One of the first questions new entrepreneurs ask is when to register a company. The answer to this is, “It depends.”
Before you even think about company structures, you need to establish that you have a viable business opportunity. Then, (and only then) decide when (or if) to move the business into a company structure, by weighing the advantages and the disadvantages.
In most countries you can operate as a sole trader (ie. in your own name without a formal structure). You can operate your business this way forever if you like and there are advantages, disadvantages and tax implications of doing so.
So why would you use a company structure?
Here’s the downside to registering a company
First of all, let’s look at the downsides of using a company structure.
The major disadvantage is that many people spend too much time focusing on registering a company before they have even established that they have a viable business opportunity. Don’t let this happen to you.
In many cases, you can test the market by doing some trial sales as a sole trader, before you register a company. This can help you determine if you have an opportunity that is worth investing more of your time and money into. (This would not be appropriate however when making sales involves you taking on unacceptable risk – for example selling a product or service that could potentially leave you open to lawsuits or other risks.)
Don’t let business structures distract you from making sure you have a business idea that has legs.
The second disadvantage is that registering a company costs money and requires more compliance than operating as a sole trader.
However the money becomes a non-issue if it is outweighed by the advantages. So let’s have a look at those.
On the other hand, there are benefits…
- Limited Liability: As a director of a business in a company structure, you are not personally liable (legally responsible) for the actions of the business – the company is. The company assumes and is liable for any risks and your personal risk is limited – meaning your personal assets (such as your home) can be protected.
For instance, let’s say you manufacture electronic components that go in the imaging machines of Global Health Conglomerate and they malfunction. Global Health is loses money because of this and wants to sue you for damages. If their contract is with your company (rather than you personally), they can only sue the company for its assets (which is bad enough). They can’t sue you personally – meaning you might lose your business, but your pension plan, personal home and any personal investments are protected. The only time when this is not the case is when you have been negligent or not acted as a director is legally obliged to.
- Tax advantages – In many countries, businesses are given tax concessions as a way to encourage people to build businesses & stimulate the economy. This means that once you are earning over a certain amount, it is better for you to run the business in a company structure as the tax man will take less of your dollars. This site has a list of personal and corporate tax rates in different countries, but of course check this with your own accountant.
- Credibility – Using a company structure can give you credibility which is important in some situations. For instance, Global Health Conglomerate (the fictitious company mentioned above) is unlikely to sign a large contract with you as a sole trader. They want to deal with companies. However, if your business is selling stuff at markets, then having a company is probably not important as far as credibility is concerned.
When to register a company
Therefore you should put the business into a company structure when any of the following apply:
- you need to take considered risks, which you wish to protect yourself from personally
- it is advantageous from a tax point of view
- you need to to appear credible to your customers or suppliers.
The application of this will obviously be different for every business.
A final (important) caution:
This is general advice and is intended to give you some general principles for deciding when to register a company. Each startup is different and you should check with your accountant, legal representative and the relevant government bodies for your area, as regulations differ all over the world.
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I agree with all your points here. I’m in software and I tested the market first as a sole trader before going the Limited Company route.
With Ltd. after our name I definitely feel that we have more credibility.
I have to sign a contract with another company to do my business. So, is it good for me to sign it as an individual or as a company.
That depends Krishna. If you are taking on liabilities (ie. you could get sued), you should definitely do it in a company structure. It could also help your credibility.
Please keep in mind that I am not a lawyer and I am speaking from my experience in Australia. You should definitely get advice from a relevant expert in your country. It’s worth paying to make sure you get this right,
i want to start a recruitment consultancy so I have to register m starting as single
Yes, you will need to register a legal entity to do recruitment. However, make sure that you have demand for your services BEFORE you register it. 🙂
I am starting a topographic mapping business, based on digital elevation data. I cannot test the market until I have written the necessary software, except through my “day job” as a hydrologist. I have business expenses, which I would like to set against the income tax I am paying through my employer. Would it be sensible to register as a sole trader now for these tax purposes, with the possibility of changing my corporate structure as I go online and start to receive income?
Hi Chris. The best way to test your market is to talk to potential customers and show them a wireframe or screen shots so they understand the functionality and features of the software and can give you feedback. Some of the design thinking tools can help you with that.
I can’t give you advice about structuring as it really depends on your situation. It’s best to talk to a lawyer about your personal circumstances.
However you could certainly test your idea using the methods above to make sure it is something the market wants without forming a company.