Choosing a legal structure for founders

This article describes the legal position under German law. German company forms are referred to by their German names, as they have no exact equivalents in other jurisdictions.

Choosing a legal structure is one of the most important strategic decisions a founder makes. It affects liability, tax, costs, how you are perceived, and how easily investors can come on board or shares can be transferred later. Deciding deliberately from the outset saves expensive restructuring and avoids personal liability traps.

I. Overview: sole trader, GbR, OHG, KG, Partnerschaftsgesellschaft, UG, GmbH, GmbH & Co. KG, AG

1. Sole trader (Einzelunternehmen)
   The classic entry point for solo self-employed people and freelancers: quick to set up, few formalities, low costs. There is no minimum share capital and you act as a natural person. The downsides: you are personally liable without limit with your entire private assets, and you cannot „leave profits in the company“. Investor participation is only possible to a limited extent, usually via loans.
2. GbR (civil law partnership)
   The simplest partnership where two or more founders start together – consultants, creative teams or small agencies. A GbR often comes into being „by accident“ as soon as several people run a business jointly. A written partnership agreement is not legally required but strongly recommended. All partners are personally liable without limit and, as a rule, jointly and severally – including for a partner’s mistakes.
3. OHG (general commercial partnership)
   A partnership for commercial businesses. It is entered in the commercial register and suits classic trading businesses with several partners. The OHG offers considerable flexibility, but here too all partners are personally liable without limit. Note that a GbR carrying on a commercial business automatically becomes an OHG.
4. KG (limited partnership)
   The KG combines fully liable partners as in an OHG – the managing general partners (Komplementäre) – with limited partners (Kommanditisten) whose liability is capped. It suits situations where some partners actively manage and accept full liability while others participate as investors with limited risk. The KG is common in family businesses and investment structures.
5. Partnerschaftsgesellschaft (PartG / PartG mbB)
   A special structure for the liberal professions – lawyers, tax advisers, doctors, architects. It allows joint practice under a single name. In an ordinary PartG the partners are personally liable; the PartG mbB (with limited professional liability) can offer partial limitation for certain risks. Professional regulations must be observed.
6. UG (haftungsbeschränkt)
   The UG is the „little sister“ of the GmbH with reduced share capital (theoretically from €1). It limits liability to the company’s assets and is structurally modelled on the GmbH. In return, part of the profits must remain in the company to build the capital up to GmbH level (€25,000). In the market the UG is sometimes seen as a transitional solution or „mini-GmbH“.
7. GmbH
   The GmbH is the standard corporate form for small and medium-sized businesses. It offers a clear separation between company and private assets, wide acceptance among business customers, banks and investors, and flexible shareholding structures. Formation and ongoing obligations (accounting, disclosure) are more demanding and more expensive than for a sole trader or a simple partnership.
8. GmbH & Co. KG
   This combines a KG with a GmbH as the fully liable general partner. Personal liability is largely limited to company assets, while the KG provides a flexible structure for participation and profit distribution. It is popular with family businesses, with former owners retaining a stake after a sale, and with larger mid-sized companies – but it is more complex and more costly than a straightforward GmbH.
9. AG (stock corporation) / SE (Societas Europaea)
   The AG, and likewise the SE, is mainly relevant for larger companies and high-growth businesses with capital market ambitions. Shares can be transferred easily without notarisation, governance structures are strict and reputation is high. Against that stand complex formation requirements, high capital needs and extensive disclosure and governance obligations. For typical founders the AG or SE is usually oversized.

II. Criteria: liability, costs, perception, investors

1. Liability

Unlimited personal liability:

• Sole traders, partners in a GbR or OHG, general partners in a KG and partners in a classic Partnerschaftsgesellschaft are liable with their private assets.
• This risk can be mitigated to a degree through specific insurance.

Partially limited liability:

• Limited partners in a KG are liable only up to their contribution; partners in a PartG mbB may be protected against certain professional liability risks.

Liability limited to company assets:

• UG, GmbH, GmbH & Co. KG (through the GmbH as general partner), AG and SE limit liability in principle to the company’s assets.

2. Formation and running costs

Low cost, few formalities: sole trader, GbR, simple Partnerschaftsgesellschaft.

Moderate: OHG, KG, UG (notary, register entry, but lower share capital).

Higher: GmbH, GmbH & Co. KG, AG and SE – with the corresponding notarial, register, accounting and publication obligations.

3. External perception

Small and informal: sole trader, GbR.

Credible in commercial settings: OHG, KG, Partnerschaftsgesellschaft.

Strongly professionalised: UG, GmbH, GmbH & Co. KG, AG and SE – with the signalling effect rising from UG through GmbH to AG or SE.

4. Suitability for investors

Limited: sole traders, GbR and traditional partnerships are only moderately investor-friendly.

Workable: KG and GmbH & Co. KG (limited partner structures), GmbH and UG allow flexible participation, employee share schemes and clear ownership ratios.

Particularly investor-friendly: AG and SE are the classic framework for broad investor bases and capital market activity, but rarely matter in the early stages.

III. Common mistakes when choosing a structure

1. „We’ll just start as a GbR, we don’t need an agreement.“
   Without an individually negotiated written GbR agreement, key points are left unclear – profit distribution, a partner leaving, non-compete obligations, liability. At the same time everyone is fully liable, including for a partner’s debts or mistakes.
2. „I’ll start as a sole trader and convert later.“
   Converting into a GmbH or GmbH & Co. KG later is possible, but involves effort, cost and potential tax consequences. Contracts signed early (lease, leasing, financing) then have to be adjusted or transferred. Transferring them requires the counterparty’s consent – particularly the landlord’s – which they often use as an opportunity to renegotiate.
3. „We’re freelancers, so we don’t need anything formal.“
   For the liberal professions in particular, a Partnerschaftsgesellschaft (possibly a PartG mbB) is often more sensible than a loose cooperation: clear allocation of liability, a common external identity and a regulated succession.
4. „A UG sounds cheap, it only costs €1 of share capital.“
   The UG is often chosen purely for the low capital requirement, without regard to image, how banks respond, or later investors. Its ongoing obligations closely resemble those of a GmbH, and profits must be retained. There is also a chronic latent insolvency risk once the company’s modest capital is used up.
5. „A GmbH & Co. KG or an AG sounds especially professional, so let’s do that.“
   Complex structures without genuine need tie up money and administrative capacity. For many founders a straightforward GmbH, or a partnership with a good agreement, is the more economical solution.

IV. Examples: founder profiles and suitable structures

1. Freelance solo service provider
   A consultant or coach starting alone, with manageable liability risk and no great capital requirement. A sole tradership can be a pragmatic entry point. As staff numbers, liability risk or the wish for a more professional profile grow, a GmbH or UG may become worthwhile.
2. Two or three founders with an agency or consultancy
   At the start a well-drafted GbR or Partnerschaftsgesellschaft may be enough. As larger projects, employees and liability risks come into play, a move to a GmbH or GmbH & Co. KG should be considered.
3. Trading business with warehouse and staff
   Three founders open a trading business with a warehouse, employees and supply contracts. An OHG offers flexible cooperation but full personal liability. A GmbH or GmbH & Co. KG may be preferable to limit liability and present professionally to suppliers and banks.
4. Family business with investors
   A family business wants to bring in children or external investors. A KG or GmbH & Co. KG allows active general partners to be separated from more passive limited partners, and gives flexibility on succession, liability and profit distribution.
5. Start-up focused on investors
   A tech start-up with a scalable model and a planned funding round is usually better served by a GmbH than by a GbR or sole tradership. The GmbH offers clear shareholding structures, governance rules investors know, and a professional profile; the AG typically becomes relevant only in later growth stages.

V. Tax and accounting: what founders should know

Beyond liability and perception, the structures differ above all in taxation and accounting obligations. That affects the ongoing burden and the planning of drawings or distributions.

1. Taxation

a) Sole trader, GbR, OHG, KG, Partnerschaftsgesellschaft (including PartG mbB)

• The entity itself pays no income tax; profits are attributed directly to the owners or partners (transparency principle).
• Each pays income tax on their share of the profit at their personal rate.
• Commercial sole traders and commercial partnerships also pay trade tax; there is an allowance, and part of the trade tax can be credited against income tax.
• Professional partnerships are generally not subject to trade tax, as long as only professional income is generated.

b) UG, GmbH, AG (corporations)

• The company itself pays corporation tax and trade tax.
• Distributions to private shareholders (dividends) are generally taxed under the flat-rate withholding tax or the partial income procedure.
• This creates a two-tier burden: taxation at company level and again at shareholder level on distribution.
• The overall burden for the shareholder usually differs only marginally from a sole tradership or partnership. However, profits can be retained in the company and used later for investment or for distributions in retirement.

c) GmbH & Co. KG (a special case)

• For tax purposes the GmbH & Co. KG is generally a partnership (co-entrepreneurship).
• The KG pays trade tax; the profit is attributed to the partners and taxed there as income.
• The GmbH as general partner is additionally its own corporation tax subject for its own income, such as remuneration and profit shares.

2. Accounting obligations

a) Cash-basis accounting (EÜR) possible

• Members of the liberal professions can determine profit on a cash basis, as long as no commercial activity is taken up.
• Sole traders and partnerships not entered in the commercial register (such as a classic GbR or Partnerschaftsgesellschaft) can use cash-basis accounting where turnover and profits are modest.
• This is particularly attractive in the start-up phase because it reduces effort and cost.

b) Obligation to keep double-entry books and prepare accounts

• Corporations (UG, GmbH, AG) are always required to keep double-entry books with a balance sheet and profit and loss account, including disclosure in the commercial register.
• Commercial partnerships (OHG, KG, GmbH & Co. KG) are merchants by virtue of their form and are likewise required to keep double-entry books.
• Sole traders and partnerships can become subject to these obligations if certain turnover or profit thresholds are exceeded, if they are registered as a merchant, or if a commercial trade is taken up.

VI. Structure check: which form fits your plans?

Whether sole tradership, GbR, Partnerschaftsgesellschaft, OHG, KG, GmbH & Co. KG, UG, GmbH or AG – no structure is automatically ideal for every founder. What matters is:

• How high is your actual liability risk?
• How important are formation and running costs compared with external perception and limited liability?
• Are you planning partnerships, employee participation or investors – and how flexible does your ownership structure need to be?
• What tax burden and accounting effort can and want you to carry?

A structured review with your lawyer and tax adviser helps to work through these questions systematically and reach a decision that fits your business model and your personal situation.