When starting a business, for those entrepreneurs who aren’t legally minded, deciding what business form their start-up will operate as, might not be seen as an obvious starting point. The reality however, is that it is one of the most important decisions you’ll make, and so it should be the very first step you take in creating a start-up.
When choosing the form of business you are going to work through, the number one issue to consider is risk. You need to decide whether your start-up will be a separate legal entity to you, or whether you will work in your personal capacity.
Where you and your start-up are the same legal entity, you will personally be liable for all debts of the business (as is the case of a sole proprietorship or partnership) – be it a company (public or private), closed corporation, partnership, trust or sole proprietor.
If you work through a company (or closed corporation or trust), then you cannot lose more money than you have invested personally. Rather, it will be the company that will have the liability.
In other words, you won’t be held responsible to pay for any debts or liabilities in your personal capacity. This is the primary reason why companies have taken off and become the preferred form of business worldwide.
To break it down:
- Sole proprietorship (i.e. if you do business in your personal capacity): you are liable for all the debts of the business
- Companies: you have limited risk, and your risk is limited to the amount you invest
- Partnerships: you and your partners are liable for all the debts
The second issue to consider when choosing your form of business is professional presentation. Start-ups should opt for the ‘company’ vehicle for these two reasons:
Operating your business through a company allows you to present it more professionally to investors, lenders, business partners and even service providers like accountants.
This is due to the fact that the company is such a clear ‘vessel’ for the business, as it has no other baggage. For that reason, bringing investors on board is much more viable.
For example, if you ran your IT development business as a sole proprietorship, the business’ balance sheet would almost always overlap with your personal balance sheet – when are expenses yours, and when are they the businesses?
This may have short term tax advantages, but this is messy and confuses investors, lenders and accountants.
On the other hand, investors and customers themselves understand how companies work, and they can more quickly evaluate the prospects of your business without having any “contamination” or “noise” from your other interests.
Companies are familiar, which makes them crystal clear from a financial management perspective (compared to partnerships, trusts or sole proprietors).
Why the other forms are less appealing for start-ups:
- Sole Proprietorships are probably the most common business vehicles, as there is no registration or legal process required. However, it is less suited if you have your sights on growing an ambitious business, and certainly less presentable to prospective investors.
- Partnerships are also common business vehicles, but not recommended as it quickly becomes complicated to manage liability within itself. Should your professional body require it, we typically recommend using the company version and Inc. Although you will still have personal liability, it will allow you to present a corporate structure with all the benefits in that regard.
- Trusts are quite unusual and clunky to do business with. Unless you have a specific reason or need to use it, this form is not recommended.
More good news is that the South African business regulations are particularly supportive of setting up a company. In fact, it is your constitutional right!
For this reason, a new system was put in place (in 2008), which created simpler, better and faster company set up processes and regulations. Numerous websites for companies such as our firm also provide portals to assist you at low cost.
In closing, setting up a company has never been easier. It limits your risk and allows you to present your business professionally to customers, investors and business partners alike.