Choosing the right legal form is one of the fundamental decisions when founding a company. It affects liability as well as financing, taxation, management, equity participation options, publicity requirements, and any future company sale.
Partnership or Corporation?
The first fundamental decision often lies in choosing between a partnership and a corporation. With partnerships, the personal relationship among the partners takes center stage. Management and partner status are often closely linked, and personal liability may also apply. The most important forms include, in particular, the GbR, OHG, and KG.
Corporations, especially the GmbH and AG, are legally much more independent entities. They possess their own corporate assets and organizational structure. As a rule, shareholders are not personally liable for the company’s liabilities. Furthermore, management and shareholder status can be separated.
In between are hybrid forms such as the GmbH & Co. KG. Legally, this is a partnership in which a GmbH typically assumes the role of the general partner with unlimited liability. This allows certain characteristics of a partnership to be combined with limited liability. The trade-off is a more complex corporate structure.
The GmbH
For startups, the GmbH is often the first choice. Its share capital is at least 25,000 euros. In the case of a cash incorporation, the entire share capital does not necessarily have to be paid in before registration in the commercial register. In total, at least 12,500 euros must generally be contributed.
The GmbH offers three practical advantages in particular: Shareholders’ liability is generally limited to the company’s assets, ownership structures can be clearly structured via company shares, and additional investors can be brought on board through capital increases.
In addition, there is a clear organizational structure. The shareholders’ meeting constitutes the decision-making body on the ownership side. The management conducts business operations and represents the company externally. Shareholders therefore do not necessarily have to be managing directors themselves.
On the other hand, there are higher formation and administrative expenses, notarization requirements, as well as commercial and accounting obligations.
The UG
The entrepreneurial company (Unternehmergesellschaft or UG (haftungsbeschränkt)) is not an independent legal form, but a special form of the GmbH. It can be incorporated with a share capital of less than 25,000 euros. This allows founders with lower initial capitalization, in particular, to establish a limited liability company. However, the low statutory capital requirement should not be confused with a low actual capital requirement. If the business model requires liquidity right from the start for development, staff, marketing, or other running costs, this financing must be secured independently of the nominal share capital.
In addition, there is a statutory reserve requirement. A portion of the annual net profit must be allocated to a reserve until sufficient capital is accumulated for a regular GmbH. The UG is therefore particularly suitable as an entry-level form, but from an economic perspective, it is not necessarily the most sensible solution for every startup.
GbR and OHG
Partnerships generally require no statutory minimum capital. Especially in an early phase, they can therefore be simple and flexible. The key difference compared to a GmbH, however, lies in liability. With a GbR or OHG, the partners are generally personally liable for the company’s liabilities. This means private assets can also be affected.
This may be justifiable for a manageable business model. However, as contract volumes, debt financing, headcount, or other commercial risks increase, the liability issue gains considerable weight. For a growth-oriented startup with external investors, a traditional partnership is also often less practical than a corporation.
Financing and Taxation: The Economic Consequences
The choice of legal structure has a direct impact on financing options. Corporations offer clearly defined equity interests under corporate law. New investors can acquire company shares or stock, in the case of a GmbH typically via a capital increase.
This is of considerable practical importance, particularly for venture capital-financed companies. Equity share sizes, voting rights, liquidation preferences, or anti-dilution protection are generally linked to a clearly structured ownership stake.
While partnerships also permit the admission of new partners, they function differently under corporate law and are more heavily shaped by the personal relationship among the partners.
Debt financing can also be treated differently depending on the legal form. What is particularly relevant is whether capital is contributed as equity or provided as a shareholder loan, and what tax implications arise as a result.
Taxation
A central difference lies in the tax treatment. In a partnership, profits are generally allocated to the individual partners for tax purposes. The partnership itself is not an independent taxable entity for income tax purposes. The partners pay tax on their share of profits at their personal income tax rate. In addition, commercial partnerships are subject to trade tax. Under certain conditions, this can be credited against the income tax of natural persons.
In contrast, with a corporation, the company itself is the taxable entity. Its profits are subject in particular to corporate income tax of 15 percent as well as trade tax. If the remaining after-tax profits are subsequently distributed to natural persons, an additional layer of taxation applies at the shareholder level.
This is why the frequently drawn comparison between “15 percent corporate income tax versus personal income tax rate” is not entirely accurate. What matters is the total tax burden on both the company and the shareholder.
Distributing profits or retaining them in the company?
For startups, it is particularly relevant whether generated profits are to be distributed to the founders or retained within the company to finance further growth. Corporations can have advantages when it comes to retaining earnings. Their profits are initially taxed at the corporate level and can subsequently remain within the company.
In the case of a partnership, by contrast, profit is fundamentally attributed to the partners and taxed by them, even if the funds economically remain within the company. German income tax law does provide a special preferential tax treatment for retained earnings of partnerships. However, this preferential retention rate is subject to specific requirements and can lead to subsequent taxation in the event of later withdrawals. For a startup that intends to reinvest profits over several years, the question of profit allocation can therefore significantly influence the choice of legal form.
Founder compensation
Managing partners of a GmbH can generally receive a managing director salary. Provided the compensation is recognized for tax purposes and, in particular, meets arm’s length standards, it generally constitutes an operating expense for the GmbH, thereby reducing its taxable profit.
In a partnership, this works differently. Remuneration that partners receive for their work, for providing capital, or for transferring assets to the partnership is generally treated for tax purposes as so-called special remuneration (Sondervergütungen). It does not reduce the overall taxable profit of the co-entrepreneurship in the same way that a managing director salary does in a corporation.
Diana B. Haidari is an attorney and founder of Haidari Legal in Munich. She advises founders, startups, and young companies primarily on corporate and contract law matters, supporting them with legal issues related to formation and growth.
As a Munich Startup Expert, she explores step-by-step in her article series the most important legal topics that founders and startups should know.
Management, Organization, and Administrative Effort
In partnerships, management is generally more closely tied to partner status. However, which partners are authorized to make decisions and with what majority resolutions are passed can be defined in the partnership agreement. The shareholders’ meeting of a GmbH can generally issue instructions to management.
The AG is organized much more institutionally. The management board, supervisory board, and general meeting each have statutorily defined responsibilities. The management board generally directs the company under its own responsibility. This structure can make sense for larger companies or a broader group of shareholders, but for a traditional early-stage startup, it typically involves considerably more effort. Co-determination and oversight requirements also vary depending on the legal form and company size.
Public disclosure and ongoing administrative burden
The legal form also determines what company information must be made public. Corporations are subject to commercial accounting and disclosure requirements. The scope and depth depend, among other things, on the size of the company.
In the case of partnerships where natural persons bear unlimited personal liability, disclosure requirements may be lower. If, however, personal liability is effectively excluded—such as in a GmbH & Co. KG—more extensive accounting and disclosure regulations apply once again. This entails an ongoing legal and administrative effort.
Sale of shares, succession, and changes of legal form
The choice of legal form also affects a future sale of the company. In principle, a distinction must be made between the sale of individual company assets (asset deal) and the sale of company shares (share deal).
In the case of a corporation, shareholders can sell their shares, while the company itself continues to exist along with its contracts, employees, rights, and liabilities.
In an asset deal, by contrast, individual assets or business units are transferred, which can entail greater implementation effort, especially when it comes to taking over contracts.
The tax consequences also differ considerably. Among other things, it makes a difference whether a natural person or another corporation holds the shares. When a corporation holds an interest in another corporation, special tax privileges apply, which can play a role particularly in holding structures.
Business succession and transfer of shareholdings
In corporations, company shares can be transferred. In partnerships, greater consideration must be given to the consequences that a partner’s departure will have on the partnership and the remaining partners.
The legal form can be changed later
A wrong decision during founding is not necessarily final. Corporate transformation law allows, for example, mergers, spin-offs, and changes of legal form. Switching from a partnership to a corporation or vice versa can also be structured under certain conditions.
From a tax perspective, there are ways to carry out corporate reorganizations without immediately and fully disclosing the company’s hidden reserves. However, the requirements of reorganization tax law must be met.
Keep internationalization in mind
As soon as founders, investors, or subsidiaries are based abroad, additional tax and corporate law questions come into play.
Foreign permanent establishments, subsidiaries, withholding taxes on distributions, and double taxation treaties can be particularly relevant. The question of which country a company is tax resident in can also gain importance in cross-border structures.
For startups with an internationally focused business model early on, it is therefore advisable not only to examine which legal form makes sense within Germany, but also, if necessary, whether it is suitable for the international structure.
Which Legal Form Is the Right One for a Startup?
A GmbH can make sense if limited liability, external financing, and a clear ownership structure are the main priorities. A UG can be an alternative if less share capital is initially available. A partnership can represent a flexible solution when risks are manageable and there is a small, closely knit group of partners. A GmbH & Co. KG can be particularly attractive if elements of a partnership are desired without a natural person being subject to unlimited liability.
The decisive factor is which corporate structure will continue to support the business model as the startup evolves into a growing company.
