Introduction
Choosing the most suitable legal structure for business has never been an easy task. Each form of legal entity has its inherent advantages and deficiencies. The case of Sarah and Jonah is not an exception in this regard. Deciding to settle a wine importing business requires careful examination of the determinants a ultimate legal structure. They include the amount of statutory fund, the number of founders, the way the want to limit their liability for the debts of a newly formed business, future growth prospects of the company and many some factors.
Thus, the purpose of this report is to evaluate different business formation options, which are available to Sarah and Jonah. Because partnership and company limited by shares are the most popular forms of doing small importing business in Hong Kong, this analysis accentuates the comparison between them, and explains why incorporation is a more advantageous option for the founders. Legally, the paper focuses on the analysis of the Hong Kong Partnership Ordinance and the Hong Kong Companies Ordinance.
Comparison between a Company and Partnership
There are several distinctive features between companies and partnerships:
Internal Business Structure
One of the key differences between corporations in partnerships lies in the way these entities are structured. The founders of a company have limited options for creating governing, auditing and other structural units. In partnerships, the founders are free to choose any method of corporate governance, which is compliant with the requirements of the local company law.
Liability
In partnerships, the founders are personally liable for all debts accrued by the company. The only exception in this regard are limited partnerships, where limited partners are not answerable for the liabilities, but at the same time, they do not participate in management.
In contrast, the founders of corporations are not answerable for its liabilities. Their potential losses are therefore proportional to the initial investments into the statutory fund of a corporation.
Registration Costs
Today, incorporating a corporation is more expensive than forming a partnership. Making a company is associated with filing constitutional documents, obtaining licenses and undergoing other obligatory administrative procedures. Professional legal assistance is often required to comply with all regulations.
In contrast, partnerships are less costly and involve less bureaucracy, and, consequently filing and attorney’s fees are smaller.
Tax Compliance
In contrast to limited companies, the members of partnership do not pay income tax. However, their income is taxed when they receive their salaries or other income, as defined in the partnership agreement. Furthermore, tax compliance procedures are simpler for partnerships. Yet, corporate taxation is more difficult, not to mention that other taxes and duties are levied (e.g. licensing fees).
The Best Alternative for Sarah and Jonathan
If the couple positions their venture a small-scale family business with limited staff, small sales and small geography of operations, forming a general partnership will be the best option for them. However, the characteristics of the case underscore the fact that there is big potential for future growth of their project. Therefore, incorporation of a company limited by shares is the best working scenario for them for them.
Moreover, potential partners are always more willing to deal with a limited company, than with a partnership. A popular prejudice among the business people is that a company is often more financially reliable than a partnership.
The Concept of Company Limited by Shares
In Hong Kong jurisdiction a company by shares is an entity, which shareholders have limited liability, which is proportional to the capital originally invested. The main difference with other companies is that its shares cannot be offered to the general public, and may be traded between the shareholders only.
In addition, in contrast to traditional public limited companies, the law does not require companies limited by shares to have and register board of directors, to conduct annual general meetings or to have other structural bodies.
Personal Liability of the Directors and Members
Trading in alcohol beverages is a risky area of international business. While it usually brings high profits, the competition is especially intense as well, not to mention that the market is susceptible to financial recessions. Therefore, protecting personal assets is important, because recovery of debts in courts is frequent in this area of business.
In the event the shareholders decide to appoint a director, who is not a shareholder, he may not be held liable for the deeds of corporation as well. However high rank and authorities of a director may be, the purview in this regard says that he is merely an employee, who is not liable for the misfortunes, which befall the company, unless his professional misconduct was intentional.
Raising Additional Capital and Regulatory Requirements.
One of the most effective methods of company capitalization is issuing new shares and offering them either to the existing shareholders, or to the general public. However, the second option is possible in public limited companies only. Therefore, if Sarah and Jonathan conclude that their project needs more funding, and they cannot invest their personal funds and an investor is not available, before offering shares for sale, converting the company into a public limited company is required.
In order to make this conversion, the founders should change Articles of Incorporation and Memorandum and, together with a copy of the balance sheet and the company auditor’s statement, submit to the Registrar of Companies. Once the Registrar of the Companies issues a resolution approving the transformation, the company may start offering shares to the general public and increase capital.
Disadvantages and advantages of Raising Additional Capital
Although raising capital is sometimes justified, as it provides additional operational financial resources for the company operations , this approach to capitalization has several disadvantages:
The company will have to pay dividends to the shareholders, upon their demand. In some cases, they may decide to reinvest profits, but such cases are quite rare.
Management is limited by the shareholders. A simple majority can easily remove directors and appoint new ones, thus, initial founders of the company may be dismissed from the corporate affairs.
How to Maintain Voting Powers
However, there is a way to preserve voting powers. In particular, the company may issue privileged shares. In this case, the company will be obliged to pay dividends, even if the profits are negative. As long as dividends are paid timely, such shareholders do not have voting rights. However, if a default on payment occurs, then they automatically receive full voting powers. Therefore, although this method is available, it should be used only when the shareholders are fully assured that it will be feasible to pay dividends.
Proof by Practice
The idea that the project of Sarah and Johan should be incorporated as a company limited be shared is not purely assumptive. Several Australian mid-sized wine-importers have been long trading in Japan (e.g. Top Australian Wines PTY ltd.), and these companies have chosen company limited by shares as their legal structures.
Summative Conclusion
It is inferable that a company limited by shares is the best legal structure available for this project. Although starting a company limited by shares is more expensive, and leads to higher taxation, the advantages significantly prevail the deficiencies. In particular, not only it safeguards the founders from potential financial misfortunes by the nature of limited liability, but also automatically increases business reputation, as well as provides different solutions for raising extra capital.
Reference List
Asia Business Center. (2015). Types of Hong Kong business entities, available at http://asiabc.co/guide-to-hk/business-registration/types-of-hong-kong-business-entities/ (accessed January 8, 2016)
Chen, J. and Ke, S. (2009). China master business law guide. Hong Kong: CCH Asia Pte Limited.
Chen, J. and Ke, S. (2009). China master business law guide. Hong Kong: CCH Asia Pte Limited.
Doing Business. (2015). Ease of doing business in Hong Kong SAR, China, available at http://www.doingbusiness.org/data/exploreeconomies/hong-kong-china (accessed January 8, 2016)
Hong Kong Companies Ordinance, Cap 622. Available at: http://www.legislation.gov.hk/blis_pdf.nsf/6799165D2FEE3FA94825755E0033E532/707C1C4DC6BDF92848257A5500549A21?OpenDocument&bt=0 (accessed January 8, 2016)
Hong Kong Partnership Ordinance, Cap 38. Available at: http://www.legislation.gov.hk/blis_pdf.nsf/6799165D2FEE3FA94825755E0033E532/DF5EA6624B5503A4482575EE0031E90A?OpenDocument&bt=0 (accessed January 8, 2016)
Kotler, P. & Keller, K. (2006). Marketing management. Upper Saddle River, NJ: Pearson Prentice Hall.
Kwan, S., Scott, J., Gilchrist, B. and Vaizey, T. (2012). Company law in Hong Kong. Hong Kong: Thomson Reuters Hong Kong.
Martin, E. (2002). A dictionary of law. Oxford: Oxford University Press.
