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Founding a startup: Which legal form is right for you?

If you’ve decided to create a startup, you’ll need to think about the right legal form. Depending on the size of the company and its purpose, there are various legal forms that make more or less sense depending on the situation. In this blog post, I go over the most popular legal forms for startups and show their advantages and disadvantages. One of the most common legal forms for startups is the sole proprietorship. This type of company is very simple and uncomplicated to establish and manage. The owner has all decision-making and control powers as well as the risk of the company. However, the risk can be high with a sole proprietorship. If something goes wrong, the owner is personally liable with all his private assets. Another popular legal form for startups is the corporation (GmbH). With the establishment of a limited liability company, the company is recognized as a legal entity, so that the owner is no longer personally liable. This can limit the risk. However, you have to observe a certain formalism, which increases the effort. In addition, there are also certain costs associated with the establishment and administration of the company. Another option for startups is to operate as a partnership. Partnerships are often an interesting choice for smaller startups with limited capital needs or family businesses. However, in the event of a dispute, liability remains with the partners – so you should think carefully about who you cooperate with in this way. Finally, you should be aware that each legal form has its advantages and disadvantages – so it is still best to seek advice with experts and find the right solution together!

A legal form is the legal structure in which a business is operated. It is a kind of framework that determines what rights and obligations each organization has. For example, may be a partnership with several shareholders or a corporation with one owner. Choosing the right legal form can be critical to how a business runs and whether it is successful. There are many types of legal forms and it is important to understand what applies to each. So when you decide to start a new business, you also need to find the right legal form. Fortunately, there are several options and it is advisable to find out the pros and cons of each before making a decision. Some of the most common legal forms are: Sole proprietorships, partnerships, limited partnerships (KGs), limited liability companies (GmbHs) and stock corporations (AGs). Each of these forms has different characteristics in terms of responsibilities and liability risks as well as tax and financing structures. Therefore, it is important to know what type of business you are starting and what is best for the business.

The different forms of corporate law:

a. Sole proprietorship

A sole proprietorship is the simplest legal form for a startup. There are no special requirements and you don’t have to register with a government agency. However, a sole proprietorship also has no limitation of liability. This means you bear the full risk for the company and are personally liable for all debts. With a sole proprietorship, you can also hire employees, but there is no separation between you and the company. So you are entirely responsible for everything that happens. For a startup, a sole proprietorship is therefore only the right choice if you want to bear the risk alone and you are aware that you are personally liable in the event of an incident.

Partnership / General partnership (OHG)

A partnership is a partnership between two or more natural persons who jointly operate a business. The trading company is the most widespread form of partnership in Germany. In a general partnership, all partners have equal rights and are therefore liable for the debts of the company with their entire private assets. The OHG is based on the Gesellschaft bürgerlichen Rechts (GbR) as the basic type of partnership, which is regulated in § 705 – § 740 of the German Civil Code (BGB). Therefore, the provisions on the GbR apply to the OHG in principle. However, priority is given to the special rules of the German Commercial Code (HGB), which defines the general partnership in more detail in § 105 – § 160 and adapts it to the needs of commercial transactions. For example, a general partnership generally has sole management and sole representation powers. The formation of a partnership is relatively straightforward. However, it is advisable to seek professional help when starting up to ensure that all legal aspects are taken into account.

Advantages:

– Simple and uncomplicated foundation

– All shareholders have the same rights and obligations

– Each shareholder is liable for the debts of the company only with his private assets

Disadvantages:

– Each shareholder is liable with his private assets for the debts of the company

– There is no limitation of liability for the shareholders

Limited partnership (KG)

Another option for founding a startup is the limited partnership (KG). A KG consists of at least two partners: the general partner and at least one limited partner. The general partner has unlimited liability for the company’s obligations. The limited partner is liable only to the extent of his contribution. The limited partnership is particularly well suited for commercial enterprises in which one partner is an active entrepreneur and the other is a silent partner. However, a KG can only be formed if at least one of the partners has unlimited personal liability. It is therefore not suitable for all founders and must be well considered. Above all, it requires trust between the two partners and a willingness to take responsibility. In addition, of course, the company’s financial resources must be adequate to cover its liabilities. A hybrid form, so to speak, is a GmbH & Co KG, in which the general partner is a GmbH, which in turn has only limited liability. By definition, however, this mixed form remains a partnership, which is why helpful tax law constructions sometimes arise.

Bottom line: a limited partnership is ideal for founders who are looking for a silent partner or want to partner with someone to run their business more effectively and invest more capital into the business. However, this legal form usually also requires proper financing and a great sense of responsibility from all parties involved.

Limited liability company (GmbH)

The GmbH is the most widespread legal form for startups in Germany. Especially when it comes to attracting outside investors. This is because the GmbH offers some advantages that other legal forms do not.

– A GmbH can already be founded with a small capital (from 25.000 Euro)

– The liability of the shareholders is limited to the company’s assets.t

– With the GmbH, the founders have more creative leeway in the articles of association and can, for example, stipulate that certain decisions must always be made unanimously

However, there are also some disadvantages that should be considered. Thus, the limited liability company is somewhat more expensive to establish and also in the ongoing administration. It must also prepare annual financial statements each year, which must be audited by a tax advisor or auditor. The legal issues surrounding the GmbH are very extensive and it is highly advisable to involve a lawyer and/or a tax advisor when drawing up the articles of association and in the event of other problems.

What risk does each form entail?

Each legal form brings its own risks. Sole proprietors are personally liable for all debts and liabilities, while corporations also have legal liability limitations. In summary, you need to carefully weigh the pros and cons of each option before making a decision.

Sole proprietors: Sole proprietors are personally liable for all liabilities of the business, which is a high risk. If your business has debt or is sued, it can put a financial strain on your personal assets. In addition, as a sole proprietor, the founder is responsible for handling all business matters and must do so himself.

Limited liability company (GmbH): A GmbH offers the founder a certain limitation of liability. Unlike a sole proprietor, the founder’s personal assets are not liable for the debts of the business unless he or she has provided personal guarantees or committed other unlawful acts. However, the formation of a limited liability company is complex and expensive compared to a sole proprietorship. In addition, the founder must follow strict rules and regulations in order to legally exist.

Stock corporation (AG): With an AG, founders receive the greatest possible protection against liability risks, but there are certain risks here as well, especially in the event of the company’s insolvency or bankruptcy. In addition, the formation and structuring of an AG is more complex than for other legal forms and can be expensive. There are other legal form options for startups, but these three represent the most common options.

Whatever you choose, make sure you carefully weigh all the pros and cons of each option and never act hastily. Depending on what type of startup you want to create, expert advice can help you make the right decision.

4. conclusion – How do you determine which legal form is right for your startup?

It is not so easy to determine the right legal form for your own startup. You have to consider many factors that affect specific goals and needs. It is important to take your time and carefully consider all options before making a decision. First, one should make list of advantages and disadvantages of each legal form. Then you can weigh up which legal form best suits your goals. Basically, it’s important to always be clear about the type of business you want to start and what your goals are when creating your startup. Good planning is the key to success. Contrary to what clients always assume, there is therefore no “right or wrong” in the choice of legal form.

Marian Härtel

Marian Härtel

Marian Härtel is a lawyer and entrepreneur specializing in copyright law, competition law and IT/IP law, with a focus on games, esports, media and blockchain.

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