Types of Business Entities in
4 minute read
Several factors determine your choice of a business structure. The nature, size, and scope of your business are important considerations. Besides, it is vital to assess the extent of your personal liability and tax implications before choosing a business entity. What amount of control do you wish to exercise over your business?
Limited Liability Company
A limited liability company is a separate legal entity. It may be a private or public company limited by shares, or a company limited by guarantee. This means your personal and business assets are distinct and separate from the business, and therefore protect you from any personal risk to the business. In Hong Kong, a limited liability company must be registered with the Companies Registry governed by the Companies Ordinance (Cap. 622).
Most investors in Hong Kong choose to set up a private limited company to protect personal assets from business risks and liabilities. Their liability is limited to the shares they have subscribed for. Most small to medium-sized companies in Hong Kong are private companies limited by shares. The share capital is divided into shares, with each holding a specific value. When the company makes a profit and there are assessable profits available for distribution, subject to the determination of the board and the general meeting, the investors may receive an interim or final dividend which is distributed by the company in proportion to their shareholding. This is one kind of return that investors usually look for.
Being a separate legal entity, a private limited company is distinct from its members and can acquire assets, or enter into contracts on its own. What’s more, a shareholder is not personally responsible for debt consolidation or lawsuits facing the company in his individual capacity.
However, the liability of shareholders is limited to their shareholdings/investment in the business. Let’s look at the common reasons why companies limited by shares are the prime choice of investors:
A limited company (limited by shares) with more than 50 shareholders is a public company. Typically, a medium to a large private company may choose to expand the shareholder base and become public. Since a public limited company can be listed on a stock exchange and raise capital from the public, they must comply with more stringent rules and regulations.
A private limited company with significant growth might choose to become public for easy access to capital and hassle-free implementation of mergers and acquisitions.
Limited by Guarantee
A company limited by guarantee has members and does not have share capital or shareholder. Members are responsible for contributing a predetermined sum to meet the company’s liabilities in the event of closure.
While there may be a lack of working capital and no profit distribution, members have democratic control over all decisions. This type of entity is ideal for non-profit making organization and corporation for specific purposes such as a charity or university alumni.
If you plan to start a low risk, small scale business on your own, you should opt for a sole proprietorship. Although it is the simplest form of business, a sole proprietorship does not consider the business as a separate legal entity. Therefore, it does not safeguard personal assets from business liabilities. As a result, it is often considered risky.
While a sole proprietorship is relatively easy to register in Hong Kong, i.e. you can simply make an application to the Business Registration office, it poses a financial risk to sole proprietors, as they are solely personally responsible for all liabilities. However, the advantage of setting up a sole proprietorship is that the setup cost is lower and you can have complete control of your business whether it’s related to profits or decision making.
It would be hard to find Investors as they view such type of business as a risky proposition.
Sharing of responsibilities and profits is the foundation of a partnership. You may enter into a partnership with two or more people for ownership of a single business. In a partnership, partners can raise capital and share responsibilities and liabilities for each other’s actions. Additionally, the business is not considered a separate legal entity from owners. This means there is no protection of personal assets in a partnership. Your personal assets can be used to pay off debts and losses.
A partnership is governed by the Partnership Ordinance in Hong Kong. In a general partnership, every partner is personally liable for business debts and liabilities. They can be held responsible for each others’ actions.
Otherwise, you may opt for a limited partnership. It comprises both general and limited partners. The former has unlimited liability to pay off business debts and is responsible for the smooth running of the firm. The latter has limited liability in terms of debts. This means they cannot be personally held liable for any company liabilities. Their liability is limited to their unpaid share capital. They have no role in the management of the partnership, nor are they liable for any wrongful act of other partners.
While a general partner is responsible for the management of everyday business operations, limited partners do not have a bigger role in the business, except for investing money. They have no other choice in the management of the business, except remain passive investors.
A limited partner can leave the business without dissolving the partnership.
Which entity type is best for me?
Your choice of the entity type depends on different factors.
- Whether the business is for-profit or non-profit?
- Whether there is an intention to raise capital from outside investors in future?
- Whether the business is on your own or you have other partners to work with?
- Whether you intend to grow the business on long term or it is just a one-off project?