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August 29, 2022

GmbH and UG: How to Choose Between the Two Popular Legal Forms for your New Business

GmbH or UG? We asked Qonto about the differences, advantages, and drawbacks of each legal form. Here's what they had to say.

Business plan set up and capital secured to start your company? Congratulations! Now it’s time to consider a suitable legal form for your new venture. And that can be overwhelming. After all, there are lots of options to choose from and some bureaucratic hurdles to overcome.

But don't worry – according to the experts from Qonto – the leading European business finance solution for SMEs and freelancers – it’s easier than it seems. Qonto has been our partner for some time now. Maybe you already know them through our betabreakfast, where they took the stage to share helpful tips on how partnerships can drive your business growth. 

Today, Qonto is back to help you out with German legal forms. To not overcomplicate things, we're just focusing on the two most popular choices among founders in Germany. First, the "Gesellschaft mit beschränkter Haftung (GmbH)," which translates to "limited liability company." It is the country's most applied legal form. And second, the "Unternehmergesellschaft (haftungsbeschränkt)," a subform of the GmbH and also a favored choice. 

But what makes them so popular? Where lie the differences between the two? And what do you need to consider during the formation process? Here our friends from Qonto answer your most critical questions about the GmbH and UG (haftungsbeschränkt).

GmbH

First things first: what is a GmbH?

The GmbH is a German business and legal form that belongs to the corporations. The GmbH formation works as a one-person GmbH or in a team as a multi-person GmbH. The owners are called "Gesellschafter" which translates to shareholders. 

What are the advantages of a GmbH?

One of the most important advantages compared to other legal forms like the GbR is the limited economic risk. In the event of bankruptcy, only the contributed share capital of the founders is drawn on; their personal assets remain untouched. However, there is one exception: sometimes banks require the personal liability of the shareholders and managing directors when granting a loan. In the event of the GmbH's insolvency, the private assets may have to be used to repay the loans to the banks.

Another advantage relates to tax law: When taxing the GmbH, the fiscal office applies the corporate income tax, which is usually not as high as the income tax for a partnership.

Also, if you need to change partners or managing directors, which goes along with adjusting the commercial register and articles of association, it is quickly done with a GmbH. And it doesn't require a lot of costs for the notary or lawyer.

Another benefit: You can sell the GmbH easily by disposing of your company shares from the share capital. 

The formation of a GmbH also enables the shareholders and managing directors to obtain loans from banks and other investors more easily. Since the partners with the GmbH stand under clearly defined conditions, lenders co-operate gladly with a GmbH. The legal form has an excellent reputation. In this way, you can obtain loans more cheaply. 

Does the GmbH also have disadvantages?

Yes. No legal form is perfect, not even the GmbH. You need to bring a share capital to the table, at least 25.000 Euro. Half of it you have to pay into your business account at the time of incorporation. The other 12.500 Euro can also be an in-kind contribution. 

Besides the money, another disadvantage lies in the administrative work that comes with the GmbH. Accounting follows strict rules, including balance sheet preparation and the publication of financial results. Among other things, double-entry bookkeeping and an annual balance sheet are mandatory. 

What do I need to establish a GmbH?

As a first step, you need to choose a name and ensure no other company is using it. The addition "GmbH" or "Gesellschaft mit beschränkter Haftung" is always mandatory following the name. Another important criterion is to set up and certify the articles of association. The shareholders can establish the articles themselves or with the help of a lawyer. 

Additionally, forming a GmbH requires registering with the Commercial Register, the Trade office and the tax office, the Chamber of Industry and Commerce (IHK) or Chamber of Crafts (HWK), and the Trade association. 

Last but not least, you will also need a business account. With Qonto, you can open it conveniently online and get a German IBAN in just 10 minutes. And since the introduction of the Act Implementing the Digitalization Directive (DiRUG) in August 2022, founders can complete almost the entire formation process of the GmbH online. For example, all notary appointments for company formations can take place via video communication.

Unternehmergesellschaft

What is an Unternehmergesellschaft (haftungsbeschränkt)?

The Unternehmergesellschaft (haftungsbeschränkt), short UG (haftungsbeschränkt) is not a separate legal form but a subform of the GmbH. It’s also called Mini-GmbH or 1-Euro-GmbH. And this brings us to the most significant difference compared to the GmbH. To form a UG, you don't need a starting capital of 25,000 euros; even a symbolic 1 euro will do. And like the GmbH, the UG offers the advantage of limited liability. So it might be a good fit if you don't have the necessary share capital to form a GmbH right from the start but want to try out your business idea. 

Important to know: If you form a UG, the law requires you to build reserves that account for 25 percent of the profit generated until you have reached the minimum share capital of a classic GmbH – 25,000 euros. As your company grows and you save the necessary amount, you then convert your UG into a GmbH. That involves some paperwork:

You have to register the capital increase with the commercial register. You also need a capital increase resolution certified by a notary public, which must refer to a balance sheet confirmed by an auditor. All changes must then be included in the articles of association, followed by a notarization. Yes, converting your UG into a GmbH will cost you time and money, but it is worth it. 

Why should I transform a UG into a GmbH?

In the long term, you benefit from its image. If you are serious about your company and would like to attract business partners, the UG will stand in your way as its reputation is synonymous with little money. Investors might shy away, and banks hesitate to give you loans. So the UG is more of a temporary solution. Also important to consider is that a UG, as a subform of the GmbH, comes with similar legal obligations, such as strict accounting requirements, which is time-consuming administrative work. 

What are alternatives to the GmbH and UG?

Although the GmbH and UG are the most popular legal forms for founders, others could also be suitable for your individual business situation, such as the "GmbH & Co KG" or the "Kleine AG." We recommend checking with your tax advisor which legal form best meets your needs.

Thanks again to Qonto for sitting down to talk with us about GmbH vs UG. Take a peek at our Startup Resources for more insights from experts in our community.