This article is part of the Startup 101: A Legal Perspective series, guest-written by Odun Longe, a startup lawyer at The Longe Practice. Click here to see all the posts in the 8-part series.
Last week, I walked you through the various legal structures available to startups. This week, we are going to go deeper, into the question of why you would choose any of the structures I explained. I will try to be as practical as possible and won’t bore you with textbook reasons.
No single entity can be termed the perfect entity. Instead, what we have is an entity that is most suitable for a particular situation. Often the question is whether to register a business name, a partnership or incorporate a limited company, as such I would restrict this article to these entities alone. If you need a definition or description of these entities, please refer to last week Thursday’s article.
Without further ado, let me speak to each entity, and explain why you may or may not want to choose any.
Other than the obvious personal liability issues (explained last week), which leave the founder(s) of a business name exposed, an important consideration is whether the founder(s) intend to take OPM (other people’s money) into their business. Particularly if these other people are institutions. No institution worth its salt would put money in an entity that is a business name, whether by way of debt or equity. So if plan on borrowing money from the bank or attracting accelerator or VC funds, a business name is not for you, despite its few advantages.
First, what are these advantages? The greatest benefit of registering a business name is the absence of double taxation. Unlike a company, a registered business name pays income tax at one level only, i.e. none by the entity itself, but by the founders alone after distributions from the business must have been made to them. Of course other non-income taxes need to be remitted, such as withholding tax, value added tax, etcetera.
Of all available entities, a business name is also the least expensive to set up and maintain. The statutory fees are the lowest. You can walk into the CAC by yourself as a non-lawyer (though I absolutely do not recommend this) to register a business name, thereby avoiding legal fees (my colleagues would crucify me). With the new CAC Portal, you can also opt to do this yourself online. In addition, there are fewer statutory filing obligations with the CAC , thereby making it not only less expensive but offering some degree of privacy.
Except I specify otherwise, when I use the word partnership here, I mean all the available partnership structures together, i.e. Partnership in its undiluted state, Limited Partnership (LP), or Limited Liability Partnership (LLP).
For a partnership, its strength also happens to be its weakness. “Sharing” is a double edged sword that is able to make or wreck a partnership. As each partner is seen before the law to be an agent of the partnership and the other partners, there is a weightier implication of shared responsibility and you want to be very careful about choosing who you partner with. Liability in a partnership rests with the partners, and not a distinct entity as obtains with a company.
For the LPs or LLPs however, some partners may have their liability limited to the extent of their participation in the partnership. For the LP, there must be at least one general partner with the other partners being able to limit their liability whilst with the LLP under the Lagos State Laws, all the partners may opt to limit their liability although a few exceptions (not relevant for this topic) where this limitation may be discarded with exist.
As occurs with a registered business name, taxation for partnerships is also only at the founders’ level which reduces the money you “dash” the tax-man.
Private Limited Liability Company
As mentioned above, if you have any plans of taking OPM and these other people happen to be institutions, this is the vehicle for you. That advantage notwithstanding, incorporating a company creates some degree of additional complexity and expenses as compared to opting for a business name.
[A bit of an aside – I have heard of founders who have walked to the CAC and gotten their company incorporated by themselves in order to avoid legal fees. Not only is this illegal, it is also so not recommended. I don’t say this just because it takes food away from the table for my colleagues and I, but also because it is an action that may sometimes be Kobo wise, Naira foolish, especially if you are a startup in the true sense of the word and not a “trading company”. I say this with no disrespect to trading companies. The good folks at the CAC would incorporate your company quite alright, but you would end up with a company having the generic Articles of Association without any exceptions and qualifications, which would come to bite at a later stage when certain actions need to be taken by the company which the company is not legally permitted to so do by virtue of its Articles and an amendment then needs to be done.
At this point, the amendment process is not only a time waster (resolutions would need to be passed, new articles prepared, fresh applications made to the CAC etc.), you would then also have to pay the legal fees you were initially trying to avoid. True story of some founders I know who did this — they ended up with a Memorandum & Articles of Association (MEMART) signed by two sets of people… Memorandum signed by the founders, Articles signed by “unknown persons”. In case you didn’t know, the entire MEMART should be signed by the same set of people.]
Okay let’s get back to why we are here — the reason a company may or may not be suitable for you.
One of the advantages of a company is its ability to continue to exist beyond the death of its shareholders, unlike in a Business Name or a Partnership (except the Partnership Agreement states otherwise). Companies like Coca- Cola, Procter & Gamble, Apple etc. are examples. It is also a separate entity distinct from its shareholders as such it is possible for a company to be liable for an action whilst the shareholders are shielded from such liability.
On the other hand however, setting up a company can be expensive, there are numerous filing obligations (annual returns, resolutions, change of directors and/or shareholders etc.), and the oft mentioned double taxation.
Double taxation, as the name implies, means being taxed twice, and this is absolutely legal
and not LIRS being LIRS. So how does this happen? When a Company declares profits, it pays tax at a corporate level, i.e. as a company to the Federal Government through the Federal Inland Revenue Service (FIRS). And then when it distributes profits (dividend) to its members, each member pays personal income tax on that dividend to the government of the state where they are resident. So if you live in Lagos, it would be our favourite people, the Lagos Inland Revenue Service (LIRS) that you would have to pay your taxes to.
Having a company also limits your privacy. As a company, you are statutory obligated to file annual returns, which must be supported by the company’s audited accounts. Whilst ideally, there should be restricted access to a private limited company’s audited accounts with a report generated (confirming just filing of the annual returns) by the CAC when a statutory search is conducted, the reality is that accessing a company’s financials is actually possible when conducting a search. Don’t ask me how.
As you can see, no one size fits all. Choosing your preferred legal structure mostly depends on your type of business, your plans for the business and the stage you are at. To make the right decision, I would advise that you consult your lawyer.
Disclaimer: Articles do not constitute legal advice, neither has a lawyer-client relationship been created by engagement in the comment section. If you require professional legal advice, kindly contact your legal adviser.