If you’re starting a new business in South Africa, one of the first considerations is business ownership. There are 3 business entities to consider:
- Sole Proprietor;
- Proprietary Limited Company, “Pty”.
We’re going to discuss the differences between these entities, their pros and cons and how you would choose which business entity is best for you.
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1. Business Entities: Sole Proprietor
You might be starting small because it’s a hobby that you’re turning into a business, or because you want to first test the market to see if someone will actually buy your product or pay for your service. The simplest and easiest way to start that kind of business is as a sole proprietor. There’s no formal registration, there are no legal requirements, and it’s easy to start.
A sole proprietor is when an individual trades in his or her own name. He or she is the business.
Advantages of doing business as a Sole Proprietor
One of the advantages is having complete control over the business. There is no profit sharing. All the profit is yours. And it’s easy to discontinue the business.
Disadvantages of doing business as a Sole Proprietor
One of the main drawbacks is personal liability. If you cannot repay the credit obligations of the business, you individually are next in line and your personal assets could be seized. This could include your car, your furniture, and even your house. Movable assets would be seized first to try and cover the business debt. But if there is not enough to pay your creditors, they can come after your house. Another drawback is that the banks can be reluctant to afford you credit because you’re seen as a high risk.
Tax considerations for Sole Proprietor business entities
Tax could be a pro or a con. This is because, since you are the business, the business income is added to your personal tax return. Therefore, the percentage at which the business income is taxed would depend on which personal income tax bracket you fall under.
2. Business Entities: Partnership
A sole proprietor is an entity for one person. However, if you want to start a small business with someone else, the simplest form of trading is a partnership. A partnership is still individuals trading in their own name, but jointly. It’s an unincorporated joint venture where the individuals are liable individually and jointly with each other.
Advantages of doing business as a Partnership
One advantage of a partnership is that together, it’s typically easier to gain access to credit. Also, as in the case of a sole proprietor, there are no formal registrations. It’s still an easy start-up procedure without any legal requirements.
Disadvantages of doing business as a Partnership
The main disadvantage is that a partnership is not scalable. Twenty partners are the limit. You can’t grow any bigger than that. The other issue is personal liability. You are still individually and jointly liable. So if the business is in trouble and you can’t pay your creditors, they can still come and take your car, for example. Even if it’s due to a decision made by your partner and it’s not your fault.
Tax considerations for Partnership as business entities
A partnership is not a separate juristic entity so the partners are still liable to add their profit of the business to their personal income for tax purposes. So that could be a pro or a con, depending on which personal income tax bracket you fall under.
3. Business Entities: Proprietary Limited Company
A sole proprietor and a partnership are both informal entities. There are no formal registration requirements. On the other hand;
- The most common formal business entity is the Company, where the shares are owned privately. In other words, a Proprietary Limited Company, or “Pty”.
A Proprietary Limited Company is a separate legal entity with rights and duties of its own. The shareholders are the owners as they own the shares in the Company. The directors are management. And sometimes a director can also be a shareholder.
Advantages of doing business as a Company
Compared to the other business entities, a Company has some serious advantages. One advantage of a Company is the fact that a Company is perpetual. Even if a shareholder dies, the Company continues its existence. A Company is scalable. So whether you’re one director or you’re ten directors, it doesn’t matter. Another advantage is the fact that you can transfer your shares or sell your shares quite easily.
Disadvantages of doing business as a Company
This entity is governed by the Companies Act and there are some legal requirements. You have to, for example, file annual returns with CIPC. Because it’s a separate legal entity, you have to register with SARS. And there are formal registration requirements to actually have a Company created.
Tax considerations for a Company
In the case of a sole proprietor and a partnership, the business is taxed based on your personal income tax bracket. However, with a Company, the income tax is capped at 28%. And it could even qualify as a small business corporation (SBC) with an even lower tax rate. It’s also easier to raise capital. Banks usually require two to three years’ financial statements when considering a credit application. Otherwise, they just see you as too high a risk.
Why Create a Company?
If the plan is to grow your business and to apply for business credit, it’s a great idea to register a Company as soon as possible so that you can start building a financial history in the name of the Company. But at the same time, you’re separating personal liability. Shareholders are not personally liable for the Company’s credit. So a shareholder can only lose the amount he or she invested in the Company.
Directors are management. Typically directors are not liable for a Company’s credit. Although, if it can be proven that they acted negligently, they could become liable. This is called piercing the proverbial Company veil. So it is possible but not as easy, to take the director’s personal car as it is to take the sole proprietor’s car.
Choosing Business Entities – a Quick Guide
- If you’re just starting up by yourself and you’re small, a sole proprietor is the simplest business entity to start.
- And if you’re two or three people and you really want something simple without registration requirements, a partnership would be the solution.
However, with both these types of business entities, you have the huge drawbacks of personal liability and the potential struggle to raise capital.
- When your business becomes feasible, that is the time to create a Company. It’s great for building a financial history. And it’s great for limiting personal liability.
Since the inception of the new Companies Act, it’s become even easier to register a Company. CIPC is really geared to quickly and cost-effectively register your Company online.
In fact, we have a video to show you step by step how you can do it yourself for only R175.
Plus, if you need help, we have IP Braai Company Registration Packages for less than R1000.