Business Forms

Introduction

There are basically three forms of business in Hong Kong: sole proprietorship, partnership and company limited by shares.

Before you start your business, you have to consider which form of business for operating your business. You should consider a few important factors such as liability, control, taxation, ease of doing business, accessibility of credit, and number of stakeholders in view of your own circumstances to determine which business form is most desirable.

Key Features of Various Business Forms

All of these business forms require business registration with the Inland Revenue Department (IRD) and hire employees as needed (thus are subject to employment and labour laws and regulations).  The following highlights the key features of each of them.

Sole Proprietorship

A sole proprietorship is the most basic business form – the business is owned and conducted by a single person (“sole proprietor”).

Advantages

  • Simple set-up procedure – The only procedure necessary is registration of business with the IRD (see Incorporation and Registration of Business).
  • Less onerous compliance duties – A sole proprietor has minimal compliance issues, such as keeping 7+ years of business records.
  • Lower profit tax rate – the normal profit tax rate is 15%.

Drawbacks

  • No separate legal identity – A sole proprietor has ownership of all the assets of the business but also has unlimited liability with regard to the debts and obligations. That is, creditor can go after the sole proprietor’s personal assets to satisfy the debt.
  • Narrower scope of capital – A sole proprietor cannot issue shares and create floating charges (a means of securing a loan), so it may be harder to obtain finance or recruit people into the business. 

Partnership

A partnership exists when two or more people come together to carry on a business for profit. Partnerships are more common for professionals such as accountants, lawyers, architects and doctors. Each member of the partnership is a “partner” and the partners are collectively known as a “partnership firm” or a “firm”.

Partners usually enter into a partnership agreement to set forth the relationship between them and how they manage their affairs in the conduct of the partnership (e.g., management, distribution of profit and control). Notably, partners have a fiduciary duty towards each other, which means that partners must act in the best interests of each other.

Advantages

  • Simple set-up procedure – The only procedure necessary is registration of business with the IRD (see Incorporation and Registration of Business).
  • Less onerous compliance duties – A partnership has minimal compliance issues, such as keeping 7+ years of business records.
  • Lower profit tax rate – The normal profit tax rate is 15%.

Drawbacks

  • No separate legal identity – Each of the partners (except for limited partners in a limited partnership) is the owner of the partnership and therefore has unlimited liability with regard to the debts and obligations of the firm. That is, creditor can go after a partner’s personal assets to satisfy the debt.
  • Narrower scope of capital – A partnership cannot issue shares and create floating charges (a means of securing a loan), so it may be harder to obtain finance or recruit people into the business. 

There are two main types of partnership: General and Limited.

  • General Partnership: Every general partner is an agent of the firm and his/her other partners. All partners are bound by the acts done by another partner on behalf of the firm and are jointly and individually liable for all the debts and obligations of the firm (i.e., a creditor can sue any one of the partners for whole or part of the debt the firm owed to the creditor). Unless otherwise stipulated in the partnership agreement, the partnership ends with the death or bankruptcy of one of its partners, or upon notice given by a partner of his intention to dissolve the partnership. Partnership Ordinance (Cap. 38) is the main legislation governing general partnership.
  • Limited Partnership: A limited partnership comprises at least one general partner and at least one limited partner. A limited partner differs from a general partner in two respects:
General partnerLimited partner
Unlimited liabilityLimited liability (up to his/her initial contributions to the firm at a stated amount)
Can manage the partnership and his/her acts will bind the firm and other general partners.Cannot take part in any form of management of the firm and does not have power to bind firm and other partners.

Limited partnership must be registered with the Companies Registry, otherwise it will be deemed to be a general partnership. Limited Partnership Ordinance (Cap. 37) is the main legislation governing limited partnership.

Company

There are two main types of companies: (1) companies limited by shares and (2) companies limited by guarantee. The former is the preferred form for many startups for its main advantages of separate legal identity and limited liability (see below). The latter is usually adopted by non-profit organizations.  

A company is “limited by shares” if the liability of its members is limited by the company’s articles to any amount unpaid on the shares held by the members. Its name must end with ‘Limited’.

Main features of companies limited by shares:

  • Separate legal identity: It means that the company is a legal entity separate from the owners of the company. A company can own property and act in its own right as if it is a natural person.
  • Separate ownership and management: The owners of a company are its shareholders while the people who manage the company are its directors (see Corporate Governance).
  • Limited liability: Shareholders’ liability is limited to the unpaid amount on the company’s shares subscribed by them, while the company’s liability is unlimited. That is, the shareholders are generally not personally liable for the company’s debts.

Advantages

  • Simple set-up procedure – A company is established when it is incorporated with the Companies Registry (see Incorporation and Registration of Business). Under the current one-stop system, the act of incorporation will also automatically register the business with the IRD.
  • Separate legal identity – A company can do thing a natural person can do in law such as enter into contract, take out loan, own property and sue/be sued.
  • Limited liability of shareholders – Each of the shareholders is the owner of the company but their liability is limited to the unpaid amount for the company’s shares subscribed by them. That is, creditor cannot go after the shareholders’ personal assets to satisfy the company’s debt.
  • Management – Flexible since it separated from ownership. Directors (as a whole) have power to manage the company and make decision in daily operation of the business, they must act in the best interests of the company. Shareholders may give directions on taking or refraining from specified actions; however, do not owe any fiduciary duty to the company.
  • Continuity of business – Unlike sole proprietorship and partnership, the operation of a company is not affected by the changes in its membership and a company can run indefinitely as long as it is solvent.
  • Easier financing – Banks and investors will usually more willing to provide finance if the business is incorporated (as opposed to sole proprietorship and partnership). Apart from loan, company can also raise funds by way of share capital (see Share Allotment and Subscription), and this is often the way for startups to get funding from angel investors or venture capital investors.

Drawbacks

  • More onerous compliance duties – A company has extensive compliance requirements, such as the need to file annual returns with the Companies Registry, report to the Companies Registry when there is a change of shareholdings, director(s) and company secretary, and hold annual general meetings.
  • Higher profit tax rate – The normal profit tax rate is 16.5%.

A company is limited by shares can be ‘private’ or ‘public’:

Private CompanyPublic Company
A company limited by shares with its articles stipulating the following: Restricts a member’s right to transfer shares, Limits the number of members to 50, andProhibits any invitation to the public to subscribe for any shares or debentures of the company.  Any company limited by shares which is not a private company.
Less compliance requirementsMore compliance requirements, e.g. the board must include 2 directors and must file annual statements at the Companies Registry.
Financing is more limited, e.g. share capital is limited to private placementAble to get share or loan capital both publicly and privately. The ability to publicly get new shareholders has a tradeoff in the increasing amount of disclosure that needs to be produced by the company to the shareholders.

More Questions? Contact the New Companies Section of the Companies Registry at 2867 2587.

Checklist – You should know that: Choosing business forms depends on a number of factors including liability, control, taxation, ease of doing business, accessibility of credit, and number of stakeholders. Different business forms will have different regulatory and registration requirements, make sure you follow them closely. Generally, forming a company would be the more common form for starting up business due to ease of raising capital and lower potential liability. You can change the business structure to suit changing business needs.
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