Establishing a company in Germany (GmbH vs. UG)
In Germany, two frequently encountered forms of capital companies are the GmbH, or limited liability company, and the UG, or entrepreneurial company.
In our capacity as tax consultants, we advise, support and accompany our clients seeking to establish a company in Germany. Often, our clients inform us of their plan to found a UG in Germany during our first discussions. However, in most cases, the UG is not the most suitable legal structure for entering the German market. Dedicated to preventing our clients from making unsound decisions, we instead recommend that they establish a GmbH rather than a UG.
The following are the seven leading reasons for not establishing a UG:
- Negative Image
The minimum capital need for establishing a GmbH is 25,000EUR, while the minimum capital needed for establishing a UG is a mere one EUR. Founding a UG creates the risk of signally to potential business partners that that you do not have sufficient liquid funds to found a GmbH. This can undermine the trust in your company that you need from clients and customers. In effect, forming a UG is the worst form of negative advertising.
- Individual Provisions in the Articles of Association
For financial reasons, the founding of a UG usually takes place using a simplified process provided for by statute. It should always be born in mind that whenever there are two or more shareholders in a company, provisions for individual protections are imperative. Such provisions include voting rights, compensation and succession arrangements in the event that a shareholder leaves the company and policies in the case that a shareholder passes away.
However, individual provisions cannot be included in a UG’s articles of association when the statutory simplified process for founding a UG is used. By creating individual articles of association for the UG, which are usually necessary, the owners lose the cost advantages of establishing a UG rather than a GmbH.
- High Risk of Insolvency
Establishing a company and launching business operations involves numerous costs, such as advertising, acquisitions of technical systems and/or inventory, and additional start-up expenses.
If the share capital of the UG amounts to merely the minimum one EUR, the company will not be able to bear these start-up costs. The UG will already be over-indebted by the expenses incurred from its initial formal founding costs and accompanying notary fees. To avoid personal financial or legal liability in the event of excess debt or insolvency, the managing director must immediately declare legal insolvency.
However, when a UG is over-indebted, the shareholders will usually grant it a loan and declare subordination. These loans could have been better invested directly into the share capital of a GmbH.
- The UG is Merely a Transitional Form
The UG is designed to be transformed into a GmbH at a later point in time. Every year, 25% of its profits must be deposited into revenue reserves. As soon as the revenue reserves, together with the original share capital, have reached the amount of 25,000EUR, the UG can be converted into a GmbH. If, however, the UG is not converted into a GmbH, the UG must continue to deposit 25% of its profits into revenue reserves every year. The revenue reserves may not be used to distribute profits, something which, in the long run, will lead to an undesired capital accumulation and stagnation within the UG.
- Notary Fees and Setup Costs are Not Lower in the Long Run
At first glance, the notary and registration fees for establishing a UG appear lower than those for a GmbH. However, this impression reflects a very short-term perspective. Eventually, the UG will be converted into a GmbH. Upon conversion, an auditor must review the annual financial statements, which entails additional auditing costs. Moreover, there will be additional notary fees for certification as well as expenses for the registration of the GmbH in the German Commercial Register.
- Problems With Subsidies
In our experience with our clients, we have found that some funding bodies are not willing to work with a UG. If the company does not want forgo its access to subsidies, the UG must be converted into a GmbH before applying for subsidies.
- No relief in the taxation procedure
Often, our clients believe that a UG would enjoy facilitations in the taxation procedure or financial reporting relief. However, this is not the case. There are no special regulations providing for simplified or expedited management of a UG, which must adhere to the same standards as a Gmbh regarding preparing annual financial statements for publication in the Federal Gazette and filing tax returns for corporate, commercial and value added taxes. In addition, liquidation is neither faster nor easier for a UG, as the same rules for liquidation apply to both a UG and a GmbH.
In most cases, and after discussing the issue with us in detail, our clients decides to establish as a GmbH.
Furthermore, registering as a GmbH in the Commercial Register costs a minimum of at least half of the share capital, or 12,500EUR. Our clients that have decided to establish as a GmbH are very satisfied with their decision.