What type of company should I choose? (sole proprietorship or limited liability company)
When you need to choose what type of company you want to incorporate in Denmark, the first question you should ask yourself, is whether or not you prefer to run the business where you are personally liable, or if you prefer to place the liability in a structure, known as a limited liability company.
Dania Accounting would advise that, first and foremost, you consider the details of your prospective company and the risks involved. What will your business actually do, and who are your clients? Will there be any potential liabilities? Are you 100% sure, that you want to go “all-in” on this new business, or would it be a good idea to test the business idea/concept first?
The most popular limited liability company is called an “ApS”.
Note: Prior to 9 April 2019 you could also choose a limited liability company type called “IVS”. This type is not longer an option, since legislation has changed.
Pros & cons of a sole proprietorship
Pro: Ease of startup
In Denmark, the easiest company to incorporate is a sole proprietorship, called “enkeltmandsvirksomhed” in Danish. When deciding between a sole proprietorship and a limited liability company, you must take into account how much money you have and the type of clients you have. If you don’t have much money and are in a situation where there’s not much liability with your potential startup, then a sole proprietorship may be your best option, because it’s very easy to start. You can register it for free within a few days. You might need to pay for an auditor to help you with the process, but otherwise, it’s quick, easy, and cheap. No requirements in terms of equity; no need to deposit any money into the bank account, as is required with most of the limited liability companies.
Pro: Offsetting the company deficit
Another benefit of choosing a sole proprietorship is that it allows you the opportunity to use other incomes to offset the inevitable deficit of starting your business. Some people make a revenue from the beginning, but most businesses have a deficit for 1-3 years or even more; so, with a sole proprietorship, if you have a job in the beginning, and you’re working full-time for six months while starting the business on the side, then the deficit produced by your company can be used as a tax deduction for your employee income. In this way, you’ll benefit a lot from your tax refund in your first year of business.
The following example will illustrate this benefit: Tax in Denmark is normally 35-45%, but as a good rule of thumb, we’ll say 50%. So imagine you have a deficit the first year of 100.000 DKK, and you have a job alongside running your business, for which you make a salary of 200.000 DKK. In this case, you have 200.000 DKK in salary, and you lost 100.000 DKK in your own business, due to all the startup costs. When you calculate your tax at the end of the year, you’d have a salary of 200.000 DKK and, from that amount, you can offset the deficit from your own company. When the tax office calculates your income, it will be 200.000 DKK minus the 100.000 DKK from your deficit, so you would only have to pay tax on 100.000 DKK. If the tax is around 50%, then the tax would be 50.000 DKK. In this way, you can actually make use of the deficit. So if you expect a big deficit and you’re low on cash, a sole proprietorship is a really good idea.
Con: Personal liability
One disadvantage with sole proprietorships is that you are more or less the company, and you’re liable for everything that might happen during the lifetime of the business. This means you could, for instance, be sued by a client or end up in a lawsuit if you fail to pay your bills. If you lose the lawsuit, then you’d be held personally liable. Worst-case scenario, you might end up in a situation where you’d need to sell your house in order to pay some obligation. So having a small company, a sole proprietorship, is in many ways easier than the limited liability companies, but you must understand the risk involved.
So when is a sole proprietorship a good choice in terms of risk? Let’s consider the following example: If your business involves writing articles for friends, family, and close acquaintances, then you’re not likely to end up in any huge lawsuits. And since your costs would be limited to a computer, paper, pen, etc., your overall risk would be limited.
However, if you then scale up your company to include two or three full-time employees, then you’d have a liability towards them in terms of salaries, as well as if something goes wrong. Moreover, if you acquire some big business which, for instance, results in sales of 1 million DKK per month, but you decide to source the work out and pay your outsourcing partners 900.000 DKK, in this scenario, your margin would not be great. Your profit wouldn’t be a million; it would be much less. But you would have provided the client a service for 1 million DKK, resulting in a big liability.
One way to avoid such big liabilities is to write your way out of them with a contract. In reality, you cannot sign a contract with zero liability; some kind of liability – an amount or percentage – will always need to be incorporated. We at Dania Accounting suggest that you look at your competition to see what they negotiate in their contracts or seek advice from a lawyer to stay competitive.
If you’re starting out with little money and don’t have liability, a sole proprietorship may be the best choice. Although you can make a limited liability company quite cheap in terms of equity capital, you should still keep in mind whether or not there’s a deficit.
Pros & Cons of limited liability companies
When comparing limited liability companies to a sole proprietorship, first ask yourself if there’s any liability in the work you do. Look at your worst-case scenarios. If you have a disagreement with a client – for instance, you did some bad work, and they lost some money – you must ask yourself if you can write your way out of the liability in a contract that will potentially hold up in court. If you can, then the liability will be limited, and a sole proprietorship is the quickest and easiest option to starting up your business. If you can’t, you really should consider the limited liability company.
Pro: ApS provides peace of mind for clients
Should everything go bad, then you will only lose the company.
All your private assets is protected.
Con: ApS requires 40.000 DKK to start
You must have 40.000 DKK in equity capital to start the business.
Con: ApS cannot offset the company deficit with your personal income
A limited liability company works differently than a sole proprietorship in that, even if there is a deficit, that deficit is isolated in the limited entity, so you can’t lose that deficit for anything. If you receive a salary from your limited liability company to pay your bills, then the company would be required to produce a payslip for you. And once that payslip is made, the company must withhold taxes and pay taxes to the government. So if you have a deficit and you also need a salary, because you have bills to pay, not only have you lost the money on the deficit, but you must also pay taxes on this personal income.
If you don’t have a huge deficit, if you have liability, if you already have some clients, and you can see from day one that you’re going to break even or make money, you should definitely look at starting with a limited liability company.