RE: Advantages of incorporation as opposed to other forms of doing business.
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There are various vehicles through which one may use to trade or transact business in Kenya. These vehicles include: a sole proprietorship business, a partnership, a company limited by shares or by guarantee, a trust, a society, or a Non-governmental Organizations (NGO).
Below are some of the comparisons of trading through a company compared to other forms of business vehicles.
Companies versus sole proprietorship business
Introduction:
Companies in Kenya are regulated under the provisions of the Companies Act (Cap. 486) of the Laws of Kenya. Under the Act one may incorporate a private or public company. Regarding liability of members in a company, a company may be limited by shares or by guarantee. Although unlimited companies may be incorporated under the Act, these are not common.
Compared to a public company, share in a private companies are not freely transferable. Besides, unlike a public company, a private company is prohibited under the Act from inviting the public to subscribe for its shares or debentures.
A company limited by guarantee is usually intended for some charitable objects and is not a suitable vehicle for trading purposes. This reason for is that; in a company limited by guarantee it is generally not permissible for the business profits of the company to be shared out amongst the members of the company by way of dividend payment.
The following are advantages and disadvantage of trading through a company compared to trading through a sole proprietorship business.
1 In the formation of a company, there is usually a substantial amount of start-up costs that must be incurred by the promoters of the company in incorporating the company. These preliminary expenses include the legal fees paid to lawyers for the preparation of incorporation documents (i.e., the memorandum and articles of association) and fees paid to government such as the registration and stamp duty fees. Besides, in the case of a public company limited by shares, additions expenses would be incurred by the promoters in the preparation of prospectuses for the purposes of inviting the public to subscribe for shares or debentures in the company. By contrast, a sole trader has little, if any, start up cost since there are no incorporation documents that needs to be prepared.
2 A company, whether private or public, has a legal personality of its own. This legal attribute makes a company distinct in every aspect from its members. For this reason, a company has the legal capacity to trade, borrow, lend, sue and be sued in its own name. On the other hand, a sole proprietorship as a form of business entity is unincorporated entity and has no legal personality of its own. Due to this fact, there is no separation in law between the sole trader himself and his business. By extension, the assets and liabilities of the business and those of the individual sole trader are the same.
3 The “life” of a sole proprietorship business is dependent on the life and fortunes of the owner. Therefore, in most cases, the death of a sole trader will mean the end of his business. On the other hand, a company is regarded in law as having a perpetual succession. By this is meant that; the existence and business of the company is not affected by death of any of its members. However, this will usually be the case for large public companies and would not apply in a small private company whose existence and business is largely dependent on the goodwill and individual expertise of its main shareholders-who usually also serve as the directors of the company.
4 Compared to a sole proprietor, a company, by virtue of its legal attributes and constitution, is better suited to raise the necessary capital for its business projects. In case of a sole trader, his main sources of funds for the business are: personal savings, trade credits and donations from friends. On the other hand, a company has diverse sources of funding. For a public company, it can raise huge funding for its business from subscription of its shares and debentures by the members of the public through the issue of prospectuses. Moreover, both private and public company can raise the business capital by issue of preference shares. Preference shares, especially cumulative preferences shares, are able to attract huge investors due to the guaranteed income in terms of dividends pay-outs and the security associated preference shares in the event a company’s liquidation. Besides, both private and public companies are viewed by lenders as more stable customers to lend compared to the sole traders. The reason for this is partly because of their perpetual succession attribute. Moreover, companies are better able to secure their borrowings by creating instruments like fixed or floating debentures over their assets. Additionally, the company’s directors are usually called upon by lenders to give personal guarantees to secure the company’s debts and liabilities.
5 The liability of a member in a company is limited. In case of a company limited by shares, the members’ liability is liability to the amounts subscribed by members in the share capital of a company. Where shares are fully paid, even in the events of the liquidation of the company by its creditors, its members cannot be called upon to put more funds in the company’s coffers to satisfy the claims by any unpaid creditors. In a company limited by guarantee, a member liability is limited to the amount guaranteed in the event of liquidation, which is usually a nominal amount. In summary, where a company is unable to pay its debts and for this reason put into liquidation by its creditors, the liability of members in a limited company remains largely unaffected. On the other hand, a sole proprietor has unlimited liability. Besides, as stated above, there is no distinction between the personal debts and liabilities of the owner and those of his business. For these reasons, if the business is unable to pay its creditors, the law permits the business creditors to go after the personal assets of a sole trader and vice versa. Besides, where a sole trader is declared bankruptcy, his business should be liquidated for the benefit of his creditors. By contrast, in a company situation, the bankruptcy of a member does not affect the company and vice versa.
6 Under the provisions of The Income Tax Act (Cap 470) of the Laws of Kenya, companies are allowed to expense the management’s fees and salaries paid to their management team when computing the company’s taxable profits. On the other hand, a sole proprietor is not permitted to deduct his salary from the taxable income of the business and is taxed for both his personal and business incomes.
7 With regard to the rate of taxation, a company is taxed at a fixed rate of 30% on its taxable income (or 37.5% for a foreign branch). This is not to mention some tax holidays and lower rates of taxation that are enjoyed by companies registered to operate in the Export Processing Zones and those that have agreed to list in the stock exchange. On the other hand, the business of a sole trade is not accorded any tax holidays or lower rates of taxation. Moreover, a sole trader is subjected to income tax at graduated rates of taxation.
8 With regard to decision making, a sole proprietor is his own boss and need not consult when taking any business decisions. For this reason, business decisions can be made quicker whenever it is necessary. In a company, the day-to-day decisions are entrusted to the Board of Directors of the company. Other major decisions like capital investments, change of the name of the company and appointment of directors and auditors are left to be resolved by shareholders of the company at the company’s general meetings. Due to the need for consultation, decision process in companies is slower compared to a sole trader situation. Despite this seemingly advantage, the lack of consultation by a sole trade in his decision making process usually precipitates strategically poor and unwise business decisions. On the other hand, in a company situation, any decision made at the board’s level by directors or at the general meeting’s level by shareholders is a result of the reconciliation of rival business ideas that are usually anchored on the experiences and individuals’ expertise. For this reason, the decisions made by company are likely to be strategically superior compared to those made by a sole trader.
9 Whereas a sole trader can keep all the profits made in his business, he equally bears all the losses made by the business. In the case of a company, although the profits will be shared between the various shareholders of the company by dividend pay-outs to the company’s members, the members have no obligation towards the losses that may be reported by the company. In fact, the worst that can happen to members when a company report a trading loss in a particular financial year is lack of dividend payments in that financial year.
10 Each company is legally obligated to file its annual return with the Companies Registry. Besides, each company must conduct its statutory and other general meetings, appoint directors, secretary and auditors for the company. Additionally, each company has a legal duty under the tax statutes to file its various tax returns like income tax returns, provisional assessment returns, VAT returns and PAYE returns with the relevant tax authorities. All these activities result in high administration costs in running a company. Besides, non-compliance with these requirements exposes the directors and the secretary of the company penal consequences. By contrast, other than various tax returns required to be filed by a sole traders under tax statutes, there is no legal obligations to file annul return or appoint directors, secretaries and auditors. In summary, a trader has lower administrative costs to bear compared to a company.
Companies versus partnership
Introduction:
A partnership is a form of business entity that is formed by a minimum of two and a maximum of twenty persons (partners) who come together, sometimes under the terms of some partnership agreement (deed), with the main aim of doing business for profit purposes.
There are two forms of partnerships allowed by law in Kenya. These are: general partnerships and limited partnership. In a general partnership, the liability of all members is unlimited. In, limited partnerships, although some partners are permitted to have limited liability, at least one partner must be a general partner with unlimited liability. Besides, under the provisions of Limited Partnerships Act (Cap. 30) of the Laws of Kenya, limited partnerships must be registered with the Registrar of Companies.
Like a sole trader, a partnership suffers from most of the incapacities and disabilities described above. Below are the main advantages and disadvantages of trading through a company compared to a partnership.
1 The formation of partnership is quicker than in the case of a company. Besides, there is no requirement for registration other than in case of limited partnership. In fact, for general partnership there is no requirement to enter into any deed of partnership or register them. In a company formation, substantial start-up costs must be incurred by the promoters.
2 A partnership is unincorporated entities. For this reason, a partnership will be dissolve as a result of death, insanity, resignation and other incapacities of any of its partners. Besides, there is there is no legal separation between the assets and liabilities of individual partners and those of their business. Moreover, the law regards partners as agents of each other and their business. As a result of these, the mistakes of one partner could bring the whole business to its knees. By contrast, a company has a perpetual succession and legal personality of its own. Therefore, in accompany situation, the company does not get affected by death, resignation, insanity and other incapacities of any of its members. Moreover, in a company situation, a member is not regarded as an agent of other members or of the company (unless where expressly or impliedly authorised to act as such). In addition, in a company situation, the mistakes and liabilities of a member are his own mistakes and liabilities, and cannot be suffered by other members or by the company.
3 Partners in a general partnership have unlimited liability. In a limited partnership situation, at least one of the members must be a general partner with unlimited liability. Due to this, the creditors of the firm may pursue the individual partners for unpaid debts and liabilities of the business without any legal limitations. As discussed above, the members’ liability is a company is limited.
4 In partnership, individual partners are taxed on their salaries and profits derived from the partnership at graduated rates of taxation. On the other hand, companies are taxed at a fixed rate of 30% on their taxable profits (foreign branches are taxed at a rate of 37.5% on their taxable profit derived from Kenya).
5 In a partnership situation, the partners share the profits of the business equally or in the agreed proportion. Similarly, partners are responsible for the losses of the business. In a company situation, the members are paid dividends from the profits of the business, but they are not responsible for the company’s losses.
6 Companies are better able to marshal the necessary resources and funding for their business compared to partnership. The main sources of business capital for partnerships are: the partners’ contributions, trade credits, bank overdrafts and loans from partners. As has been explained above, companies have wide range of sources of funding. Besides, lenders are more willing to lend to companies than to partnerships due to the stability associated with the companies and their ability secure their borrowings by creating debentures over their assets. Partnerships have no legal capacity to create debentures over their assets to secure their borrowings.
Companies versus trusts
Introduction:
A trust is usually constituted by the founder entering into a deed of trust with the intended trustees. To forming a trust, the founder will vested some fund or other resources in the trustees to be administered by them for the benefits of some charitable objects or the beneficiaries. Trustees will usually be permitted to accumulated fund and resources to enlarge the trust fund and resources. The powers and duties of trustees are to a larger extent regulated under the Trustees Act (Cap. 176) of the Laws of Kenya. Moreover, the trustees must obey the directions given by the founder under the instrument of trust.
There are two forms of trusts that can be incorporated in Kenya. These are: private and charitable (public) trusts. Public trusts are intended for some charitable purposes. On the other hand, private trusts are generally intended for the benefit of founder’s family members or other beneficiaries.
Both public and private trusts are not intended as business vehicles. However, a trust can run a business or a company for the benefit of the intended beneficiaries. Compared to a company, the formation of a trust is quicker as there is no compulsory requirement of registration.
Where trusts are used as business vehicles, the trustees will be required to use any profits in furtherance of the trust objects or for the benefit of the beneficiaries. Where trusts are involved in trading, the trustees will be responsible to pay the relevant government taxed and will be jointly and severally liable for any defaults.
The following as the advantages and disadvantages of doing business through a company compared to a trust:
1. Though a trust is not required to be registered, the lack of registration will usually translate into the absence of government’s assistance as government does not generally favour dealing with unregistered entities.
2. If a trust wishes to own land, the trustees would have to incorporate themselves under the Trustees Perpetual Succession Act (Cap. 164) of the Laws of Kenya. However, despite their incorporation, the trustees would not enjoy limited liability and are potentially jointly and severally liable for the mistakes of each other and for breach of trust.
3. The investments in which the surplus funds in trust may employed in regulated by The Trustees Act. These is no such regulations in case of a company.
Companies versus societies
Introduction:
Societies are unincorporated associations of ten or more people established for any purposes that are permitted in law and include establishments such as clubs. Societies are regulated under the Societies Act (Cap. 108) of the Laws of Kenya. These are usually formed for some charitable objects. Political parties are also formed and regulated under The Societies Act.
For charitable societies and political parties, these are exempted from tax payment. Other societies like clubs will be subject to pay taxes unless otherwise exempted. Societies are required to find annual returns and other changes in their management structures, offices and constitutive documents with the Registrar of Societies.
Compared to a company, a trading through a society has the following disadvantages.
(a) Societies are regulated by the Registrar of Societies and their registration is subject to strenuous scrutiny by the security agencies. Companies limited by shares are easy to form and do not get subjected to security agencies scrutiny before they get registered.
(b) Societies have no personality of their own and can only own property though a company or trustees. This increases the administration expenses of running a trust.
Companies versus NGOs
Introduction:
NGOs in Kenya are regulated under The Non-Governmental Organizations Coordination Act, 1990. An NGO by its nature is meant to undertake charitable purposes. In deed, in the Act, an NGO is defined a “a private voluntary grouping of individuals or associations, not operated for profit or for commercial purposes but which have organized themselves nationally and internationally for the benefit of the public at large or for the promotion of social welfare, development, charity or research in areas inclusive of, but not limited to, health, relief, agriculture, education, industry and the supply of amenities and services”. This definition implies that an NGO should be formed for benefit of public at large and not for trading purposes.
However, like the NGOs, companies limited by guarantee are usually formed for charitable purposes. Both the guarantee companies and NGOs will usually be vetted by the security agencies before there are granted registration. By contrast companies limited by shares do not undergo such vetting before they are granted registration.
Like in the case of a company, the formation of a NGO involves quite substantial preliminary expenses. NGOs, like companies, are body corporate and can own property, purchase property, enter into contracts and do all other things in their own names. NGOS are regulated in accordance with the requirement of the Act by the NGO Coordination Board.
Although an NGO may engages in trading activities, any profit derived from such business must be ploughed back to the activities of the NGO. Distribution of profits made by an NGO to its members is prohibited by law. NGOs are usually granted income tax and other tax exemptions on application. However, an NGO that engages in trading risks losing eligibility to be exempted from income tax under paragraph 10 of the First Schedule of the Income Tax Act (Cap. 470) of the Laws of Kenya.
