In 2016, 64,937 new businesses were set up in Singapore. Of these, many were probably small-medium enterprises (SMEs) – businesses that have annual sales of not more than S$100 million, or employ less than 200 workers. Indeed, the Singapore Government recently recognised that SMEs, making up 99% of businesses, are at the heart of the Singapore’s economy.
However, SMEs come in many shapes and sizes. There are companies, partnerships, sole proprietorships, limited liability partnerships, and even more. Amongst the various business structures available, it may be difficult to ascertain which is the best structure for your business. This article will go through the three most basic business structures and their characteristics, to help you make a better decision about which to adopt.
What is a business structure?
A business structure is the legal structure behind a business. Essentially, a business is the activity of trading goods and services in exchange for monetary value. The business structure determines how this activity is carried out and regulated.
A good comparison would be driving. Driving is the activity of operating a vehicle and moving it from one place to another. A vehicle is a physical structure that you use to drive. However, there are many different vehicles that we can use, and using different vehicles may affect the way you drive. For example, you could use a car, which is smaller and more efficient than a truck. However, a truck can carry more load. A car might be allowed on certain roads that a truck is not allowed on, while there may be certain parking lots that only cater to trucks. At the end of the day, however, both are vehicles that allow you to drive from one place to another.
Similarly, business structures are different ways of carrying out a business. Each business structure has its particular characteristics and may be governed by different regulations, which may prove to be advantageous or disadvantageous depending on the business.
What are the different business structures?
The three most basic forms of business structures are the sole proprietorship, partnership and company. Other business structures such as the limited liability partnership, limited partnership and company limited by guarantee are merely variations of the three basic forms.
Before going through the three different business structures, an important concept to understand is that of the separate legal entity. This refers to the idea that the business is a “person” that is legally separate from its owners – it has its own legal entitlements and obligations. It may sue and be sued in its own name. Just like two distinct human beings, the business and its owner(s) are separate legal entities in the eyes of the law. For example, a business that is a separate legal entity can own property in its own name, whereas a business that is not a separate legal entity cannot, and the sole proprietor will own the business’ property in his/her own name.
A sole proprietorship is a business owned by one person or company. It is the simplest business structure in Singapore. The sole proprietorship is not a separate legal entity. This means that the owner and business are treated as the same entity and the sole proprietor is spared from having to maintain different accounts for auditing purposes. Essentially, the business is seen as an extension of the owner.
A partnership is, in some senses, an evolution of the sole proprietorship. It is similar to a sole proprietorship, except that it is owned by two or more persons or corporations. This allows more than one person to establish and co-own a business. Similar to a sole proprietorship, a partnership is not a separate legal entity from its owners.
A company is a business entity that is registered under the Companies Act. It is commonly seen as the most complex business structure. As the term “business entity” suggests, it is a separate legal entity from its owners. However, because its separate personality is a legal construct – it is not an actual person – this means that it still requires people to own and run it. The people who own the company are known as its members, and they are the ones who appoint the directors who run the company on a daily basis. A company’s member can also be its director. For companies that issue shares, the members are its shareholders.
How do I select between these different business structures?
Clearly, these different business structures have their similarities and differences. Here are a few considerations you should have in mind when choosing amongst them.
#1 – Number of owners
Different business structures allow for a different number of owners. If you are looking to set up a business by yourself such that the business requires only one owner, a sole proprietorship may be preferable.
On the other hand, if you are looking to set up a business with several other people, a partnership or company may be preferable. There is a limit of 20 persons who can form a partnership. Unless the partnership is a professional partnership, any business owned by more than 20 people must be registered as a company. However, there is no limit on the number of members in a public company but a private company can only have a maximum of 50 members. Nevertheless, it is important to note that a company can also be owned by a single member.
#2 – Level of risk
Different business structures also carry different level of risks for its owners. This risk is seen in terms of whether the owner(s) are personally liable for the company’s liabilities and obligations, and this is linked to whether the business structure is a separate legal entity.
For sole proprietorships and partnerships, the owner(s) are personally liable for the business’ liabilities and obligations. This is because the business is not a separate legal entity. Therefore, its liabilities are an extension of the owner’s own liabilities. The third party can only sue the business owner(s), and the owner(s) must be responsible for any liability incurred by the business since the business is not a separate legal entity. Therefore, if the business takes on a debt that it cannot eventually repay, the owner(s) will be responsible for repaying the debt. In this sense, sole proprietorships and partnerships are riskier because the owner(s)’ personal assets are at stake.
In contrast, for companies, the shareholders are not personally liable for the business’ liabilities and obligations, except for the money that they initially contributed to setting up the company. If the members have not paid in full for their shares, they cannot be asked to pay more than the amount unpaid on their shares. This is because the company is a separate legal entity. Therefore, its obligations are its own. If the company is sued or incurs debts, but is unable to satisfy these obligations, the person suing or claiming repayment on a debt cannot then go after the company’s shareholders. The shareholders can thus be seen to be “protected” from the company’s liabilities and obligations. In this sense, the company is a less risky business structure.
However, there are instances where the courts have lifted or pierced the corporate veil to hold personally liable those behind the company’s actions or omissions. Directors may also be held liable. One instance is when the corporate entity and the limited liability protection that it offers have been abused by the shareholders or directors at the expense of third parties.
#3 – Capital
There are two main ways of obtaining capital: from the company’s members, or by taking a loan. Generally, it is easier for companies to acquire capital than for sole proprietorships or partnerships. There are three reasons for this.
First, companies can sell shares. This means that an investor can pay a certain amount of money to the company in exchange for its shares. The money paid by the shareholders forms part of the company’s capital and can be used for running its business. This mechanism of buying shares is more attractive to investors because it is a less risky way to become an owner of a business. This arises from the fact that members of a company are not usually personally liable for its obligations, as discussed above unless the corporate veil ought to be lifted. Therefore, more investors are willing to buy shares and become members of a company. In comparison, investors are less willing to co-own a partnership, which will expose them to greater liability.
Second, companies have more owners to obtain capital from. A sole proprietor has only one owner, while a partnership must have less than 20. In contrast, because a private company can have up to 50 members and a public company can have an unlimited number of owners, the amount contributed by all the owners combined would be greater.
Third, it is easier for companies to secure a loan. This is because they are generally larger, more stable and credible than sole proprietorships and partnerships. Therefore, banks are more willing to lend to companies.
#4 – Formalities
The different business structures also involve different levels of administrative and compliance requirements in the setting up, running and closing of the business. On one end of the spectrum, a sole proprietorship requires the least amount of formalities. At the other end, a company requires the most amount of formalities. This is because a company is a more complex business structure, often involving greater sums of money and people. Therefore, more safeguards must be put into place to ensure that it is managed properly. Generally, the fewer formalities involved, the easier and cheaper it will be to run the business.
In the setting up of the business, the cost of registering a sole proprietorship or a partnership is generally less than that of a company and the process of setting up is also quicker and easier.
In the lifetime of the business, administrative and compliance requirements are generally simpler for sole proprietorships and partnerships, as compared to those for companies. For example, sole proprietorships and partnerships need only renew their business registration every few years and declare income tax. In contrast, companies are required to do more. Companies must appoint secretaries and auditors (do note that small companies can be exempted from having its accounts audited if they fulfil certain criteria) to carry out administrative tasks and comply with certain statutory requirements, file Annual Returns and comply with comprehensive statutory requirements concerning, for example, general meetings, directors, accounting records and share allotments.
The same can be said of closing down of the business. For sole proprietorships and partnerships, the owners need only to cease doing business. The business of the sole proprietorship or partnership will be closed by ACRA (the Registrar) if it is not renewed. On the other hand, a company must be officially wound up or struck off the register. Ordinarily, this will involve obtaining the approval of a majority of the company’s shareholders, lodging documents with the relevant government bodies and appointing a liquidator. In certain cases, it may even involve complex court proceedings brought by the company’s shareholders or creditors.
#5 – Profit sharing
The profit sharing arrangements also differ amongst the various business structures. For sole proprietorships, the owner takes all of the business’ profits. For partnerships, profits are shared by all the partners. For companies, profits are shared amongst the shareholders in the form of dividends, in proportion to the number of shares they own.
#6 – Tax and tax exemptions
Different tax rates and exemptions apply to sole proprietorships and partnerships as compared to companies. The profits of sole proprietorships and partnerships are taxed at the owner(s) personal income tax rates, whereas the profits of companies are taxed at corporate tax rates.
In terms of tax reliefs and exemptions, sole proprietors and partners may apply for personal tax relief. On the other hand, companies that meet certain criteria can avail themselves to corporate tax exemptions, such as the Tax Exemption Scheme for New Start-Up Companies and the Partial Tax Exemption for all companies. For shareholders in Singapore, dividend tax exemptions may also apply to them personally.
#7 – Continuity of business
Generally, it is easier for companies to maintain continuity in business. This is for two reasons. First, a company has perpetual succession; it exists indefinitely until it is wound up or struck off the register. This is due to it having a separate legal personality from its owners. Therefore, it is easier for a company to continue existing indefinitely even after its owner(s) pass away. Second, it is easier to transfer ownership of a company because ownership of a company is in the form of shares, which are easy to buy and sell.
On the other hand, the maintenance of continuity is more difficult for sole proprietorships and partnerships. Because sole proprietorships and partnerships are not separate legal entities, their existence is tied to their owner(s). Generally, a sole proprietorship ceases when the owner has passed on, while a partnership ceases when all the partners die or when the partnership agreement ends.
Summary – Which business structure is suitable for you?
|Personal liability||I don't think I will be subject to substantial personal risk of lawsuits and I can manage this.||I want to limit my personal liability and that of my shareholders. I want to be sure that if the company is sued, they will not come after my/our personal assets.|
|Capital raised||I don't need to raise much money externally and will be able to raise funds on my own.||I don't need to raise any or much capital - it will primarily be money put in by a few partners who will be the main stakeholders.||I want or need to raise substantial capital to fund the business operations, and will likely have many shareholders now or later in the company's future.|
|Number of people||It's just me.||It's just a few of us. 2-20 people in the partnership.||It could be any number of people less than 50.|
|Continuity||It's ok if my business ceases to exist after I pass away or if I decide to stop working on this business.||I need the business to have stronger continuity. I envision it to continue running for a long period of time even after myself or other directors and shareholders of the company pass away.|
|Sharing of profits||I'm keeping all the profits.||We're dividing the profits between a few partners.||I would like to distribute this to many members of the company.|
|Costs and formalities||I'm okay with paying up to $175 to register my business for 3 years. Additionally, I would prefer not to manage high costs of complying with administrative and governance requirements during the life of the business.||I'm okay with paying around $315 to register my company. Additionally, I will be able to manage higher costs of complying with ongoing administrative and governance requirements.|
|Tax||It is fine to pay taxes at personal income tax rates.||It would be better for me to pay taxes at corporate income tax rates. I would also like to take advantage of corporate tax exemptions.|
|Examples||Freelance graphic designer or photographer, a small bakery or grocery, small businesses offering personal services such as housecleaning and catering.||A small law firm with a few partners, a tuition business, a start-up between friends.||A large business with franchises like Breadtalk and Sushi Tei.|
Ultimately, the suitability of the business structure depends on the nature of the business, who is involved in setting up the business, and the owners’ long-term plan for the business. Just as the type of vehicle depends on who is driving, the budget allocated for it and for what purposes, the business structure chosen will depend on the circumstances and needs of the business and business-owner.
Frequently asked questions
Question 1: If I want to start a business, is it necessary to incorporate a company?
It is not necessary to do so. However, please note that before a person carries on business in Singapore, he or she has to register with ACRA under the Business Names Registration Act 2014.
Question 2: Can I just start my business first, and change my business structure later?
It is possible to do so, but it is advisable that you think through the appropriate business structure to use, before commencing your business.
Question 3: What is a “joint venture” or JV?
Broadly, this involves two parties cooperating with each other, in furtherance of a common objective. Note that a wide range of business structures can be used for a JV. It is also possible for a JV to be entirely contractual i.e. with no new business entity created for the JV.
Question 4: What legal documentation do I need, to incorporate a company? Do I need a lawyer to start a company?
You do not need a lawyer to start a company. However, if there are multiple shareholders, you may wish to enter into a shareholders’ agreement with the shareholders. You would also have to prepare a Constitution of the company. You may wish to engage a lawyer for such matters.
Looking for business advice?
If you have any questions about setting up a company, you can get a Quick Consult with Lau Kah Mei or other lawyers for a transparent, flat fee of S$49. You can expect a call back within 1-2 days on the phone to get legal advice and have your questions answered.
This article does not constitute legal advice or a legal opinion on any matter discussed and, accordingly, it should not be relied upon. It should not be regarded as a comprehensive statement of the law and practice in this area. If you require any advice or information, please speak to a practicing lawyer in your jurisdiction. No individual who is a member, partner, shareholder or consultant of, in or to any constituent part of Interstellar Group Pte. Ltd. accepts or assumes responsibility, or has any liability, to any person in respect of this article.