Previously we discussed what the difference was between a business and a company. Then we gave several reasons why it would not be necessary to register a company to run your business. In this article we will give several reasons why it would be a good idea to register a company and use it to run your business.
Not every business needs to be run by a company. Some are partnerships, some are close corporations and some are sole proprietors. So what makes the company structure so popular? Well here follows some good reasons to register a company (Pty Ltd) and use that to run the business.
Easier to have more than one owner in the business
If you have more than one owner involved in the business, then the company structure is a very useful way to share ownership in the business. Whenever a company name is used in an official capacity, it is followed by the letters “Pty Ltd” which indicated that it is a private company. This company then owns the business and anyone who buys from you or who you sell to, is trading with the company. Here the “business” pretty much becomes the “company” in common language, but it is still necessary for a business person to understand the subtle difference between the two.
The owners of a company are called shareholders and they each have a share in the ownership of the company. The ratio of this ownership can be anything. Shareholders can have the same share as each other or one can have more than the other shareholders. The shareholders will appoint employees of the company to run the business. These special employees are called directors and are responsible for managing the company and it’s business. Often a shareholder is also a director of a company, but they don’t have to be in both roles.
This company structure with shareholders have a share in the company, allows important decisions to be made by all the owners involved. If there are disputes, it can be voted on. If an owner wants to sell his part of the business or if he dies, the business does not stop but rather carries on as normal. A new shareholder or an existing shareholder can now buy the share that the previous shareholder had. Its also possible for new shareholders to buy into the business by simply adding new shares. This will mean that the existing shareholders will end up owning a slightly smaller portion of the company than before, but usually the new shareholder brings other benefits to the company, such as extra cash or expertise, so it is worth their while.
In the case of a legal partnership, when one partner leaves the business, a new partnership must be formed. In the case of the sole proprietor, when they die, the business ceases to exits because they are the business. The estate can of course sell the assets that are left over, but there is no real business to sell.
Business owner liability protection
Starting and running a business has many risks. Many new businesses fail and even long established ones will mostly go out of business at some stage. Sometimes the reasons for these business failures is the faults of the business owner, but other times it is something totally beyond their control. Some examples would be:
- Government could change legislation making your product highly controlled and the bureacracy makes it impossible for the small business to compete against big business (pharmacies and cigarette manufacturers).
- Municipalities could change road networks or simply do maintenance on roads, preventing your customers from getting access to your shop for several months.
- Your main product could become suddenly obsolete and replaced by an alternative (Metered taxis).
- Your business premises could become a victim of theft, extortion or fraud to the extent that it cripples your cash flow.
- Your biggest customer goes broke or runs into cash flow problems (Edgars, SAA, Eskom)
The list can be much longer, but you get the idea. Whatever the reason, they may fail. Often the value of assets in a business can be much higher than the personal assets of the owner, especially if its been running for a few years. In many cases the liabilities and debts of the business will be much higher than what one person could afford. This is fine when your business is running as the cash coming in from your customers each month generally pays what your business owes to staff and suppliers. However, when something goes wrong and that incoming flow stops or reduces below what you owe, there is a problem. If it carries on the business fails and is liquidated. If you are a sole proprietor, you will need to personally pay every single supplier, all loans,, staff salaries and taxes. If your business has grown, this is often simply impossible. In theory the assets should be sold to cover the debts, but this may take many months, and often you don’t get the full value of the asset if its a forced sale.
On the other hand, with a company. all the debts belong to the company. So the creditors can only get what they are owed from the company. The owner does not owe them the money. So the owners can then carry on with their lives in different businesses or jobs, whilst the liquidation mess is sorted out. If there is not enough money generated from the sale of the assets to pay all the debts, then the creditors just have to make do with a lower payment. This gives protection to entrepreneurs and business owners from excessive debts from failed businesses and allows them to continue to make a living.
There are some exceptions of which the most common or significant are:
- If you sign a document called a surety, it means that you personally agree to pay the debt in case the company cannot. Many bank loans will have this clause and many suppliers will try and sneak it in too.
- If you are a director and trade recklessly and allow your business to trade where your assets are obviously less than your liabilities, then you may become personally liable for some of the debts.
- SARS can sometimes claim from certain directors in the case of some taxes.
This benefit is not meant to trick creditors, but in business it must be realised that a company takes on its own “personality”. Customers buy from the company. Suppliers supply goods and services to the company. The owner of the company is a separate person or group of people and can quite possibly have no direct or obvious link to customers or suppliers.
Registration for taxes, especially VAT and Employers taxes
If you register for VAT in your personal capacity or become an employer in your personal capacity, which is what is meant when you are a sole proprietor, then it adds a huge amount of complication to your life later on. When you sell the business, or close it down, or retire, you are still left with this administrative burden. De-registering from VAT can be tricky. Having an employee can be a huge liability. Are you able to pay them retrenchment packages?
The company structure allows these administrative issues to stay with the company. Whoever is the new director, then becomes responsible for managing them. The original owner can sell on this responsibility and move away to retire in relative peace.
In conclusion, we would recommend that you register a company in any of the following situations:
- You business will be employing staff.
- Your business will be registering for VAT.
- There are more than one owners in the business.
- The size of the business in terms of sales turnover, assets and liabilities becomes much greater than the personal assets of the owner – a factor of 10 is a good guideline.
Note that it is quite possible to start your business as a sole proprietor and then later create a company and start trading with that, once it is up and running and profitable.