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Basic Business Structure: Sole Proprietorship versus Limited Company

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Basic Business Structure: Sole Proprietorship versus Limited Company

What kind of business structure would you want to have in your company? Of all the decisions you make when starting a business, the type of legal structure you select for your company will be a high priority since it will be directly proportional to the manner in which you will be remitting your taxes. In addition, it will also have a direct relation to the team structure and funding options you will use.  Every business structure has its own pros and cons and it is more dependent on the level of where your business is starting. But nevertheless, it is important to know that you’re not locked into one business structure for the life of your business. As the business grows, one will need to change the structure to adapt to the changes in your business.

There are 3 major business structures within African context that anyone can use when starting a business. These are Sole Proprietorship, Partnership, and Corporation.

For this case, we’ll at an in depth view and the major differences between a sole proprietorship and a corporation. Sole proprietorship and partnership are more or less the same in terms of tax and legal liabilities. The only major difference between the two is the ownership structure. Unlike a partnership where the minimum ownership is two people held together with a partnership deed, sole proprietorship only requires only one person to start the company.

So in this case, we’ll look at sole proprietorship versus a limited company.

 

Sole Proprietorship

This is the simplest and cheapest business structure since it usually involves just one individual who owns and operates the business. Whether you intend alone or you are looking at testing your business idea, this is the best structure to go with. The owner will require registering a business name within a maximum of 3 days depending on the country you are in. Licenses can be secured from the local authority.

In a sole proprietorship, this business structure has no separate legal existence from its owner. The owner acquires full liability for the debts and losses of the business. The taxes are pegged on the on the name of the owner and filed as personal tax returns and not on the company’s name. This is because it does not create a legal entity separate from the sole proprietor owner. In addition, bank account names and cheques addressed to the business as put under the name of the business owner.

An example of a sole proprietor: Jane K. starts a cake business. She names it Sweet Treats. In this case, Sweet Treats becomes the trade name but not the legal name of the business. The legal name is Jane K. The bank account, tax returns and licenses from the local government will be done under Jane K.

Two disadvantages that this structure has are the unlimited liabilities it attracts. First, when the business is in debts, then the owner’s personal assets can be attached to recover the debts. Secondly, raising outside funding from investors can be difficult and thus the owner is limited to personal sources and loans from friends and family.  These are is the major risks associated with a sole proprietorship.

 

Limited Company

Limited companies are separate legal entities from the owners. Unlike a sole proprietorship, setting up this business structure is not a straightforward process. It requires a corporate lawyer who will be able to draft the complex paperwork required to meet the statutory legal and tax regulations.

In this structure, the owners of the company are described as shareholders and each has a percentage ownership. In most cases, especially for small and private limited companies, the shareholders can also be the directors of the company. The shareholders can pick a director who is not a shareholder of the company, especially in large private limited companies.In addition, one of the directors on the board can also be the chief officer of the company.

Since the company is a separate legal entity from the owner, bank account names addressed to the business are put under the business name.

The liability, in this case, is limited and it the company name is registered entity from the owners. That means debts and losses are not assumed by the owners of the company or pegged on their personal assets. The tax structure varies from country to country and its payable on the taxable income under corporate tax laws. Profits are distributed to shareholders through dividends.

Despite the complex nature of setting up this structure, it provides a more advantageous option. Especially when it comes to matters of raising funding from investors. In addition, it also separates the liabilities of the company from the owners.

The bottom line in choosing the best structure for your business depends more on the stage your business is in. Remember that you can change the structure from a sole proprietor to a limited company.

NB: We have other forms of structure not discussed on this post like limited liability partnership and public limited companies. The ones stated here are the most popular that are early entrepreneurs are likely to implement.

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