Why LLP is not the best business structure for your startup

Time and time again, I listen to people suggesting aspiring entrepreneurs and founders form a limited liability partnership (LLP) as their legal entity to start their entrepreneurial journey as a startup founder.  In my experience, creating an LLP may not be a good idea if you are an entrepreneur or a startup founder, especially if you are planning to fundraise in the future. Here are several reasons why.

What is a Limited Liability Partnership (LLP) in Malaysia?

A limited liability partnership is a business entity structure in which at least two parties (known as ‘partners’) decide to come together and form a business together. The preferred business tends to fall within the service space like professional services from accountants, lawyers, consultants, architects, and other types of services where a partnership tends to work best compared to a Sdn Bhd (private limited company). 

When it comes to personal liability, an LLP offers the same legal protection against personal assets like a Sdn Bhd (or a Sendirian Berhad, i.e. a ‘Sdn Bhd’).  Both LLP and Sdn Bhd gets taxed as a body corporate (i.e. the same tax treatment),

To me, LLP is, of course, better than a sole proprietorship (i.e. a business which is owned by an individual) but you cannot compare the LLP to the benefits of having a Sdn Bhd. I won’t get too much details on the benefits of a Sdn Bhd this time round as this post will get too long since I want to cover more about why LLP is not a good idea if you are planning to run a technology startup.

It will be hard for you to raise money from venture funds or investors

If you decide to fundraise, it can be hard for you to get monies. Financial and sophisticated investors like venture capital funds rarely invest in your business if you’re structured as an LLP. 

An LLP is an ‘unfamiliar’ investment structure and the usual investment instruments like ordinary shares or preference shares are non-existent in an LLP. In other words, an investor cannot have the legal protection provided in a Sdn Bhd like a priority over dividend or liquidation. Fundraising can be more difficult, and the whole process can put you in a bind if you’ve already operated a startup or a business using the LLP and receive payments from the entity.

Additionally, you should also carefully consider the fundraising challenges you will have when raising funds from investors. Although LLP is one of the two recognised legal entities apart from the plain vanilla Sdn Bhd to raise funds on an equity crowdfunding Malaysia, in practice, I have not seen any LLP raising funds on a campaign for several years now.  It is uncommon, and it can also be challenging and time-consuming when you have to explain to investors (which tend to be mostly retail investors) about why you decided to form an LLP instead. I mean, who’s got the time for that?

You need to get someone to become a compliance officer

Unlike a private company with a board of directors where directors (usually the founders) will be personally responsible for ensuring that the usual statutory duties of filing reports are satisfied, an LLP requires you to have a person designated as a compliance officer of the LLP instead. 

A compliance officer can be nominated among any existing partners in the LLP, or the LLP can appoint a licensed company secretary instead. In practice, company secretaries usually shun away from acting as a compliance officer as the duties can be onerous. You need to make sure that the necessary update is made to the online filing every time there is a partnership structure change.

As a compliance officer, you can be personally liable for fines and penalties if the LLP fails to submit statutory filings like the registrar’s annual declaration. So if you want to outsource this compliance officer role to a company secretary, expect to pay a monthly retainer to justify their trouble and liability. 

It doesn’t cost that much different to form a new Sdn Bhd nowadays

I know bootstrapped entrepreneurs and founders want to save money as much as they can on initial incorporation fees. For example, LLP formation incorporation fees payable to the company’s registrar tend to be significantly cheaper (around RM1000 to RM1500).  And anyone can form an LLP by logging in to the online MyLLP customer portal system. So LLP formation is usually preferred than a Sdn Bhd which generally costs between RM2800 to RM3500. But nowadays competition between corporate secretarial firms is getting fierce with the emergence of the new “digital company secretary” services offering cheaper rates.

It will be hard for you to sell your business

Anyone that wants to buy your LLP may get stuck because they cannot take over 100% of your LLP. Remember that an LLP requires at least two partners at all times. So if I decide to buy your LLP, I may have to find someone else to act as my ‘co-partner’ to acquire the LLP. 

The whole acquisition of an LLP can be messy. If I were acting as a legal counsel for the buyer, I might suggest that the buyer consider buying the LLP’s assets instead (which usually complicates things). Instead of purchasing the LLP entity, the buyer will then pick and choose the specific assets acquired and owned by the LLP by novating and assigning to the buyer.

You need a partnership agreement as soon as you’ve formed an LLP

In an LLP, there is no legal distinction between a shareholder and a director.  In other words, anyone who is a partner in an LLP is also a shareholder and a director. 

Suppose you want to vary or alter individual partners’ rights or obligations in an LLP. In that case, you need to put that in a limited liability partnership agreement (or partnership agreement in short form). For example, all partners can agree to nominate one partner to act as the ‘managing partner’ with specific duties in managing the LLP. 

By default, if you don’t have this partnership agreement in writing, all the partners must agree in writing if you want to decide on behalf on an LLP. What if a partner disagrees with a decision or refuses to sign the document? Sounds like a great disaster waiting to happen if there’s a deadlock.

You cannot ‘transfer’ an LLP to a new company

I keep hearing from time to time founders saying to me something like this: “Once I’ve got some funding I can ‘convert’ or ‘transfer’ my LLP to a new Sdn Bhd”.

Legally speaking, there is no legal mechanism for an LLP to be converted or transferred into a Sdn Bhd. Both LLP and Sdn Bhd are governed by two different laws. LLP is under the Limited Liability Partnership Act 2010, and a Sdn Bhd is one of the legal structures under the Companies Act 2016.

In practice, you can transfer your existing assets in the LLP to a new entity by selling business and assets transfer. The sale of business agreement needs to spell out clearly the list of assets in granular detail, including the fair value of the respective assets.

Closing an LLP is a nightmare 

I know this may not apply to everyone, but what if you decide to call it a day and get back to employment and shut down the business. Anyone who has gone through an LLP closure will tell you their regret of ever setting up one in the first place. 

Remember I mentioned earlier about being a compliance officer? Guess what. In practice, if you happen to be the compliance officer, you may be the one that ended up ensuring that the closure is done correctly including filing the required paperwork. Briefly, here are the steps needed:

  • Get a closure clearance letter from EPF, SOCSO and IRB 
  • Submit final tax return to IRB 
  • After getting IRB clearance notice to send notice of winding up to all partners in the LLP
  • Publish a notice of LLP closure in local newspapers to announce the winding-up declaration
  • If there’s no objection by a creditor or anyone against the LLP closure, Companies Commission will declare the LLP dissolution

Sounds like a nightmare to me. Of course, you can outsource the above work to a corporate secretarial firm (the fee is around RM4,50 to RM5,000 including the government filing fee and newspaper ads fee).  Corporate secretarial firms dread this because it’s time-consuming and not productive. I mean, who likes shutting down a business?

For all these reasons above, just stick to the basic. Spare yourself all these unnecessary headaches by forming a Sdn Bhd for your company and get back to work.