FORMALIZE THE BUSINESS
Formalization of a business entails selecting a format (e.g. sole proprietor or corporation), name, and logo, and registering these with registration authorities. Making these choices and registering them is a crucial step in how to create a business. Before you formalize your business, you need first to decide what type of business you want to be in. This is necessary because the structure that you choose depends on the type of business. The main types include manufacturing, wholesaling, retailing, services and a franchise which can be in the form of any of the preceding four types of businesses.
The formalization of a business is governed by laws and regulations. These rules and regulations vary from country to country and even from state to state in the case of the USA. This is because each jurisdiction has its set of laws. However, no matter where you are, the laws and rules tend to follow common commercial principles that differ only in some minor details. To be sure, you need to check your jurisdiction’s laws and regulations governing the registration of businesses. These are usually available on the registration authorities’ websites. Generally, formalization of a business involves several things that include:
Legal format or structure
You require deciding whether to operate your business as a sole proprietorship, partnership or a limited liability company. The legal structure chosen will influence the business name, your liability, and how you file and pay your taxes. Each form of ownership has distinct characteristics and advantages and disadvantages. Below is a brief description of the various formats:
a) Sole Proprietorship
- It is a business that is operated by one individual and operates under a personal or any other name that has to be formally registered and has no legal entity separate from the owner.
- Affairs of the business and those of the owner are merged into one. There is no limitation or separation in the eyes of the law between his assets and liabilities and those of the business. The proprietor runs the business and makes all the decisions alone and is responsible for all actions, liabilities, assets, revenues, expenses, and profits of the business.
- The success or failure of the business is wholly dependent on the proprietor.
- A sole proprietorship can only raise capital from himself, family, friends or a financier like a bank.
- Any profits made by the business will, for tax purposes, be counted as the income of the proprietor and not of the business. Similarly, any liabilities incurred by the proprietorship during the business will be the responsibility of the proprietor.
b) General and Limited Liability Partnership
- Two or more people with a common vision join up to start and run a business. Common unions are husband and wife, relatives, friends, professional colleagues or a mixture of all these.
- Operates under a name that has to be chosen and registered with the registrar of business names and companies. Common names include one name of each partner that are then put together into one long name.
- Has no legal entity of its own and the partners are jointly and severally responsible for the assets, liabilities, and actions of the enterprise. Some countries’ laws allow registration of limited liability partnerships where one unlimited partner runs the show and the liabilities of the limited partners are limited to their financial contributions to the partnership.
- Any profits made by the partnership are, for tax purposes, counted as incomes of the individual partners shared according to an agreed formula.
- Rights, obligations, and responsibilities of each partner are spelt out in a partnership agreement usually drafted by a lawyer.
- Capital for a partnership is raised from either partner or borrowed from a bank and not from the public through the sale of shares like a corporation would do. However, a partnership can raise money from investors willing to buy what is known as units or fractional shares in the partnership and share in the profits of the partnership.
c) Corporation/Company (Public Limited Company)
- It can be formed by two or more people.
- It is a legal entity like a natural person with a legal status separate from that of the owners or promoters and can, on its right, conduct business and sue or be sued.
- A company that has sold shares to the public (quoted or listed company) is known as a public limited company and its name ends with the abbreviation plc standing for public limited company. A private limited company whose shares are held privately ends its name with the word limited or Ltd.
- Has to have a memorandum of association and articles of association registered with registrar of companies. The memorandum spells out the scope and objectives of the business while articles are the by-laws of how the business is to be governed. The articles also spell out the rights and obligations of the shareholders, board, and management.
- Typically the company would be structured and has to have shareholders (owners or promoters), a board of directors-appointed by owners, a Chief Executive Officer (CEO)-appointed by the board and employees who are appointed by the board and CEO. Decision-making in the company is therefore through these organs. In a small company, the shareholders can be the directors and the only employees of the company who run the business and make all the decisions.
- Rights and obligations of shareholders, board and management are governed by company laws and regulations.
- A corporation raises funds through borrowing from a bank or by selling shares of the corporation or borrowing from the public through issuing a bond (Commercial paper). Shareholders then own the company through the shares they each have in the company. A shareholder who has 50% plus shares control the company and control is usually exercised through the nomination of directors on to the board. Despite this control, minority shareholders have rights too.
- All assets belong to the company and the company is responsible for all its liabilities without recourse to the owners or employees.
- The owners’ responsibility and liability in case of failure of the business are limited to their contributions as shares in the company and that is all the owners can lose. This is the beauty of the concept of limited liability.
- A company is required to pay tax on its profits and is expected but not obliged to pay dividends to the shareholders. Shareholders, in turn, are taxed individually on the dividends they receive from the company.
- A company is also required to file annual returns with the registrar of companies. Failure to file returns may lead to the deregistration of the company.
d) Limited Liability Company (LLC)
- In jurisdictions where company laws allow, LLC is a hybrid between a company and partnership or sole proprietorship that can be formed by even one person.
- Offers limited liability to owners like a plc or a private limited company does but also offers tax pass-through flexibility whereby profit of the company is taxed on the owner only instead of on the company as well as when the owner receives dividends. This is the feature that makes it the same as a partnership or a sole proprietorship.
- An LLC is said to be organized when it is formed as opposed to incorporated when a plc or a private limited company is formed. As a result, memorandum and articles of association are called memorandum and articles of organization and the registration certificate is called the certificate of organization. Its internal operations are governed by an operating agreement rather than bylaws.
- Owners are known as members and not shareholders and ownership interest is represented by membership interest rather than stocks or shares. The equivalent of the share certificate is called a membership certificate.
- The sale or transfer of shares is governed by what is in the operating agreement.
e) A Holding Company
- Another format in which to own a business is by setting up a holding company. One business or company can own another business or company. Such a business owner is called a holding company. You own a holding company and the holding company owns companies on your behalf. A holding company is a parent company, a limited liability company or a limited partnership that owns enough voting shares of another company to be able to direct the owned company’s management and policies. It exists not to produce its goods and services but purely to own and control another business which could be a limited partnership or limited liability company. A holding company does not have business operations, instead, it owns assets in one or more companies such assets can be sub-sets like real estate, patents, trademarks, shares, franchise or any other assets.
- If a company is wholly (100%) owned by a holding company, it is known as a wholly-owned subsidiary. A holding company can hold less than 100% shares of other companies. The only work a holding company does is to oversee the operations of the companies it owns. It is not responsible for the day to day operations of the subsidiaries but it still has to be aware and appreciate what is going on in the subsidiaries, evaluate performance and make decisions. It can also hire and fire managers of the subsidiary. A good example of a holding company is Berkshire Hathaway of the USA which is owned by Warren Buffet. Berkshire owns assets in over a hundred public and private companies including companies like Duracell and GEICO and minor assets in companies like Coca-Cola Company, Goldman Sachs, IBM, American Express, Apple, Delta Airlines, etc.
Choosing a Business Name
All businesses must have a name. A name is necessary in all types of transactions that the business may engage in, for example, registration of a business, opening a bank account, applying for a permit, general correspondence, obtaining a Personal Income Tax Number and filing tax or business returns. A name gives a business a separate identity from that of the owner. So it is important and necessary to have and register a business name.
Besides being a legal requirement, a name is also the identity and brand of the business and is, therefore, an important marketing tool. A name is part of your brand. For this reason, it merits careful consideration bearing in mind the branding strategies that will be developed from time to time when the business is running using the name and the brand. A brand is the sum of all the features, features, benefits, and reputation of the product or service that people have come to associate with the product which gives them satisfaction whenever they use the product.
The name should reflect the image and the brand of the business, the business’s product or service and the benefits a customer would derive by associating with the business. If your business is in house cleaning a name like Perfect Touch Cleaning may be suitable. A name should also not appear to be geographically limited or time-bound. In addition to the name, it is a good idea to also have a logo and both the name and log can become the logo. A good name can create first impression benefits and open doors. A bad name can close doors. A good brand name should have the following characteristics:
- A name should give the promises or qualities and benefits of the product. When a name is said or read or thought about, it should bring to mind all the positive impressions, experiences, and guarantees of the brand.
- For a name to be successful, it should be creative and catchy and project a degree of seriousness and class of the business.
- It should also fit the company, its products or service lines.
- As a business name is used every day in print and conversation, the name should, therefore, be memorable; unique; short and easy to spell, remember and above all pronounce-e.g. Google.
- It should be extendable. Remember at one point, you may need to tweak the name a bit and you will also require a web domain URL.
- It should be easily convertible into foreign languages and when it is done, it should not portray negative connotations in those languages.
- It should be capable of legal protection and registration.
- It should suggest a product or service category- for example, Daily News or Newsweek.
Registration of a Business Name
Formation of a business whether it is a sole proprietorship, partnership or a company starts with the registration of a name. A business has to be registered under a name. Registration is necessary so that the name is reserved and made unique to that business such that no other business can use the same name. Registration of a name and formation of the business is a straight forward exercise that involves the following simple steps:
- Placing a search with the registrar of business names and companies to confirm whether the chosen name is available for registration and reserving the name if the name is approved for registration. Three names are usually forwarded for reservation and all; some or none may be available for registration. A small fee is payable for this.
- Completing a simple registration process after the proposed name is approved and reserved. This entails the provision of details of the business and those of the founding directors and shareholders including Memorandum and Articles of association and paying the prescribed registration fees. The memorandum of association is a document that sets out the nature of the company and its purpose while articles of association define how the company is to run, governed and owned including the duties and responsibilities of its members, owners and the board of directors. The two documents are usually combined and registered with the registrar of companies. It is also possible to opt for the standard format of memorandum and articles of association which are available on the registration menu.
- Once all details have been provided and the prescribed fees have been paid, a registration certificate is issued shortly thereafter.
Where there is a logo, the name and logo should be registered together to give the business exclusive use of name and logo and more importantly, identity. Since the authorities who perform registration of names may be separate from those who register logos, it may be necessary to register the name first before the registration of the logo. For the name to be accepted for registration without questions by the registrar of companies, the name should not be the same or similar to another company’s name or have nationalistic or official connotations.
This registration process is a simple online job in many jurisdictions where online payment is also part of the process. The owner can easily do it and complete the process within a few hours. Guidelines of how to register are usually available on the website of business and company registration government authorities which in some cases is the Attorney General’s offices. For more complex registrations such as company incorporation, services of lawyers and accountants may, for modest fees, be enlisted during the registration process.
Logo and Name
A logo is a sign or combination of signs that are put together to form a symbol or emblem that can be associated with a company and by extension a product or service. It is mostly an extension of the name and the name of the business can form part of the logo. Logo and name give the business a unique identity. The components of a logo are symbols, letters, and colours. The same components can make a name as well. These components and the background colours around both the logo and name should be weaved together to form one brand image. Logo, name and the chosen background colours usually go together and this one image of logo, name and background colours should be depicted or displayed together every time the business’ logo and name are used for whatever purpose.
Look at how reputable companies display their logo, name, and colours. For example on this, look at the logos and names of Burger King and McDonald’s of USA or Diamond Trust Bank of Kenya. Burger King’s logo is a combination of name, designs letters and background colours. Unlike a name, it is not a must for every business to have a logo. However, a logo helps to build consumer awareness, give identity to the products or services of the enterprise and the enterprise itself. If the consistency of quality and performance of the product is maintained and therefore the risk of variation is eliminated or minimized, customers quickly begin to see the logo as a sign of quality, trust, and reliability. To maintain this image, the colours and the shape of the logo together with the business name should be consistent wherever they appear.
Licenses And Permits
As a general rule, all businesses require one type of license or another. Licenses and permits are not part of how to form a business but a business cannot start to trade without these. So if one is thinking of forming a business, it a good idea to think about these even at the formation stage. A permit or license is a signed piece of paper that proclaims the authority of the licensing body allowing the business to carry out its business in the given location for a definite period usually a year before renewing the permit once more for a prescribed fee. A permit is a form of tax levy and it is also a way that is used by regulation authorities to ensure that businesses meet prescribed conditions before being permitted to commence operations. In many municipalities, a business needs to have a general business operating license. In addition to this, there may be a need for another license that is specific to a particular business.
To qualify for the specific type of license, the business may need to fulfil certain conditions set out by the licensing authority for the type of business. The restaurant business, for instance, will over and above a business operating license also require clearance by the government department of health. A lawyer, for example, will require a practising license from the local Law Society or some professional association like that. So does a doctor and an engineer. In a municipality also, some areas may be zoned off for particular businesses only and it is good to be aware of this. It is important therefore to find out all the licensing and permit requirements before commencing business, as it may prove costly in the long run to operate outside the prescribed law and regulations. For all types of licenses, prescribed fees are payable by the business. Depending on the business, the licensing authority may be the local authority, a relevant department of the central government or a quasi-government authority.
Register For Taxation
Taxation is a complex subject and is governed by laws and regulations that vary from jurisdiction to jurisdiction. However, the laws tend to follow common commercial tenets. For example, all forms of business in most jurisdictions are required to pay taxes that may include direct taxes like income tax, corporate tax, and indirect taxes such as Value Added Tax (VAT) and import tariffs (import duty and excise duty). The processes of how to create a business include registration for taxation because a business may not be fully formed to commence operations without this registration. An individual, sole proprietorships and partnerships pay income tax on all forms of income or profits paid to the owners while companies pay corporate tax on the corporation’s taxable profits. Individuals and businesses all pay indirect taxes and import tariffs whenever they purchase goods and services that have VAT or when they import goods or services.
It is therefore important from the outset to register for taxation and obtain the necessary tax identification numbers for income and corporate tax and VAT. It can be costly not to have these registrations. In some cases, your business may be denied the opportunity to participate in tenders advertised if this registration is not in place or if the payment of taxes is not up to date. Registration is governed by rules and thresholds of sales or turnover. To get to know exactly how to register, professional advice from experts and tax authorities should be sought. Some of this information is on websites of tax authorities and registration and payment of taxes are all online nowadays.
In addition to registration required for taxation, employers are usually agents of tax collection authorities for purposes of collection of pay-as-you-earn which is the tax that employees pay on their employment income. Employers are normally required to collect the taxes from employees’ earnings as they pay their employees at the end of the month and remit the collections to tax authorities within a certain date in the following month. In other jurisdictions, employers may also be required to deduct certain monies from their employees for medical and pension schemes and remit the same to the schemes. All these may require registration with the relevant authorities for purposes of becoming the authorities’ collection agents.
In Kenya for example, employers are required to deduct some small money from employees and remit the money to National Hospital Insurance Fund (NHIF) to allow employees to benefit from medical covers of the Fund. Another example from Kenya is the requirement for both employees and employers to contribute pension-related money to the National Social Security Fund (NSSF) which is a form of retirement plan. When starting a business, therefore, there is a need to find out what registrations are necessary and comply with them as prescribed to avoid unnecessary penalties.
Take Insurance Covers
Before commencing business, it is advisable to take insurance covers. Steps of how to create a business need not strictly include taking insurance covers but is risky to commence business without the essential insurance covers. The mandatory insurances required for any business vary from jurisdiction to jurisdiction. However, the essential and common ones are property and casualty, third party liability, workers’ compensation, and disability insurances. Others include employees’ health, errors and omissions, loss of business or business interruptions, key-man and life insurances. Property insurance covers assets against fire and damage while liability insurance protects the business from third-party claims on the business arising from damages, errors, omissions, and negligence.
Workers’ compensation insurance provides employees injured on the job with financial benefits to cover medical, rehabilitation, loss of benefits and other costs. In many countries, third party liability insurances are compulsory and have to be taken. Even if this was not compulsory, it makes business sense to take them to cushion your business in case of third party claims on the business. The other insurances may be necessary too to cushion the business in case of incapacitation of the business by fire and other vagaries that cause losses.
Several companies offer insurance services and these services are usually accessible through insurance brokers who are agents of the insurance companies (underwriters). An important thing about insurance is records. The business should keep very good records that can be accessed with very little delay in making insurance claims. Very well kept records speed up payment of insurance claims and this allows the business early access to cash for operations. Delays in receipt of insurance settlement can bankrupt a business.