Choosing a Legal Structure When Starting a Business: A Decision with Far-Reaching Consequences

When looking for the right legal structure for your self-employment, a large number of factors come into play. Think through the choice of legal structure carefully and take all aspects into account, such as personal liability, equity requirements, and administrative burden. As part of a start-up consultation, your Guhr Steuerberatung will give you many valuable tips!

The business structures available in Germany can be categorised according to several criteria. For founders, it is interesting, for example, whether a legal structure is available to freelancers or traders. Some forms are suitable for both types of self-employment; others are reserved exclusively for freelancers or traders. A further distinguishing feature is whether a legal structure permits single-person or team incorporations.

There is a fundamental distinction between partnerships and corporations (Kapitalgesellschaften). Partnerships do not constitute a separate legal entity — this affects, among other things, liability and the method of taxation. Corporations, by contrast, function as legal entities. A key characteristic of corporations is that liability in the event of insolvency is limited to the company's assets.

The following sections provide an overview of the most important legal structures. Bear in mind that German company law is complex. This is partly because different legal bases, such as the Income Tax Act (EStG) and the Commercial Code (HGB), all play a role. We limit this discussion to the most well-known legal structures!

In a sole proprietorship (Einzelunternehmen), the operator is the sole owner of the business. You may choose this legal structure regardless of whether you have employees. Sole proprietors operate either as solo self-employed individuals or as self-employed persons with staff. Even a firm with thousands of employees can be a sole proprietorship. This legal structure is equally open to freelancers and traders. Traders operate as a registered merchant (eingetragener Kaufmann/eingetragene Kauffrau).

Three characteristics define the sole proprietorship:

• The owner is personally liable with their private assets.
• No capital contribution is required.
• Sole proprietors pay tax on their profit at their individual income tax rate.

Many freelancers join together in a civil-law partnership (Gesellschaft bürgerlichen Rechts, GbR). This legal structure is notable for its minimal administrative burden. The partners can, for example, conclude the partnership agreement informally. There is also considerable flexibility in how the agreement is structured. No capital contribution is required for this type of business.

GbRs are not directly subject to profit taxation, as they are not regarded as a separate taxable entity. Instead, the tax office calculates income tax on each partner's individual share of the profit. The level of the tax burden depends on the individual's tax rate. An exception applies to trade tax (Gewerbesteuer), which the tax office levies directly on the GbR.

A disadvantage of this legal structure is the unlimited personal liability of all partners with their private assets.

The partnership (Partnerschaftsgesellschaft, PartG) and the partnership with limited professional liability (Partnerschaftsgesellschaft mit beschränkter Berufshaftung, PartG mbB) are two further legal structures specifically for freelancers. Their operation is largely identical to that of a GbR — this applies, for example, to taxation. There is one significant difference regarding liability:

PartG: As a rule, the partners are personally liable with their private assets without limit. However, this does not apply where a liability obligation arises from the professional error of a partner. Only partners who were directly involved in handling the relevant assignment are liable for the resulting damage.

PartG mbB: Certain professional groups, such as doctors, architects, solicitors, and engineers, may join together under this special legal structure. The advantage is that liability for professional errors is limited — even partners who bear responsibility for the relevant damage benefit from this. This legal structure requires the conclusion of professional indemnity insurance.

Among traders, too, there are various business structures. Operators of retail shops, craft businesses, and the like frequently opt for the sole proprietorship. As with freelancers, unlimited personal liability is a significant disadvantage. The low administrative burden and the absence of financial barriers speak in favour of this structure.

Alternatives include the two partnership forms: the general commercial partnership (Offene Handelsgesellschaft, OHG) and the limited partnership (Kommanditgesellschaft, KG). In an OHG, at least two partners join together. All partners are personally and unlimitedly liable with their private assets. Each individual partner may act independently in the name of the firm — this presupposes a strong relationship of trust.

The KG, by contrast, consists of at least one partner with unlimited liability (Komplementär) and one limited partner (Kommanditist). The limited partner acts as a financial backer; their liability is restricted to their contribution. Management and external representation fall exclusively to the Komplementär or Komplementäre.

In the area of corporations, the private limited company (Gesellschaft mit beschränkter Haftung, GmbH) is extremely popular. Establishing a GmbH requires a share capital of at least 25,000 euros. In return, the shareholders are relieved of all personal liability. In the event of insolvency, the insolvency administrator realises only the company's assets, including the shareholders' contributions.

Management is assumed by a person appointed by the shareholders by simple majority. This may be a shareholder or an external specialist. The managing director runs the company and represents it externally, receiving a salary for this role. Shareholders benefit from the company's success through profit distributions, which must be resolved at a shareholders' meeting. One further peculiarity: GmbHs, like other corporations, are subject to direct taxation in the form of corporation tax.

The great advantage of a GmbH is the limitation of liability. Its drawbacks include the required share capital and the considerable administrative challenges. The entrepreneurial company (limited liability) (Unternehmergesellschaft (haftungsbeschränkt), UG) offers an alternative by which start-up founders can at least circumvent the financial hurdle. The share capital need only amount to 1 euro; in return, the founders must build up a reserve from a portion of their future annual surpluses.

Aktiengesellschaft (AG), eingetragene Genossenschaft (eG), GmbH & Co. KG: German company law offers numerous options. If the business structures described so far do not fully suit your needs, it is worth looking at the various alternatives. For every type of business and all individual circumstances, the optimal solution can be found. Moreover, for many legal structures there is the option of adapting the articles of association to the specific requirements and wishes of the parties involved. For variants such as the GbR, the legislature provides for extensive freedom of design. Guhr Steuerberatung will advise you competently!

When choosing a legal structure, you should take several relevant factors into account.

In particular, the following aspects deserve consideration:

• How many people intend to found the company?
• What economic risks exist, and are you willing to accept the risk of personal liability?
• For legal structures such as the GmbH, can you raise the required equity capital?
• What type of management do you prefer?
• To what extent are you able or willing to take on administrative obligations?
• How important is creditworthiness for your project, and how do different legal structures affect it?

Guhr Steuerberatung addresses these and other points in detail as part of a start-up consultation. Specialist tax advisers explain the advantages and disadvantages of the different legal structures to you. They also explain clearly which structures best suit your business concept, and they cover the tax implications of your choice of legal structure comprehensively!

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