Should I register a company for my freelance/consulting/side hustle/startup?
Many people want to just register a company, as they feel it’s the first step to making their offering official. I receive a call like this exceptionally often: “I have this awesome idea for a startup, and want to register a company. I know it will make so much money”. When considering registering a business (a company/Pty Ltd) for your startup, side hustle or consulting – while very noble, you need to consider the pros and cons from all angles before making a call.
Don’t just register a company because it sounds like the right thing to do. It needs to fit you and your business/project/side hustle.
Note: If you need more info on how tax and money is affected when you are an employee, freelancer or contractor – then check my post out here.
Your entity options and tax
Let’s start out with the options available to you in South Africa.
You can do business in your own name (e.g. Frugal Local trading as StartupConsultant). This is called a sole proprietary. All profits will be taxed at your normal tax rate that SARS charges all employees/people with income.
If you’re in a partnership, the partnership will determine which part of the profits will be paid over to you. The same tax rules apply to a partnership as to a sole proprietary.
You can also register a company – a registered proprietary limited company. Note that going forward I will refer to a company like this one! Though you might own the company (i.e. all the shares), you need to remember that you are not the company. SARS sees them as 2 different entities. Company tax is 28% (2021). Please note that you cannot use company money for personal expenses such as groceries and medical aid! You would need to declare all money paid over from the company to you as income! Remember you will need to pay for accounting and other fees as well – it’s not as simple and cheap as it sounds!
An honourable mention is trusts. Generally, we don’t do business through trusts, as this incurs a 45% tax. There are uses for trusts though, but more about that later. In some cases, such as wine farms, the holding is kept in a family trust to avoid large transfer costs and estate duties.
What is your goal?
Some people work as freelancers or contractors. Others are full-time employed. Still, others work for themselves. With such a broad spread of interests and factors, you might want to consider why you want to register a company in some of these scenarios:
- Do you have an exit strategy for your venture? Are you looking at selling it or listing it on a stock exchange?
- You have IP that you want to lease to other parties
- Do you want to grow your business exponentially and start hiring people?
- Do you want others to have a share in your company or profits?
The intention is very important. For example, if you trade as a sole proprietor, you will not be able to sell your soul if someone is interested in buying your company. This will make it challenging to establish the value of the company or IP.
In short, any structure will always be sandwiched in a balance between legal liability (who to blame), tax and profitability. The combination of these three will always need to be considered when making the final decision.
Entity structures
Okay, so below you will see me (Frugal). I have the following choices – either a sole proprietary or owning the company. I know there are more complex structures such as trusts owning companies, but for the purpose of this article, I don’t think it’s relevant.
Register a company with shareholders
The trust-company structure is a terrible idea for many startups though. If you have an exit strategy and want to sell your company, you will run into issues with tax (45%) on all profits. For this reason, you might consider the company-shareholder model.
Some startups are hesitant to dash out equity. And with good reason. We know that many founders get voted out of their own companies at some stage. For this reason, you can offer valuable people profit share. This is when you share any profits made by the company with staff members, friends or other parties.
Consider registering a company if
There might be some factors that will drive you towards a certain entity. For example, you might want to consider a company:
- Your startup is risky – financially, explicit or will require the buy-in of share/stakeholders
- Your side hustle will have huge financial risk and you don’t want to be liable in case there is a financial failure.
- The outsource and contractor model is not serving your business efficiently anymore – you need to consider other options.
- Your business is only you – and you want to first find your feet before going too public.
- You’re in the idea phase of your business – and you don’t have concrete proof that your business will work.
I don’t want to register a company just yet
Many people feel that they don’t want to register a company just yet (if ever). This is 100% acceptable and understandable. There are a lot of things that you need to figure out before you get to that point. For example:
- Am I able to get the clients I need to make this work?
- Have I done due diligence and validated learning to confirm the viability and take-up of my product or service?
- Am I able to bootstrap the idea and avoid massive overheads, costs and complex decisions for now?
- I want to be a company of one and outsource all my extra work
- I work in a low-risk industry with few issues with regard to litigation and cash flow/bankruptcy issues.
Conclusion
Being Frugal, I believe that you should postpone your decision-making concerning legal structures as much as you can. Once you have a compelling reason to choose a legal structure, then act on it.
Whether you choose to do the work in your own name, a company (Pty Ltd) or a trust – you shouldn’t take the decision lightly. It might be in your best interest to seek legal advice before registering the needed structures. Always count the cost (legal fees, liability and tax costs) of your investment structures.