Once you have decided to start your new venture, it is imperative that you choose the right business structure for your company.
Do research to find out if you should register as a sole trader, a limited liability company, or a partnership. Don’t rush to the Corporate Affairs Commission to register an LLC because your friend did and their business is profitable.
If in doubt, this piece will help you to make the right choice.
Sole proprietorship (“the lone walker”)
A sole proprietorship is owned and managed by one individual—the owner. The owner is liable for the business’s financial obligations. For example, in some jurisdictions, as a sole proprietor, your business profits and losses are included in your personal tax returns.
Consequently, if your new venture experiences losses, such losses may offset your income from your “day job.”
The drawback of this structure is that you’re liable for your new venture’s liabilities. Which means is your personal assets (houses, cars, jewelry etc.) are on the line if you fail to repay a debt or run into financial trouble.
If you love working alone and do not mind being personally liable for your business, this may be a good option for you.
But note that raising funds for your business as a sole trader will be difficult.Banks and institutional investors tend to shy away because of the risk of losing their investments if your business goes south.
Partnership
A partnership is appropriate if your new venture is owned by two or more individuals. Partnerships are named differently in different jurisdictions and vary in structure, which dictates you and your partner(s) liability.
For example, under a general partnership, you and your partner(s) are responsible for the financial liability and daily operations of the venture.
On the other hand, a limited partnership constitutes a general partner and a limited partner. A general partner owns and assumes the liability of the partnership, whereas the limited partner is the investor (the limited partner only provides the money!). The limited partner does not participate in the daily operations of the new venture and is not liable for the new venture’s debt.
Generally, a partnerships have a better chance of raising funds from banks and institutional investors than sole proprietorships.
More on partnerships
Thoroughly review the different partnership structures in your jurisdiction and determine what works best for venture, then if necessary negotiate with your business partner(s) and sign a contract. Even if your partner is your best friend.
Have these questions at the back of your mind when drafting the contract:
- What is your business continuity plan if your partner leaves or dies?
- What role will each partner play?
- Do you want only one partner taking decisions on behalf of the company (e.g. taking out loans)?
- How will you resolve conflicts between partners? (Stay away from litigation!)
There is no better time to agree on the terms of the partnership than during the early stages when everyone is excited about the venture. Sign the agreement during the honeymoon phase as it will be extremely challenging to agree on anything during the divorce phase.
Corporation
Like partnerships, corporations vary from one jurisdiction to another. Nonetheless, corporations are generally separate entities from their owners, and personal assets not at risk. However, there are some exceptions where a court could pierce the corporate veil and make make owners liable.
As with partnerships, banks and institutional investors are more likely to consider issuing loans or making investments. Corporations also have the benefit of raising funds by issuing stocks.
Limited Liability Company
A limited liability company has one or more partners (depending on the jurisdiction) and combines elements from partnerships and corporations. For example, all partners in a limited liability company can all participate in the daily operations of the business, but partners are not personally liable for the venture’s debt. What’s more, LLCs can raise funds from institutional investors and get bank loans.
Nonetheless, this veil of protection against liability is lifted if you personally guarantee the venture’s debt.
You want to keep a clean slate? Here’s how to do that…
Once you have chosen a business structure, it is imperative that you register it with the relevant regulatory authorities.
Contrary to popular belief, the Lagos Internal Revenue Services can track your Lagos-based business if your business fails to make relevant tax payments.
Moreover, you do not want to give potential investors the impression of one who evades regulatory processes.
Some practical steps to registering your business
1. Choose a name for the business.
2. Check with the Corporate Affairs Commission that the name is still available. In some jurisdictions, this search can be conducted online.
3. If it’s available, register the name or reserve the name (some jurisdictions allows for name reservations for 30 days).
4. After the name is confirmed, draft your legal documents e.g. Partnership Agreements, Memorandum & Articles of Association, etc. The Memorandum & Articles of Association should enumerate the purpose of the new venture, the name of the partners and their percentage ownership, the office address etc.
5. Register your company with the relevant tax authority and get a tax identification number.
6. If applicable, apply for a business permit/license.
In sum, the business structure you choose determines the extent to which you will be personally liable for your business debt, your tax liability, your responsibilities as a business owner as well as the required regulatory filings.
This is one of the most important early stage decisions you will make as a business owner so think through it carefully and decide what works for you!
In the next segment, we will discuss legal considerations when raising funds for your new business.
Have a question to ask? Write to us! We are listening.
Follow this series with Part 1 of Efe’s Legal Corner on The Best Way To Resign Your Job To Start Your Business.