How to decide the right legal-form for your start-up
Eight years ago, I set up Justice Studio, a social justice consultancy. At that time, I had a dearth of knowledge about the legal form of organisations. Indeed, for most budding entrepreneurs excited about setting up a new venture, the last thing they want to think about is legal forms/structures. But whilst they don’t have a stimulating reputation, your legal form is a vital first step. Take it from me, if you don’t pay attention to the legal structure of your organisation at the beginning, you will wish you had once you are further down the line.
Know what you are giving birth to
Actually I genuinely think legal forms can be pretty exciting. They are so important, that recognising their role as the structural skeleton of your organisation gives them a stimulating gravitas that some might even call sexy. As most social justice activists know, structures matter. What legal-form your organisation takes reflects its identity and what it stands for.
When I first started out, I didn’t have anyone to ask about the legal form of my organisation. In fact, the conversation was mainly had with my accountant. As helpful as she was, I’ve seen too many entrepreneurs blindly follow what their lawyer or accountant says about their legal form, based purely on tax considerations. Yet tax implications should only be secondary to the overriding purpose of the organisation. If you don’t make a decision on legal structure based on the organisation’s purpose at its birth, then it may not be structured appropriately to fulfil that purpose, and you could be welcoming problems down the line.
Do you want more freedom or protection?
The first main decision to make is between freedom and protection. You can either do what you want with your income, but end up taking on personal risk (unlimited liability), or you can protect yourself (limit your liability), but recognise that your venture is no longer of yourself, and along with it comes great responsibility. This distinction of freedom + risk versus protection + responsibility is a central one, and relevant whether your aim is to make money or do good, or both at the same time.
Another decision to make is if you want to do this on your own, or venture out with others, now, or in the future. If you like your freedom and just want to work on your own, then a Sole Trader, or Sole Proprietor in the US, could be for you. If you want freedom, but want to work with people, then a Partnership or an Unincorporated Association will allow you to do that without the legal restrictions of having your own entity. You don’t need much to set up, although there are some requirements for Sole Traders or Sole Proprietors, and I would recommend you have a partnership deed or agreement setting out the roles and responsibilities of partnerships or associations.
For more protection (and the associated responsibility), you limit your liability. This essentially means that if something does go wrong, your own finances are not harmed as a result. However, at the same time, it means that you are creating an entity other than yourself: something with its own legal personality, that needs its own protection from harm. By founding it, you also have responsibilities towards it. Think of it like a baby or a plant. It’s not you. It’s something separate from you, and you have a duty to ensure that it flourishes. Once it is born, you are its guardian.
Do you want to make money or do good, or do both?
When working out the best type of limited liability, it’s crucial to to be clear on your motivation for setting up your organisation. It is this motivation which will lead you ultimately to the correct legal form.
If you just want to set up a simple profit-making business, then you can either set up a private limited company or a Limited Liability Partnership (LLP) — the half-way house between a partnership and a limited company. All businesses in the UK need to be registered at Companies House. In the US, be aware that in setting up your LLP or Limited Liability Company (LLC) every state has its own code of business laws authorising the formation of business entities, so check out your responsibilities. You’ll need ABN entitlement to set up your Proprietary Limited Company (Pty Ltd) in Australia.
Doing good usually means that you will be aiming to set up a charity or not-for-profit entity. A Company Limited by Guarantee (CLG) is the most common form of organisation in the UK and it has members rather than shareholders. The majority of charities that were established before 2013 were set up as a CLGs, and registered as a charity through the UK Charity Commission. However, now there is a simpler structure called the Charitable Incorporated Organisation (CIO), which has been designed specifically for charities, meaning you just need to register once with the Charity Commission and you don’t need to worry about registering with, or reporting to, Companies House. In the US, charitable status is recognised through your tax code, so to do charitable work you need to register as, the catchy sounding, 501(c)(3).
If you want to do good and make money, then there are more options to consider. Generally, organisations that have a double or triple bottom line, can operate under a few different legal forms. In the UK, it is possible to simply use a limited company structure and have an added social purpose. Alternatively, you can have a specific status such as a cooperative or, since 2005, a Community Interest Company (CIC). CICs have an asset lock to ensure that their assets and profits are used for the benefit of the community. If you want to set one up you need to get it registered with the CIC Regulator.
Whilst the CIC is close, there is no specific legal structure for a social enterprise in the UK, so for validity, you can join a membership body such as Social Enterprise UK, where my organisation is registered. In the US, the Social Enterprise Alliance is the equivalent body. The US also has a new certification for companies driven by profit and purpose: B-Corps. These self-managing and purpose-driven organisations, who care about social mission and profit, remind us to think of an organisation as an organic, living thing, that should benefit society.
If I haven’t convinced you about how exciting legal structures are yet, then I hope you can at least see that they are important. And then finally we get to the genuinely fun bit: thinking of a name. If you are in the US, working out what names are available might take a while, however, in the UK or Australiathere are handy company name checkers. Suffice it to say I have spent many a happy hour on these platforms working out the best available names.
Now, with your legal form and your name you are good to go. Good luck and enjoy!
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Marianne is an entrepreneur, business and leadership specialist. She is on a mission to de-legitimise the structures and values of traditional business, helping the world to see that a new way is possible. Marianne set up her first company Justice Studio in 2011.