How Insurance Differs Between a Sole Trader and a Company
Whether you currently run or are looking to start a business, consider if you’ve got the best-fit business structure to suit your needs.
The two most popular types are sole trader and company. As a sole trader, you and your business are considered a single entity, while a company is a separate legal entity. This article will explore the pros and cons and explain how insurance cover differs between sole traders and companies.
About six in 10 Australian businesses are sole traders. The high ratio may be because it’s easier and cheaper to set up than companies. You can apply for free for an Australian Business Number (ABN), pay a nominal fee to register your business name, and should set up a separate bank account.
Meanwhile, a new company will also need an ABN, but must also select and reserve a company name, then register it, and the company – all attract fees – plus open separate business banking accounts. You’ll have more paperwork and possibly higher overheads with more detailed financial records. The Australian Securities and Investments Commission will review your annual statements, and there’s a cost involved for that.
Comparing your business risks
There are some major differences, too, between sole traders and companies regarding business income and their debt liability.
As a sole trader, you’re liable for every aspect of your business, including debt. All your income is taxed at more than the full company rate of 30%. When sole traders need an injection of funds to boost business growth, they have limited options. They can only raise capital from banks, other lenders, or by partnering with other sole traders. Your lender will ask for your personal assets – such as your home and car – as security. And, importantly, sole traders who are successfully sued could lose those assets because they’re in your name, so could be used to pay off business debts.
However, you can limit your personal liability when you change your business structure from sole trader to company. This involves different taxes, costs, and legal reporting obligations. You’re creating a separate legal identity, so directors, not you, run and shareholders own the company. You’ll need a separate tax file number. To comply with the Corporations Act, you’ll appoint directors to manage the company. As well, to operate your business, you may need licences and permits, as this government website details. Each sector of industry has legal, operational, and business requirements.
Switch on to the real risks
However, a sole trader whose business is on a growth trajectory may shirk at changing the structure. Such a change might seem like adding a lot more hassle when it’s easier to work in not on the business. However, doing so risks:
- Getting a hefty tax bill
- Receiving outstanding personal tax returns which balloon your business debt
- The ATO threatening prosecution
- Being unable to untangle your personal and business income
- Relying too much on your accountant to keep your finances legal.
Finding the right cover
Your insurance needs will vary depending on your business structure and the state or territory in which you operate. However, both structures may need public and product liability as well as professional indemnity insurance. That depends on your business activities and if your clients require you to have a particular cover. Claims made under those policies could well put you out of business, and if you’re a sole trader, and see you lose your personal assets.
Despite the name ‘sole trader’, many such businesses have employees, in which case it’s compulsory to have workers’ compensation insurance. But, that insurance won’t cover you as the sole trader, which is why many gain peace of mind with a policy package that includes:
- Income protection/trauma or disability insurance (such as total and permanent disability cover)
- Life insurance
- Personal accident and illness insurance (usually a one-off annual payment, handy for a short or long-term illness or injury)
- Property and tools cover
- Tradesman insurance
We’re part of the brains trust for your business to better manage its risk profile. We might not be part of your in-house team of advisors, but we work for you, not insurers.