When setting up your business, deciding between a sole proprietorship, partnership, or private company is crucial, each carrying distinct pros and cons. Picking the right structure for your venture demands careful evaluation. Factors to weigh include:
Key features: If you’re planning a one-person business, you may consider running a sole proprietorship which is the simplest form of business entity that involves very little administration – although note that a sole proprietorship is not a legal entity and does not exist separately from the owner. In the case of multiple business partners, the available options include setting up a partnership (or joint venture) or registering a private company. What is important to appreciate is that personal liability in each structure varies, which we will deal with in greater detail below.
Trading name: As a sole proprietor, you’re free to choose any name for your business without any registration requirements, with the option to trade under your own name or any fictitious name for trading purposes. Similarly, there are no registration requirements for a partnership and the partners remain 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) which will first need to approve the chosen name for your business.
Personal liability considerations: If running a sole proprietorship, keep in mind that as you and the business are one and the same person, and you will be legally liable for all the debt of the business. Similarly, a partnership is not a separate legal entity and, because the partners have unlimited liability, they may be held personally liable for the debts in the business. This can be risky especially when one partner acts negligently or recklessly causing financial loss to the partnership. On the other hand, 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). Limited liability means that should the company become insolvent, the creditors cannot claim from the personal estates of the shareholders.
Business registration: A notable advantage of setting up a sole proprietorship is that there are very few setup requirements. 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 registered as a taxpayer, you’ll simply need to file your tax returns as usual, with any business income being declared as part of your personal income tax. Although there are no legal requirements for registering a partnership, it is always advisable to set up a partnership agreement. The registration of a private company is strictly regulated by the CIPC, and you’ll need to provide them with all supporting documentation, including a Memorandum of Incorporation and shareholder’s agreement, bearing in mind that there are registration costs involved. 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.
Decision-making: Naturally, as a sole proprietor, you’ll have full autonomy over the running of your business. In a partnership, the duties and responsibilities of each partner should be set out in the partnership agreement remembering that all decisions will need to be made collectively. As partnerships can have up to 20 members, decision-making can be slow and cumbersome if there are too many people involved. In the case of a private company, all directors have shared control of the business, and all decisions must be recorded in the form of company resolutions.
Planning for growth: A significant advantage of setting up a private company is that this type of entity is perfect for future growth of the business. If you’re the only shareholder in your private company, it is relatively easy to bring on additional shareholders without having to change the structure of the business. On the other hand, if you initially set up as a sole trader and then decide to bring in additional resources, you will likely need to change the structure of the business to accommodate the growth. On this note, keep in mind that if you subsequently register a private company, you may not be able to register the same name as you’ve been trading under as a sole proprietor.
Financial reporting: Sole proprietors and partnerships have no obligations to prepare financials for the business. However, legislation requires that all private companies submit financial statements prepared by an accounting officer to SARS. Depending on the company’s turnover and public interest score, 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, and all business income and expenses must be declared on the company’s tax returns. Company profits will be taxed at a flat rate of 27% (as of 1 April 2023), and any dividends declared will be taxed at a rate of 20% on distributions made to shareholders. As sole proprietorships and partnerships are not separate legal entities, the owners are personally responsible for all business and personal taxes which must be declared on their personal tax returns, bearing in mind that each partner in a partnership will be taxed on their share of the partnership profits.
Dissolution: When it comes to terminating a business, there is technically no need for a sole proprietorship to be dissolved. In the case of partnerships, it is important to note that each partner has a personal interest in the venture which means that every time a partner leaves 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.
Have a super day.
Sue
