German Federal Statistical Office, about 20% of all registered companies in 2016 are a GmbH
According to the most recent numbers roundabout 20 percent of all the companies in Germany a GmbH. This is a lot, and therefore it is also known as the best export product of the German law as a lot of countries copied this form. Why is this type of corporation than so advantageous? To gain a better understanding of the GmbH, the paper starts with clarifying the GmbH and how it can be founded. When there is a basic understanding, it continues with the advantages and disadvantages of the GmbH.
GmbH founding process
The GmbH is the abbreviation for A ‘Gesellschaft mit beschränkter Haftung’ translated a limited liability company. It is a legal entity under the Germany civil law and as the name implies it has two main characteristics. It is a legal person: the GmbH holds subjective rights through certain relevant acts, it can sue and be sued, purchase and sell property and conduct business in its own name. And second the shareholders are limited liable which means that their liability is limited to the amount of share capital invested. Shareholders’ personal property is protected.
As compared to other countries it was relatively difficult to start a business in Germany that’s why the German government decided 1892 to introduce a new form of a corporation with a simple founding process: the GmbH. There are three main steps which needs to be taken. The rules and condition of the GmbH can be found in the GmbHG or translated the limited liability companies act.
1. Decisions and name:
First of all, a name for the company has to be created this always needs to include the corporation form GmbH. This name has to be checked by the chamber of commerce to ensure that the name and objective are unique and cannot be mistaken for another company.
2. Notary and the articles of association
Than the company agreement is drafted and a list of shareholders. After that the shareholders have to go to a notary where they article of association need to be signed by all the shareholders under the supervision of a notary.
The articles of association can have two forms
- On the one hand you have the uncomplicated standardized formations of a GmbH model articles of association. This already includes all the necessary points and only still need to be ‘filled’ in.
- In the standard procedure, the articles of association need to be stipulated. These articles need to contain the purpose of the enterprise is described as well as the business name, the place of its registered office, who the shareholders are and who is in charge as director. The director(s) can only be a natural person with full legal capacity .
3. Commercial register:
Than the company has to be registered at the German commercial register. The purpose of the register is to provide the public with reliable information on the corporate data of a business.
According to § 5 GmbHG the company’s share capital must amount at least twenty-five thousand euros . And to start the registration process at least half of the stock capital needs to be paid (minimum € 12.500.-) and proof that there no other criminal obstacles. After the notary checked everything and submitted it to the commercial register, the GmbH in process of founding the so-called GmbH i.G. any other requirement can be found in §8 of the GmbHG, When the register court approved everything the founding of the GmbH is official.
4. Trade register
Company needs to be registered by the municipal trade office (Gewerbeamt).
The advantage of a GmbH is mainly that it is very flexible:
At this point, the law regarding the articles of association gives the founder – within the rules of law – the opportunity to create articles as it is desired. This specific character has made the German law as one of the most “Erfolgreichster export Artikel auf dem Gebiete des Rechts”. As long as the company has any legal commercial purpose: you can be an artist, a candy seller or to start a catering everything is possible.
Another point of flexibility is that the GmbH can appoint any natural person with unlimited legal capacity as a managing director. There is no special requirement regarding the qualifications of manager and even foreign managers can be put in charge. This is attractive for foreign investors when they already have company abroad and one of the employees has the desirable capacities to lead his company they can put him in charge.
In a lot of cases the reason to decide for a GmbH is because of the limited liability. As opposed to a general partnership, a GmbH has a limited liability of the shareholders because the private owner’s equity is separate from the company’s equity. When the company has a debt, generally the debt is paid from the company’s equity and the private owner’s equity is not liable. As a result of its separate legal personality, when the company enters into transactions with third parties, its shareholders are not personally liable towards those third parties. Very special – as compared to Dutch law- is the fact that a Gesellschaft mit beschränkter Haftung combined with a Compagnie Kommanditgesellschaft (GmbH & Co. KG) even leads to the situation that only a legal entity (GmbH) is liable (and not a legal person, the Gesellschafter)
So, the risk reduces for the shareholders. In specific industries or professions who have to deal with high risk as this can be a huge advantage. But there are exceptions: this will be explained later on in this paper.
The average overall tax burden for corporate company’s amounts is 29.83 percent. The median rate in Germany approximately 14% business tax – depending on location, business taxes can be higher or lower. How big the tax advantages are, is depending on the use of profit. As the corporate income tax are way lower than the income taxes it is smarter to reinvest your profit in the business than to decide for own income.
Own legal capacity
A GmbH has an own legal capacity, it can conclude legal transaction, can sue and can be sued. The founders and shareholders finance the company but not necessarily have to do anything with leading the business. It is the managing director who legally represent the GmbH to the outside world and is in charge of the daily business. This is an opportunity for the founder(s) to stay in the background and only finance (a part) of the company, when there is an interest in selling the company to a third party this can be done without disturbing the operation of the business. The company existence does not end with the death of one of the shareholders or director as a shareholder is generally free to dispose of his/her share as opposed to for example sole proprietorship.
Furthermore, the high amount of minimum capital stock the company has a higher credit-worthiness. Creditors will earlier give the company a credit as the creditors have higher guarantee that the they get it back. This makes is easier to raise capital and plus the investors can be assured knowing they are not personally liable for corporate debts.
Minimum capital stock
The company agreement states the capital stock of the company. This is divided into initial contributions: this determines how much each of the shareholders participates in the company. The GmbH can only be registered when the company can contribute 25.000 to the capital stock. But this is not the only the condition: during the formation the shareholders has to pay at least 25% of the subscribed capital contribution to the account of the GmbH and the total amount has to be at least 12.500. The stock capital must be freely available to the GmbH either as a cash deposit or as a non-capital cash contribution. But still as founder you need to see how you raise this money, in comparison with other business forms this is definitely a disadvantage. Also a non-capital cash contribution exists out of assets but it is difficult to estimate the good value, a specialist is necessary But to be honest a minimum capital can be seen as advantage because it avoids as, in Holland the reality, that a GmbH is only set up with a capital of one euro which can lead fraudulent and ’empty’ set ups
A GmbH is a great deal of work, already the set-up procedure is relatively time consuming. It takes roundabout 3 to 5 weeks. As the notary has to certify the articles of association and need to hand it over to the commercial register, this process takes roundabout 3 weeks. Besides that, the GmbH is obligated to publish their financial statements. Which means that they need to have double financial documentation (one internal and one external determined in HGB). As a result, the management of a GmbH takes a lot of time and cure to the financial accounting and balance sheet- law. This time and indirectly money could also be differently spent.
Risk of limited liability
This is a bit a contrary headline, as said before the liability of the managing director in principal limited but there are a lot of exceptions on this rule. The right to represent the GmbH cannot be limited to the outside. This means that all the business transactions that the managing director concludes for the company with a third party shall be effective, even if they are not covered by his internal powers of representation. When the managing director was not entitled to make those transaction, the company can claim damages suffered by the GmbH from the director’s private equity. Last but not least when the director violates the law when he is for example not filing for bankruptcy on time, he is also unlimited liable.
Banks and other investors are in general demanding for an unlimited liability when they grant them a credit. That means the shareholders always have to pay the credit back to the creditors with their personal equity. Unlimited liability is almost never valid in practice with the creditors only with other business partners.
From the creditors point of view: the limited liability might be a disadvantage. Once the GmbH is bankrupt in the case of legal transactions (especially in the case of a GmbH & Co KG) it is very difficult to collect the debts.
Strict separation between company equity and shareholders’ equity.
A GmbH has strict division between the companies’ capital and the shareholders capital. Profit gets distributed according the share of the business. As opposed to a general partnership for a distribution a shareholder agreement is needed.
In practice the division between company capital and owner capital is often difficult. Not every founder can comply with this guideline as possible consequence is therefore the blame of the hidden profit division with the corresponding legal consequences.
To legal form of a business is essential in Germany. Depending on the choice, there are important differences regarding the formalities, liability and fiscal effects. In this paper these formalities are discussed which resulted in several advantages and disadvantages.
The most common reason why a GmbH is chosen is because the shareholders are limited liable but as it appears there are lot of exceptions on this rule. For example, the directors do not comply with their obligations or when they violate the law. Furthermore, when the company wants to take a loan, a lot of creditors require a person who is liable. So, in what degree the unlimited liability is really an advantage can be questioned. It is often only applicable when contracts with other business partners are closed.
The easiness of the set-up process is also not always what is seems to be. The standard model of the articles of association is only suitable for a small percentage of companies. The model only can be used when the set-ups is by cash subscription and with a maximum of three shareholders and one managing director. This can be impracticable as there is a great variety of different companies in real economic life. Instead, the articles of association can be stipulated, it can adapt the best to the individual needs, but this again more time-consuming and expensive.
Last but not least the high amount of start capital is often seen as a disadvantage, but this can also appear to be an advantage as the credit worthiness of the company increases and the companies get easier credits. Also, this avoids that you get fraudulent companies as in other countries. But a point of attention: after the company proved to the notary that they transferred the money nobody can check if they transfer it straight away back, which means that companies can ‘cheat’ with this.
All in all, there are a lot of pros and cons as already said before it depends on the kind of business and the availability of own equity. In my opinion each business form has so its own ‘charm’ and it is up to the founder and the purpose of the business to decide what is the most suitable.
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