BUSINESS ENTITIES & FORMATION

ENT/ETR300 – FUNDAMENTALS OF ENTREPRENEURSHIP BUSINESS ENTITIES & FORMATION BUSINESS ENTITIES & FORMATION Hj. Ramli Raya Hjh. Zanariah Zainal Abidin Mohd. Ali Bahari Abdul Kadir Zainal Lode

ENT/ETR300 – FUNDAMENTALS OF ENTREPRENEURSHIP BUSINESS ENTITIES & FORMATION FORMS OF BUSINESS ENTITIES

Forms of Business Entities Businesses in Malaysia can be registered under: • Business Registration Act 1956 (Amendment 1978) & Procedures Of Business Registration 1957 • Company Act 1965 • Cooperative Act 1948 • Parliamentary Act or State (Government) Enactment

Types of Business Entities Under Business Registration Act 1956 (Amendment 1978) & Procedures Of Business Registration 1957: • Sole Proprietorship • Partnership Under Company Act 1965 • Limited Company by Guarantee • Limited Company by Share • Private Limited Company (Sendirian Berhad) • Public Limited Company • Foreign Owned Company • Unlimited Company

Types of Business Entities The most common forms of business entities registered by small and medium enterprises (SMEs) are: • Sole Proprietorship • Partnership • Private Limited Company

Sole Proprietorship • Formed under the Business Act 1956 (Amendment 1978). • This form of business structure is solely owned by one person, where management rests on that person whose liability is unlimited. • A sole proprietorship is the simplest business structure. • As for the name of the business, the name of the owner or any other name may be used. • Typically, a sole proprietorship business requires a small amount of capital to start with, compared with other forms of business entities

Advantages of Sole Proprietorship • Easy to manage because the owner or proprietor can make decisions by himself. • The owner enjoys a certain degree of flexibility since as a sole owner he can react quickly and positively regarding necessary changes in the business. • Easy to form and dissolve with minimum formalities. • As nobody shares the rewards of the business, all profits will go to the owner. • Not subjected much to government rules and regulations. For instance, the yearly financial statement that needs to be submitted to the Inland Revenue Board does not require validation by a qualified auditor. • The owner pays income tax based on his total individual income

Disadvantages of Sole Proprietorship • Limited source of capital that could limit the business activity. • The liability of the business is unlimited. If the business incurs debts for which the business assets are not sufficient to cover, the owner must be prepared to settle the debt with his personal assets. • The future development of the business is limited and depends on the management capability of the owner and the condition of his health. • The owner is solely responsible for carrying out all the tasks, therefore, a lot of time and effort needs to be spent in managing the business. • The life span of the business depends upon the age of the owner and how efficiently he manages the business. In addition, the business will be dissolved if the owner passes away. If someone wishes to continue the business, it will have to be re-registered.

Partnership • A partnership is a legal business entity with two or more partners. • In this form of business, a person forms a partnership with one or more persons to carry out a business with a view to making profits. • A partnership business is also incorporated under the Business Registration Act 1956 (Amendment 1978). • A partnership is carried out by more than one person but not exceeding 20 persons. In a partnership, partners agree to undertake a joint business and jointly own the business. • Professional businesses (legal firms, architect and accounting firms the members could number up to 50 persons). • In this form of business entity, partners carry out the business, share the capital, profits and losses.

Advantages of Partnership • Easy to set up with few formalities. • Easier to secure financial assistance from financial institutions compared with sole proprietorship. • Equity can be increased through enlisting additional partners. • Business risks can be reduced and distributed among partners. In case of losses, each partner will share the burden. • The responsibility of managing and handling the business can be divided equally among partners. • A lot of ideas, talents and skills can be pooled together for better management. • As in a sole proprietorship business, income tax is not imposed on the partnership itself but on the owners as individuals.

Disadvantages of Partnership • Business liabilities are unlimited, which may involve personal assets of all partners of the company • The life span of the partnership business depends on the life span of the partners. If any of the partners passes away or is declared a bankrupt, the business is automatically dissolved, unless there is an agreement otherwise. • If no Letter of Agreement is being made, unethical or misconduct behaviour may happen. • Risk of personal clashes among partners

Partnership Agreement • The Business Registration Act 1956 does not specify that the formation of a partnership business must be followed by a written agreement between or among partners. However, it is necessary for the business to have some kind of Contract or Partnership Agreement to avoid any misunderstanding that may occur among the partners

Partnership Agreement Some of the important elements that need to be stated in a Partnership Agreement: • Name of the business • The duration of the partnership (to prevent the dissolution of the business). The agreement should also state that in the event one partner passes away or withdraws from the partnership, the business will not be dissolved. • Individuals involved in managing the partnership business. • The accounts of the business and share capital that show the contribution of each partner and the right and obligations of each partner towards the capital. • The properties are considered as assets of the business.

Partnership Agreement Partnerships are governed by the Partnership Act 1961. If partners do not have their own agreement, the provisions of the Act will become applicable. Sections 26 and 27 of the Act, among other things, stipulate that the following must be provided for in a partnership agreement:. • Profits or losses are to be shared equally. • No interest is payable on a partner’s capital. • Each partner is entitled to actively participate in the management of the business. • No partner is entitled to a salary for participating in the partnership business. • Partners have the right to be paid based on their contribution to the business.

Partnership Agreement • Daily normal things in business can be • decided by the majority of the partners, but any • changes that regularly occur need to be made with • consensus from all partners. • g. A partner may withdraw after getting the consent of • the other partners. • h. The introduction of a new partner must have the • unanimous consent of all existing partners. • i. All business accounts books need to be kept at the • main business premises. Partners are allowed to • check through the books and they have the right to • keep a copy of the books.

Registration of Sole Proprietorship and Partnership Business • A proprietorship or partnership can be registered with the Business Unit of the Companies Commission of Malaysia (CCM). • A business is allowed up to seven days after the start of its operation to be registered. • For registration procedures ( Sole proprietorship and Partnership business please refer http://www.ssm.com.my/DOINGBUSINESSINMALAYSIA/GuidelinesDoingBusinessInMalaysia.pdf

Registration of Sole Proprietorship and Partnership Business Why applications are turned down: • The applicant does not use capital letter when filling out the application form; • Application form is too dirty or untidy; • Corrections are made using liquid eraser; • The business is already registered, but the owner has not taken any initiative to terminate the existing business before applying to register a new one;

Registration of Sole Proprietorship and Partnership Business • Verification of application form has been made by unauthorised personnel; • The applicant does not attach a copy of the approval letter from other respective agencies in the case where the business is required to have other licences or permits; and • Other things that may cause the Registrar of Business to have doubts.

Private Limited Company • A private limited company is one of the business entities set up under the Companies Act 1965. • As a corporate body, it has characteristics that differentiate it from a sole proprietorship and partnership. This is because a private limited company is a legal entity and its identity is separate from the identity of the company’s members.

Characteristics of Private Limited Company • Right and Responsibility • A company has a specific right and responsibility. It can acquire assets under its own name. A company can also take legal action and face legal action under its own name • Life Span • The life span of a company is not dependent upon the death or resignation of its members. A company can be dissolved when its members are no longer interested in continuing the business • Liabilities • The liabilities of the members in a company are limited to the total shares contributed to the company’s capital. Personal assets are not affected regardless of what happens to the company • Membership • A company must have at least two members who are of Malaysian nationality. These two members can act as a director and founder of the company. The members of the company will appoint the Board of Directors who will manage and run the business operation subject to the Companies Act 1965

Terms & Conditions of Private Limited Company • The number of members does not exceed 50 people; • It has specific authority to transfer ownership of members’ shares with the approval of the company’s Board of Directors; • A company is not allowed to offer or sell any share or debenture to the general public; • A company is not allowed to offer the general public to deposit money within a stipulated time frame; and • A company must use the word “Sdn. Bhd.” or “Sendirian Berhad” at the end of its name.

Requirements of A Private Limited Company • Memorandum of Association • Articles of Association • The Share Capital of a Company • Authorised capital • Paid-up capital • Members of Shareholders • Board of Directors • Company Secretary • Auditors • Registered Office • Company Seal • Authorisation Letter

Advantages of Private Limited Company • Funds are easy to acquire through the exchange of share ownership or loan from a financial institution. • All shareholders are legally protected by law. • Shareholders are not burdened with the management of the business because the responsibility to manage and run the business is held by the Board of Directors, who are appointed by the company’s shareholders. • The liabilities of the company’s members are limited to the capital that they contribute to the company. Shareholders’ personal assets are not affected. • The life span of the business is not dependent upon the age or resignation of its members. • It has greater potential for expansion. • Legally, the company is one business entity by itself

Disadvantages of Private Limited Company • A Private Limited Company is subject to more rules and regulations compared with a Sole Proprietorship or Partnership. A company must always abide by the rules and fulfil the terms set by the Companies Commission of Malaysia. • The company’s shares cannot be transacted through the share market. • The company must pay corporate tax. • The qualified Auditors must audit the company’s yearly financial statement and the statement must be complete and regularly updated. • The financial affairs of the company must be made transparent to the general • The cost of setting up a company is high

Procedures in Registering a Private Limited Company • The registration of a private limited company must use the services of a company secretary. The company secretary will then forward the form together with relevant documents to the Companies Commission of Malaysia in the state in which the operation will take place. • For further details, please refer to http://www.ssm.com.my/DOINGBUSINESSINMALAYSIA/GuidelinesDoingBusinessInMalaysia.pdf

ENT/ETR300 – FUNDAMENTALS OF ENTREPRENEURSHIP BUSINESS ENTITIES & FORMATION BUSINESS FORMATION

BUSINESS FORMATION There are four common methods of starting a new venture: • Starting from scratch • Buying an Existing Business • Family Business Succession • Acquiring a Franchise

1. Starting From Scratch • The most popular method among start-up entrepreneurs • Entrepreneur has to make decisions on: • Appropriate form of business • Business or trade name • Business and product/service image • Suitable location of the business • Appropriate funding to kick-start the business • Proper business planning for everything that needs to be take into consideration.

Advantages of Starting From Scratch (cont.) • Entrepreneurs are free to make his/her own decisions. • Entrepreneurs have the opportunities to try and practice his/her own ideas. • Entrepreneurs are free to choose suitable business location and premise, and acquiring appropriate machine and equipments for the business. • Entrepreneurs are free to develop business image and personality that suits their desire and interest.

Disadvantages of Starting From Scratch (cont.) • Entrepreneurs need to put in a lot of efforts. It requires more time, energy and money in ensuring the business kick-off. • Higher chances of losses due to high project implementation cost. • Entrepreneurs are not able to accurately estimate sales, cost and profit. ( zero business history (i.e. sales record, costing and so on) • A new venture usually has no track record. Therefore, it is difficult for entrepreneurs to convince the financial institutions in getting the financing

2. Buying an Existing Business • Entrepreneurs start a new venture buy taking over an existing business either buying the whole business or partial shares in the existing business. • Entrepreneurs must “investigate” before buying. previous owners have reasons why they wanted to sell their business. So, it is the entrepreneurs’ responsibilities to “investigate” the business that they want to buy as well the “background” of the existing owners

Advantages of Buying an Existing Business (cont.) • The time entrepreneurs spent to start the business is faster compared to starting a new venture form scratch • The probability of getting the financing is greater if the existing business has a good track record. • Existing market and loyal customers of existing business. • Established networking with suppliers, supporting agencies and communities.

Disadvantages of Buying an Existing Business (cont.) • Buying existing business requires bigger amount of capital either to buy the whole business or part of the business. • If the existing business is not well managed by the previous owner, entrepreneurs need to put in a lot of efforts, money and time to improve the situation. • Entrepreneurs have to respect and abide the agreements that have been made by the previous owner with related parties (i.e. suppliers, agencies etc.) • Conflicts could arise between the new owner and existing employees

3. Family Business Succession • Entrepreneur is the successor of the business which was started by the earlier family members (predecessors). • Entrepreneur did not face the difficulties of starting-up a new venture.

Levels of Family Business Generally, there are four levels of family business: Level 1: Business Inception (the founder) Level 2: Business Growth & Development (the founder & 1st generation) Level 3: Business Maturity (the founder,1st generation & 2nd generation) Level 4: Business Transition Period (1st generation, 2nd generation & 3rd generation)

Challenges of Family Business • Financing – debt financing versus equity financing • Liquidity/Cash – family’s need for cash versus business’s needs for cash • Transition period – older generation versus new generation (to let go or not to let go – ownership & mgmt power) • Succession - finding the right successor (competent, motivated, and the most important getting consensus from all family members) • Emotion – family interest versus business interest • Rivalry – siblings, cousins

Advantages of Family Business • Freedom and flexibility in decision making. • Pride of family culture, high commitment and motivation lead to business stability. • Family members willingness to “sacrifice” their time and money (e.g. no salary taken for 1st year of operation). • High possibility of achieving great monetary success due to high commitment. • Family members have good exposure to business environment.

Disadvantages of Family Business • Unstructured early-stage business organization. • Early-stage limited financial resources. • Family conflicts such as siblings and/or cousins rivalry. • Nepotism among family members (e.g. incompetent family member is given a better management position). • Traditions practiced by older generation passed on to new generation could lead to resistance to change. • Difficulty in getting the right successor.

4. Acquiring a Franchise • Another alternative of starting a new business • A franchise is a product and/or service distribution system which is governed by a contract • Made between two parties namely, the franchisor and the franchisee • The franchisor is a company which sells the right to another party to operate the franchise. • The franchisee is a person who purchases the right from the franchisor to operate the franchise

Acquiring a Franchise (cont.) • Operating a franchise includes selling and marketing the products and/or services using the trade name and trade mark, as well as a set of systems developed and owned by the franchisor.

Acquiring a Franchise (cont.) • The right to operate the franchise granted by the franchisor to the franchisee involves a few payments made by the franchisee agreed upon the signing of a franchise. These fees are: • Franchise Fee – one-off payment made by the franchisee to purchase the right to operate the franchise • Royalty - an on-going payment made by the franchisee to the franchisor based on the percentage of sales as agreed upon the signing of franchise contract (monthly or yearly) • Advertising and Promotional Contribution - an on-going payment or contribution made by the franchisee to franchisor’s advertising and promotional fund.

Types of Franchise Systems Two major types of franchise system: • Product/Trade name Franchise • Business Format Franchise

Product/Trade name Franchise • This type of franchise system involves the franchisee acquires sales right which includes the trade name, trademark, and/or products from the franchisor upon the signing of the so-called dealership contract, and agreed to sell the product line identified by the franchisor. This type of franchise system is commonly used in the automotive, petrol kiosk and service station, soft beverages, and tyre industries.

Business Format Franchise • This franchise system is also named “full-fledge franchise” The franchisee is granted the right to manufacture and market the franchisor’s product and/or services using a complete franchisor’s business “set-up” which comprises of intellectual properties (trade name. trade mark, etc.); marketing strategies (pricing structure guideline, promotional activities etc.), guided operational activities (franchisee is equipped with operation manual and has to undergo a training), premise settings and layout ( exterior and interior layout; ambience, colour scheme and decoration must in-line with franchisor’s brand and image).

Advantages of Franchising To the Franchisee: • Lower business risks as franchisee shares the business risks with the franchisor. • Better market acceptance of products and/or services offered as they are established products and/or services of the franchisor. • Benefits of economies of scales • Guidance by the franchisor’s management team • Continuous support from the franchisor and government agencies that involved in the development franchise industry.

Advantages of Franchising To the Franchisor: • The franchisor’s business expansion can be done through recruitment of new franchisees. • Benefits of economies of scales • Lower business risks as franchisor shares the business risks with the franchisees. • Problems related human resource management is reduced due to the fact that the franchisees have to manage the human resource related matters themselves. • The franchisor can put more focus on product research and development since business expansion is done through franchise system.

Disadvantages of Franchising To the Franchisee: • Limited freedom and flexibility to manage the business according to franchisees’ desire • The franchise right granted by the franchisor has its price to pay; the franchise fee, royalty and advertising & promotional contribution • Limited product varieties; the franchisees are allowed to market and sell only the franchisor’s products • Fear of chain-reaction; bad reputation and tarnished image due to the fault of either the franchisor or the franchisee would affect the whole franchise system

Disadvantages of Franchising To the Franchisor: • Franchisee conformity; it is difficult to manage the franchisees especially in ensuring the conformity of the operational methods of all franchisees in the system due to the fact that they are not franchisor’s employees. • The franchisor/franchisee goal incompatibility; The franchisor and franchisees may have different business objectives as well as personal objectives that could jeopardize the business “marriage”. • “Wrong” franchisee; There are franchisees who want an “easy-ride” in an attempt to gain instant popularity for the business. • Competition through imitationof business concept and model

END OF MODULE 5

BUSINESS ENTITIES & FORMATION