The correct business structure is the key to success
Choosing a business structure for your small business is a decision not to be taken lightly. The right business structure can affect your personal liability, taxes, administration costs, paperwork and your ability to raise money.
To understand the different structures, it is important to first understand the meaning of a natural person and a legal person. A natural person refers to a living and breathing human. A legal person can be a closed corporation or company. In South Africa there are four types of business structures which are common.
Sole Proprietorship (Sole trader)
This entity is run by a single person. It does not need to be registered. If you do business, you are automatically considered to be a sole proprietorship. The advantage of the sole trader is that it is cheap to set up.
The disadvantages of a sole trader are:
- You are personally liable for any debt you create.
- There can only be one owner.
- The business ends when the owner passes away.
- It will be hard to declare what is owned by the business and what is owned by the owner should you wish to change the business structure.
- It is difficult to get funding for the business and the owner will have to make use of their own capital.
This structure is best for small business with minimal risk, an owner that wants to work alone and the turnover is low.
This legal form of business is similar to a sole proprietorship. The difference is that it can have two to twenty individuals who come together to run a business.
The advantages of a partnership:
- You need to create a partnership agreement where you state the responsibilities of each individual in the partnership.
- No formal auditing needs to be done.
- You can convert it to a company quite easily.
The disadvantages of partnership:
- The partners are each personally liable for the debt created and their personal assets can be taken to settle the debt of the partnership.
- The partnership is not a separate entity, so each individual in the partnership needs to pay their own tax.
- If a partner leaves or passes away, the partnership ceases to exists and a new partnership needs to be formed.
Since the Companies Act (Act 71 of 2008), no new close corporations can be founded. Ones which existed prior to the implementation of the Act are still valid.
A private company
The private company (Pty Ltd) is owned by the shareholders. The shareholders can be natural people, other companies or legal persons such as trusts.
The advantage of a private company:
- The company is its own entity which means that the debt is owned by the company. The shareholders will have limited personal liability if the company cannot pay its debts.
- Having a company seems more professional so you may attract bigger and better clients and investors.
- You can sell portions of the company as shares.
- You can setup favourable tax rates for your business. You can also contact the South African Revenue Services to see what special tax rates are offered for small businesses.
The disadvantages of a private company:
- You need to register your company with the Companies and Intellectual Property Commission (CPIC)
- You may need to audit or review your financial records every year.
- Shares cannot be offered to the public and you can’t register on the stock exchange.
- There are many legal requirements which are best attended to by a professional.
When choosing which structure is best for your business, it would be advised to contact a professional who understands the law that govern the various structures.