One of the most common questions persons looking to start their business ask is whether they should start as a sole trader or else whether to set-up a limited liability company. This short article aims to provide the reader with a synopsis of the pros and cons of both approaches and list down the factors one should consider in arriving to a decision.
In the past, the most common factor that used to convince sole traders to convert to limited liability companies was tax savings. However, since 1990 both the top personal tax bracket as well as the company tax rate has been stream lined at 35%. With the recent increases in the tax brackets, where an individual earning up to Euro 60,000 is taxed at 29% there is very little tax incentive to justify, on its own, the conversion of a business to a limited liability company.
An important factor that, in our opinion, is even more important than taxation, when evaluating such a decision, is the question of LIMITED LIABILITY. This principle is rarely understood by a person starting up his business. But in simple terms as a sole trader, your business creditors have access to all your business assets as well as all your personal assets.
As a limited liability company the only assets they can claim on are the business assets provided that no fraudulent activity or wrongful trading was committed whilst trading under a company name.
This can be looked at as a RISK UMBRELLA that protects the personal assets of the trader should the business encounter any type of financial storm. The problems can result from the trader’s inability to repay his/her creditors or from claims by a client, an employee or any third party seeking redress in court against the trader for presumed damages suffered.
The transfer of the business assets from a sole trader to his heirs can sometimes be very cumbersome requiring the opening of the will, transfer of legal titles to property etc. This can also be very costly, especially where a will is challenged in a court. Such a challenge can spell the death knoll for such a business.
In the case of a company, as this is a legal person in its own right, the only procedure required is the transfer of ownership in the share capital. Its legal rights and obligations on its property, assets, debtors, creditors, bank facilities and employees are not disturbed. Therefore the business should encounter few problems in continuing to trade.
First of all, the major providers of credit finance in Malta do not have any preference since through their review for the granting of loans and/or overdrafts to companies, they always ensure that the directors provide a personal guarantee on the company’s facilities secured by their personal/business assets.
Many trade creditors nowadays have become much more restrictive as to credit terms in view of their experience over the past few years when bad debts have become a common reality. But an increased reporting to the Registry of Companies and Inland Revenue, as well as to other authorities such as the National Statistics Authority by limited liability companies; as well as the current ease by which anybody can obtain copies of such reports, provides more weight to both banks and trade creditors, and these tend to give a company more weighting in view of this requirement. From these reports, at least, when they have any doubt, they can obtain a limited amount of financial information on their customer. These matters are furthermore corroborated by the fact that companies are auditied.
Accounts of limited liability companies are normally prepared by qualified accountants according to international reporting standards and covered by an auditor’s certificate as to their truth and fairness, and therefore the reliability of such financial information is more secure and credible. In the case of a sole trader banks can demand a copy of the accounts but in most cases these are not prepared to any specific standards and nor are they audited.
When the business has more than one owner, and these are not husband and wife, the registration of a company is normally more advantageous.
Under Maltese law, the administration of jointly owned property, including business assets, is subject to mutual consent. Therefore, unless all parties agree to it, no action can be taken. Also unless a detailed partnership agreement is signed by all parties, such partnership is bound to run into difficulties at some date or another. These problems can become even more serious should one of the partners die, when the heirs have a right to be paid his/her share of the business which can mean the disposal of important business assets.
In the case of a company, these issues are normally covered by the Memorandum and Articles of Association in which, the partners become shareholders. Such a document, when properly drawn up, will normally cover for most eventualities, including the process of decision making when unanimous consent is not possible. This will ensure that the business will continue to function.
In the case of the death of one of the shareholders, the company’s activities need not be affected severely, since the shareholders are distinct legal persons from the company itself.
When a trader has more than one business, it is always advisable to incorporate each into a separate company thereby ensuring that the problems of one business will have no effect on the other business. Distinctly different businesses are like a boat floating on stormy water. If two boats are tied together, when one goes under it will normally pull the other one with it. So it is advisable to leave each boat floating on its own.
For the above reasons, an incorporated business normally enjoys more prestige, both with its suppliers and its customers.
Customers tend to think that a company has a better organisational structure, is more professional in its approach and has less chance of closing shop in the near future than a sole trader. But suppliers, especially overseas ones, tend to look down on non-incorporated businesses as being small, unregulated and difficult to check for credit rating.
There is also the issue of brand value since most companies normally trade under a brand name whilst most self-employed persons trade under their name.
Neville Cutajar is 3a’s Managing Partner and Director and has extensive business experience working as an Accountant, Auditor and Consultant with a top mid-tier accountancy and audit firm. He was one of the founding members of 3a in 2008, with the vision of providing fresh, innovative and personal service to businesses both in Malta and abroad. Neville may be contacted at: firstname.lastname@example.org; or tel: (+356) 2757 2757.