Criteria for the choice of legal form of a company

Criteria for the choice of legal form of a company

The exercise of the business activity by the entrepreneur can take different forms, which the legal system makes available to individuals to meet their specific needs. This being so, the criteria for the choice of one or another type of company are very varied, and will take into consideration liability, taxation, legal requirements, the legal form that best suits the activity to be carried out and the prospects, if any, of the business plan, etc.

Normally, the first thing to consider is whether the law requires a specific corporate form for the activity to be carried out. In this case, the choice of one form or another is not an option, it is a sine qua non requirement if you want to develop that specific activity. For example, for specific activities in the financial or insurance sector, a corporation is required.

Criteria for the choice of legal form: factors to take into consideration

Another factor to be taken into consideration has to do with the limitation of liability, since depending on the legal form chosen, one will be liable or not with all one’s assets, present and future, for the debts incurred in the development of the business activity.

On the other hand, it is not the same to opt for the figure of the individual entrepreneur or to be a partner in a partnership, where one is liable with one’s personal assets, directly or subsidiarily, than to be a partner in a limited liability company, where liability is limited to the contribution made to the capital stock.

Similarly, another factor that should be taken into particular consideration when choosing the legal form is the taxation applicable to the subject and the activity carried out by the company.

In general, the taxation of the profits of the activity differs if one chooses to carry on the activity personally or if one chooses to use a corporate form. In the first case, in addition to the tax applicable to a corporate form, the income from the economic activity will be taxed by the Personal Income Tax (IRPF), in which the rate varies in relation to the profit obtained.

In the second case, it will be taxed by the Corporate Income Tax (IS), applying a fixed rate. For this reason, it is convenient to take into account elements such as the volume of invoicing and/or profits that the activity is expected to have in order to determine whether the most favorable tax rate is the one provided by the IRPF or the IS.

Incorporation and maintenance expenses

Another criterion consists of the incorporation and maintenance expenses, since some forms of company require compliance with a series of formalities that imply an additional cost whose forecast and estimation are key to ensure the viability of the project (e.g. minimum share capital, audits, public deeds, registration in the registry, hiring lawyers or accountants, etc.).

Finally, if an organizational form is chosen, it is important to discern, among all the existing possibilities, which one can best reflect our interests in the organizational documents (e.g. governance structures, decision making, control over the entry and exit of new partners, etc.) In short, which of the regulations of the different corporate forms is flexible enough to configure it according to the needs that are demanded.

For this it is very important to determine which interests are to be protected and which needs are to be satisfied. Likewise, the choice will be determined by the form of financing, since there are legal forms that prevent or complicate the use of specific forms of financing.

At Letslaw by RSM, we specialize in corporate law, and our team of commercial lawyers would be delighted to advise and support you with any corporate or commercial inquiries. Get to know us and contact us at the following link.