Before you get to work on that start-up, decide which business vehicle you should use
At the early stages of a start-up founder’s journey, before any significant expenses are incurred, any material contracts are signed, and more importantly, before anyone can take your business seriously, the question of ‘Which business vehicle?’ should come to mind. For many, this is one of the milestones that a business owner will certainly remember, for better or worse.
In Malaysia, the common choices are (i) Sole Proprietor (“Enterprise”), (ii) Partnership, (iii) Private company limited by shares (“Sdn Bhd”) and more recently, (iv) Limited liability partnerships (“LLP”). After advising entrepreneurs from the outset and through various stages of growth, I’ve distilled a total of 6 factors that come into play when deciding on the type of business vehicle to use. Every situation is different, even for start-ups within the same industry. Each entrepreneur may place different weight to each consideration. Different strokes for different folks.
Here are my top 4 factors that, among themselves, form a close interplay and often present a dilemma to anyone who takes the time to mull over.
- Liability – “Will I be personally liable?”
The extent to which the owners and their personal assets are shielded from business risks and legal liabilities tends to be the most important consideration to any business owner.
In anticipation of buying equipment or inventory, substantial contracts, potential law suits and claims by third parties, or just any freak occurrences that life throws at us, business vehicles such as sole proprietorships (also known as enterprises), expose owners directly to personal liability. In the case of partnerships, there is the ever looming possibility of even joint liability for the actions of one’s business partner i.e., getting into hot soup even when it is not your fault.
On the other hand, using the common private company limited by shares (i.e., Sdn Bhd) under the Companies Act 1965, would limit the owners’ financial liability to the extent of any amounts unpaid on their issued shares.
The Limited Liability Partnership Act 2012 introduces a ‘hybrid’ business vehicle known as the limited liability partnership (“LLP”). An LLP offers a business with 2 or more owners the protection of limited liability like a Sdn Bhd, yet allows greater flexibility, lower formation costs, and fewer compliance and audit requirements than a Sdn Bhd.
- Costs (formation and ongoing) – “How much will it cost?”
In addition to formation costs, the on-going costs of record-keeping, regulatory and tax filings, corporate resolutions, notice requirements, audit and bookkeeping could run into a couple of thousands annually…at a minimum.
Based on SSM’s official figures as at 28 February 2009, there are 3,779,415 sole proprietorships and partnerships registered compared to 839,853 companies incorporated in Malaysia. Cost is a compelling factor that results in many business owners choosing the options of a sole proprietorship or partnership.
Nevertheless, looking at ‘actual costs’ alone will not yield a complete picture. A sharp business owner will also be aware of ‘opportunity costs’. Choosing an enterprise or partnership to save on actual costs may deprive the business owner of valuable tax planning opportunities, business related tax deductions, incentives, and other indirect benefits, which are available to companies and LLPs.
Having a knowledgeable advisor to take you through these ‘advanced class’ considerations at the outset may lock-in the ability for your business to enjoy valuable savings throughout its years of growth. Remember folks, be lean, not green.
Making the right decisions will ensure your start-up runs like a well oiled machine
- Credibility & Recognition – “Sorry, what type of company is this again?”
Your business entity will be your front, your image, your credibility. What does your choice of business vehicle communicate to the world at large, your suppliers, your potential investors, your customers, your staff, and banks? How do people perceive an established sole proprietorship vs a RM2 minimally capitalised company? How many will actually look deeper? First impressions do matter.
In theory, the choice of one type of business entity may suit your needs perfectly. In practice, though properly recognised under law, your choice of business entity may not be ‘familiar’ to others. This may present practical and often frustrating obstacles.
For example, LLPs, being a relatively recent introduction, may face uncertainties with property ownership and transfer. The application of visas/work permits or licences may encounter difficulties or further delays by the local authorities due to unfamiliarity by the officers on the ground. Even savvy investors, backed by competent professionals and advisors, may hesitate to invest in certain entities, notwithstanding that they are after all investing in the business, not the entity. In business, uncertainty is a real cost.
- Tax – 1 of 2 certainties in life…
The choice of business vehicle will firstly impact the rate at which your business is taxed. Tax rates could range between 0% to 26% for sole proprietors and partnerships, compared to a fixed rate of 20% or 25% for companies and LLPs.
Other differences could be the type of tax deductions available yearly (even double deductions), and the ability to carry forward business losses suffered in the initial years, which are not uncommon. Special tax statuses and incentives (MSC status, Pioneer status) may also be available to your tech start up, which tend require the use of a specific type of business vehicle to even qualify for consideration.
From April 2015 onwards, GST planning and the ability to claim (or not) input tax credits may directly impact your bottom line. Even indirect taxes such as stamp duties may be relevant upon sale/exit of a founder. Basic tax planning on the date of ‘commence of business’ may allow you to claim tax deductions on big ticket expenses.
Additional factors to consider:
The 5th factor is “Flexibility”. Key words and phrases that commonly fall under this heading are degree of commitment, speed, convenience, scale/size of business, full time or part time, ability to convert to another type of business entity, ease and speed of de-registration and dissolution, ease of transfer and sale.
The 6th factor is “Future needs”. This heading comprises of some “advanced class” considerations which are no less important, but tend to be left to the back burner for all but the most seasoned entrepreneurs. The ability to increase capital and 3rd party participation, customization of owners/investors’ rights, array of methods to list and raise funds, use of premiums and redeemable preference shares, employee incentives and participation (equity in lieu of salary/EPF contributions), business structure (subsidiaries, group benefits), rapid future expansion with third party partners, ownership and exploitation of specific assets and IP rights.
To tie it all up, here’s some food for thought. Would you rather file away your registration certificate into a dark drawer as soon as you receive it, along with your lingering doubt, or worse, blissful ignorance? Or, would you rather celebrate your ‘first mini milestone’ with a confidence that you have made the best decision (at that time) for your new business? Start right, start strong.
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About the Author: Shawn Ho is a partner of Donovan & Ho. He is experienced in corporate matters such as acquisitions, cross-border transactions, restructuring exercises, sale of businesses, joint venture arrangements, shareholder agreements, and franchise businesses. His background in tax advisory has enabled him to assist several multi-national companies achieve considerable tax-savings through cross-border tax planning, implementing tax-efficient structures using Labuan companies, and incorporate tax advice into commercial transactions.
