Quick Guide to Picking the Right Business Structure for Your Company
In this guide, I will show you how to pick the right business structure for your business.
Step 1: Understanding the Types of Business Entities
There are three main types of business entities:
- Sole proprietorship
- Corporation (Sdn Bhd)
Let’s take a quick look at the differences between these three types of business entities. We will be looking mainly at three factors – liability, taxation and record-keeping – factors you should pay attention to when you are choosing the type of business entity for your business.
Sole Proprietorship (for the solopreneur)
The sole proprietorship is the most common form of business organisation. It usually involves just one individual who owns and operates the enterprise. If you work alone, this may be the way to go. It’s easy to form and offers complete managerial control to the owner.
The owner is also personally liable for all financial obligations of the business. Selecting the sole proprietorship business structure means you’re personally liable for your company’s liabilities. As a result, you’re placing your own assets at risk, and they could be seized to satisfy a business debt or legal claim filed against you.
The tax aspects of a sole proprietorship are such that income and expenses from the business are included on your personal income tax return. If your business is making huge profits, you may wish to consider the Sdn Bhd option.
Raising money for a sole proprietorship can be difficult. Banks and other financing sources are reluctant to make business loans to sole proprietorships. In most cases, you’ll have to depend on your own financing sources, such as savings, home equity or family loans.
Partnership (For Businesses with More Than 1 Person)
A partnership involves two or more people who agree to share in the profits or losses of a business. A primary advantage is that the partnership does not bear the tax burden of profits or the benefit of losses-profits or losses are “passed through” to partners to report on their individual income tax returns.
A primary disadvantage is liability – each partner is personally liable for the financial obligations of the business.
If your business will be owned and operated by several individuals, you’ll want to take a look at structuring your business as a partnership. Each partner is required to report profits from the partnership on his or her individual tax return.
Personal liability is a major concern if you use a general partnership to structure your business. Similar to a sole proprietorship, general partners are personally liable for the partnership’s obligations and debt.
In addition, each general partner can act on behalf of the partnership, take out loans and make business decisions that will affect and be binding on all the partners (if the general partnership agreement permits).
Therefore, partners in this partnership must protect themselves and the business with a partnership agreement. A written partnership agreement helps guide the partners when questions arise.
Corporation (Sdn Bhd)
A Corporation (Sdn Bhd) is a legal entity that is created to conduct business. The corporation becomes an entity – separate from those who founded it – that handles the responsibilities of the organization. Like a person, the corporation can be taxed and can be held legally liable for its actions.
The corporation can also make a profit. The key benefit of corporate status is the avoidance of personal liability. The primary disadvantage is the cost to form a corporation, the extensive record-keeping that’s required and the hiring of corporate professional such as company secretary, auditors and tax agents to render their professional services to ensure compliance, corporate governance and transparency.
Using the corporate structure is more complex and expensive than most other business structures. A corporation is an independent legal entity, separate from its owners, and as such, it requires complying with more regulations and tax requirements.
The biggest benefit for a small-business owner who decides to incorporate is the liability protection he or she receives. A corporation’s debt is not considered that of its owners, so if you organise your business as a corporation, you’re not putting your personal assets at risk.
A corporation also can retain some of its profits, without the owner paying tax on them. Another plus is the ability of a corporation to raise money. A corporation can sell stock, either common or preferred, to raise funds. Corporations also continue indefinitely, even if one of the shareholders dies, sells the shares or becomes disabled.
The corporate structure, however, comes with a number of downsides. A major one is higher costs. You will need the assistance of a company secretary or accountant to incorporate the Sdn Bhd.
In addition, because a corporation must follow more complex rules and regulations than a partnership or sole proprietorship, it requires more accounting and tax preparation services.
Step 2: Understanding the Costs, Procedures & Documentation Required
The details of the costs, procedures and documents for the setting up of a sole proprietorship and partnership are straightforward and won’t be covered in this quick guide.
We will instead explain how the more complex Corporation and Limited Liability Partnerships (LLP) are set up.
Setting Up a Corporation (Sdn Bhd)
To start the process of incorporating, contact the company secretary that is responsible for registering corporations. Ask for instructions, forms and fee schedules on business incorporation.
It’s possible to file for incorporation without the help of a company secretary but it will be too troublesome. Besides, you’ll still have to hire a company secretary to maintain your company records. Your expense will be the cost of these resources, the filing fees, and any other costs associated with incorporating.
If you do file for incorporation yourself, you’ll save the expense of using a company secretary, which can cost from RM500 to RM1,000. The disadvantage of going this route is that the process may take you some time to accomplish. There’s also a chance you could miss some small but important detail.
One of the first steps you must take in the incorporation process is to prepare a Memorandum and Articles of Incorporation. It is your company’s Constitution which governs what you can do and what you cannot do. Usually a standard printed copy is provided by your company secretary.
The information requested includes the proposed name of the corporation, the purpose of the corporation, the names and addresses of the parties incorporating, and the location of the principal office of the corporation.
The corporation will also need a set of bylaws that describe in greater detail than the articles how the corporation will run, including the responsibilities of the shareholders, directors and officers; when stockholder meetings will be held; and other details important to running the company.
Once your articles of incorporation are accepted, your company secretary will send you a certificate of incorporation.
It’s important to follow all the corporation rules required by law. You should keep accurate financial records for the corporation, and be audited once a year.
Your company secretary will keep all the records for filing purposes. You’ll also be require to pay a monthly retainer to your company secretary which usually ranges from RM60 a month to RM150 a month depending on how extensive your company secretary has to work for you.
The corporation issue stock, file annual reports and hold yearly meetings to elect officers and directors, even if they’re the same people as the shareholders. Be sure to keep minutes of these meetings. On all references to your business, make certain to identify it as a corporation, using Sdn Bhd.
Setting up a Limited Liability Partnership (LLP)
A hybrid form of partnership, the limited liability partnership (LLP), is gaining in popularity because it allows owners to take advantage of the benefits of both the corporation and partnership forms of business.
Limited liability partnership, often referred to as “LLPs,” was first introduced in 2012. An LLP is a hybrid entity, bringing together some of the best features of partnerships and corporations.
LLPs were created to provide business owners with the liability protection that corporations enjoy. Earnings and losses pass through to the owners and are included on their personal tax returns.
There’s no limitation on the number of shareholders an LLP can have, unlike a Sdn Bhd, which has a limit of 50.
Limited liability. Your only risk is capital paid into the business. Business debts and other liabilities can’t be squeezed out of your personal assets. Caution: If you personally guarantee a debt, you’ve forfeited your “limited liability.”
Tax simplicity. Profits and losses are reported and taxed on owners’ individual returns.
Flexible management. A “member” (shareholder equivalent) can be a person, partnership or corporation. Members get a percentage of ownership.
And now for the downsides:
No stock. LLPs are tough if you have several investors or raise public money, since you don’t have shares or stock certificates to offer. If you need more flexibility in terms of corporate stock ownership, financing options, etc. If so, the LLP is probably not a good option. You will have to incorporate a corporation.”
Step 3: Understand the Criteria for Selecting a Suitable Business Entity
When making a decision about the type of business to form, there are several criteria you need to evaluate. You can focus on the following areas when you chose the business format for your company:
Legal liability. To what extent does the owner need to be insulated from legal liability? If you have a hefty investment in equipment, and the contracts you work on are substantial; plus if your business need to borrow money with potential liability and you don’t want to take on personal liability for potential losses associated with the business, then sole proprietorship or partnership may not be the best way to go.
Tax implications. Based on the individual situation and goals of the business owner, what are the opportunities to minimize taxation? There are more tax options available to Sdn Bhd (corporations) than to proprietorships or partnerships.
Cost of formation and ongoing administration. Tax advantages, however, may not offer enough benefits to offset other costs of conducting business as a corporation. There will be a high cost of hiring company secretaries for record-keeping and paperwork, as well as the high cost of incorporation and accounting audit compared to sole proprietorship, partnership or limited liability partnership.
Flexibility. Your goal is to maximize the flexibility of the ownership structure by considering the unique needs of the business as well as the personal needs of the owner or owners. Individual needs are a critical consideration.
No two business situations will be the same, particularly when multiple owners are involved. No two people will have the same goals, concerns or personal financial situations. If you are raising investment money and have to issue company stock, a Sdn Bhd will be the way to go.
Future needs. When you’re first starting out in business, you’ll be focued on getting the business off the ground and usually aren’t thinking of what the business might look like five or ten-let alone three-years down the road. What will happen to the business after you die?
What if, after a few years, you decide to sell your part of a business partnership? The issue of ownership is key. If you are planning to sell stock and getting more shareholders on board, then forming a corporation may make more sense.
A corporation’s capital can be expanded at any time in a private offering by issuing and selling additional shares of stock. This is especially helpful when banks are being tight with money.
Another important question to ask yourself is, “What do I want to happen to the business when I’m no longer around to run it?” While a sole proprietorship or partnership may dissolve upon the death of its owner or owners, a corporation can be readily distributed to family members.
Keep in mind that the business structure you start out with may not meet your needs in years to come. Many sole proprietorships evolve into some other form of business – like a partnership or corporation – as the company grows and the needs of the owners change.
As a summary here is a comparison chart on the different types of business structures available (click for a larger image). Conclusion
The bottom line? Don’t take this very important decision lightly, and don’t make a choice based on what somebody else has done. Carefully consider the unique needs of your business and its owners, and seek expert advice, before settling on a particular business format.
The answer to the question of “What structure makes the most sense?” depends on the individual circumstances of each business owner. Each situation is different. You can’t just make an assumption that one form is better than another. It is not a decision to be entered into lightly, either, or one that should be made without sound counsel from business experts.
It is important for business owners to seek expert advice from business professionals when considering the pros and cons of various business entities. That advice can come from a variety of sources, ranging from the Commission that handles business registration, Suruhanjaya Syarikat Malaysia (SSM), to business incubators, entrepreneur development organizations, accountants and company secretaries.