Forms of Ownership 2 Deciding on the form

Forms of Ownership

2 Deciding on the form of ownership of a company can have a huge impact on the success of the company. How do we decide on which form of ownership we should take? Factors that influence these decisions are: • Who will own the business? • Who will manage the business? • How will the business be taxed? • Capital - How will the business raise capital? • Continuity – What happens if the ownership changes? • Division of Profits – who gets what? • What legal capacity does the business have? • Legislation – what legislation impacts on the business The form of ownership also impacts the following: • Growth • Ability to raise capital • If they continue when ownership changes • Apply for government tenders • Enter into other contracts

3 The five different forms of Ownership are: 1. Sole Trader/Proprietor 2. Partnership 3. Close Corporation 4. Private Company 5. Public Company There are several pros and cons of each which can influence the success of the business. Sole Trader/Proprietor For • Self Interest • Easy start-up • Close relationship with suppliers and customers • Experience of all forms of business and management Against • Difficult to get good employees (security) • Unlimited liability for debt • No continuity • Limited capital for expansion • Only decision maker • Difficult to obtain capital/loans

4 Sole Trader – characteristics • One owner taking responsibility for everything • Personal interest in management and service delivered • No legal formalities • Name is owners choice – no legal requirements • Unlimited liability • No legal personality – therefore no continuity • Don’t have to audit financial statements • Can sell at anytime Partnership – characteristics • Agreement between two or more people • Provide own capital, controlled by partners • Joint control – personal interest in management • No legal formalities to start – just written partnership agreement (attorney must draw this up) • Unlimited liability – debts divided amongst partners depending on agreement, as are profits • Name is owners choice – no legal requirements • No legal personality – therefore no continuity • Auditing optional • Partner can transfer their share to someone else, with permission

5 Partnership For • Simple and inexpensive formation • Easy to obtain loans (partners jointly and severally liable) • Combined capital strengthens position • Unlimited liability • Combined skills, also able to specialise in best skills • Capital can be adjusted without legal procedures Against • Limited capital (contribution of 20 partners) • Actions of partners affect others • Lack of continuity • Slow decision making – consult other partners • 1 partners’ misfortune can affect others • Problems can develop between partners

6 Close corporation • • • No further registrations of cc’s permitted under new companies act Min of 1 and max of 10 members Each member makes a monetary, asset or service contribution Name ends in CC – close means all members involved and participate in management Limited liability – except where the CC has had more than ten members for six months or longer Own legal personality – unlimited continuity Auditing of books is optional – an accounting officer must check your books Can transfer members interest – all members must agree Interest expressed as a percentage – profits shared in relation to this

7 Close Corporation (CC) For Against • No meetings required • Limited liability • Easy and inexpensive to change founding statement (vision) • Registration also easy and cheap • Interest of members does not have to be in proportion with contributions • Capital restricted to contribution of 10 members • All members must agree on member leaving • Member can be liable for losses • Can not sell CC to a company, CC must convert, making sale complicated • Do not need auditing, but statements required for bank loans etc

8 Companies • Profit and non-profit companies • New companies act came into effect on May 1 2011 • All are governed by the companies act and are incorporated in terms of the Memorandum of Incorporation (MOI) Formation and registration of companies 1. One or more to start a profit company, three or more for a non-profit company 2. Draw up Memorandum of Incorporation 3. File it, together with a Notice of Incorporation 4. These two need to be registered at the Companies and Intellectual Property Commission (CIPC) 5. Once CICP are satisfied that all requirements are fulfilled for incorporation, a registration certificate is issued to the company • All companies are taxed on income of the business at a fixed rate (28%) • They also pay 10% Standard Tax of Company (STC) on members dividends

9 Profit Companies Private company – characteristics • Minimum one shareholder – no max shareholders • Minimum of one director, board of directors responsible for day-to-day running of the business • Cannot offer shares to the public • Shareholders have limited liability – only lose their initial capital if business goes bankrupt • Name must end in ‘(Pty) Ltd’ • Legal personality – continuity if people leave • Appointment of auditor – optional as well as auditing financial statements • Raises own capital – issuing shares to its shareholders • Profits shared in the form of dividends in proportion to shares held

10 Private Company For Against • Suitable for people which have good ideas but limited capital • Unlimited shareholders– more share capital can be raised • Limited liability • No meeting required • Act forces personal liability on directors who are knowingly involved in reckless or fraudulent business • Not required to file annual financial statements • Board of directors of choice can be appointed - experience • Double tax – taxable income and tax on dividends distributed • No members of general public can buy shares • Cannot be listed on JSE • Difficult and expensive to establish • Financial statements must be reviewed by qualified person – extra expense

11 Public Company – characteristics • Minimum of one person required to start up • Capital raised from public and by being listed on the JSE • MOI allows public companies to sell shares to the public • Shareholders have no personal interest in management • Minimum of three directors required • Additional of three directors needed for audit committee • Three for social and ethics committee • Shareholders elect 50% of directors • Shareholders have limited liability • Act forces personal liability on directors who are knowingly involved in reckless or fraudulent business • Name of company must end in ‘Ltd’ • Unlimited continuity • Required to hold an AGM (Annual General Meeting) • Auditing of financial statements compulsory, those statements are available to shareholders and public • Profits shared as dividends in proportion to shares held • Company raises own capital by issuing shares to public and borrowing capital by offering debentures • Prospectus issued to public to raise capital

12 Public Company For Against • Losses are not harsh due to amount of shareholders – separate legal identity • Investors can buy shares in several companies – spread risk • Large amount of capital can be raised – shares and debentures • Small investors have a part in the economy • Competent directors can be appointed • Only one person needed to start • Shareholders have limited liability • Public have access to info – maybe motivating them to buy shares • Double tax – taxable income and tax on dividends distributed • Shareholders may have little or no impact on decisions • Expensive formation costs and complicated procedures • Have to publish financial reports, helpful to competitors • High admin costs (shares) • Failure of large companies have terrible results • Memorandum of Association cannot be changed easily • More people to share profits with – less income • Decisions/disagreements take longer

13 State-Owned Company (SOC) Ltd • Government owned and operated for profit • Listed as public companies Advantages • Limited liability for shareholders • Support of government • SOC has greater power when negotiating with businesses Disadvantages • Shares not freely tradable – difficult to raise capital • Strict regulations for operation functions • More ‘red tape’ – costs more • Financial statements must be audited • Red tape – collection and completion of forms and procedures for approval for something

14 Personal Liability Incorporated (Inc. ) • All directors (past and present) are severally liable together with the company for any debts during their term as directors • These are used for professional services – engineers, attorney and accountants Advantages Same as private company except shareholders do not have limited liability Disadvantages • Same as private company • Unlimited personal liability

15 Non-Profit company (NPC) • Not formed with the intent to make a profit, but established for public benefit • Could be religious, charitable, educational, literary or scientific purpose • Income and property may not be distributed to the incorporators, members, directors or officers • Profits must be retained for existence and expansion • Staff may be paid but many are volunteers • Funded by donations – tax deductible if from the private or public sector • NPOs are tax-exempt Advantages • • • Free from income tax Donations are tax exempt Can receive grants or aid Contributes to social development Surplus of income retained for company improvements Disadvantages • • • Creation takes time and effort Stricter reporting requirements No personal gain for members etc Getting grants can be slow Incorporators cannot take along assets accumulated when they leave

16 Co-Operatives • Organisation formed by group of people who agree to work together and pool their resources so they can be more economically effective • Act of 2005 – five people needed top establish a co-op • Must register with CIPC Advantages • Co-op has continuity • Limited liability for members • Resources of many pooled together • Not large amount of money needed (depending on type) • All members help in running business • Profits shared equally Disadvantages • Decision making time consuming – all members have an equal say • All members have one vote, no matter how much interest they have • Difficult to get a loan – main objective is not always to make a profit

17 Types of ownership and their impact on the success of a business • The following factors should be taken into consideration when choosing the form of ownership of a business: Formation Procedures • Some are easier than others, following factors taken into consideration: • Sole trader – easy and inexpensive • Partnership – as above, plus agreement • CC – Founding Statement and Name Reservation • Companies – most expensive to establish. Memorandum of Inc and a Notice to Incorporate filed to CIPC • The more legal requirements in formation – the more costly and time consuming • High start-up costs affect a business’ cash flow and can put pressure on a new business • Legal requirements, e. g. , auditing and publication of financial statements further contribute to costs in the business

18 Continuity of the Enterprise • Ability to survive independently from its owners • Sole traders and partnerships depend on the owners lives – no continuity • CC’s and companies have UNlimited continuity – not dependent on owners to keep going. • Sole Trader & Partnership businesses do NOT pay tax. • The owner/partners pay tax. • Owners are legal people/entity not the business! • Limited continuity can put pressure on a business if a current form of ownership ends • Directors can die or retire and the Company continues to “live”! • The Company is the legal “person” or entity. . . not the owners or directors. • SO BASICALLY : ) • UNLIMITED CONTINUITY = CC & Companies • LIMITED CONTINUITY = SOLE TRADER & PARTNERSHIPS

19 Legal Personality and Liability • Protection of personal assets is an important factor in ownership Taxation Sole Traders and Partnership – personal tax on profits they earn, up to a max of 40% - progressive tax system CC’s and Companies – fixed rate of tax (28%) on profits, shareholders pay a further 15% dividends tax Sole traders, partnerships and incorporated businesses – that turnover less than R 1 million may register as micro businesses – pay tax at a max rate of 7% on turnover

20 Taxation • All people earning an income above a certain amount must pay tax!! • Businesses generate income and must therefore pay tax • Your business must be registered to pay tax • Non legal entities • Sole traders & partnerships only register the name of the sole trader or the partners. Sole Trader & Partnership businesses do NOT pay tax. The owner/partners pay tax. Owners are legal people/entity not the business!! • Legal Entities • CC’s & Companies must register their name of the CC or company. • Legal entities by law must have something after their name: • Close Corporation = CC • Private Company = (Pty) Ltd or Public Comapny = Ltd • Members and shareholders of both the above still pay personal tax.

21 Sole Trader • Calculates by taking their income and then deducting all expenses. P = I -E • Profit is added to any other income the owner receives and taxed accordingly • Owner is taxed not the business itself. Owner = legal person. Partnership • Calculates by taking the income of the partnership and then deducting all expenses. P=I-E • The partners pay tax in a personal capacity • Partners are taxed not the Partnership business itself. • Profit is added to any other income the partners receive and taxed accordingly • Close Corporation • Pays tax on income brought into the business after taking away expenses of the business • Profits belong to the CC • Income tax is payable at 28% • Profit (after tax) is distributed to members • Shareholders then pay a further 15% on all dividends received

22 Companies • Pays tax on income brought into the business after taking away expenses of the business. P=I-E • Profit belongs to the company • Companies pay tax at 28% of taxable income • Profit after tax is distributed to shareholders – dividends • Shareholders also pay a further 15% tax on any dividend received Special Tax • Some small CC’s and private companies qualify for a reduced tax rate

23 Capacity and Management Capacity is therefore influenced by legal status NB!! If a business is not a legal entity there is not separation between the owner and the business An Owner: • Enters into contracts • Pays tax • Lends/borrows money in their personal capacity as they are the business • Remember the laws differentiates between members of a CC and directors of companies • Members, shareholders and directors act on behalf of the business and not in a personal capacity

24 Sole Trader ONE owner • No difference between personal and business assets & debts. • Owner goes bankrupt not the business. UNlimited liability • Usually managed by owner but managers are sometimes appointed to manage the business Partnership 2 to 20 Parners (owners) • As above with both assets and debts • Law does also not recognise the difference between assets of different partners, therefore the debt of one partner can become the debt of another. UNlimited liability • Partners decide who will manage the business Close Corporation CC (1 to 10 members) discountinued. • Owners and managers called members. • Each member has an interest of the business (expressed a s a %) • Total interest 100% • CC is legally separate from its members = limited liability • Therefore assets and liabilities are the businesses not the members • All members manage the business in some way

25 Private Company (Pty)Ltd • Have shareholders and directors • Shareholders can be people of other businesses • Shareholders own the company, directors run it • Company is legally separate from shareholders and directors Public Company Ltd • Legally the same as a private company • Companies are managed by a board of directors – voted in by shareholders (owners) at the AGM Capital Requirements • The amount of capital needed to start a business will depend on the size of the business and type of product or service offered • Eg – a medium size business that needs expensive machinery for manufacturing will need more capital than a business offering a service • Small – medium businesses are usually set up as partnerships or sole traders eg hairdressers, mechanics etc • Growth in these companies will depend on success and the ability of the owners to make cash available for the business