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Business Info 3: Choosing the right business structure

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Sole Proprietorship

Sole proprietorship is a form of business entity which is set up solely by one person only. Everything within this kind of entity will be the responsibility of this one owner. For this entity, his liability is unlimitedUnlimited liability means that the owner will be personally liable for the debts owing by his/her Sole Proprietor business.

A further elaboration on the meaning of unlimited liability is this: if the Sole Proprietor business fails or unable to repay its debts, the creditors have the right to sue and obtain a court order to claim the debts owing by the business, against his personal assets. Personal assets mean cash savings, houses, cars and any other “cash-able” items own by him in order to repay debts created by the Sole Proprietorship.

Advantages

  • This form of business is cheap, easy to set up, with minimal documentation and paperwork.

  • There are much fewer guidelines and formalities wherein there is no requirement to appoint auditors, company secretary or tax agents.

  • You do not need to disclose your financial statements to the general public.

  • Relatively easy to change your legal structure if the business grows, or if you wish to wind things up.

Disadvantages

  • Unlimited liability which means all your personal assets is at risk if things go wrong.
  • Little opportunity for tax planning – you can’t split business profits or losses made with family members and you are personally liable to pay tax on all the income derived.

Partnership

As its name suggests, this form of entity is when two or more persons come together to carry out a business. However, the maximum number of persons allowed in a partnership is 20. Same like the Sole Proprietor, liabilities for the Partnership is also unlimited

Partnership Act 1961

Unlike Sole Proprietor which does not have an Act created for it, all Partnerships are governed by the Partnership Act 1961. In the event that the partners make their own agreement, that agreement will prevail. However, for matters that are not covered within that agreement, the particular provisions in the Partnership Act will be applicable. In the Partnership Act, the main provisions spell out the following:-

  • All profits or losses are shared equally.
  • Partners are not eligible for interest on their capital injected into the partnership.
  • All partners are entitled to take part in managing the business.
  • Partners are not eligible for salary.
  • Loans or advances by partners to the business will carry an interest at the rate of 8% per year.
  • Most decisions require majority of the partners. However, change of nature of business requires consent by all partners.
  • There must be expressed agreement when a partner is required to leave the partnership.
  • All existing partners must give consent if they want to introduce new partners into the business.
  • Accounts and books must be kept at the principal place of business and be made available to all partners. All partners are allowed to keep a copy of the accounts.

Advantages

  • Simple and inexpensive to set up.
  • Minimal reporting requirements.
  • Shared management/staffing responsibilities.
  • More opportunities for tax planning (such as income splitting between family members) than that of a sole trader.
  • A partner’s share of the business’s tax losses may be offset against other personal income, subject to certain conditions.
  • Combined skills, experience and knowledge can provide a better product/service.
  • Relatively easy to dissolve or exit and recover your share.
  • Access to capital.
  • Partners are not employees. Superannuation contributions and workers’ compensation insurance are not payable on partners’ profits or drawings.

Disadvantages

  • Potential for disputes over profit sharing, administrative control and business direction.
  • Joint and several liabilities of partners. This means that each partner is fully responsible for debts and liabilities incurred by other partners – with or without their knowledge.
  • Changes of ownership can be difficult and generally require a new partnership to be established.

Private Limited Company

In Malaysia, the most common type of limited companies is those limited by shares. These companies are incorporated and governed by the Companies Act, 1965. Companies limited by shares will carry “Sdn Bhd”, “Sendirian Berhad” behind their names according to Section 22(4) of the Act.

The meaning of private limited companies is that the liabilities of its members are limited to the amount of shares they hold in the company. For example, if Mr. Tan’s shares in a Sdn Bhd amounted to RM10,000.00, and he has fully paid for the shares, in general, he has no further liability with regards to the Sdn Bhd concerned.

private limited company can only be incorporated if its memorandum and articles:-

  • Restricts the right to transfer its shares subject to the approval of its directors;
  • Limits the numbers of its members to not more than 50 (requires a minimum of 2 natural persons, but allow another company to wholly own 100% of its issued shares).
  • Prohibit any invitation to the public to subscribe for any shares or debentures of the company;
  • Prohibits any invitation to the public to deposit money with the company for fixed periods or payable at call, with or without interest.

Advantages

The most obvious advantage is the liability “protection” to its shareholders, limited their exposures to the amount of share capital that they subscribed for. Any amount of debts beyond their shareholdings, they are not liable but provided there is no fraud or other malpractice.

Another advantage is the simplicity to transfer existing shares or issue additional shares to new investors. Existing member can transfer his shareholding, wholly or partially, through selling of his shares (subject to directors’ approval, which is). Unlike sole proprietors or partnerships, there is no need to wind up the company in the event of death of its shareholders or directors.

Disadvantages

  • The company’s financial affairs will be accessible by the public.
  • Compliance with the Companies Act, 1965. Although complying itself is not a disadvantage, the amount of effort required to comply with the Act is much more than a sole proprietor/partnership.
  • The company had to perform annual audits on its financial statements.
  • At least one company secretary is required to manage its statutory submissions and returns as well as attending and preparing minutes for board and shareholders’ meetings.
  • Incorporation cost is high, and there are yearly recurring fees to be paid such as audit, accounting, company secretarial and tax fees.

Why are there still so many private limited companies being incorporated given the disadvantages?

As the business grows, revenue and business volume will increase. Customers will request for longer credit term and higher credit limit, hence an increased credit risk. In turn, the company will also request suppliers and bankers to extend their credit facilities, which means higher liabilities.

The limited liability “protection” given to the shareholders clearly outweighs all the operational and financial disadvantages listed above.

Trust

Unlike a company, a trust is not a separate legal entity. Trusts are often used in connection with running a business for the benefit of others. A trust is a structure where a trustee (an individual or company) carries out the business on behalf of the members (or beneficiaries) of the trust. Family businesses are often set up as a trust so that each family member can be made a beneficiary without having any involvement in how the business is run.

Advantages

  • Reduced liability – especially if corporate trustee.
  • Asset protection.
  • Flexibility of asset and income distribution.

Disadvantages

  • Can be expensive and complex to establish and administer.
  • Difficult to dissolve, dismantle, or make changes once established particularly where children are involved.
  • Any profits retained to reinvest into the business, will incur penalty tax rates.
  • Cannot distribute losses, only profits.

Join Venture

A joint venture is a business agreement in which parties agrees to develop, for a finite time, a new entity and new assets by contributing equity. They both exercise control over the enterprise and consequently share revenues, expenses and assets. There are other types of companies such as JV limited by guarantee, joint ventures limited by guarantee with partners holding shares.

The venture can be for one specific project only – when the JV is referred more correctly as a consortium or a continuing business relationship. The consortium JV (also known as a cooperative agreement) is formed where one party seeks technological expertise or technical service arrangements, franchise and brand use agreements, management contracts, rental agreements, for ‘‘one-time’’ contracts. The JV is dissolved once that goal is reached.

Source by: SMEinfo

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