Discover more from Rafael Alvarez
Lowest Cost of Registering
a business in Colombia
One of the most frequent questions when deciding to start a business is whether or not to formalize it. That is, to operate as a natural person or create a legal entity where all equity, corporate, accounting, legal and tax matters are legally separate from the founding partners.
Lawyers and accountants will often advise a person not to formalize until achieving a certain amount of cashflow or business deals that would cover the initial and recurring costs that formalizing implies. However, if you look deeper, nobody ever knows exactly what these costs are.
Let’s answer this question coherently by looking at financial statements and accounting records, and from these build a basic model of initial and minimum monthly expenses for a small business registered in Colombia. Consequently, this analysis is validated by the market, which means that for each spending component there exists a provider who, at the time of this publication, offers this service satisfactorily.
All expenses mentioned will be gross values: i.e., before taxes and deductions. The reason behind this is that taxes have to be paid whether you’re registered or not, so we don’t count them as a cost of registering. The VAT collected must be returned at another time, therefore it is not an expense but simply deferred income. Income tax only applies if there are profits, and in any case it also applies to natural persons under certain circumstances.
The design criteria for our Simplest Business Entity (like a corporate MVP) will be as follows:
Minimum team: one (1) full-time partner
Laptops: supplied in kind by the partner
Wages: (see this article)
Work Culture: No teleworking, therefore leasing office space must be considered
Independence of partners: P.O. box, phone line, partnership
Partners experts in the product, though not in design, accounting or law
No favors liabilities: paying cash for required help
Economies of scale: annual or multi-item purchase orders from a key supplier
Target: marketing of a single clearly defined product or service
Rounding up: overestimating instead of underestimating costs in order to stick to the budget
Complying with all legal obligations in a timely manner
We invite readers to challenge all costs and concepts in this article. If a reader of this blog considers that an expense
is not mandatory,
has a better,
cheaper alternative or costs less than presented,
please explain your disagreement in the comments so that we can obtain a better consensus on the minimum cost of formally starting and operating a company in Colombia.
We’ll start by identifying all strictly mandatory expenses related to being registered. K will be used to designate thousands, M to designate millions. If currency is not specified, it refers to COP. USD will be used for US dollars and for the conversion between currencies we will assume an exchange rate of $2,500 COP.
Articles of Association ($350K/one time): These are the constitution and definition of the purpose and basic governance of the new entity that is to be established. They can initially be written with standard templates found online, but it’s prudent to hire an attorney to validate them at the end. The lowest fee for this service is 1/2 Minimum Monthly Salary (MMS).
Constitution ($400K/one time): Chamber of Commerce and Dian (equivalent of IRS) registration procedures must be carried out for the new entity.
Accounting and Tax Services ($2.4M/year): To keep accounting records, record them in the information system, present financial statements and settle taxes and reports required by the DIAN (IRS), it is necessary to have an accountant. The value is estimated at $200K/month
Commercial Registration ($300K/year): During each year of operation and regardless of incorporation date, all companies in Colombia that carry out commercial activities must maintain a record of existence.
Industry, Commerce and Notices Tax ($480K/year): Depending on the municipality in which the company has its operations, the ICA must be paid. This value changes with annual sales but is initially paid in Medellín at $40K/month.
Certificates of Existence and Legal Representation ($60K/year): Once the company exists, this document issued by the Chamber of Commerce with limited validity (2 to 3 months) becomes its identification. It must therefore be obtained periodically, and we’ll estimate needing 12 updates per year with a cost of $5K/unit.
Fixed Financial Expenses ($720K/year): Once the business exists, a bank account is required, one (1) debit card for physically carrying out procedures ($10K/month), and a virtual branch with a user to be able to do work online ($50K/month). It should be noted that what is most needed as an entrepreneur is a low limit credit card in the company´s name, however this is impossible to obtain for a start-up company. All of the above prices and restrictions are based on Bancolombia's policies.
Variable Financial Expenses ($150K/year): This refers to the fact that once a company begins to exist in the financial system it must begin to pay a series of commissions for using different services. In the historical review of our supports, the best model to predict these expenses is as a percentage of total operating expenses and costs. That is, the value increases or decreases depending on what is spent as a company.
The suggested model is to estimate between 0.5% and 1% of period operating expenses for this point. To calculate the annual value, we will assume an average value of 0.75% with annual operating expenses of $20M. This point breaks down as follows:
Tax on financial movement: 4 out of every 1000 pesos transferred
Third Party Payment Fee: $2,500 COP for each payment made
Interbank transfer fee: $14,000 COP for each payment made
Fee per email sent: $200 COP for each email sent
Interest credit in savings account: <6% per annum on the balance
Taking the aforementioned points, a small company would have initial mandatory expenses of $750K ($0.8M) and annual recurring ones of $4.110K ($4M), therefore, monthly recurring expenses of $342K ($0.3M), for a total investment of $4,860K ($5M).
The previous section is the minimum cost of existence, however at the beginning, investment in other minimum items not mandatory to formalization is also required. Below are those we consider to be in this category:
Brand Design ($1M/once): Most companies are created to market a product or service. This is marketed by positioning a brand in the mind of the consumer. Creating the brand means defining the audience, the message to convey and with it, basic graphic elements: logo, slogan, fonts, colors, templates for slides and for documents, etc. This is an initial cost and from this other graphic elements can be derived quickly and inexpensively.
Landing design ($1M/once): At the beginning of this MVP company, creating a website--in addition to being slow and expensive--can be useless. Initially, a serious, simple, rapidly deployed Internet presence that serves as a sales and conversion channel rather than an informative site is what is needed. To fulfill this purpose, designing a landing page is the best solution.
Landing Page Service ($1,620K/year): Prices of the two previous items can be achieved if a web designer is given a tool so that--without engineers—they can build a decent site for the customer in less than a week. The landing page service costs $135K/month, and includes hosting, statistics, A/B testing and can be modified in minutes by the entrepreneur without needing HTML knowledge.
Basic Communications Expenses ($460K/year): The most basic cellphone plan costs $35K/month, and a P.O. box $40K/year. These two items allow the company to have a point of contact which is independent of its partners (no registering mom´s address in the company's RUT) and minimizes changes in contact info for the international world.
Location Expenses ($1.8M/year): Cubicles in co-working spaces or in nearby companies can be obtained for $150K/month per spot. This includes chair, work desk, electricity, telephone, shared wireless Internet and possibly, access to some meeting rooms. Although it seems like a good option, our philosophy is that we are against teleworking, therefore it is presented as a minimum non-compulsory expense.
Domain registration ($150K/year): Every company has a domain that represents its brand on the Internet. Unless you want to call yourself Coca Cola, the annual cost of the domain and its anti-spam protections for contact information is $150K/year.
Communications Services ($125K/year): Lastly, email, calendar, chat, forms, online document editing and file sharing are required in order to be in touch with the world and market services. Each Google Account costs $50 USD/year.
Consolidating the above, we now have minimum initial non-compulsory expenses of $2M, annual $4,155K ($4M), that is, monthly payments of $346K ($0.3M), for a total investment of $6,155K ($6M).
It’s important to note that of the $346K/month, $160K/month correspond to cubicle and communications expenses for each person. That is, the highest and most significantly rising investment goes to work culture (not teleworking). If, instead of one person, we have a team of three, the minimum monthly non-compulsory expenses practically double:$667K/month (92% more than the minimum). On the other hand, if the only person in the company decides to work at home, the $346K/month decreases to $192K/month (56% less than the minimum). In this category, work culture is actually the relevant discussion.
Therefore, adding the two groups of previous expenses--mandatory and non-compulsory--starting a small company requires $2,750K ($2.8M) initially and $8265K ($8M) annually, plus $1,920K ($1.9M) per additional person. That is, monthly payments of $689K ($0.7M) plus $160K per additional person, for a total capital requirement for a one person company of $11,015K ($11M). $13M if there are two people.
If you need to formally register a business, you must understand that no less than $5M of investment or income is required just to pay the corresponding registration, without accruing or investing a penny in other aspects of the business, and additionally between $6M and $8M are required for some minimum but not mandatory aspects.
To determine the annual sales we need to expect in order to make registration worth it and be able to cover costs while leaving a minimum of profitability, let’s carry out a comparative analysis of Colombian companies with sales of less than $200M/year and with a net profit between 5% and 10%. In this way we only analyze actual registered businesses and not registered subsistence businesses that don’t generate surplus capital.
The proportion of administrative expenditure above revenue is between 10 and 20%. This ratio is 20-30% for sales expenses. In other words, on a consolidated basis, operating expenses without cost of production or goods fluctuate between 30 and 50%. Clearly these values include the labor component, which is usually the most important.
Based on this analysis we suggest that to maintain returns which are comparable and competitive to industries of the same size, registration expenses need to be between 5 and 10% of sales. Considering the $5M necessary for registration, annual sales must be between $50M and $100M.
To place these values in perspective in a small company, and considering the cost of labor, we discover that a company with an annual income of $100M is equivalent to a natural person with a monthly income of $8M or one who receives $6M from a labor contract.
I believe that after the financial exercise and knowing the reference ranges for registration, many questions arise as to why you want to formalize: to gain access to Chamber of Commerce benefits? Access to income tax benefits for startups? To abide by the law?
The final conclusion is that registration makes little immediate financial sense. It’s purely overload. All the good things you can do as a registered formal business you can also do as a natural person, such as keeping accounts or paying taxes properly. However, these are the two structural reasons to register despite the extra cost:
It groups risk-sharing into a single entity: This applies when there is more than one partner and allows profits as well as risks (lawsuits and losses) to be distributed in a single entity and in proportion to the risk. If not formalized, the invoicing and contracting partner will have full control on paper over profits and claims in which the company may incur.
It generates trust for market interaction: For investors it’s different to invest in a legal entity than in a service belonging to a natural person. For the government it’s essential that companies be more than two years old in order to grant promotional resources; for some customers doing business with companies is more suitable than doing business with natural persons; for attracting talent it’s different to be hired by a company than by a person.
In short, don’t formalize if:
You are a single partner
You are not expecting to receive investments
You are not expecting to receive government resources
You are willing to sacrifice some customers
You do not need to attract new employees
Otherwise, invest approximately $5M/year to have access to investors, promotional resources, all types of clients, and to improve your position for hiring staff. Additionally, seek to invoice between $50M and $100M during the first year to make sure you stay in good corporate shape.