What you should know before setting up a business
Five out of seven business start-ups in South Africa fail in their first year according to Rob Davies, Minister of Trade and Industry. Globally, one out of two start-ups fails during its first year.
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5 Forming a business
You can either set up a brand-new business, buy an existing one or join a franchise. In order to determine which structure would help your business thrive, you will have to think through the implication of the laws governing each business structure, the tax implications of each options and how much experience and credibility you (or your franchiser) can bring to the table to allow the business to grow.
Choosing a business structure
One of the key decisions you will have to make when you start your business is choosing a legal business structure to use. This will also impact the way SARS will tax your business. Because it’s such an important decision, you should get advice from a qualified independent business, financial or legal advisor.
The structure of your business will depend on the size and type of business that you are establishing, as well as your personal circumstances. If you need more support, a partnership could be what you need. Otherwise you might consider registering as a sole proprietor if you want to maintain decision-making control over the business’s operations.
Below, we review the advantages and disadvantages of the different types of businesses, ranging from sole proprietorships and partnerships to private companies and public companies.
A sole proprietorship is the simplest form of business structure and it is relatively easy to establish and maintain. As a sole proprietor, you maintain complete control of your business and there is no division between business assets or personal assets. This means that your personal assets could be used to pay off business debts.
|You can maintain full control of your business and run it without the interference of anyone else.||If your business gets into debt, you will be liable which may place your personal financial wellbeing at risk.|
|You can retain all of the profits of the business.||It might be difficult to raise finance to fund your business or expand it.|
|Your information will be kept private and the legal requirements and restrictions are less than those of other business structures.||The life of the business can be limited since legally, the proprietorship and the owner are considered one and the same.|
|As a sole proprietor, you can offer a more personal service which could appeal to potential customers.||Because of a limited customer base, you may be unable to buy in bulk and thus benefit from the economies of scale. This could increase the price of your products or services.|
|Your business is flexible and you will be able to act on decisions quickly and cater to your customers early.||The success or failure of the business rests on the business owner, which can lead to pressure and a lack of work/life balance.|
|There is a great sense of accomplishment in knowing that you are working for yourself and over time, you will grow more confident in your abilities.||You will have to assume responsibility for most managerial tasks such as purchasing, selling, financing etc.|
If you are setting up a business and you want to keep it small and control every aspect of it yourself, this might be the structure for you.
If two to 20 people come together to form a business, this is called a partnership. A partnership is not taxed in the same way that a company would be and there are no statuary audit requirements. When forming a partnership, a “partnership agreement” is essential and it will include information about the formation, profit sharing, salaries, banking arrangements, changes of partnership, liquidation and stipulate each partner’s responsibilities.
Depending on the needs of the business or the partners’ preferences, all the partners can be involved in running the business or there could be ‘silent’ partners (those who invest money but are not involved in managing it). A partnership may be the structure you want to establish if you can think of people who you trust, who have multiple skill sets and can complement your talents. However, if you are only bringing in a partner because of their financial contribution, then you should be aware that you could also be giving the person a significant say in how the business operates when they become a stakeholder. You will also have to think about how profits will be shared in the future.
When you are establishing a partnership, you will need to have a lawyer draw up a partnership agreement to ensure that everyone is clear about what they are contributing, their responsibilities and how they can benefit from the partnership. This will also help to prevent disagreements at a later stage.
Ultimately, forming a partnership should be based on what is best for the business.
|Partnerships provide mutual support and companionship. There is always someone to share the burden of the business with.||There may be differences in personal aims and objectives for the business.|
|You gain access to another individual’s skills, knowledge and experience. In addition, you are able to complement one another’s skillsets.||Decision-making can be slower since you will be collaborating together. Having a business partner to whom you have to justify your reasoning is an excellent way to ensure that you’re making sound decisions.|
|Having an alternative perspective to an issue in the business could help you find unique solutions to problems.||You have to ensure that your partner can match your work ethic otherwise you risk developing resentment in the relationship.|
|A partner could be able to invest financially in the business, thus lessening your personal monetary risk.||A partner will, however, also have to take a share in the profits or gain a controlling stake in the business. A partner will usually expect to be paid more than other staff.|
|The partners are free to set their responsibilities and benefits as they see fit or as the needs of the business indicate.||If things go wrong, the partner may leave you dealing with liabilities or lawsuits. The business-related acts of one partner legally bind all other partners.|
|Having a partner enables the business to cope with expansion and you might even consider inviting additional partners as the business grows.||Depending on the nature of the partnership, there could be a substantial amount of paperwork and legalities to deal with when you are setting up the business.|
|By bringing in a partner, you have access to a new network of contacts, which could help you find more suppliers, establish a solid client base or provide more opportunities for capital.||Being in a partnership can be compared to being married in that you will probably end up spending as much time around your partner as you do your spouse. If that makes you uncomfortable, you might want to consider an alternative arrangement.|
There are different types of partnerships, one of which could work best for your business. A general partnership means that each partner is involved in managing the business and is responsible for the liabilities of the business. If one partner is sued, all the partners are liable.
In an en commandite partnership, there are one or more general partners and one or more limited partners. While general partners are active managers and are also liable in terms of partnership obligations, limited partners do not participate in management and have no liability for partnership obligations beyond their capital contributions. This means that limited partners are protected against personal liability for the partnership’s debt and other obligations. However, they do receive a share of the profits for their involvement as limited partners. In this way, the limited partner plays the role of a silent partner.
An en commandite partnership provides each owner with liability protection against the actions of their partners. Each partner has an equal role in the decision-making processes of the business, and equal shares in the business’s profits and losses. However, it is important to know that en commandite partnerships are only available for particular occupations.
Since the implementation of the Companies Act (Act 71 of 2008), no CC can be registered and no conversions from Companies to CCs will be allowed. However, existing CCs will be maintained.
This is the most likely structure for entrepreneurs who want to benefit from the advantages of running their business as a company in that it is essentially a new entity which is separate from the business owner(s). The private company has shareholders who own the business and managers (or directors) who run it – depending on the business’s needs, these may be the same people.
Private companies are registered with www.cipc.co.za and must submit an annual return each year, to ensure that they are still trading. Smaller businesses will have an annual accounting review completed by an accountant (which is simpler than an audit).
If your business is running as a private company, you have a more professional image and are able to have several people share ownership of the business. This also makes it easier to sell portions or all of the company to future buyers.
Private companies comprise of between one and 50 members, cannot sell shares to the public and are not listed on the stock exchange. This means that the private company does not need to publish their financial statements publicly.
|The company has a perpetual lifestyle and can continue even if one of the owners dies.||Private companies have many legal requirements and are difficult and expensive to register.|
|Shareholders have limited liability, but directors are personally liable, if they are running the business in a reckless or fraudulent manner.||At least one director is required.|
|Private companies can be adapted to both small and large businesses.||Shares may not be offered to the public and cannot be listed on the stock exchange.|
|The financial statements of a private company are not public.||A minimum of two shareholders are required for a meeting, unless it is a one-person company.|
|Raising capital for a private company is easier, as long as the business has a track record of profitability or shows potential for growth.||Annual financial statements must be audited.|
|If you enjoy being a passive investor, you can invest in a private company without having to take responsibility for the day-to-day management of the business.||If you are investing in a private company, your investment is illiquid, which means you will have to wait before you are able to generate an acceptable return on investment.|
If you have established a private company and it outgrows your ownership, you could consider going public at a later stage. Public companies are owned by shareholders who are members of the public, and are listed on the stock exchange. A public company requires at least seven members with a minimum of two directors.
By going public, a company can raise capital which can increase its potential for expansion, product development, construction, expansion into new markets and acquisitions. Public companies must inform shareholders about and get approval for the company’s operations, financial performance, management actions and other decisions. However, it is expensive to change the structure to a public company and there are intricate legal requirements concerning board regulations and responsibilities.
|Public companies tend to have more prestige and visibility.||Public companies tend to take longer to make decisions since management will require approval from a board of directors or group of shareholders.|
|Shareholders can diversify their investment portfolios, due to the marketability of their shares.||If shareholders are looking for quarterly performance, management might lose sight of long-term objectives.|
|If you are a member of management, you will usually be compensated at a higher level than if your company stays private.||Financial disclosures and their announcements could also lead to a loss of secret competitive information.|
|Shares that are publicly traded are usually more expensive than shares that are not publicly traded. This means that the business’s value is likely to increase.||More time is spent meeting regulatory requirements, meeting investors, preparing for conference calls and communicating with key stakeholders.|
|Gaining access to additional capital assists in enabling the business’s financial standing.||The costs related to managing the company increase, in terms of accounting systems and auditing costs.|
|Public companies are usually large and, thus, can take advantage of the economies of scale and save costs on equipment or materials.||Control of the company and management positions can be taken away from existing management if a dissident investor or group of investors acquires majority control.|
This is a very broad explanation of business structures and there are always exceptions to the rules. Before you sign any legal documents, do your research and contract the services of an independent legal, accounting or auditing professional with expertise in this area.