP Salt.

50/50 Company Structure

Yeah, we’re 50/50!

This separation between the ownership of the business and the business itself created a lot of confusion in the law initially because the courts did not know how to handle a “business that wasn’t an actual person”, like a sole trader.

Eventually, with the evolution of business ownership, the courts decided that a business will be recognised by law as if it were a person in its own right. This meant a business would be an “entity” just as a person is an “entity”. In Australia (in most instances), this is called a company.

That means in our example, JP Salt would be a company and treated as if it is an actual person.

So if JP Salt were to be sued, John and Pia would not liable, JP Salt itself would be liable. If JP Salt went broke, John and Pia would not lose their assets, JP Salt itself would lose whatever assets “it” had.

The law has developed and continues to develop around companies, so it’s not quite that straightforward in regard to the protections for owners, but the basic premise remains the same – the company is treated as if it were an actual person in its own right separate from the owners.

Companies Are Not Just For Multiple Owners

Many people believe that companies are meant to be formed when more than one person wants to start a single business, but this is no longer the case in our day and age, even though it once was the case early on in history.

Most authoritative sources you may have read, even legal firm websites, mention in their articles that companies are for when there are multiple owners – this is not true anymore, and there are many benefits of single-owner companies.

In Australia, a company can have one owner which means the company and the single owner are treated under the law as separate entities.

There are obvious benefits to this for the protection of the owner, which we will get to shortly, but it is important to know that a company with a single owner is an available option, and not only that, it’s a very common business structure in Australia.

What Are the Pros and Cons of being a Sole Trader?

At first glance, it might seem like a company is the best choice because of the obvious advantages of being a separate entity from you, but there are advantages and disadvantages to both types of business structures.

To understand the more detailed difference between a sole trader versus a company, we need to understand the advantages and disadvantages, and pros and cons of a sole trader versus a company in Australia. Some of the pros and cons of the sole trader business type are listed below.

Advantages of Sole Trader Business Type

  • It’s easier and faster to start: You actually don’t need to do anything but get an Australian Business Number (ABN) and start charging people for the goods or services you’re delivering.
  • Setup costs: You don’t need to set up and register a company, and you don’t need to start bank accounts in the company’s name (remember, a company is just like a person, so it needs its own bank account).
  • Ongoing costs: Companies have annual costs to maintain registration as well as other administrative and accounting costs.
  • Income is yours immediately: Because you are the business, money coming into the business, goes straight into your bank account for your personal or business use.
  • Less paperwork: You don’t need to maintain your personal paperwork as well as company paperwork.
  • No workers compensation: You don’t have to pay for worker’s compensation insurance if you’re a sole trader, because you are not considered an employee. To protect yourself, however, you should consider income protection and other types of insurance if you are a sole trader.
  • Single tax return and accounting fees: You only need to submit a tax return and pay accounting costs for one entity (you).
  • Superannuation contributions: You don’t need to pay superannuation contributions which means you’re free to invest your profit however you like.
  • Deductable startup costs: You can claim the costs of starting up your business against the business income you receive.
  • Tax losses: As a sole trader tax losses are more easily offset against any other income you earn.
  • Failing: If you’re “having a go” to see if a business works, a sole trader business structure incurs less cost in the event of business failure (which is common).

Disadvantages of the Sole Trader Business Type

  • You’re liable: You are the business and the business is you, which means you’re liable for anything the business does and can be sued directly.
  • Tax inflexibility: Any income you make is taxable, and doesn’t go through another entity to provide flexibility with tax treatment.
  • Business longevity: If you retire or die, so does your business.
  • Bank transaction confusion: Often income and expenses come from a joint bank account with a spouse or partner, which can get confusing when determining your profit and tax liability.
  • Capital raising: You can’t raise equity capital as a sole trader, because you can’t sell shares in yourself.
  • Growth: It becomes more complicated to employ people, and scaling is limited as a sole trader.
  • Selling the business: It’s more difficult to sell the business when the income and expenses of the business versus the person are not as clear, and the assets and goodwill are not as straightforward.

If you need advice, our accountants are here to help.

What Are the Pros and Cons of a Company?

Companies have a more complex business structure compared to a sole trader, but as with anything, there are advantages and disadvantages that need to be considered against your unique circumstances.

To understand the more detailed difference between a sole trader versus a company, we need to understand the advantages and disadvantages, and pros and cons of a sole trader versus a company in Australia. Some of the pros and cons of the company business type are listed below.

Advantages of a Company Business Type

  • Personal liability: This is a big advantage of a company over a sole trader. When you run a company, you are not the business, which means your personal liability is limited.
  • Tax flexibility: In the first instance the company is the entity being assessed for tax by the ATO, which gives you flexibility in how you distribute company profit and how much tax you pay.
  • Business longevity: Because the business is separate from you, it survives your retirement or death.
  • Clear accounting: Your personal transactions are not mixed up with your business transactions which makes accounting much easier.
  • Capital raising: You can raise equity (share) capital as well as debt capital.
  • Growth: It’s easier to employ people and scale a company.
  • Selling the business: It’s easier to sell a company, either as a share or asset transfer.

Disadvantages of a Company Business Type

  • Profit distribution: Profit is not immediately in your bank, and you need to distribute profit through a mechanism.
  • Compliance: You need to maintain more paperwork to remain compliant with the Corporations Act 2001, which governs companies in Australia, as well as other regulatory bodies.
  • Startup costs: Startup costs are more as you simply need to do more, transact with more government bodies, and pay more fees when starting up a company.
  • Ongoing costs: You need to pay ongoing fees to maintain a company, as well as paperwork to comply with legislation and associated accounting and legal costs. You also need to lodge a tax return for the company, and for yourself which increases ongoing costs.
  • Control: Many people list having less control as a disadvantage to the company business type, however, it is important to know that this is only where there is more than one owner. If you are the only owner of the company, this is not an issue. Where there is more than one owner, decision making can be more complex and take more time.
  • Tax losses: It’s not as easy to offset tax losses against other income you earn personally.
  • Cost of failure: Due to the increased startup and maintenance costs of a company, the costs incurred if the business fails are greater than a sole trader business type.

If you need advice, our accountants are here to help.

How Do I Know Which Type of Business Is Right for Me?

It can be difficult to understand the difference between a sole trader versus a company. However, by considering the pros and cons of each option, you can make an informed decision that is right for you.

Generally, if you’re just “having a go” to see if a business works for you, and the risk of personal loss is low, a sole trader business structure may be the best choice.

If you have a lot of confidence in the business, want to scale it, or there is a higher risk of personal loss, a company structure may be the best for you.

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