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What type of company should I establish? Advantages & disadvantages of the most common legal forms in Germany

The question of which legal form you decide on for your company has an impact on the image, liability, pension provisions and tax expenditure. That is why in this article I have summarized the advantages and disadvantages of the most common legal forms in Germany.

You will learn the most important details about the following legal forms:

This post was updated on 17 August 2021.

Why is the legal form so important?

The choice of legal form has far-reaching implications. Many aspects are obvious (e.g. tax), but many adverse effects only emerge years later and can catch entrepreneurs out (e.g. lack of a company succession plan).

To help you make an assessment, I have compiled the following list of considerations that you should definitely factor into your decision:

Image vs. disclosure obligation: For many people, the public image of a company is important. Generally speaking, for example, a limited liability company is seen as more reputable than a sole proprietorship. However, although you certainly have a better image with a limited liability company you also have costly disclosure obligations.

Limitation of liability to third parties vs. increased expense and efforts: Depending on the legal form, you can limit your liability in Germany – for example through a GmbH. At the same time, however, the costs are higher compared to a sole proprietorship. A GmbH has to comply with more regulations so you should expect higher tax consultancy fees.

Pension provisions: To stay with the comparison between a limited liability company and a sole proprietorship: With a GmbH, all avenues are open to you in terms of company pension schemes. With a sole proprietorship, on the other hand, company pension schemes are not possible.

Safeguarding the family: The legal form is of particular importance for the regulation of succession. What happens to the company or your shares in the company in the event of your death? Is you family provided for? Who inherits your shares in the company? With some legal forms, you can clarify these points directly in the articles of association.

Tax considerations: Depending on the legal form, you will have certain tax opportunities, but also obligations. Here you have to compare regular income tax, the more favorable retention rate for income tax and the combination of corporation tax, trade tax, as well as the income tax distribution rate.

Legal form #1: Sole proprietorship

Probably most companies in Germany started out as sole proprietorships. Often, when a company develops positively it needs to be transformed into another legal form.

We have compiled a short list for you with information on when you should establish a sole proprietorship or when there is no need for a company transformation.

The advantages of the sole proprietorship

  • No insolvency delaypossible: It is a criminal offence to delay filing for insolvency. However, this can also be committed unwittingly. With a sole proprietorship this is not possible at all as there is no limitation of liability.
  • Fewer regulations and formalities:Unlike a limited liability company, with a sole proprietorship you have to abide by fewer regulations (accounting, annual financial statements, etc.).

The disadvantages of the sole proprietorship

  • Full liability:In contrast to a GmbH, if your sole proprietorship fails, you are liable with your full private assets for any damages incurred.
  • Lower status:Sole proprietorships do not have the same reputable public image as larger corporations.
  • No possibility to set up company pension schemes:As a sole proprietor, you are not employed by your company, so you cannot access company pension schemes.
  • Owner‘s salary is not tax-reducing:Pre-tax profits are calculated based on the earnings of the business minus the outgoings. In the case of a company the owner’s salary is also tax deductible, whereas with a sole proprietorship comparable withdrawals do not count as profit-reducing expenses.

Legal form #2: Limited partnership (KG)

The KG (Kommanditgesellschaft) is a limited partnership with at least two partners. The so-called general partner is liable without limitation with their private assets, while the limited partner is only liable up to the value of their contribution.

The general partner is usually responsible for the management, while the limited partner often does not work in the company at all.

The advantages of the KG

  • No minimum capital required: No fixed capitalis necessary to set up a limited partnership. Theoretically, you could set up a limited partnership with only one euro.
  • Low taxes on retained earnings:Thanks to the so-called retained profit benefit you pay only 28.25% tax on retained profits (see Section 34a German Income Tax Act (EStG)).
  • Positive image and good credit rating:Although you do not have to pay in any minimum capital with a KG, this legal form has a good reputation. As a rule, you have a better standing with banks and business partners than a sole proprietor or UG.
  • Private withdrawals are possible:In contrast to a GmbH or UG, you can simply withdraw money from the limited partnership (KG). These cash withdrawals do not have to be taxed and are also not considered to be hidden profit distribution.
  • Lower administrative costs:With a limited partnership, your ongoing costs for accounting and annual financial statements are lower than with a limited liability company.

The disadvantages of a KG

  • No limitation of liability for the general partner:As managing director you are always fully liable for the debts of the KG with your private assets. The liability risk here is therefore definitely higher than if you have a GmbH or UG.
  • You need at least 2 partners to set up the company:It is often difficult for a sole trader to set up a KG. However, you can register your spouse or another family member as a limited partner.
  • Company pension schemes are not possible: Compared to pension provisions for employees, as an entrepreneur you are largely on your own when it comes to retirement plans. Popular ways of providing for retirement, such as a pension commitment are not possible with a KG.

Legal form #3: “Mini” limited liability corporation (UG)

A UG (Unternehmergesellschaft) is a limited liability corporation with almost no initial stock capital. The UG or so-called mini-GmbH was introduced in 2008 as the German answer to the British Limited and is the little sister of the GmbH.

To found one, you only need a minimum of €1 initial stock capital. This is the main difference to the GmbH, otherwise the UG is basically subject to the same laws as the GmbH (see Section 5a German Limited Liability Company Act (GmbHG)).

The advantages of the UG

  • Low liability capital: In theory, a UG can be founded with only €1 of liability capital. However, bear in mind that you also have to pay notary and court costs. Leading to total costs of at least €1,000.
  • Company pension scheme: With a UG you have the option of a company pension.
  • Succession is easy to regulate in the articles of association: Company succession is easy to regulate with a UG, since the “right in rem”, which refers to the legal assignment of things, such as property, to persons, is inherited. In other words: With a UG, you can actively participate in determining how something is distributed. With partnerships (e.g. GbR), on the other hand, everyone involved must agree.
  • Low cost of converting into a GmbH: If you already own a UG, it is not expensive to convert it into a GmbH. You have, in essence, created a platform for other corporations.

The disadvantages of a UG

  • Higher level of administration: There are more formal regulations and requirements governing a UG.For example double entry accounting, which leads to higher tax consultancy fees, additional costs for your own payroll system, etc.
  • Higher tax rate: The tax rate for a full distribution is 49%(corporation, trade and income tax). The maximum tax rate is 45% for sole proprietorships or partnerships (e.g. a KG). This means: Even if you have low profits you already pay the highest possible tax rate with a UG!
  • Poor credit rating: The low stock capital can affect your company’s credit rating. As a result of this low liability capital, banks and contractual partners may be suspicious of you.
  • No absolute limited liability: Limited liability can be disregarded by tax offices or bank guarantees.

Legal form #4: Limited liability company (GmbH)

The German Gesellschaft mit beschränkter Haftung (GmbH) is the world’s oldest form of limited liability corporation. In Germany, it is also the most popular form for corporations. Estimates show that there are more than 1 million GmbHs in the Federal Republic.

However, just because this legal form is particularly popular among domestic entrepreneurs does not mean that it is the right legal form for all businesses. I have summarized the advantages and disadvantages for you here.

The advantages of a GmbH

  • Limitation of liability:With the payment or contribution in kind of the liability capital (also called stock capital), the entrepreneur’s liability to third parties is limited. This means: You are not liable with your private assets. However, there are exceptions: 1. Non-equitable use of liquid assets, 2. Delay in filing insolvency, 3. Tax fraud, 4. Fiscal evasion and 5. Possibly providing guarantees to banks.
  • Better image:Even if the the letters after the company name basically say nothing about the quality of your work, limited liability companies usually enjoy a better public image for the outside world compared to sole proprietorships.
  • Opens up five possible corporate pension schemes:Unlike partnerships or a sole proprietorship, if you have a GmbH you are an employee and can avail of a corporate pension scheme.
  • Owner’s salary reduces tax:If the owner receives a salary from the GmbH, this reduces the profit accordingly and therefore also the tax.

The disadvantages of a GmbH

  • More regulations and formalities:From now on you need shareholders’ resolutions for every decision.
  • High running costs:More administrative work due to double-entry bookkeeping, more comprehensive annual financial statements and disclosure obligations.
  • You cannot make private withdrawals:Unlike a sole proprietorship or partnership, you cannot simply withdraw money.
  • High overall taxation of 48%:If you want to distribute profits, the overall taxation is always higher than with a partnership or sole proprietorship.

Legal form #5: Limited partnership with a GmbH as general partner (GmbH & Co. KG)

If you would like to combine certain advantages from a partnership and a GmbH then a Gesellschaft mit beschränkter Haftung & Co Kommanditgesellschaft (GmbH & Co. KG) could be the right choice for you.

Basically, the GmbH & Co. KG is a special form of limited partnership (KG).

Unlike a typical KG, however, the general partner, who has unlimited personal liability, is not a natural person but a GmbH.

The advantages and disadvantages of a GmbH & Co. KG are summarized for you here.

The advantages of a GmbH & Co. KG:

  • Limitation of liability like with a GmbH:Since the role of the fully liable general partner is taken over by a GmbH, there is no natural person who has unlimited liability.
  • All five types of pension schemes are possible: Even if it is not basically a feature of this legal form, a company pension scheme can be accessed.
  • Maximum tax burden of 42% or 45%:When distributing profits, you pay 48% tax with a normal GmbH. Therefore, you can save up to 6% with a GmbH & Co. KG.
  • You can make private withdrawals:As with the KG or a sole proprietorship, you can simply withdraw money from the company.

The disadvantages of the GmbH & Co. KG:

  • Poor public image:This legal form was sometimes used fraudulently in the 1980s. Although this has not been possible for decades, this type of company still has this negative reputation.
  • Owner salaries do not reduce profit:The salaries of the so-called co-entrepreneurs (the owners) do not generally reduce the profit, but this can be managed in individual cases.
  • More regulations and formalities:From now on you need shareholders’ resolutions for every decision, articles of association and you have higher formation costs, etc.
  • Higher level of administration: Since balance sheets have to be prepared for both the KG and the GmbH, your tax consultancy costs may double.

Legal form #6: Atypical silent GmbH (GmbH & atypisch still)

GmbH & atypisch still refers to a GmbH with an atypical silent partner. This is atypical if the silent partner is outwardly silent, but actively participates internally in the corporation.

The atypical silent partner therefore  participates in the profit, losses and hidden reserves. This company form is mainly used in succession planning as an “accrual model” for the future heirs. Initially, these become only weak shareholders without external representation and can gradually take on more prominent roles in the company over time.

The advantages and disadvantages are very similar to those of the GmbH & Co. KG, but differ in a few points.

The advantages of an Atypical silent GmbH (GmbH & atypisch still)

  • Conversion to a GmbH & atypisch still happens without any detrimental change to the public image:The GmbH in the company name is retained. Only the internal relationships change.
  • Limitation of liability like with a GmbH:Although a GmbH & atypisch still becomes a partnership for tax purposes, your liability is still limited to your contribution.
  • All five types of pension schemes are possible:Even if it is not basically a feature of this legal form, a company pension scheme can be accessed.
  • Maximum tax burden of 42% or 45%:With the conversion into an atypical silent GmbH, the company becomes a partnership for tax purposes. Therefore, in the event of a profit distribution, you no longer pay 48% but a maximum of 45% tax.

The disadvantages of a GmbH & atypisch still:

  • More regulations and formalities:From now on you need shareholders’ resolutions for every decision.
  • Higher formation costs and running costs:You have to prepare two balance sheets, which leads to higher tax consultancy costs.

Legal form #7: Partnership limited by shares (KGaA)

The partnership limited by shares Kommanditgesellschaft auf Aktien (KGaA) combines elements of a stock corporation (AG) and a limited partnership (KG). This is a stock corporation which has personally liable partners (the general partners), instead of a board of directors. These partners’ ownership is divided into stocks.

A KGaA is particularly suitable for inheritance planning in the case of a large family and/or extensive business assets.

The advantages of the KGaA:

  • As a shareholder you retain the personal connection to the company:This point is particularly relevant in succession planning, as you can retain your unbroken “position of power”. Nevertheless, you can already grant your heirs shares in your assets (in the form of stocks).
  • The KGaA is very resistant to takeovers:Since voting rights are not linked to the share of capital assets, you can sell more than 50% of the stocks on the stock exchange without losing control of the company.
  • Unexpected events (death, incapacity, etc.) can be dealt with easily:In terms of civil law this company form can be very attractive and is particularly popular when it comes to large assets.

The disadvantages of a KGaA:

  • High formation costs:In order to set up a KGaA correctly, you need extensive help from your tax consultant. This of course leads to high fees.
  • High capital requirement:You must pay at least €50,000 into the KGaA.

So which legal form is right for you?

The type of company you choose, be it a GmbH, GmbH & Co KG, sole proprietorship or something else, depends on your actual circumstances as well as your personality.

Based on the circumstances, you should consider the following points:

  • Which company type makes sense from a legal point of view in the short, medium and long term?
  • Which legal form offers the greatest financial advantages?
  • Which type of company is best from a taxation point of view?

On a personal level, you should also consider:

  • What are your wishes?
  • Do you already have certain requirements in mind that this legal form must absolutely fulfil?
  • What goals do you have in mind for you personally and for your company?

Due to the enormous impact of this decision on your company and your own personal future, outlined above, it is worth examining these questions with a professional and not just contemplating the situation on your own to the best of your present knowledge.

In the end, only a professional tax consultant who has carried out a detailed analysis of your situation is qualified to know what the right legal form for you is. In this situation general recommendations are not reliable.

The overview in this article is only intended to give you food for thought.

Here’s how to find the right legal form for you: Detailed video explanation

Would you like more information on choosing a legal form? Then the following video is just right for you. In an entertaining discussion with York, I explain clearly what you need to be aware of.

Just press play!

Conclusion: Compare and calculate carefully to be sure of the right legal form

As you can see, there are many things to consider when deciding on a legal form. Knowing the advantages or disadvantages can give you a lot of certainty when transforming your company or when drawing up your inheritance plan.

My aim with this article was to help you understand the differences between the legal forms. This should give you a first impression of the options you have when founding or converting a company or when planning succession.

However, you should always make the final decision in close consultation with an experienced tax consultant. Only your tax consultant knows your situation and can really recommend the legal form that suits you best from a tax, business and personal perspective.

If you have any further questions about legal forms or need more advice, you can contact me at any time by phone (+49 40 44 33 11), email (anfrage@steuerberatung-breit.de) or contact form.

Kind regards,

Thomas Breit

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