Choosing the right format is an important part of setting up a business, especially since some forms of enterprise must be registered with the Registrar of Companies and need to meet certain legal requirements.
The kind of business format you choose will depend on the nature and size of your business and should suit your specific needs.
Small and medium enterprises (SMEs) can take one of three forms: a sole proprietorship, a close corporation or a private company. Before deciding which form your business should take, it is important to know the pros and cons, the requirements and obligations that come with each model.
This is the simplest kind of independent business, as a sole proprietorship does not need to be registered as a legal entity. You can only choose this option if you are a single owner, irrespective of whether you employ or contract other people during the course of your work.
A sole proprietorship is often the ideal choice for a professional in private practice, a guest house owner or the owner of a small craft business. This model does have some disadvantages.
For many, though, the advantages outweigh the disadvantages, as long as the business is carefully managed.
Some advantages of a sole proprietorship:
- It does not have to be legally registered;
- It is a simple format to set up and manage;
- It is suitable for a single owner, whether or not he or she employs or contracts other people;
Disadvantages:
- There is no distinction between the business's assets and the owner's assets;
- There is no distinction between debts incurred by the business and those incurred by the owner;
- The owner is fully responsible for all debts and liabilities incurred during the course of business;
Another option for a small business is to trade as a close corporation. Close corporations need to be registered as legal entities but provide owners with more legal protection than a sole proprietorship.
This option is suitable for single-owner enterprises as well as businesses owned by up to 10 partners, usually with turnover of up to R1 million a year.
The biggest advantage of a close corporation is that it separates the business's assets and liabilities from those of the owner or owners, providing them some legal protection without imposing the requirements that have to be met by a private company.
In a recent ruling, however, the Cape high court established new law for the circumstances in which members and managers of a close corporation can be held personally liable for the firm's debts.
The lack of immunity from company debt is one of the reasons why many clients and suppliers have come to distrust close corporations, as the owners effectively have little legal obligation in the case of business failure.
Managed well, however, close corporations provide a good structural framework for smaller businesses.
Some advantages of a close corporation:
- It is a legal entity that separates the rights and liabilities of business and its owner(s);
- The legal requirements for registration are less stringent than for a private company;
- It is suitable for businesses owned by between one and 10 owners;
- Members have a predetermined share in the business;
- It is under no legal obligation to produce audited financial statements;
- It is under no legal obligation to have an annual general meeting (AGM);
- There are no prohibitions on a close corporation to avail itself of financial assistance to purchase a member's share;
- It benefits from a flat tax rate, which may be advantageous if the business has a high turnover. However, this may put the business at a disadvantage if the turnover is low;
Legal requirements:
- Close corporations have to be registered at the Companies and Intellectual Property Registration Office (Cipro);
- Only individuals may be members, not companies;
- When registering, the members must provide a founding statement outlining the nature and purpose of the business;
- The business's name has to be reserved and registered;
A private company is usually the preferred choice for medium-sized enterprises with up to 50 shareholders.
It has to be legally registered and must have a managing director.
The shareholders are not personally liable for any debt that the company might incur during the course of doing business.
It has the added advantage that both individuals and close corporations may be members.
Unlike a close corporation, however, it has more well-defined legal obligations to meet and is a more complex and expensive structure to set up and run.
Private companies must:
- Be registered with Cipro;
- Have strict laws governing the duties and responsibilities of the company's directors and officers;
- Issue annual audited financial statements;
- Hold an AGM;
- Avail themselves of financing to purchase members' shares when necessary;
- Have a memorandum of agreement defining the company's nature and purpose;
- Have registered articles of association;
- Reserve and register the company name; and
- Have a registered physical address and a postal address.
These three formats are clearly applicable to three very different types of business.
The choice between them is usually straightforward, determined by the nature of the business and by its short- to medium-term business plan.
- Reprinted with permission from Business Partners, South Africa's leading investor in SMEs.