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Legal issues: What is the best legal form for my business?  
 
Are you asking the right question?
  • You should be in business already or you should have decided to start one.
  • You should be quite some way into your planning process, and have a very good idea of the partners involved, if any
Remember that registering a close corporation (CC) or company, or remaining a sole trader, is not such a crucial
 
question when starting a business. It certainly helps to lay a clear foundation, but it is by no means a prerequisite for doing business. If you don't register anything, you automatically operate a sole trader, and it is fine to do business as a sole trader for as long as it suits your needs.
 
Remember that registering a CC or a company in itself means nothing. You haven't created any value. Only by doing business (trading, buying-and-selling, wheeling and dealing, getting paid for doing things, etc) are you building a business. You can operate as a sole trader without registering anything.
 
Introduction
 
The most common forms of small businesses are the sole trader (also known as "sole proprietor"), partnership, close corporation (CC) and the private limited company (company).
 
The entrepreneur must decide which is the most suitable. Look at the following table. The most appropriate forms of business are marked against each of the scenarios. Keep in mind that it is impossible to list all scenarios, and that your choice can very easily be influenced by more than one factor.
 
Sole Trader Partnership CC Company
If you are in business on your own, for yourself, without major expansion plans X   X  
If you have partners   X X X
If you know your partner well and trust them, and if the business is simple with not too many assets over which dispute can arise   X    
Partners with a short-term business in mind   X    
If some of your partners are not people but organisations       X
If you want to sell the business one day     X X
If shareholding is (or will become) more complex than a simple 50/50 or 60/40 split.     X X
If you will be running a really low-risk business X X    
If the business risk is slightly higher     X X
If you want to tender for government contracts     X X
If you are working on an absolute shoe-string budget X X    
If you have some resources to start with but need to keep costs very low     X  
If you have a fair amount of financial resources       X
If you don't have to convey an impression of being a substantial business X X X  
If you have to convey the impression that you have a substantial business       X
 
Before you take a decision on which form your business will take, you need to understand the concept of a "legal person". A natural person is a "living and breathing" human being, whereas a legal person is an organisation, such as a CC or a company. The law regards the CC as a person, a legal person. A CC can be sued, for example, as opposed to suing the owners of the CC. It's a bit of a strange thought to get your head around at first, but it will become clearer as you read this sheet.
 
The sole trader
 
Sole traders (and the partners in a partnership - see below) are natural persons ("living and breathing" human beings). A single person running his or her own business is a sole trader - for example, Mrs Manana Jack trading as "Siphumelele Supermarket".
 
Advantages
  • Cheap and easy to set up.
  • No formal registration, although the business must be licensed with the local municipality.
  • No formal auditing requirements.
  • For the very small business, the owner may qualify for primary tax rebates (companies do not).
  • Conversion to a CC or company is relatively easy.
 
Disadvantages
  • The owner's personal assets are not separated from those of the business. If your business fails, creditors are going to come after you and your personal belongings (assets), as opposed to the assets of the business.
  • The business is not a separate legal entity, so the business comes to an end when the owner dies or goes out of business.
  • The trading name lacks legal protection, although it may be registered as a trademark. But that doesn't stop anyone else registering a company or CC of the same name. Correcting this can be costly.
  • The owner has to rely on his own capital and collateral.
  • Transferring ownership may be complicated by the close relationship between the business and the owner's assets, liabilities, name and personality.
  • The business is not a separate tax payer. The owner is taxed on ALL income, even if such income is not in cash.
The partnership
 
A partnership may be set up between two or more (up to a maximum of twenty) individuals who want to go into business together.
 
Advantages
  • There are few formalities when setting up. You don't even need a formal partnership agreement, although it is recommended that you do draft one.
  • No formal auditing requirements.
  • Conversion to a CC or company is relatively easy.
Disadvantages
  • Assets and liabilities of each partner are intimately associated with those of the business. If the business fails, a creditor will come after your personal possessions.
  • Each partner is held "jointly and severally" liable (that is, together and separately) for all the debts of the partnership. So if you and your partners incur debt together, a creditor can claim the full debt from you alone if your partner disappears or is unable to pay.
  • Every partner pays his own tax. Taxable income consists of each partner's profit share from the business - even if he or she did not receive the profits.
  • If a partner dies or leaves, the partnership ceases to exist and a new partnership must be formed.
Companies and CCs
  • The CC or company is a legal person, and has its own distinct legal personality and identity. Once registered with the Companies and Intellectual Properties Registration Office (Cipro), a company or CC holds its assets and trades in its own name, not in the name of the owners (called shareholders in the case of a company and members in the case of a CC).
  • May enter into contracts, and may be sued.
  • Survives the death of its owners.
  • Exists forever (or until formally de-registered) and is sold by selling the company's shares or CC's membership interest.
  • Is taxed separately from its owners.
The CC
 
Only natural persons may be members of a CC. Another CC or a company may not be a member of a CC.
 
Advantages
  • Easy and cheap to establish, and with few formalities. You can do the registration yourself.
  • Members have limited liability. This means that if the CC incurs debt that it cannot pay back, the creditor can only claim the assets of the CC, not your personal assets. But in practice very few creditors will give a CC credit if the owners do not sign surety in their personal capacity. So this advantage only really plays itself out when a CC is sued for some injury to a member of the public, for example. But even here, the owners of the CC is only protected if they haven't acted negligently in any way.
  • Unlike companies, CCs do not have to be audited. This is cheaper, as anyone with a recognized accounting qualification may be appointed as accounting officer.
  • Transfer of ownership is relatively easy.
  • Tax breaks are also available for CCs (or companies) with turnover under R5-million. But it is very easy to be disqualified from these tax breaks, so don't bank on getting them.
Disadvantages
  • More administrative requirements than sole trader or partnership.
  • A maximum of ten members.
  • If you have one main client, the taxman may classified you as an "employment broker" or "personal service company", which can lead to crippling tax complications.
  • The advantages of not having to be audited every year is offset by the following: Banks sometimes regard a CC's financial statements with some skepticism
  • The taxman watches CCs more closely
  • Potential customers may ask for regularly audited financial statements as a contractual condition.
  • A series of audited annual results are useful for valuing the business.
The company
 
The private company (Proprietary Limited Company or (Pty) Ltd) is owned by its shareholders, who may be natural persons, other companies, CCs or legal persons such as trusts.
 
The main difference between a company and a CC is that a company is subject to stricter accounting and reporting requirements than a CC.
 
Advantages
  • Shareholders' liability is limited to the issued share capital of the company, unless they have signed personal sureties or have acted illegally or negligently.
  • Trading as a company carries more weight. People tend to take you more seriously. The idea is that, because your books are audited every year, there is a smaller chance of your being a "fly-by-night" operation (theoretically, at least!).
 
Disadvantages
  • Formal and expensive to set up and operate. In practice, this is best left to accountants and auditors.
  • An annual audit is among several onerous requirements of the Companies Act. You can face heavy penalties if you do not comply. An annual audit costs thousands of rands.
  • As the owner of a formal company, you will most likely be a director - this places further legal obligations on your shoulders.
  • If you have one main client, the taxman may classify you as an "employment broker" or "personal service company", which can lead to crippling tax complications (as with being a CC).