When setting up your business it is essential to choose the right format at the outset so as to avoid administrative, financial, and legal difficulties as your business grows. Each type of business entity has its own distinct advantages and disadvantages and before choosing a business structure you will need to consider the nature, size, ownership, tax implications, and growth potential of your business. In this article, we explore the nature of sole proprietorships, partnerships, private companies and personal liability companies, and how each entity can be used effectively to achieve your business goals.
A sole proprietorship, or sole trader, is the simplest business entity that allows a business owner to operate or trade under his/her own name. In setting up a sole proprietorship, you will not need to set up or register a separate legal entity although you will need to register with SARS for the applicable taxes. Your sole proprietorship is you, and you are your sole proprietorship, meaning that no separate juristic person exists. Essentially, this means that in a sole proprietorship, there is no separation between your personal assets and liabilities and those of the business. As a sole proprietor, you will benefit from all the profits made and assets accumulated through your business, meaning that you will not enjoy what is referred to as ‘limited liability’ (such as directors of a private company enjoy). Being an ideal structure for a small business where the sole trader does not anticipate a big turnover or growth in the operations of the business, there is very little administration and relatively few costs involved in setting up a sole proprietorship. Notably, there is no registration required, set-up is relatively easy, and the sole trader retains full autonomy over the business. As a cautionary word, it is important to keep in mind that a sole trader remains personally liable for the debts of the business and if the business fails, his/her assets can be attached by creditors. If you’re planning to operate as a sole proprietor, be sure to take a longer-term view of the expected trajectory of your business. If it is likely that your business will expand to the extent that you will need to bring partners or shareholders into the business, setting out as a sole proprietor may not be the most appropriate option. While you can change your business entity at a later stage, keep in mind that it may be difficult to differentiate between what is owned by the business and what is owned by you. That said, a well-constructed business plan will provide deeper insight into the entity best suited to your needs.
Whereas a sole proprietorship involves one individual, a partnership can have between two and twenty individuals. This type of business entity is effectively a joint venture between two or more people who agree to come together for the purpose of carrying out a trade, business, or profession for the joint benefit of all the partners. That said, it is important to note that a partnership does not constitute a separate legal persona. A partnership is created by agreement that should preferably be reduced to writing, although keep in mind that this is not a legal requirement. The partners setting up the partnership are not required to register a separate legal entity although it is advisable to ensure that each partner signs a well-constructed agreement that sets out the duties and responsibilities of each partner. The nature of a partnership is that each person contributes in respect of money, property, labour, and/or skills with the common goal of making a profit, with each partner being taxed on his share of the partnership’s profits. Naturally, each partner can expect to share in the profits (or losses) of the partnership and, as such, it is advisable that the partnership agreement includes a profit-sharing ratio. It is important to note that partners in a partnership agreement have what is referred to as unlimited liability meaning that each partner remains personally liable for the debts of the business. Once again, before setting up a partnership, it is important to take a longer-term view of the business and its growth trajectory. Remember, the nature of a partnership is such that every time one partner leaves or a new partner is introduced, the previous partnership ceases to exist and a new one is effectively formed which affects business continuity and planning. Further, because of the shared responsibility between the partners – of whom there could potentially be twenty – decision-making can be slow and ineffective especially where there are multiple partners spread out geographically. Having said that, keep in mind that it is relatively easy to convert a partnership into a private company should the need arise.
Being a separate legal entity, a private company – or (Pty) Ltd – may be founded and managed by up to fifty people. However, the registration requirements for a private company are quite onerous and the entity must be registered with the Companies and Intellectual Property Commission (CIPC) meaning that administration and set-up costs are higher and will include annual fees payable to CIPC. In terms of legislation, only one shareholder is required in a private company with shareholding limited to a maximum of fifty shareholders, keeping in mind that private companies are prohibited from offering securities to the public or registering on the stock exchange. As separate legal entities, private companies are taxed in their own right and provide shareholders with limited personal liability if the company cannot pay its debts. This limited liability enjoyed by company shareholders is due to the fact that the debt is effectively owned by the company and not by the individual shareholders. Generally speaking, a private company entity is ideal for more complex business which anticipates long-term growth, faces higher risks, and anticipates hiring more employees down the line. This type of structure can also make a company seem more professional and attract a higher calibre of clients as well as investors. If the company is required to be reviewed or audited, keep in mind that this will add costs to the bottom line. There are many intricate legal requirements when setting up a private company and it is highly advisable to use a professional.
Personal Liability Company
A personal liability company is a private company mainly used by associations such as lawyers, engineers, and accountants, with there being no limit to the number of shareholders in this type of entity. This type of company must be set up by a Memorandum of Incorporation which must specifically state that the company is a personal liability company and, as such, the name of the company ends in the word ‘Incorporated’. The directors of an incorporated company (including previous directors) are jointly and severally liable for any debts and liabilities of the company during their respective periods of office as they are. As a director (or past director) of a limited liability company, you may be responsible for any contractual debts and liabilities incurred by the company during your tenure – in other words, debt that was incurred during the company’s financial and commercial activities – although this debt does not include liability for delictual claims or unjustified enrichment claims as these are not contracted liabilities. This type of company is best suited to professionals such as attorneys, doctors, and accountants who are statutorily prohibited from enjoying limited liability. Owners of a personal liability company are free to decide how they want to distribute the profits to the members of the company and there are no fixed rules as in the case of a private company. In addition, personal liability companies are subject to fewer disclosure and transparency requirements than private companies.
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