THINKING ALOUD (BusinessLaw) BUSINESS STRUCTURE:

A Closely-held Company
A Closely-held Company
Writer: Chn Rng
Benjamin Franklin once said: "If you fail to plan, you are planning to fail!" Hence, this guideline plan
will be designed to meet particular requirements, stating specific articles and rules for inclusion
alongside general ones. General articles will be excluded to keep this write-up concise and readable,
providing space for sharing our thoughts on legal and commercial considerations to grow our
business.
Just suppose, business partners (they include some family members) and I intend to jointly form an
international trading business, and we decided on incorporation to limit our liability to outsiders for
reason that Asian societies are now more litigious. Many other entrepreneurs may prefer their startups as limited liability partnerships. Whatever the desire may be, every business structure has its
own nuances with different features in terms of regulatory requirements, taxation, and liability to
owners. For our purposes, we have in mind a closely held firm in the form of a private company
limited by shares. It will be a corporate structure with specific articles of incorporation and rules
essential for the long-term building of relationships between owners of the business and those
appointed to managing the company.
Basically, a closely held company is one with a relatively small number of shareholders; and there is
no active trading market (stock exchange) for its securities. This definition fits our bill. Being a
private company limited by shares, our small group of shareholders will control the operation and
managerial policies of the firm. In other words, we will serve as shareholders, officers and directors
in the day-to-day running of the company. Our closely-held company will run in manner similar to a
quasi-partnership between members; and it is the raison d'tre of every founding member to get
involved in the management of the company.
We should never set up a company on the fly. Instead, close attention has to be given to the
formalities of establishing and operating the corporate structure to avoid future problems. Many
issues can and do arise when the company is up and running -- matters such as an unexpected audit
by the tax authority, in the event of disputes between shareholders or unforeseen lawsuits against
the company. For these reasons, the limited liability protections of the corporate form have to be
properly installed. In addition, as founding members we, too, need to seek legal advice to ensure
that the foundations of our business are on firm grounds.
There is no legal requirement that we have to incorporate in the place where the business will be
conducted. There is also no restriction that the company has to conduct business in the state of
incorporation, although a company generally must have a registered agent in that country.
Nevertheless, every company needs to comply with regulatory rules on conducting of business in a
foreign country. Each country has its own set of rules to regulate commercial activities of foreign
entities. Our company is not different from other establishments, so before embarking on
substantive activities, due diligence will ensure we do not contravene any law. Falling foul of rules
might also lead to disqualification of rights to sue in a court of law in the event of commercial
disputes.

For our purposes, both Singapore and Hong Kong are suitable venues for incorporation. Both cities
have well-established corporate laws and commercial men consider their commercial courts
generally receptive of the concept of separation of powers between shareholders as owners and
directors as managers. Nevertheless, this is a moot point in the case of closely-held companies
where the shareholders are also the managers of the company. But our preference for either
Singapore or Hong Kong is one reason why we have chosen for the limited liability company route.
These jurisdictions encourage risk taking and entrepreneurial activities to grow the business in Asia
through the use of subsidiary firms or forming joint venture companies with foreign partners.
The tax system in Hong Kong and Singapore allows transfer of group relief tax losses and capital
allowances to related companies within a business group as one way to lowering of business costs.
Such a group tax relief system, while subject to regulatory conditions, will also assist in improving
cash flow of the business. We will write our thoughts on holding company structures in a sub-hub for
future reference. Company laws in these two cities are still evolving and expect to continue to be
more friendly toward small and medium sized companies in the coming years. One common
advantage shared by both cities as homes of choice for foreign companies is the absence of
bureaucratic red-tapes as companies can be up and running within a relatively short time. But Hong
Kong is often preferred by entrepreneurs for strategic purposes.
The proximity to the huge China market may be reason why foreign companies prefer to have their
holding companies incorporated in this post-British era colony. In our case, our shareholders might
prefer to have our joint venture or subsidiary companies in Hong Kong and our closely-held holding
company incorporated in Singapore because our other important markets are Indonesia, Malaysia
and Vietnam.
But are we not setting up our business in questionable corporate tax havens or their hybrid entities?
There were accusations by western governments that both cities served as tax havens for tax
evaders, putting them in the ranks of Switzerland, Luxembourg and Cayman Island. Money
launderers and tax-dodgers were found incorporating shell-holding companies in tax haven countries
for evasion of taxes. Using a sham company as the nominal account holder puts a layer of secrecy
between an account and its beneficial owner - similar to numbered accounts prohibited by
international anti-money laundering regulations. We will not deviate to discuss the merits of these
accusations. Nevertheless, with the signing of information exchange treaties with partner countries,
both Singapore and Hong Kong are no longer on the black list of partner governments.
Roles of the Shareholders
The shareholders are the owners of our company. They are the ones to elect and change directors
when appropriate; and to vote on all major corporate changes -- mergers and acquisitions;
consolidation or liquidation, change in capital and events that could fundamentally change the
business of the company. In general terms, public shareholders do not get to manage the company.
Management is a function which rests solely with a Board of Directors. In a closely-held company,
this separation of powers is less transparent because shareholders, directors and officers are the
same group of people. For this reason, care must be taken in choosing the right people for
partnership in a business. It is equally important to appropriately select who should be on board as
directors, as they are crucial to the determination of business direction of the company.
A person should not be given a board seat for reason that he is a shareholder. This may be a
fundamental rule; invariably, in a closely-held or controlled company, management must continue to
control at least 70% of the voting shares. That is how our founding members will structure the

company as it grows to invite others to join as equity holders in future.

We will follow tradition: one share, one vote for all shares with voting rights. A shareholder with
more shares will have more control over the making of decisions and hence control of the company;
although this is not always what shareholders want in other situations. Sometimes it can be
beneficial for everyone to have an equal say. But we consider it more beneficial to give a greater say
proportionately to someone who has contributed more.
Roles of Directors
The Board of Directors are duty bound to oversee the company's management and all its business
affairs including the appointment of officers in the day-to-day running of the company.
In our closely-held company, owning shares in the company is a pre-requisition for board seats. Size
of shareholdings is not a deciding factor for a member to serve in the position of a director in this
quasi-partnership but the same requirement may change for companies of the group as the business
grows. Although the number of directors may be as few or as many as the number of shareholders, a
suitable number with each director having unique qualifications and experience may serve us better.
Other qualifications required for serving as a director, if any, can also be decided upon by our
members for laying down in the bye-laws of the holding company and member companies.
The Board is to hold regular meetings, but these may be done by telephone or telephoneconferencing without physical meetings, if written consent is given unanimously.
Conflicts of interest can occur when a director-shareholder makes an operational decision that
benefits him, but not all other shareholders. It is difficult to ascertain if he was acting in his capacity
as a director accountable to all shareholders; or acting as a shareholder and not accountable to his
fellow shareholders. Disclosure of decision making is important. A shareholder-director may be able
to make decisions without first reporting to other shareholders. By clarifying what a directorshareholder may or may not do without notifying the shareholders will prevent him from acting in
manner that is against the interests of other members. The way to ensuring no conflicts of interest is
to use a Shareholders Agreement to set out the role of a shareholder, and a director's service
contract to set out the role of a director. The Agreement by lying down situations on decision making
by director-shareholder will clarify when he may or may not do so without the consent of other
members.
A director's service contract should also serve as an employment agreement that sets out
disciplinary and grievance procedures. All executive directors are also employees. This gives
shareholder-directors additional rights over non-employed shareholders because an executive
director can threaten great disturbance and expense by taking the dispute to an employment
enforcement agency.
The Roles of Officers
Officers are responsible for the management of the company. In many closely-held companies, the
shareholders will usually elect themselves as officers and run the company with few corporate rules,
using their official positions only in formal situations. Running a company in a Wild-West style
management means that directors are completely hands-off, allowing officers to manage their
various departments without regard to formalities. It is not a recommended corporate governance
style. The company's by-laws will need to define the scope of duties of each managerial position
within the organisation. Without such regulatory provision, senior executives may choose not to give

management comprehensive details of problems they identified. Such internal control breakdowns
are breaking a cardinal rule of good corporate governance, depriving the Board of Directors critical
information it may need to fully assess the company's problems. It seems like a lot to ask for a small
closely-held company. Perhaps. But it is not. Because a small group of almost equal shareholders are
wearing many hats, it will be difficult to make changes once bad habits are in place. The growth of
the company with the inclusive of new shareholders and, probable public listings of its shares in a
major stock exchange may be hampered because of the initial improper planning.
Articles of Association (By-laws)
A company's Articles of Association serves as contracts between the company and its members, and
among the members themselves. The Articles govern every aspect from the conduct of board and
general meetings to the appointment of directors. They form the internal regulations governing the
running of the company - matters such as powers, obligations and rights of shareholders and
directors of the company. The Articles of Association is open to public viewing once filed with the
Registry of Companies. Hence, for all sensitive company details, we prefer to set them out in a
Shareholders Agreement.
The Articles of Association is also the place in which the corporation may opt in or opt out of very
important elective provisions under governing corporation laws of the choosing country (i.e.
Singapore or Hong Kong)
An Objects Clause
Companies may be formed for any lawful purpose. The certificate of incorporation should actually
state a broad catch-all lawful purposes clause -- a practice generally adopted by companies in past
years. This is to avoid limiting the company to acting in furtherance of the stated purpose, depriving
itself of business opportunities that may arise in the ensuing years. However, the Object Clause is no
longer required under the Hong Kong and Singapore laws. Some founding members may not be
comfortable investing in a business intended for too wide-ranging activities; businesses that may be
totally unrelated and considered speculative and risky. Stating the objects of a business in the
Articles may not be a bad thing. If a change is to be made at a later stage, it can still be amended by
a way of a Special Resolution i.e. 75% or more of the shareholders in a general meeting.
A word of caution: In some countries, laws do allow closely-held private companies (even if their
subsidiaries may be public-listed) to prevent the amendment of their Objects Clause. For instance,
The Articles of Association of furniture conglomerate - Ikea's Foundation in the Netherlands - and
registered as a public record, state that its Objects Clause cannot be amended. Even a Dutch court
can make only minor changes as its objects are cast in stone, figuratively speaking.
Board of Directors
Retirement by Rotation: Articles of some private companies may provide for directors to retire by
rotation. This provision is not always appropriate for small private companies as there is a chance
that this requirement may be overlooked. A failure to deal with it at an Annual General Meetings,
e.g. by re-electing the retiring directors, can lead to issues as to whether or not certain directors
may hold office.

Resignation: Some Articles permit a director to resign on his own accord by tendering his

resignation in writing. We opt for the requirement that a director resigns by agreement with the
company.
Some Articles may contain comprehensive provisions for the removal of directors. The quasi
partnership status of our company requires our consideration to restrict the Articles to authorising
removal of directors under the following circumstances:
A director shall be removed if he (i) is adjudged a bankrupt; or (ii) becomes incapacitated or of
unsound mind; or (iii) is convicted of an indictable offence or (iv) is disqualified under corporate laws
of a country.
Removal by the shareholders may be done by an ordinary resolution and that is how the Articles are
to be framed. Removal by the directors shall be done by resolution of the Board and directors are
expected to exercise this power bona fide in the best interests of the company and not out of ulterior
motives.
A person may be disqualified from acting as a director under relevant sections of corporate laws. A
disqualified director can have no involvement in its promotion, formation or management of any
company for the duration of his disqualification. This will also trigger automatic removal under a
company's Articles.
Share Capital
Authorized Shares: The authorised capital provisions (now abolished) were created in the days when
stamp duty was paid on registration of a company's memorandum. The amount of duty paid depends
on the amount stated as authorised capital. The higher the figure, the higher the duty paid. There is
now no stamp duty payable on authorised capital. So why place an artificial ceiling on share capital?
It is an unnecessary hurdle in its way! Shareholders can always agree among themselves to increase
a company's share capital.
Different classes of Shares: All private companies in Singapore and Hong Kong, including those that
are subsidiaries of public companies, are allowed to issue ordinary shares with no votes or any
number of votes per share.
Our company, as it grows to include new shareholders, can issue new ordinary shares with no votes.
Alternatively, we may prefer having a class of shareholders with special voting rights or preferential
treatment for payment of dividends or upon liquidation. Nevertheless, it is to be noted that If the
company creates different classes of stock, each member within the class must be treated equally - a
basic principle of corporate law. Each shareholder holding the same class of shares must be afforded
the same rights as all others in that class e.g. Ultimately, estate preparing is concerning comfort.
The procedure itself is extremely important and also could assist you create an excellent, strong
functioning plan that will deal with you, your kids, and also your properties in instance of your
fatality or handicap.each shareholder must be afforded a pro rata share of dividends and equal
voting rights.
In some closely-held companies, owners of the company may be given considerable freedom in
allocating their initial contributions between debt and equity, that is, between loans to the company
and purchase price for shares. We do not recommend having this arrangement as it can lead to
serious legal and accounting issues.
Injection of Capital: But we will authorise the issuing of preferred stock in our financing

arrangements with lenders. We will authorize the board of directors to issue preferred without
having to first seek the best site approval of existing shareholders. This financing option is a tool
that will empower the Board to broaden the capital base. Debt and equity can be combined.
Convertible debt, being a loan, can be converted to equity under circumstances specified in the
instrument. Preferred stock is preferred by financiers because it has some of the characteristics of a
loan. It pays a preferred annual dividend in a fixed amount. Moreover, in the event a company goes
bankrupt, the preferred stockholders (the bank) will get paid before common stockholders.
Loan agreements usually restrict what a company may do. It may not take on more debt or sell off
certain collateral. This gives the lender considerable power. There are added complications when
the lender is also a shareholder. Our Shareholders Agreement shall include provisions for changes of
rights if a large creditor-financier be introduced into the corporate scene.

There may be a need for our Articles granting a particular shareholder or group of shareholders
enhanced voting rights on a resolution to remove certain directors. For example, where a financier
in a company is given the right to appoint a director, the Articles may provide that the financier may
exercise ten votes for every share it holds on a resolution to remove him from office.
Employment Agreements for shareholders
Some closely-held companies use Shareholders Agreements to provide for employment of
shareholders as their officers and employees. We prefer using separate employment agreements
giving each employee-shareholder established terms of employment and provisions for rights of the
parties on termination. Employee benefits and share options that are not appropriately included in a
shareholder agreement can readily be included in an employment agreement. It may seem strange
to allow for termination when employees are shareholders, but there may be circumstances that call
for an employee-shareholder to leave the company.
An employee-shareholder will have certain rights which a general employee has, including those in
relation to unfair dismissal, redundancy and certain statutory rights to request flexible working and
time off for training. Every employee-shareholders will be protected from unfair dismissals, such as
those stemming from discrimination or events brought about by whistle-blowers. Existing employees
cannot be forced to take up employee shareholder status, but employers can choose to offer only
employee shareholder contracts to new joiners.
The Articles of Association is open to public viewing once filed with the Registry of Companies.
Hence, for all sensitive company details, we prefer to set them out in a Shareholders Agreement.
Management structures and corporate governance rules may be customized to suit closely held

companies and this may be done through the use of Shareholders Agreements. For this reason, this
document may be the best way to set out what a shareholder-director may or may not do in his role
as a shareholder; and a director's service contract to set out his role as a director.
Another purpose of the Shareholders Agreement is to restrict the freedom of action of the directors
and other shareholders to protect the rights of one or more minority shareholders. Such
identification of the interests of all parties is crucial and the protection of minority rights should be
upheld in the Agreement.
Approving a change in business direction:
Every business evolves, and over a period of time, it may change in its product lines or services
offered. It may choose to re-locate its business which calls for new management style in running the
business. Some changes may be more risky than others, especially when they involve shareholders
acting in apparently conflicting roles such as when they trade with a company with its majority
shares owned by a shareholder. A Shareholders Agreement should set out when approval of
members will be required for change of business transactions. The Agreement may also set out the
business directions in which approval of shareholders will be needed for all business plans produced
by the directors on a regular basis such as at an Annual General Meeting.
These procedures to be taken will enable us to form and organise a company but there is yet one
major step to be done for a working and long-lasting business arrangement. When there are two or
more shareholders in a closely-held company like ours, there should always be at hand a
comprehensive Shareholders Agreement to address the affairs of the company. With this in mind, a
Shareholders Agreement is also a contract among shareholders covering any corporate matter the
owners think should be included, not just how their shares should be voted and what restrictions
should be placed on them.
Management of the Company:
The Agreement stipulates the number of seats on the board given to each shareholder and set out
any company actions that will require a great majority or unanimous consent of the shareholders. In
our case, each shareholder gets one seat regardless of the amount of voting shares that he holds.
Shareholdings of the company:
The Shareholders Agreement shall provide rights of first refusal to buy out shares of departing
shareholders, such as death and disablement of a member. This would enable the remaining
shareholders to acquire those shares and retain control over the company; including the decision on
who will join them as new shareholders. Buy-outs will be funded with the purchase of key-person life
insurances to cover purchases on death.
- The Shareholders Agreement shall spell out rights of every shareholder to have his shares
transferred to family members such as his spouse or children in the event of his death. It shall also
list out circumstances if a shareholder may transfer shares to family members for other reasons,
such as estate planning.
- The Shareholder Agreement shall list out circumstances under which shareholders will have a
demand-purchase rights which enable existing shareholders to buy out other shareholder(s) or to
force the buyout of his or her shares.

Valuation of Shares:
Valuation of a private company is highly subjective. There are many ways to estimate its value such
as discounted cash flow or multiples of earnings methods; although it is impossible to put a definite
value on a company. Any value in its books of accounts is subjective opinions of the accountant or its
owner. When considering the protection of shareholder value, each shareholder may place more
value on some things than others.
Book value method may be a good measure of the company's worth of fixed assets and adequately
depreciated in its books. Moreover, a trading firm has few or no intangible assets that may be
difficult to place proper values on; hence, a book value valuation method may be suitable for our
purpose. That is one option which we can consider using.
Other options used by trading companies is the valuation method based on sales or earnings taken
over a period of time and the use of a proper multiple. It seems like a fast and easy method for
shareholders to use. However, a start-up has no earnings and little sales, therefore, such a valuation
method can only be used after the company has completed at least three years of operation.
In today's competitive business world, success requires an edge. It really comes down to the wow
factor that makes a company stand out in the crowded corporate world. In the context of forming a
lasting and coherent business partnership between like-minded people, the wow factor is to see how
a few individuals working from scratch is able to build and grow a business that lasted a few
decades. The writer himself saw how three young and highly motivated persons successfully built a
group of companies in the offshore marine business; building much from scratch and with little seed
capital. They made it into a multinational business empire listed on the Singapore stock exchange.
Today, these three grey-haired partners have retired from active management but remained bosom
friends. In the writer's opinion, much thinking and planning go into organising such a highly
successful company from the word - go. By paying close attention to all formalities of establishing
and operating a company, partners can overcome problems, sometimes unforeseeable ones such as
unannounced audit by the government agencies and misunderstanding that leads to disputes among
shareholders. At other times, events may threaten the company position as a going-concern or the
protections accorded to it by the corporate form of organisation.
If you are reading this article because you have in mind to start a business partnership -- we wish
you good luck. But luck enters the equation when you seize the moment in building a great
corporate structure from day one.
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Disclaimer
The writer makes no warranty of any kind with respect to the subject matter included herein or the
completeness or accuracy of this article which is merely an expression of his own opinion. The writer
is not responsible for any actions (or lack thereof) taken as a result of relying on or in any way using
information contained in this article and in no event shall be liable for any damages resulting from
reliance on or use of this information. Without limiting the above the writer shall have no
responsibility for any act or omission on his part. Readers should take specific advice from qualified
professionals when dealing with specific situations.
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