Business Entity Basics for the Entrepreneur

The registration of a new business entity comes with structural, legal and other consequences. Also when acquiring an existing business, it may be prudent to reconsider the type of entity being deployed. This editorial seeks to highlight the basic differences between the available options and to provide a brief summary of the main characteristics of each.

Close Corporations

A close corporate (“CC”) is a limited liability entity, which has its own distinct legal identity separate from those of its owner(s). CCs are frequently encountered in South Africa and are often deployed by small to medium businesses. The reason for the popularity of this business structure is its relative simplicity and informal processes. For example, the CC is not required to have its financials audited by a chartered accountant. Only natural (living and breathing) persons are allowed to hold the members interest in a CC and other legal persons may only do so under limited circumstances such as a Trustee of a testamentary or inter vivos Trust provided that a juristic person is not a beneficiary and the total number of members, including beneficiaries does not exceed ten.

A Close Corporation:

• is governed by an association agreement which, amongst other things, governs the rights and responsibilities of Members and their relationship with each other;
• may enter into contracts or agreements with other parties;
• may sue or be sued in its own name;
• continues to exist even after the death of its Members; and
• is exempt from submitting annual financial statements, unless its public interest score requires it to do so.

Since implementation of the Companies Act (Act 71 of 2008) (“the Act”) on 1 May 2011, no new CCs are capable of being registered and no conversions from companies to CCs are allowed. Existing CCs will endure for the foreseeable future.

Companies

With the advent of the Act, the legislator made allowances to entrepreneurs to fashion companies in ways which cater better for their specific needs. Companies are suitable for conducting both larger and smaller businesses.

Some of the characteristics are:

• A private company has a separate legal identity, distinct from its shareholders and directors;
• A company may sue or be sued in its own name and continues to exist beyond the death of its shareholders or directors;
• A company is governed by its Memorandum of Incorporation (MOI);
• A company is free to direct the way in which it conducts its business and all these elections must be contained in the Company’s MOI;
• A company’s structure and processes are founded in the MOI and contains, amongst other things:
  • the purpose of the company;
  • determination whether it has to submit to audits or hold annual general meetings;
  • the dividend policy;
  • the composition of the board of directors and the manner in which meetings of the board are to be conducted;
  • the rights and obligations of Shareholders.

Sole Proprietorships

A sole proprietorship is a natural person who conducts business and is perhaps the simplest form of a business structure. It does not have an identity separate from the owner and consequently, no limitation of liability in the way a CC or company has. All transactions are tantamount to the owner acting in a personal capacity and as such, no stipulations exist as to how the business should be conducted. The sole proprietor is the owner of the business’ assets and, conversely, is also personally liable for all the debts.

The characteristics of a sole proprietorship are:

• no legal formalities are required to establish a sole proprietorship;
• the owner may alter, change or cease the business as he/she sees fit and it comes to an end upon the death of the sole proprietor;
• the owner is personally liable for the debts of the entity and can be sued or may sue in his own name.

Although compelling reasons may exist for electing this form, such as its relative simplicity and taxation advantages in certain circumstances, the inherent risks associated with doing business have significantly reduced the popularity of this type in recent times.

Partnerships

A partnership is constituted by an agreement between 2 to 20 people to operate a business in partnership with each other. Each partner undertakes to contribute money, goods, services and the like and is entitled to share in the profits and losses of the business. No registration is required as a partnership agreement is simply concluded between the parties.

Some of the characteristics are:

• the partnership has no separate legal identity to those of the partners;
• the partners are personally liable for the debts of the partnership, jointly and severally the one paying the other to be absolved;
• in the event of execution against the partnership, the personal assets of the partners are also subject to seizure;
• the net profits and assets are usually distributed amongst the partners on dissolution of the partnership;
• a partnership ceases to exist upon the death of- or termination by any one of the partners;
• upon termination of a Partnership, the assets are liquidated, creditors are paid and the partners share in any residue or shortfall.

Partnerships could be described as commercial marriages and unless this form is required by statute or preferred for some other compelling reason, great care should be taken when considering this form, as it poses significant liability risks to both the partnership and the partners in their personal capacities.

Conclusion

Gaining a basic understanding of the options available to entrepreneurs and having a working grasp of the characteristics of the form ultimately deployed, goes some way to minimise the inherent risks associated with conducting business. As each business’ particular circumstances are unique and as other business entity options also exist, it may be advisable to consult an expert before registration or conversion in order to ensure fitness for purpose.