For those founding a business in Germany, choosing the right type of business is one of the most important decisions you will have to make. Not only does it affect the business’s liabilities and overall tax affairs, but it also affects the business’s reputation among partners and customers.

In this article, we will discuss two of the most common forms of business in Germany: the limited liability company (GmbH) and the sole proprietorship. You will discover the advantages and disadvantages of both formations when it comes to taxes, costs, liabilities, accounting and regulatory requirements, as well as external reputation.

What’s in this article?

• What is a GmbH?
  
• What is a sole proprietorship?
  
• Tax comparison between a sole proprietorship and a GmbH
  
• Cost comparison between a sole proprietorship and a GmbH
  
• How is liability regulated for sole proprietorships and GmbHs?
  
• Comparison of accounting and regulatory requirements
  
• External impact and reputation of sole proprietorships and GmbHs
  
• Comparison table for a sole proprietorship and a GmbH
  
• When does it make sense to set up a GmbH?
  

What is a GmbH?

A GmbH, or limited liability company, is a legally established form of business in Germany. Its main features are the limitation of the shareholders’ liabilities relative to the share contribution and the requirement to have a share capital of at least €25,000. Management of the GmbH is carried out by the managing directors, while the shareholder or shareholders provide the capital. Registration and publication of business data is done via the Commercial Register.

What is a sole proprietorship?

In Germany, a sole proprietorship does not require any special documentation in order to be founded. Legally, the business consists of the entrepreneur themselves, with all liabilities covered by both their personal and business assets. This type of business is suitable for individuals who want to start a business with low risks and minimal startup capital.

Tax comparison between a sole proprietorship and a GmbH

GmbHs are subject to corporation tax, trade tax, and capital gains tax on all distributed profits. Sole proprietors tax their income through income tax, which can lead to different tax rates depending on the level of income. This could be an advantage or disadvantage depending on your individual circumstances. A GmbH is subject to corporation tax, which in 2024 is currently set at 15% of taxable income. In addition, corporation tax has a solidarity surcharge of 5.5%. Trade tax varies depending on the municipality’s assessment rate. On average, it is around 15%. Shareholders must also pay capital gains tax (25% plus solidarity contributions and, if applicable, church tax) on distributed profits.

Sole proprietors tax their income through income tax, which ranges from 14% to 45% (for income exceeding €277,825 in 2023). Furthermore, trade tax may be payable if the sole proprietorship operates commercially. An allowance of €24,500 on business income helps reduce the burden on smaller businesses. Sole proprietors can also claim a basic income tax allowance of €11,604 in 2024, which further reduces the tax burden.

Cost comparison between a sole proprietorship and a GmbH

Choosing between a GmbH and a sole proprietorship has a significant impact on the costs incurred—from setup costs to daily operations. When setting up a GmbH, you can expect to incur costs of around €600 to €1,200 for notarial certification and entry in the Commercial Register. Furthermore, a GmbH is subject to a minimum share capital of €25,000, of which at least €12,500 must be deposited immediately. Running costs, including fees for accounting and the preparation of annual financial statements, are at least €1,250, in addition to any costs for tax advice.

In comparison, the startup costs for a sole proprietorship are significantly lower. You can expect to pay €20 to €60 to register the business, and you do not require a minimum level of capital. This allows for a more flexible start. Ongoing costs for accounting and tax advice are, generally, lower than in a GmbH.

These cost differences underline the importance of taking the time to carefully consider which type of business is right for you. In particular, startups and small businesses should carefully examine the ongoing costs and tax burdens, so that they can choose the legal formation that is most suitable for their specific situation.

How is liability regulated for sole proprietorships and GmbHs?

A key consideration when choosing your preferred type of business is liability, which varies considerably between a GmbH and a sole proprietorship. In a GmbH, the shareholders’ liability is limited to the level of their share contribution. This means that, in the event of liabilities or insolvency, their private assets remain protected. The required minimum share capital of €25,000 serves as security for creditors. This limitation of liability makes the GmbH a particularly attractive proposition for projects with higher risks. However, you should note that there are certain circumstances, such as breach of duty, in which directors can be held personally liable.

In contrast, sole proprietors operate with unlimited liability, meaning their business and private assets can be taken into consideration. This form of liability involves significant risk, particularly when it comes to business activities that may result in high liabilities. Creditors have the opportunity to pursue the entrepreneur’s private assets in order to settle claims. Direct and unlimited liability therefore requires a careful risk assessment, as well as effective management to ensure financial losses can be minimized and entrepreneurial risk is kept manageable.

Comparison of accounting and regulatory requirements

Choosing between a GmbH and a sole proprietorship can significantly influence your accounting and regulatory obligations. GmbHs require double-entry bookkeeping and the publication of detailed financial statements, which increases transparency but can also lead to higher costs and administrative effort. As soon as certain businesses exceed the criteria defining them as a small business on two successive balance sheet dates—specifically, a balance sheet totaling €6 million, revenue of €12 million, and a workforce of 50 employees—they are obliged to have their annual financial statements audited by an auditor. This requirement applies to corporations such as a GmbH or a stock corporation, as well as general partnerships and limited partnerships—provided no natural person acts as a personally liable partner. Furthermore, according to Section 316 Paragraph 2 of the German Commercial Code (HGB), the consolidated financial statements must, generally, be audited.

Sole proprietors, on the other hand, benefit from simpler rules: for revenue of up to €600,000 and profit of up to €60,000, an income statement is sufficient, while disclosure and audit obligations are removed, which reduces effort and cost. However, if profits exceed €60,000, sole proprietorships will need to comply with additional accounting requirements. These may vary depending on the specific circumstances and may involve more extensive accounting and disclosures.

External impact and reputation of sole proprietorships and GmbHs

The external image of the business, shaped by its legal formation, contributes to its perception among business partners and customers. A GmbH is often considered a sign of seriousness and stability, due to the stricter registration and reporting requirements, as well as the limitation of liability. These elements signal commitment and long-term planning, which helps increase trust. Furthermore, setting your business up as a GmbH increases the likelihood of accessing loans and investment, since it enjoys greater credibility thanks to its structure and transparency. For businesses that operate internationally, a GmbH can open doors to foreign markets due to its worldwide recognition.

In contrast, sole proprietorships offer flexibility and a personal touch. Having a direct connection between the business and its owner can create trust and attract customers, especially in markets where individual service is highly valued. The simpler formal requirements allow sole proprietors to react quickly to changes, which can be advantageous in dynamic industries. However, the unlimited liability and blending of corporate and private assets can limit expansion and impact the search for external funding, since the increased risk could deter potential investors.

Comparison table for a sole proprietorship and a GmbH

The following table provides a comprehensive overview of the main differences between a GmbH and a sole proprietorship in Germany.

When does it make sense to set up a GmbH?

The decision to form a GmbH or a sole proprietorship depends on various factors, including business risk, your financial situation, and growth potential. A GmbH is often the better choice for businesses that plan to grow, invest, and build a professional brand. Sole proprietorships are ideal when flexibility, lower costs, and simple administration are the priority.

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