Types of business structures

Jakarasi

In our previous discussions I highlighted that your choice of a legal structure for your business is very critical because it will affect operating efficiency, transferability of ownership or shareholding, the control of the business, the way you report income, the taxes you pay and your personal liability. An entrepreneur can choose from these basic structures, namely, sole trader/proprietorship, partnership, private or public limited company. All business legal structures are regulated by governments in terms of initial registration, annual reporting, taxes and operating licenses. So the type of structure you choose has future implications. Some laws make it difficult to change your legal structure once you have commenced operations. To avoid these potential problems, it is advisable to consult your accountant or lawyer who will help you to make well-informed choices.

The simplest of the legal structures for any business is the sole trader/ proprietorship.  With this type of business the owner is not legally separated from the business. The business is controlled by one person. Because the business is not separated from the owner all liability rests on the owner. Business creditors can sue the owner for any debts incurred for the benefit of the business. This business structure exposes the business owner’s personal assets. If you want to protect your personal possessions then this structure is not ideal. If you have to raise capital through equity contributions it’s impossible because the structure does not allow outside investors. You will have to change the structure.

The owner is responsible for the taxes. A sole proprietorship does not continue in perpetuity. As soon as the owner passes on the business stops existing. Ownership can be transferred by selling of the assets. The advantages of a sole trader is that it is inexpensive to start and simple to run and when paying tax you don’t have to make separate tax returns. However the disadvantages are that personal liability is unlimited and ownership is only limited to one person.

The second structure is a partnership. It is almost like a sole proprietorship in that the owners are not legally separate from the business. The only difference between a sole proprietorship and partnership is that a sole proprietorship has only one owner and a partnership has two or more owners. The owners pay taxes in their individual capacity after sharing profits. The partners have equal management rights and control, or their responsibilities and control can be spelt out in a written partnership agreement. If a partner dies or leaves the partnership, the partnership will be dissolved unless the agreement specifies or provides for the continuation of the business by the remaining partners.

All partners have equal ownership of all business assets and liabilities or in proportions defined in the partnership agreement. The partnership agreement determines how a departing partner will be paid for part ownership when he or she leaves, dies or retires. The advantages are that ownership is not limited to one person, you can have more than one owners. The disadvantages are that the partners have unlimited personal liability, each partner is legally responsible for the business acts of other partners. On tax issues each partner is required to submit separate tax returns.

The third legal structure is a private or public company which is registered as a separate legal entity from its owners. On registration you have to file company documents with the registrar of companies to effect registration. A fee is paid for the company to be registered. The company will have a separate corporate bank account and all transactions for the company are recorded separately from the owners’ personal transactions. The money generated from the transactions is owned by the company. The company will be required to pay income tax on its profits and also whenever it pays dividends to its shareholders.

The operations of the company are governed by the articles of incorporation which would have been approved by the shareholders. The shareholders appoint directors who will be responsible for overseeing the running of the company and would be responsible for major decisions, including selection of company officers. A company can exist in perpetuity even if one or more of the shareholders/owners dies. The ownership of the company can be transferred by sale of shares. The advantages of a company are that shareholders have limited personal liability and ownership is easily transferred by sale of shares. Other investors can be added by sale of shares. The company can exit in perpetuity. The company submits separate tax returns. The disadvantages are that it is more costly to set up and maintain a company.

The type of business structure to use will depend on a number of factors, from the type of business you are operating to tax implications.

About the author

Stewart Jakarasi is a business & financial strategist and a lecturer in business strategy and performance management. He provides advisory and guidance on leadership, strategy and execution, preparation of business plans and on how to build and sustain high-performing organisations. For assistance in implementing some of the concepts discussed in these articles please contact him on the following contacts: sjakarasi@gmail.com or +266 58881062 or on WhatsApp +266 62110062