The new buzz-word on the street is “start-up.” New and innovative business ideas and concepts are popping up all over the place. But often, having that brilliant new idea is only half the job. Setting up the appropriate business structure for your specific needs is as crucial to the success of your start-up as the idea behind it is. You don’t want to be driving a sports car on a 4×4 track. Therefore, understanding the basic company structures will assist you to make the right choice. In this article, we provide an outline of the three business structures which are most likely to suit your start-up.
Before delving into the different structures, one important distinction needs to be highlighted, namely the distinction between a natural person and a juristic person.
- A natural person is a person in the ordinary sense – a human being that lives and breathes.
- A juristic person, also referred to as a legal person, is an entity (normally a company) which the law has recognised as competent to attract some of the same rights and obligations which a natural person can attract, such as the incurrence of a debt. It is an entity which is distinct from its stakeholders. Such an entity is said to have attained legal personality. Despite having no physical presence, the company itself owns assets and incurs debts, not its shareholders. The company has the same rights and liabilities as a natural person (to the extent possible). The directors of the company are said to have “limited liability”, a very important concept which is explored in further depth below. Another important feature is that, since it exists as an independent entity, a juristic person has perpetual existence i.e. its continued existence is not dependent on the existence of its stakeholders.
A sole proprietorship is arguably the most basic business structure. It is a structure in which a single person owns the entire business. In essence, the person operating the sole proprietorship and the sole proprietorship itself are considered one and the same for legal purposes. Importantly, the sole proprietorship does not have juristic personality. Therefore, the debts of the sole proprietorship are the debts of the individual, and likewise, all profits accrue to the individual. This means that should the sole proprietorship be unable to pay its debts, debtors would come after the assets of the individual to settle the debt. Similarly, when the sole proprietorship enters into contracts with another person, such contracts will be entered in to in the name of the individual. A sole proprietorship does not enjoy perpetual existence, and consequently, when the individual dies, the sole proprietorship immediately ceases to exist. Many businesses start as a sole proprietorship, but as they grow, they morph into different business structures which offer the benefit of limit liability. A sole proprietorship is only suitable for small businesses. If your business is growing or expected to grow, operating as a sole proprietorship is not recommended.
A partnership is a business structure often used by individuals (at least two) who wish to operate a business together. These individuals, called partners, conclude a partnership agreement from which the partnership arises. The partners must have the goal of making a profit, must each make a contribution to the partnership and the business of the partnership must be carried out for the joint benefit of the partners. Generally, the partnership assets are owned by the partners in equal, undivided shares. Like a sole proprietorship, a partnership does not enjoy separate juristic personality. The partners share in both the profits and losses of the partnership in agreed shares and are co-debtors in respect of the liability of the partnership. Like a sole proprietorship, a partnership does not enjoy perpetual existence, and is automatically dissolved when a partner resigns or dies.
A private company is arguably the most common commercial vehicle. A major feature of a private company is that it is a juristic person, meaning its directors enjoy the protection of limited liability (to an extent, because in certain circumstances directors can be held personally liable). The two primary organs of a private company are its shareholders and its directors. The shareholders own the company whilst the directors are responsible for running the company on a day to day basis. In the context of a start-up, the shareholders are likely to also be the directors. The board of directors is what is known as the “controlling mind” of the company. Both the shareholders and directors make decisions relating to the company. Generally, day to day decisions are made by the directors, while shareholders vote on more consequential decisions. The founding document of a company is its Memorandum of Incorporation (“MOI”). It is compulsory for a company to have an MOI. The MOI sets out the basis on which shareholders, directors and the company interact within the parameters of the Companies Act. It is a crucial document and must, ideally, be carefully prepared to suit the needs of the company. The company and its shareholders may also conclude a “shareholders agreement” to further govern the relationship between the company and shareholders and the shareholders inter se which, while recommended, is not compulsory.
Since the company has juristic personality, it owns assets and incurs liabilities in its own name. Therefore, its directors and shareholders are not personally liable for the debts of the company. The company itself is a party to the contracts it enters into. Further, the company has perpetual existence, meaning that it will remain in existence notwithstanding a change of directorship or a change in shareholding.
Hopefully, the above basics can assist in ensuring that your start-up can thrive. Once you have the right structure in place, you can put all your energy back into your new idea with the peace of mind that your business is sitting on a stable launchpad.
Chris Immelman
Candidate Attorney
Themis Commercial Legal Advisors (Pty) Ltd