Choose An Ideal Business Vehicle

Of all the choices you make when starting a business, one of the most important is the type of legal structure you select for your company. Not only will this decision have an impact on how much you pay in taxes, it will affect the amount of paperwork your business is required to do, the personal liability you face and your ability to raise additional capital.
In Malaysia, small and medium enterprise business owner can choose their business vehicles from the following four types:
  1. Sole Proprietor
  2. Partnership
  3. Private Company Limited By Shares (Sdn. Bhd.)
  4. Limited Liability Partnership (Plt.)
Each of the business vehicles has their own unique features. When making a decision about the type of business to form, there are several criteria you need to evaluate.
The business owners will be the person in charges of the business operation in most of the circumstances (e.g. Sole proprietor, partnership and limited liability partnership). All partners/owners will share same business risks and liabilities. However, Private Limited Company (Sdn. Bhd.) is different from others.
“Members” (Shareholders) in Private Limited Company (Sdn. Bhd.) are legal owner of the company, they can be purely investor and only receive profit sharing in the form of dividend. Only major business issue (e.g. purchases of property, change of auditor, etc) needs members’ approval. Members’ liabilities to the business is limited to the shares that they invested in the company.
The person run the business in Private Limited Company (Sdn. Bhd.) is “Director”, they are employees of the company and making operating decision as a manager. They can be appointed or removed in company ‘s Extraordinary General Meeting.
Therefore, you may consider setting up a private limited company (Sdn. Bhd.) if your business is combination of investors and managers.
No matter what we do, cost is always one of the key factor we need to consider of. The reason why most of the business owner choose to set up a sole proprietorship or partnership is that the incorporation cost is much lower compare to set up a private limited company (Sdn. Bhd.) or limited liability partnership (Plt.) in Malaysia.
In addition to incorporation cost, the on-going cost of record-keeping, tax filings, secretary, audit and bookkeeping of a private limited company (Sdn. Bhd.) or limited liability partnership (Plt.) could easily costs a few thousands or more annually.
Therefore, you shall take these cost in consideration and put them in your budget before you determine your business vehicles.
The what extent does the owner need to be insulated from legal liability tends to be the most important consideration to any business owner. Especially when the business involved in high risk industry or faced potential law suits and claims by third parties.
Sole proprietor and partnerships will expose owners directly to personal liability. The business owners shall personally liable to any claims or loses in the business. In the case of partnerships, there is also a possibility of even joint liability for the actions of one’s business partner.
Therefore, business owner may choose private limited companies (Sdn. Bhd.) or limited liability partnership (Plt.) to limit their financial liability to the extent of any amounts subscribed/contribute on their issued shares or capital.
In theory, the choice of anyone type of business entity may suit your needs perfectly. In practice, your stakeholders may treat you differently according to your business entity.
For example, due to barriers to entry (higher cost for setting up and maintaining), a private limited company (Sdn. Bhd.) seemed to be a more established firm compare to sole proprietor or partnership. Some of big corporates (e.g. Multinational companies, listed companies) will only accept private limited companies’ tender in their projects, bank will normally offer better loan to private limited companies, and some government’s permits (e.g. employees’ work permit) or contracts are only granted to private limited companies (Sdn. Bhd.).
Therefore, business owner shall understand their stakeholder’s perception and requirements before they set up their business entity.
Different business vehicles will result in different income tax rate. Tax rates could range between 0% to 28% for sole proprietors and partnerships, compared to a fixed rate of 18% or 24% for companies and limited liability partnerships.
Sole proprietors and partnerships income are charged under business owner’s personal income tax. In Malaysia, personal income tax is taxed at progressive rates, so business owner may enjoy lower income tax rate if their business income (from sole proprietors and partnership) are lower than RM70,000 every year.
Private limited companies (Sdn. Bhd.) and limited liability partnership (Plt.) are taxed separately with business owners’ personal income tax. It is taxed at lower income tax rate compare to sole proprietors and partnership when they are generating higher chargeable income (e.g. more than RM250,000 yearly), so you could easily save hundreds to thousands by changing your business vehicles.
However, you still need to look at other factors such as incorporation cost, yearly maintenance cost, liquidation cost and so on. You shall always consult with a professional accountant or company secretary before making your decision.
When business owner first starting out in business, they are consumed with getting the business off the ground and usually aren’t thinking of what the business might look like five or ten years down the road.
Some business owner may want to bring in new investors for raising additional capital. Some may want to pass their business to next generation or sell it off when he is no longer around. Keep in mind that the business structure you start out with may not meet your needs in years to come.
Therefore, you shall consider your future needs too when you decide your business vehicles.