Choosing the Right Outfit for your Business

You have identified a business idea, done research on its viability in the market, made a business plan and prepared your finances. Now you need to make it official by choosing the right legal entity to actualize your business. The choice of legal entity is an important one as it has critical implications on payment of tax, the level of control, liability and ongoing administration. Luckily, there are various options available for a new business whether it’s a one man show or an undertaking with multiple persons injecting capital.

For every legal entity there is a law corresponding to it setting out its features, how the entity is to be setup and its management. This article will delve into the different attributes of the legal entities in an effort to help you find the right fit for your business.

Sole Proprietorship

This is the simplest legal entity to start a business. It usually involves one person who owns and runs the business. It is best suited for a person who is new to business, has limited capital or wants to retain total control of the business.

Set up – it is easier to set up and run compared to other entries. In Kenya all you need to do is register a business name and you can start trading as a sole proprietorship.  Other entities require extensive documentation and have to maintain their records e.g. by filing returns and notifying respective Registrars of material changes.

Liability – Being a sole proprietor means that you are personally liable for liabilities incurred in running the business. Your assets can be seized to settle debts or legal claims. 

Tax – in a sole proprietorship there is no distinction between the business and the owner. Therefore the tax obligations for a sole proprietorship are assessed in the same way as an individual taxpayer i.e. using PAYE tax bands just like an employee. A sole proprietor can therefore claim a tax relief.

The beauty of a sole proprietorship is that it can easily be converted into a different entity depending on the changing needs of the business. It can be converted to a partnership or a company etc.

Partnerships – under the Partnership Act

Section 3 of the Partnership Act Cap 29 defines a Partnership as the relationship which subsists between persons carrying on a business in common with a view of profit.

A partnership is the simplest entity for two or more people to own a business together. Like a sole proprietorship there is no distinction between the partnership and the owners. A partners’ personal property can be seized to settle debts or legal claims. 

Liability – section 11 of the Partnership Act provides that every partner in a firm is jointly liable with the other partners for all debts and obligations of the firm incurred while they are partner.

Tax – because a partnership is not a separate legal entity from its members it does not pay taxes. However the Partners pay taxes on their income individually.

Agency – each partner is deemed to be an agent of the other partners and each transaction entered is binding on each of the partners and the partnership.

Set- up – The process of setting up a Partnership is similar to that of sole proprietorship. However, a partnership subsists if to or more people carry on business for profit. It is good practice for the partners to have a partnership deed setting out how the business is to be run and the rights and duties of partners.

Limited Liability Partnerships (LLP)

 An LLP is a unique form of business association that combines elements of a company with those of a partnership.

Separate Legal Personality – Section 6 of the LLP Act provides that upon registration a LLP becomes a body corporate with perpetual succession with a legal personality separate from that of its partners.

Limited Liability – Partners’ liability in an LLP is limited to their capital contribution. Section 10 of the LLP Act provides that each partners shall be liable personally liable for acts of negligence and fraud committed by them without liability extending to other partners.

Membership – an LLP must have at least 2 partners. If an LLP carries on business for more than 2 years with one partner, that partner will be jointly liable with the partnership for any obligations incurred during that period. There is no limit on the maximum number of partners. Partners in LLP’s can be natural persons or legal entities such as companies however all LLP’s must have a manager who is a natural person.

Tax– LLPs are not subject to corporation tax. Partners pay tax on their income after profits have been distributed. There are additional tax savings in an LLP compared to a company where tax is paid on dividends in addition to corporation tax.

Setup and management – to register an LLP you need at least Kshs.25,200 and to complete a form with the particulars of the LLP, the partners and the manager. LLPs are also required to file a declaration of insolvency annually and notify the Registrar of any changes.

Compliance and reporting – LLP’s have fewer reporting and compliance requirements compared to companies which must prepare audited accounts, hold statutory meetings and prepare documentation for transferring shares, reduction of capital, returns etc.

LLP’s are more attractive entities for investment because of the tax benefits they enjoy, the fewer reporting requirements and the ease of formation and dissolution. LLP’s can also easily raise capital or reduce capital, to reduce capital in a company you would need a court order and raising capital through an IPO is extensive process.

LLP’s are also suitable for professional businesses such as accounting or legal practices where partners wish to enjoy limited liability.

It is good practice for partners to prepare a partnership deed which sets out how the LLP is to be run and the rights and duties of partners. It’s also important to note that partnerships and private companies can be converted to LLP’s. However LLP’s cannot be converted to partnerships or companies.

Companies

Section 2 of the Companies Act 2015 provides that a company means a company formed and registered under this Act or an existing company. While this is unhelpful in understanding what a company really is the following features create a better picture.

Separate entity – a company is a separate and distinct entity from its members or management. Unlike sole proprietorships and partnerships. The company has capacity to bring legal proceeding and contract in its own name.

Limited Liability – the liability of the shareholders is limited to the amount unpaid on shares they have taken up in the company. Personal assets of the shareholders are also protected from being seized to discharge company debts and claims.

Perpetual Succession – because a company is separate legal entity it outlives its members unlike sole proprietorship and partnerships which terminate upon death or incapacity of the partners or proprietor.

Membership – the Companies Act 2015 provides that a private company can have a minimum of one member and a maximum of fifty members. It is therefore a viable option for single member business where you want to limit your liability but still maintain control of the business. It is also great where multiple persons have contributed capital and what a stake in the business. Here one is able to enjoy limited liability but there is lesser control in how the business is run.

Set-up and management costs – to incorporate a private company in Kenya you need extensive documentation and at least KSh.12,000. A company is also required to file returns annually, prepare audited accounts and notify the registrar of changes in directorship, address, shareholding etc. It is more expensive to set up and run a company compared to a sole proprietorship or partnership.

Tax – in Kenya, profit making companies pay corporate tax at 30%. Additionally if a company pays dividends to their shareholders withholding tax is charged at 5% for resident shareholders and 10% for non-resident shareholders.

Types of companies

The Companies Act provides for four different types of companies:

  • Private Companies –are companies which restrict the rights of members to transfer shares. What this means is, if you are a shareholder of a company you cannot transfer your shares to persons outside the company before first offering the shares to existing shareholders. If none of the shareholders take them up you can offer them to persons outside a company. Private companies must have at least 1 director and 1 shareholder.
  • Public companies –are companies that do not restrict member’s right to transfer shares and allow invitations to public to subscribe to shares of the company. If you are a shareholder in a public company you are free to transfer shares to anyone whether or not they are members of that company. Public companies must have a company secretary and at least 2 directors and 7 shareholders.
  • Companies limited by guarantee – unlike private and public companies which are limited by shares, companies limited by guarantee restrict members’ liability to an amount which members have undertaken to contribute to assets of the company in case of liquidation. Companies’ limited companies are great for charitable purposes.
  • Foreign Companies – a foreign company wishing to operate business in Kenya can register a branch or a subsidiary. A subsidiary is considered a local company with compliance requirements that are similar to local companies while a branch office has unique compliance requirements different from ordinary companies.

Cooperative societies

Section 4 of the Cooperative Societies Act defines a Cooperative society as an entity whose objects are promotion of the welfare and economic interests of its members and which as incorporated in its bylaws principles of open and voluntary membership, economic participation of members, education and training, democratic member control and concern for community.

Cooperative societies are formed to improve welfare and economic well being of people in a particular class or industry. In Kenya there are numerous cooperative societies such as Agricultural Cooperatives, Professional Cooperatives, Housing cooperatives etc.  Cooperatives do not conduct business solely for profit but if profit is generated it is distributed among members.

Membership – it must have a minimum of 10 members who are over 18, residents in the area where the society operates and of the occupation for which it is formed.

Corporate body – upon incorporation a cooperative society becomes a corporate body separate from its members.

Compliance – section 27 of the Cooperative Societies Act provides that cooperative societies are required to keep proper books of account and hold annual general meetings for their members.

Management – cooperative societies are required to have a committee which is the governing body responsible for management of its affairs. Members have a right to vote and elect members of the committee.

Cooperatives societies that conduct deposit taking and lending business are known as SACCOS and must be licensed by the Sacco Societies Regulatory Authority (SASRA).

 Societies

Section 2 of the Societies Act defines a society as an association of 10 or more persons whatever its objects established in Kenya or having its chief place of business in Kenya. It includes, clubs, religious organizations.

Because of the unlimited objects, a society can be formed if any of the other entities are unsuitable. They can be used for education and training associations, sporting activities, chamas, religious and charitable organizations etc.

 Setup – all societies must be registered or exempt from registration. Societies that are not registered or exempted from registration are deemed unlawful societies.

Compliance – societies are required to have a constitution/rules setting out the objects, registered office, membership criteria etc. They are also required to keep updated account records and hold annual general meetings. Registered Societies are required to file annual returns with the Registrar of Societies.

Societies do not include: Building Societies under the Building Societies Act, Cooperative societies, Schools registered under the Education Act, Registered Trade Unions and any International Organizations which Kenya is a member.

Self-help Groups (SHG)

Self-help groups more popularly known as chamas have mushroomed over the past years to become formidable entities for investment and running business. In the beginning chamas were used for small- scale investments and households needs such as school fees. They have now grown into entities where individuals can collectively own property and make other large scale investments.

Self-help Groups are recognized by the Ministry of Gender Children and Social Development and can apply for registration. The process for registration of a SHG is simpler and less costly compared to other entities. Registration of an SHG gives it formality and clarity as regards member obligations, leadership and holding of property. Upon registration the SHG can also apply for loans for projects or assistance through the Ministry of Social Development.

Membership – an SHG should have at least 10 members to be eligible for registration.

Set- up and management – to register an SHG, members need to complete an application form and attach the groups’ by-laws, minutes electing officials and a list of the members. The documents are then presented to the nearest DC office for registration with a fee of Kshs.1,000.

Compliance – the SHG is required to file Annual Returns with the Registrar at the DC office and hold an annual general meeting. If there are any changes in membership, officials, constitution etc. the officials are required to notify the Registrar within 14days of the change.

Conclusion

Choosing a legal entity to run a business has significant implications for the business’s success. The choice should be informed by the objects of the business, the budget for formation and maintenance, the level of control you want to retain and future needs. Most of the entities can be converted depending on changing needs of the business. This offers flexibility for entrepreneurs as a business grows.

  • What Our Clients Say About Us