Why a formal business structure?

One of the most frequently asked questions the “Ask an expert” column of whichfranchise receives is: “Why is it necessary to form a formal business structure (CC or [Pty] Ltd)? I will be trading under the network’s brand anyway, so why doesn’t the franchisor allow me to operate the business as a sole trader or partnership? It costs good money to set up a formal structure and the rules governing its operation appear to be much more onerous. All this for what?”

There are several sound reasons for franchisors’ insistence that their franchisees set up formal business structures, including the following.

1. Although a franchisee trades under the network’s name, legal contracts need to be entered into in the registered name of the business. If the business is not registered, these contracts would be entered into in the owner’s name. Image considerations aside, this would increase the owner’s exposure to liability.

2. If the franchise is owned and operated by a formal structure, it is far easier to take in additional business partners, or to buy out a retiring one. This also simplifies the sale of the business if, for example, the owner wishes to retire. The business itself continues to trade as before.

3. Although several other formal structures exist, CCs, trusts and, albeit to a lesser extent, private (proprietary limited companies usually abbreviated to [Pty] Ltd) are the most popular. Especially a CC is cheap to set up and relatively easy to administer. In fact, we cannot think of many statutory obligations a CC has that would not apply to a sole trader as well.

4. As long as they act in good faith, owners of formal business structures enjoy a certain amount of protection against attacks from creditors should the business be unable to pay its debts. You should be aware, however, that most grantors of credit, including major suppliers, will insist on the owner signing a surety document in their favour on behalf of the business structure. This negates the protection.

5. Many tenders are open only to registered businesses. The reason for this is that the issuer of the tender wants to deal with an established concern.

6. Grants and assistance schemes are accessible only to registered businesses, very much for the same reasons.

7. SARS allows small registered businesses to register as small business corporations. This provides significant tax benefits to qualifying businesses that are not accessible to sole traders.