Money Management

All You Need to Know About Business Structures

June 10, 2022

Setting up a business is an exciting, terrifying, and, let's face it, baffling experience.

The good thing is you don't need an MBA or professional business training to start and run a very successful business, but there are some crucial decisions you'll need to make right away, beginning with your business structure or entity.

Choosing the legal structure for your business or startup is the first big decision you'll need to make when starting a new business. It's a complex and confusing decision.

We explain the main types of business structures and when to consider them.

What is a Business Structure?

The legal framework of a company that relevant authorities acknowledge is the business structure of that organization. Accordingly, an organization's legal structure is one of the most important factors determining the types of activities it can undertake.

These activities include the ability to raise capital, taking responsibility for the obligations of the business, and the level of taxation that the business owes to the various taxing authorities.

Factors Influencing the Choice of Business Structures

Selecting a business structure is among the critical decisions you will have to make for your business. The following factors will play a significant role in influencing your choice:

Taxes: The Kenya Revenue Authority has different guidelines that give directives on taxation modalities acceptable for varying business entities. Therefore, it is essential to familiarize yourself with the types of taxes and how they may impact your choice. In addition, the business structure that you opt for will directly impact your tax burden owing to the difference in tax rates for personal income and business.

Liability: When it comes to liability, structures such as limited liability companies (LLCs) can shield your private assets if you face a lawsuit. In case of an accident, can you take up a personal liability against the losses sustained? If not, a sole proprietorship or partnership might not be your best option.

Paperwork: Various tax forms correspond to the various business legal structures. In addition, if you choose to organize your business as a corporation, you will have to file articles of incorporation and maintain specific reporting requirements with the government on an ongoing basis. If you form a business partnership and conduct transactions under a pseudonym, in addition to the standard paperwork, you will need to submit additional documentation.

Hierarchy: When you set up a corporation, it has its own set of legal requirements, which may include the meeting frequency for the board of directors. Corporate hierarchies have closure protection when an owner transfers shares, leaves the company or the founder dies. Other business structures lack this.

Registration: A business structure is part of the legal requirements when registering your business, as it will help in processing crucial documents and permits. Depending on your choice, you will also receive your company's PIN if necessary.

Although you can modify your business structure in the future, the initial form of your company is one of the most important decisions you will make. Changing the form of your business, on the other hand, can be a disorderly and complex procedure that may result in unanticipated implications for your company's taxes as well as the dissolution of your company.

Sole Proprietorship

Business entities can't get much simpler than a sole proprietorship. The profits and debts of a business belong to just one individual under a sole proprietorship.

A sole proprietorship is the best option if you want to be your sole boss and operate a business from home without needing a physical storefront. However, in the future, as your firm expands and additional aspects hold you responsible, you may find it challenging to keep your professional and personal assets separate in this entity.

Ownership expenses vary depending on the market. However, the most common early costs are national and county fees and taxes and the leases for office space and any other professional services your company engages in. These businesses include bookkeepers, freelance writers, cleaners, tutors, and babysitters.

It can get numerous benefits by operating your business as a sole proprietorship.

Easy to begin. If you are the sole owner of your company, this may be the best option. Since you don't have any shareholders or board members, there is relatively little paperwork.
Low price: The only fees involved with a proprietorship are licensing costs and business taxes, which vary depending on the business size and location.
Special sole proprietor tax deductions, such as health insurance deductions, may be available because you and your business are a single legal entity.
Getting out is a breeze: Forming and terminating a proprietorship is simple. Single-owner businesses can get dissolved at any moment with no need for formal paperwork. For example, don't advertise or operate your daycare center while you're shutting it down.

You can follow these steps to start up your sole proprietorship:

Apply for a business name
Register for tax with the KRA
Register your business name
Apply for a business permit
Register with the National Social Security Fund (NSSF)
Register with the National Health Insurance Fund (NHIF)

Partnership

In a partnership, the owners are two or more people. It is possible to have either a general partnership or limited partnership, in which one partner controls the business and receives a portion of the profits. Sole proprietorships and limited liability partnerships are two types of partnerships that can form based on a partnership's financing structure.

If you want to start a business with a close relative, friend, or business partner, this entity is perfect for you. A partnership enables the associates to share losses and profits and decide things within the business model. Note that you will be held responsible for the decisions and actions of your business partner.

Because you need an attorney to review your partnership agreement, the general partnership costs can be more expensive than a sole proprietorship. In addition, the cost of a lawyer's services can be affected by their experience and location.

A partnership has a greater growth potential than a sole proprietorship since you can easily obtain loans to continue funding your business. In addition, since you also have a KRA PIN, you can also get easy access to tenders.

When registering your partnership business, you need to submit the partnership deed, which has the following information:

The firm or partnership's name
Name and addresses of the partners
Nature or business type
The partnership's duration
The capital contribution from each partner
The nature and amount of drawings that each partner can make
Projected interest on capital and drawings charges
Responsibilities and rights of the partners
Duties of the partners
Partners remuneration
The ratio of sharing losses and profits among the partners
The basis and rationale for calculating goodwill during a partner's admission, death, or retirement
Proper accounting and preparation of balance sheets
The settlement amount for each partner when dissolving the firm
Dispute resolution processes and procedures among partners
The arbitration clause in case of a disagreement or dispute

Limited Liability Company

A limited liability company (LLC) is a diversified business model that includes the best features of both partnerships and corporations in one package. It protects business owners from personal liability while lowering their tax and regulatory burdens. Pass-through taxation means that each business owner is responsible for reporting a portion of the company's profits and losses on their tax returns.

A limited liability company does not have a cap on the number of shareholders. Upon forming an LLC, it must file its articles of organization with the jurisdiction where it intends to conduct business. Operating agreements may be required in some cases.

A limited liability company has fewer rules and regulations than a corporation. For example, limited liability protects the owners' securities from being sold to offset the entity's debts, requiring less paperwork. In addition, there is no restriction on the number of shareholders that a limited liability company can have.

Registering with the county where you plan to do business makes starting a limited liability company more expensive. In addition, to ensure compliance with taxation requirements, the entity may require the services of an accountant and an attorney.

To register your LLC, you need the following information:

Proposed company name
The company's proposed physical address
Nature and objective of the firm
Names of the company's directors
Shareholders' names if different from that of the directors
Directors and shareholders' contact information
Division of shares amongst shareholders
Class of shares offered by the company
Scanned Passport bio-data and the directors' and shareholders' passport photos
Company's nominal capital

Corporation

A corporation is a more complicated and expensive way to run a company. In addition, as a separate legal entity from its owners, a corporation necessitates more regulatory and tax compliance.

When a small-business owner incorporates, they receive a great deal of liability protection. If you structure your business as a corporation, you're not placing your assets at risk because a corporation's debt is not regarded as the debt of its owners. In addition, a corporation can keep a portion of its profits in its coffers without the owner having to pay taxes on them. A corporation's ability to raise funds is an additional benefit. A company can sell common or preferred stock to raise money. Despite the death, sale, or incapacity of a shareholder, corporations continue to exist.

The corporate structure has drawbacks. Cost is a major factor. You'll likely need an attorney to navigate the legal system. A corporation's accounting and tax preparation needs are greater than a partnership or sole proprietorship.

Another disadvantage is that business owners are subject to two levels of taxation on their profits. Individual income tax rates apply to dividends paid to shareholders and corporate income tax levied at the national level for corporations.

You may pay the money out as dividends to you and any other company shareholders to escape double taxation. Then, when employees receive reasonable compensation, the company does not have to pay taxes on that money, and it can write it off as a business expense.

The following procedure is critical when incorporating your company:

Name approval and reservation by the Registrar of Companies
Preparation and issuance of the Memorandum, Articles of Incorporation, and Statement of Nominal Capital
The signing of the Compliance Declaration
Completion and submission of the required paperwork
Registration with the Kenya Revenue Authority (KRA) for tax purposes
A request for a business license
Registering with the social security administration
Developing a company seal

Choosing the Right Business Structure

It is not always simple for new enterprises that fall under two or more of these categories to pick which structure to choose. First, consider your startup's financial requirements, risk, and growth potential. After establishing your business, changing your legal structure might be difficult, so give it great consideration in the early phases of business formation.

Here are some important considerations when choosing the legal form for your firm. It's best to seek advice from a business expert to avoid unnecessary pitfalls.

Flexibility

Where does your business intend to go, and what form of legal structure permits the growth you anticipate? Refer to your company plan to examine your objectives and a structure that best matches them. Your organization should encourage the prospect of development and change, not impede it.

Complexity

Nothing is simpler than a sole proprietorship in setup and operating complications. Register your business name, commence operations, record profits, and pay taxes on them.

Liability

As a separate legal organization, a corporation has the lowest level of personal guilt. Creditors and customers can file lawsuits against the corporation but cannot access the personal assets of directors and shareholders. A limited liability company provides security with the tax advantages of a sole proprietorship. According to their partnership agreement, partners share the liability.

Taxes

The owner of an LLC is subject to the same tax obligations as a sole proprietor: all profits are deemed personal income and taxed as such at the end of the year.

Early on, as a small businessman, you want to dodge double taxation. An LLC prohibits this and ensures you are not taxed as a corporation but as a person.

People in a partnership report their profit portion as personal income. To minimize the impact on your tax return, your accountant may recommend quarterly or biannual advance payments.

Each year, a corporation submits its tax returns and pays taxes on its profits after deducting all expenses, including wages. If you reimburse yourself from the corporation, you will be responsible for personal taxes.

Conclusion

The structures discussed here are more beneficial when setting up profit-generating businesses. Sometimes the entire selection process could be confusing, especially if more than a single structure fits your business. You can consult with professionals within the field to ensure that you make the right decision.

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Ian Job is an articulate writer with over four years of experience in SEO writing, digital marketing and screenwriting. Away from writing, he's probably producing an indie movie if you don't find him mentoring upcoming content writers. You can connect with him on Medium.