If you’re planning to set up a business, you may be struggling to decide which legal entity is the most appropriate for your needs. Choosing between a sole proprietorship, partnership or private company are your most obvious options, with each entity presenting its own notable set of advantages and disadvantages. There is much to consider when selecting the most appropriate structure for your new business, which includes the following:
If you are planning on going it alone, you may be considering registering as a sole proprietor which is the simplest form of business entity that involves very little administration. A sole proprietorship is not a separate legal entity, and the business does not exist separate from the owner which has implications in respect of owner liability. If you are planning to launch your business with a couple of other entrepreneurs, setting up a partnership is something you may wish to consider. As in the case of a sole proprietorship, a partnership is not a separate legal entity but is rather a joint venture between two or more people who wish to carry out a business together. This means that the partners have unlimited liability in their personal capacities, and it is important to consider the implications of this upfront. On the other hand, a private company is a separate legal entity in its own right and, as such, the shareholders have limited liability. However, a private company is subject to more legal and administrative requirements and requires more upfront capital to set up.
Naming your business
As a sole proprietor, you are free to choose any name for your business without any obligations to register the name. You can trade under your own name or set up a fictitious name for trading purposes. Similarly, there are no registration requirements for a partnership and the partners are free to choose their trading name. On the other hand, setting up a private company requires that your entity is registered with the Companies and Intellectual Property Commission (CIPC) who will first need to approve the chosen name for your business.
If you set up as a sole proprietor, it is important to keep in mind that you have unlimited liability as the owner. Because you and your business are one and the same person, you will be legally liable for all the debt of the business. Similarly, because a partnership is not a separate legal entity, the partners have unlimited liability and may be held personally liable for the debts in the business. This can be problematic especially where one partner acts negligently or recklessly causing financial loss to the partnership. Shareholders of a private company enjoy what is referred to as limited liability in that they are generally not responsible for the liabilities of the company, subject to a few exceptions. This means that if the company becomes insolvent, the creditors cannot claim from the personal estates of the shareholders.
There are very few requirements when it comes to setting up a sole proprietorship. While there is no need to register your business with the CIPC, you will need to register with Sars for tax purposes if you are not already registered. Once you are registered, you will simply need to file your taxes as normal, with any income that you make from your business being declared as part of your personal income tax. In setting up a partnership, there are no legal requirements for registration although you will need to ensure that you set up a partnership agreement. Registering a private company is highly-regulated and you will need to ensure that your company is registered with the CIPC with all supporting documentation, including a Memorandum of Incorporation and a shareholder’s agreement, keeping in mind that there are registration costs involved.
A significant advantage of a sole proprietorship is that you are your own boss and will have full control over your business. In the case of a partnership, your duties and responsibilities will be set out in your partnership agreement and decisions will need to be made collectively. Bearing in mind that a partnership can have up to 20 members, decision-making could be slow and cumbersome if there are too many people involved. From a decision-making perspective, all the directors of a private company have shared control of the business, and all decisions must be recorded in the form of company resolutions.
From a registration and set-up perspective, there are very few costs involved when setting up a sole proprietorship. However, there are registration costs involved when setting up a private company, so keep this in mind. Further, it is likely that you will need a legal expert to draft your Memorandum of Incorporation and shareholder’s agreement and to possibly structure a buy and sell agreement if required.
From a future planning perspective, a significant advantage of setting up a private company is that such an entity is perfect for the future growth of the business. If you set up a private company with yourself as the only shareholder, you can easily bring on additional shareholders without having to change the structure of the business. However, if you start out as a sole proprietor and then realise you need to bring in additional expertise, you may need to then change your entity to a partnership or private company, keeping in mind that if you register as a private company you may not be able to register the same name as you have been trading under as a sole proprietor.
When it comes to raising capital in order to expand your business, note that it will likely be easier to raise capital for a private company than to attempt to raise capital in your personal capacity as a sole proprietor.
As a sole proprietor, you have no obligations to prepare financials for your business. Similarly, there are no statutory audit requirements in respect of partnerships. All private companies must submit financial statements prepared by an accounting officer to Sars. Depending on the company’s turnover, audited financial statements may need to be prepared and submitted.
Tax and VAT
A private company, as a separate legal entity, must be registered as a taxpayer in its own right, an all business income and expenses must be declared on the company’s tax returns. Company profits will be taxed at a flat rate of 28%, and any dividends declared will be taxed at a rate of 20% on distributions made to shareholders. In the case of a sole proprietorship and partnership, as they are not separate legal entities, the owners are personally responsible for all business and personal taxes, and these must be declared on their personal tax returns. Each partner in a partnership will be taxed on his share of the partnership profits.
A sole proprietorship does not technically need to be dissolved, meaning that if you stop trading as a sole proprietor there is no need to de-register or close down a business. When it comes to a partnership, each partner has a personal interest in the venture which means that every time a partner leave or a new partner joins, the partnership needs to be dissolved and reconstituted in terms of a new partnership agreement. A significant advantage of a private company, being a separate legal entity, is that its lifespan is perpetual. Shareholders may come and go, but the legal entity of the company will remain in place until it is intentionally de-registered by the shareholders.