New Year, New Business - How to Pick the Right Legal Entity for It

 “Owning one's own business is an adventure – enjoy it every step of the way.” (From the SME Toolkit article referenced below)

 

First, three questions to ask yourself…

If you dream of going into business for your own account in 2023, ask yourself these questions before you get started –

1. Am I an entrepreneur? You have an amazing idea, you can’t wait to launch your new business, success and wealth beckon! But wait a second - are you really suited for the hurly-burly of entrepreneurship? It can be hugely rewarding, not just in the financial sense but also in terms of lifestyle and life satisfaction. But it also carries far more risk than the classic “9 to 5 employee” option, so think long and hard before choosing. There are many online quizzes to help you decide – try for example DeLuxe’s “Quiz: Are you ready to start your own business?” here.
   
   
2. What’s my plan? Without a plan you sail rudderless through some very treacherous and shark-infested waters. Start-up failure rates are high, but luckily there is plenty of advice available to help you plan your course. Read for example the Business Partners “Ten Simple Rules For a Successful Start-up” on SME Toolkit.
   
   
3. What legal entity should I use to trade? Don’t make the rookie mistake of setting sail in just any old boat. Starting off in the wrong entity and then having to change mid-stream will mean a lot of unnecessary expense, hassle and risk. Rather plan long term – ask yourself where you want your business to be in 5 or 10 years, how big it will be, what your exit plan will be and so on.
   
   We set out below some brief thoughts on the various alternatives available to you, but upfront professional advice, specific to your particular needs and circumstances, is a real no-brainer here.
   
   So, what are your choices?

…and four business vehicles to choose from

You have four main options –

1. A sole proprietorship (“sole trader”).  You are the business, trading for your own personal profit and loss, perhaps under a trading name such as “Syd Smith trading as ‘Syds Plumbing’”.
   
   
2. A partnership of 2 to 20 individuals or entities, pooling resources to carry on a trade, business or profession for a share of the profits.
   
   
3. A private company (“Pty Ltd”) with any number of shareholders. Controlled and administered by directors.
   
   
4. A trust (number of trustees and beneficiaries not restricted). There are various types of trust, with trustees controlling and managing trust assets and/or trading for the benefit of beneficiaries.

Note that you might be advised to combine one or more of these entities in a corporate structure, and that there are other specialised types of entity available to, for example, non-profit organisations (charities etc), professionals (lawyers, accountants, doctors etc) and the like.

The pros and the cons of each

Have a look at the illustrative table below for a summary of the advantages and disadvantages of each of these options.

   

Don’t forget the tax and estate planning implications!

Each of your choices carries with it a mixed bag of positives and negatives when it comes to both tax and estate planning implications. For an overview, have a look at SARS’ “Starting a business and tax” webpage, with a link to its “Tax Guide for Small Businesses” PDF.

That Guide is 102 pages long, and unless you are comfortable with the complexities involved, professional advice specific to your circumstances is again essential.

In a nutshell –

• Estate planning: You may be advised to use companies and trusts for tax-efficient and practical transfer of wealth to future generations, as well as for asset protection from creditors both before and after you die. Both companies and trusts are “perpetual” in the sense that they survive changes in directors/trustees (resignation, removal, retirement, insolvency, death etc), with potential multi-generational savings in estate duty and avoidance of the cost and delays inherent in deceased estate administration.
  
  
• Tax efficiency: Sole traders and partners are taxed at individual rates; trusts other than special trusts at a flat rate of 45%; companies at a flat rate of 27% (27% for years of assessment ending on 31 March 2023 and later, previously 28%) with 20% dividends tax when you take profits out. There are a host of other factors to take into account here, including aspects such as Capital Gains Tax inclusion rates, exclusions, exemptions, small business breaks and the “trust conduit principle” all being highly relevant to the ultimate question – will you be better off being taxed as an individual or will some form of corporate and/or trust structure be more tax efficient for you?

Take that professional advice!