How do I decide what entity to use for running my business?
Deciding which entity to use to run your business is a lot like buying a car. There are quite a few options and it can be a bit overwhelming working out if you need the Range Rover or if a good old bakkie will do. There are many things to consider depending on if you run a business on your own or with partners, what your appetite is for personal liability, and what tax implications you may be in for.
Some of the more common entities businesses might consider include a:
Sole proprietorship
Partnership
Private company
They each come with their own pros and cons. For example, it’s much easier to start off with a sole proprietorship or a partnership, as they don’t require a formal registration process, but these potentially have higher tax rates and expose their members to a higher risk of personal liability. Registering a company can incur more costs upfront, but they provide better tax rates and security for directors further down the road.
Which vehicle should you choose to drive your business? Let’s take a quick look at some of the options.
Sole proprietorship
A sole proprietorship is, well, a business that’s run by a single member trading under their own name. Sole proprietorships are easy to set up, as they don’t require any registration with CIPC or additional tax steps with SARS.
Because a sole proprietorship does not create a separate legal entity, you will use your individual tax number to manage the business. When it comes to tax time, you will fill out the income and expenditure of the business in the same tax return as you do for yourself. However, you will pay tax according to the tax bracket that your total income falls into.
The downfalls of this set-up is that there is always a risk of personal liability and potentially less access to investors as most of these will only want to work with registered companies to minimise their own risk. Another disadvantage is that no matter how low your turnover is for the business, a sole proprietorship can never qualify as a small business corporation. That said, you can still register as a micro business for tax purposes.
Examples of sole proprietors are freelance writers, graphic designers, and some lawyers.
Partnership
A partnership is similar to a sole proprietorship, in that it does not require any formal registration, except that there are two or more people involved. Usually, these people bring different skills to the business and make a decision to join forces to leverage off the other.
In a partnership, the partners will share in the profits and losses of the business. Also like the sole proprietorship, partners will be personally liable for the debts of the business. It is therefore recommended that a partnership agreement be entered into between the partners that sets out what everyone’s contributions are (be it time, money, or skills), and what percentage of profits and losses each will be responsible for.
An example of a partnership could be where various medical practitioners with different offerings (a doctor, a chiro, a dietician) come together to share office space and refer patients to each other.
Private company
A private company needs to be registered with CIPC. You’ll know a private company when you see the letters “(Pty) Ltd” behind a business name. This is a separate legal entity that also needs to register with SARS and have its own tax number and submissions. The directors of a company will also need to be registered with CIPC.
In addition to directors running the operations, a company will also have shareholders that each own bits of the company in proportion to how many shares they have. You can be a director and a shareholder, but you don’t have to make all directors shareholders. Directors usually get paid a salary from the business (like other employees), but shareholders will only get paid out of the profits of the company. These profit nuggets are called dividends and they can get paid at times the company decides, like quarterly or annually.
Like something out of Hogwarts, registering a company provides its directors a kind of cloak of invisibility. This gives the directors legal protection of their personal assets from the debts of the company. Unlike fiction though, this is not a full cloak but rather a “corporate veil”, which means that directors are not protected if they act in a reckless or fraudulent way in conducting business.
In addition to protection from risk, one of the major benefits to registering a company comes to tax payments. Companies are charged a flat rate of 28%, but this can be significantly lower depending on how you structure your business. For example, your company will automatically be considered as a “small business corporation” if it has a turnover of less than R20 million. An SBC is charged at a sliding scale tax rate of 0% - 28% based on its turnover.
Even better, if your company’s turnover is less than R1 million rand, you can register with SARS as a microbusiness and pay tax on your turnover, rather than your taxable income. Microbusinesses are taxed between 0% - 3% on their turnover. Whilst turnover tax is quite attractive at face value, because it’s much less of an administrative nightmare, you might need to crunch your own numbers to see whether going this route gives you a better tax rebate.
If you’ve ever bought a car, you will know that salespeople are usually very helpful until the paperwork is signed and you drive away. But, not everyone has your best interests in mind when they make the sale. This is why it’s important that you have a full grasp of what your needs are right now, and where you’d like your business to go in future.
It is quite possible for your business to evolve from a sole proprietorship, into a partnership, and then into a registered company. For some people, registering a company straight away (even if they are trading on their own) might be the most sensible way to go.
Choosing to go the Range Rover or bakkie route should be made with the intention of keeping everyone in your car safe, and ensuring you get from A to B in the most straightforward and least stressful way possible.