Criteria for Choosing the Legal Form
An entrepreneur can choose out of several forms of business when setting up the business initiative. The options range from a representative office or small and large partnerships through to corporations such as a GmbH or Aktiengesellschaft.
Before founders select a legal form for their company, they should answer the following questions:
- Is direct business activity planned in Germany or is the focus initially on maintaining contacts and initiating business?
- How many people are going to establish the company?
- Should there be as few formalities as possible in establishment?
- Who is going to manage the company, just the partners or others, too?
- How much equity capital can be raised?
- Is personal liability to be restricted?
- Should the company have a high credit standing?
- Is a registration with the commercial register required?
- Is a bank account in Germany required?
If a company wants to be present in Germany mainly to initiate business and maintain contacts with business partners, credit institutes or government offices, the establishment of a representative office is the first and easiest step. The personnel, financial, and organizational expenses are relatively low. Depending on requirements, it is enough to establish a representative office with one or several employees.
The establishment of a representative office in Germany by a foreign company only requires approval in exceptional cases. For example, representative offices of foreign banks that aim to independently initiate or conduct business with domestic customers require the approval of the bank supervisory authorities.
Sole Proprietorship, Registered Business Person
Anyone wanting to start up immediately with his/her business is advised to establish a sole proprietorship. This is the easiest way of forming a company, because special formalities such as deeds of partnership or minimum capital are not required. A registration with the commercial register as a registered business person (eingetragener Kaufmann, e.K.) is only necessary if the annual turnover is more than approx. EURÂ 250,000.00 and the profit is over EUR 25,000.00 (depending on the facts of the individual case). Of course, as a sole proprietor you have full liability for the debts of your business.
Civil Law Association (Gesellschaft bÃ¼rgerlichen Rechts, GbR)
A civil law association is often formed to launch a business idea together with others. This form of company is a type of partnership because at least two partners agreed to establish the company. The partners are liable with their private assets for debts incurred by the company. Written articles of association are recommended on the formation of a GbR but are not compulsory. A GbR will not be registered with the commercial register.
General Partnership (Offene Handelsgesellschaft, OHG)
The legal form of a general partnership (OHG) is the classic form for medium-sized and larger companies. Every GbR whose purpose is to run a commercial enterprise, that is a business enterprise of a type or size that requires business operations to be set up in a commercial way, automatically qualifies as an OHG.
An OHG is required to be registered with the trade licensing office and with the commercial register. The accounting regulations for an OHG are also stricter than those for a GbR.
Limited Partnership (Kommanditgesellschaft, KG)
The limited partnership (KG) is a legal form related to the OHG, but with the options of limiting liability for some of the partners. In the KG, at least one partner (the general partner) is personally liable without limitation. The liability of the other partners (the limited partners) is limited to their monetary contribution. Like an OHG, a KG must be registered with the trade licensing office and be entered in the commercial register. The most important advantage of a KG over an OHG is the greater flexibility offered by the option of being able to increase the capital base by including additional limited partners. However, the limited partners only have a limited power to rule the company, which is always represented by the companyâ€™s general partners.
GmbH & Co. KG
A GmbH (please see below for this legal form of a limited liability company) and KG can be combined to create a GmbH & Co. KG, a special form popular because it minimizes the risk of liability of its shareholders. However, because of its basic structure as a KG, this form is a partnership, not a corporation. In this combination, though, a GmbH â€“ whose liability is limited to the paid in capital â€“ acts as the personally liable general partner of the KG.
Partnership Company (Partnerschaftsgesellschaft)
The partnership company is specifically for the joint exercising of professional freelance activities. Mere capital participations are therefore excluded. This form of company enables members of the same or different freelance professions to join forces to form a mutually profitable company. As a result, a number of different professional services can be offered from a single company. The personal liability of the partners can be excluded with regard to professional errors for which other partners alone were responsible.
Corporations are the alternative to partnerships. The company bears liability itself, because as the result of the establishment of a corporation, a legal entity is formed with its own rights, obligations, and name. The company itself concludes contracts, possesses assets, and must pay taxes. Liability is limited to the business assets. A minimum capital is required, and the accounting obligations are more extensive than those for partnerships.
Limited Liability Company (Gesellschaft mit beschrÃ¤nkter Haftung, GmbH)
The limited liability company (GmbH) is the most popular legal form among the corporations, as it combines high flexibility with relatively few obligations. There has been a reform on GmbH law in 2008, which was supposed to make the GmbH more attractive for entrepreneurs.
The GmbH is established through the articles of association. For a GmbH to be established successfully, a notary has to certify the companyâ€™s articles of association and file the newly incorporated company with the commercial register. A GmbH can be established by a single shareholder. The transfer of shares in a GmbH requires notarized form.
To establish a GmbH a minimum share capital of EUR 25,000.00 is required, which can also be made up by contribution in kind. At the time of registration with the commercial register, however, it is sufficient for half of the minimum share capital, i.e. EUR 12,500.00, to be actually and verifiably contributed. In the case of a contribution in kind, documents must be attached to the application for registration verifying that the value of the contribution in kind actually corresponds to the specified counter value of the contribution.
Since the reform of GmbH law the formation of a â€œUnternehmergesellschaft (haftungsbeschrÃ¤nkt) (entrepreneur's company with limited liability) is possible. The abbreviation â€œUG (haftungsbeschrÃ¤nkt)â€ can be used. However, this is no new type of company, but a GmbH for which special rules apply. The main feature of the UG (haftungsbeschrÃ¤nkt) is, that only a minimum share capital of one Euro is required. However, there are certain restrictions regarding the distribution of annual net profits, as one fourth of the annual net profits have to be put into reserves until the amount of EUR 25,000.00 is reached.
Stock Corporation (Aktiengesellschaft, AG)
A stock corporation (AG) offers the advantage of a higher status among business partners and makes it easy to extend the equity base through the issuance of shares.
Shares in an AG can be transferred easily without any specific requirements as to the form of the transfer. The share capital for an AG has to amount to at least EURÂ 50,000.00. Disadvantages of an AG are the higher costs for planning and establishment, and the more extensive organizational obligations in day-to-day business. An AG can also be established by a single person; the articles of association â€“ statutes â€“ have to be certified by a notary.
Further Types of Corporations
There are further types of corporations for special purposes, such as cooperatives and mutual insurance associations. However, these are very special legal forms and further legal advice should be utilized in case one of these legal forms are contemplated.
A trust uses assets to pursue a purpose determined by the founder. Unlike the various company forms, which are characterized by a membership-based structure, trusts do not have any members/shareholders, but beneficiaries. The trust body that represents the trust is the board of management.
Trusts can be established for every legal purpose, including a commercial purpose. They are established by a declaration of will by the founder, known as the trust deeds, which must also contain the trust statutes. State recognition by the supervisory authority for trusts is also necessary. The trust takes on legal status once it has been recognized in this way. No minimum capital is stipulated. In practice however, the supervisory authorities for trusts assume that, depending on the purpose of the trust, yield-bearing trust assets of at least EUR 50,000.00 should be available.
Advantages of a trust are that it is not subject to domination by third parties, and that the trust assets are legally separated from the founder and his or her descendants.