One of the first decisions made by an entrepreneur when starting a business should be the legal structure of their business.
The legal structure can have serious long-term consequences for your business’ success, says Kobus Engelbrecht, head of marketing at Sanlam Business Market.
There are four current legal entities that entrepreneurs can choose from, says Engelbrecht, including:*
“The type of business you register with the relevant authorities will depend on the nature and size of your business, as well as on your specific business needs. You need to structure your business in a tax-efficient way, but you should never choose a certain kind of business for tax reasons only,” says Engelbrecht.
He says the following aspects should also play a role in selecting the optimal legal structure for your business:
A sole proprietorship can be used only by one business owner. But even if you are the sole owner, you can also use a private company, an incorporated professional practice (if your professional association allows the use of this legal entity), a business trust, or a combination of legal structures.
If it is important to you that your business continues after your death, you should choose a legal entity that will allow this:
Running your business as a sole proprietorship will cost you nothing extra, but using a private company as a legal entity will be on the other end of the cost scale. If, however, the benefits you derive from the particular structure you choose, outweigh the cost, it would be worthwhile to incur the extra cost of the administration.
The different legal entities are taxed differently. Sole proprietorships and partnerships are taxed according to individual income tax scales (currently between 18% and 41%). A private company is taxed at a flat rate of 28%. On any amount declared as a dividend, 15% dividend tax will be levied. A business trust is taxed at a flat rate of 41%.
The different legal entities are also treated differently for capital gains tax purposes. Any capital gain by a sole proprietorship or partner is included at a rate of 40%. For private companies and trusts, the inclusion rate is 80%. All legal entities will pay transfer duty on the purchase price of an immovable property according to a scale of between 0% and 13% of the value of the property.
A question every business owner must ask is: What will happen to my personal assets if my business goes insolvent? In the case of a sole proprietorship or partnership, the business owner’s personal estate is always at risk. If you trade as a private company or trust, your business and your personal assets are separated. In the event of your business going insolvent, your personal assets will be protected, provided that you did not sign surety in your personal capacity for the debts of your business.
A sole proprietorship, a partnership and a trust can only raise finance from outside the business in the form of a loan. A private company can sell shares in the company to an investor, and therefore provides more options for financing the business.
It is possible to structure your business in a way that you use the benefits of different legal entities. You can, for instance, run your business as a private company, and set up a family trust which owns the shares in the company. In doing so, you can save huge amounts of money in estate duty, as the value of the shares in the company appreciates in the hands of the trust and not in your own.
“It is important to note that deciding on the legal format of your business can be tricky, and it is always advisable to employ the services of legal experts in the field of small business ownership. They will be able to weigh up the costs and benefits of all the options open to you, and help you to ensure future business success by choosing the most appropriate structure for your business needs,” Engelbrecht concludes.
*Note: Since no new registrations of closed corporations have been allowed since the promulgation of the Companies Act of 2008, this option is not discussed in this article.