Most entrepreneurs start off as Sole Proprietors, running and operating their business as an individual. At some point, however, it may make sense to formally register your company with the Companies and Intellectual Property Commission (CIPC). But how do you know when the time is right, or if it’s necessary to do so at all? Here’s a quick guide to understanding why you would register, and when it makes sense to do so.
Understanding the lingo – what do all these terms mean?
Firstly, it’s important to understand the difference between a Sole Proprietorship and a registered company. If your business is not currently registered with the CIPC, then you are operating as either a Sole Proprietor or a Partnership. A Sole Proprietorship means that your business functions and exists in your own personal capacity, and not as a legal entity. A Partnership runs in much the same way, except that there are two or more people running the company, all of whom contribute to the business and share in the profits and losses. From a tax perspective, each partner will be taxed individually on their profit
A company that has been registered with the CIPC is commonly referred to as a Private Company, and usually ends with the suffix ‘(Proprietary) Limited’ or ‘(Pty) Ltd’. Once registered, the business is treated by South African law as a separate legal entity, and becomes subject to a wide range of legal requirements such as submitting annual financial reports to the CPIC. The company must also be registered with SARS as a taxpayer (unlike in the case of a Sole Proprietor, who pays tax as an individual).
Running as a Sole Proprietor is generally more hassle-free, and involves fewer administrative costs and hurdles than running a registered business.
So why would you choose to register? And when is the timing right?
When it makes financial sense
As a Sole Proprietor, you are entirely responsible for the financial risks involved in running your business. Yes, you’re liable for all debts, but more importantly if the business fails then all of your assets – even those unrelated to the business – can be seized and will be subject to the claims of your business creditors. This is a huge personal risk to take on as your company begins to grow; registering as a Private Company will alleviate this burden by limiting your personal liability.
Being formally registered also allows you to apply for business loans or investments, and to take on shareholders, and to make use of the various funding and investment sources available to Private Companies – from angel investors through to government funding options (FYI Yoco Capital allows any type of business to get funding).
In a nutshell, if you find that your profits are increasing and continued growth is both necessary and inevitable, then it may make financial sense to register officially and formalise your structure and finances.
When it makes business sense
Registering your business could broaden your potential client and supplier base, because many customers and suppliers prefer to deal with a Private Company as opposed to an individual. Furthermore, being registered will allow you to pitch for business to larger corporates and government.
You may also be building your empire with the ultimate vision of selling it off and retiring to a tropical island. If this is the case, you need to build a company that will sell. And this can only be done if the business is officially registered.
When it’s more tax efficient
In South Africa, an individual is taxed on a sliding scale whereby the more they earn, the more their average rate of tax will increase. This applies to individuals earning more than R78 750 per annum. A registered company, however, is taxed at a flat rate of 28% of profits (as of 2019), and a further 20% when shareholders receive their dividends.
Based on this system, you can see how initially, as you start up and remain within the lower income bracket, it makes sense to operate as a Sole Proprietorship. However, as your company grows and your profits increase, you may lessen your tax burden by registering as a (Pty) Ltd. That said, it’s important to perform an in-depth analysis of both situations and assess which will be the most beneficial, taking into account factors such as tax incentives for registered companies, deductions and allowances.
Generally, the same rule applies regardless of the nature of your business: As your company grows, you are more likely to benefit from formal registration. Registering with the CIPC as a (Pty) Ltd may initially seem complex and arduous, but it will ultimately broaden your potential customer base, alleviate personal financial risk, eliminate unnecessary tax burdens and open you up to funding, incentives and support services provided by the government.