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11 Jan 2017

Starting a Business in 2017: The Private Company Option

“My best entrepreneurial advice is to start”
(Dave Morin, entrepreneur, angel investor, CEO and co-founder of social network Path)

In our last article in the series “Choosing the right legal entity for your business” we looked at the partnership option.  Let’s move on to the private company option, where your business is owned and operated, not by you as an individual or by a group of individuals, but by a “(Pty) Ltd”.

Although CCs (close corporations) still exist, no new ones are registered, so we will not consider them here other than to note that the owners of a CC are “members” not “shareholders”).

What is a private company?

Our law treats a private company as a separate legal entity, a “judicial person” with its own “legal personality”.  It exists in law separately from its managing officials (directors and management employees) and its owners (shareholders).  You can have as many shareholders as you want (the old limit of 50 has fallen away).

Your personal assets are separated from your business risks. In fact the whole concept of modern laws recognising separate “corporate entities” traces its roots back to the idea that entrepreneurship would be encouraged when individuals could limit their trading liability to their own investment in the business.

Like sole traders and partnerships, a company can use a separate “trading as” name like “XYZ Enterprises (Pty) Ltd t/a Plucky Plumbers” perhaps.  But it’s always the actual company that trades, contracts and pays tax.

7 advantages of private companies…

  1. A company has “perpetual succession” – it survives the death/incapacity/insolvency/exit of the directors and shareholders.  That carries a host of practical benefits, including making it a possible estate planning tool.
  2. Transferring ownership and management is easy – shareholders and directors change but the company lives on.
  3. Directors and managers have limited liability.  Note however that directors and senior managers can be held personally liable in cases of reckless or fraudulent trading, non-compliance with statutory duties and the like – the “new” Companies Act in particular has imposed a whole new set of duties and risks in this regard.  Bear in mind also that that your limited liability falls away to the extent that you sign personal surety for company debts.
  4. Shareholders are in general not liable for the company’s debts, although they do risk liability for some tax debts e.g. if they control or are regularly involved in the management of the company’s financial affairs.
  5. It is generally easier to raise funding for a company than it is for a sole tradership or partnership.
  6. Similarly, a company is adaptable to both small and large businesses, so if you are starting off small but planning to grow substantially, consider using a company from day one.
  7. Tax:  Sometimes an advantage … see below.

… and 3 disadvantages

  1. Formation:  Unlike sole traderships and partnerships, companies require formal registration and compliance with various formalities.  Factor the attendant delay and cost into your plans.  Using a shelf company can reduce the hassle but make sure you buy it from a reputable business.
  2. Costs of administration:  Prepare for a higher administrative and regulatory burden than with your other choices.  Factor in both the time and financial costs of complying with the host of legal requirements, statutory returns and general red tape associated with companies.  Find out up front for example whether you are going to have to pay for a full audit or independent review every year.
  3. Tax:  Sometimes a disadvantage … see below.

The tax angle

It is impossible to give general advice here; seek specific guidance on what is the most tax-efficient entity or structure of entities for your particular situation.  Consider the different tax rates applying to corporate entities for income tax, capital gains tax, transfer duty etc; also the implications of dividend tax, estate duty, exemptions and rebates only available to individuals and so on.

The bottom line is this – take full professional advice on both the legal and the tax implications of using each type of entity before choosing.

Next time we’ll look in more depth at the business trust option.

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