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Choice of Legal Structure by Technology and Internet Start-ups

Q: Why the liability risk of a technology start-up is a significant consideration?

A: The liability risk of a business can be divided into insurable and uninsurable risks. Insurable risk is like employee's injury in the course of his work. An employee's compensation policy can cover this area of liability. Some risks are uninsurable. This includes the economic risk of technology start-up which business or business model is likely to be adventurous and innovative. For example, a voice over IP telecommunication business is highly subject to such type of risk.

Q: In what situation a technology or Internet start-up may not need a separate legal structure in operating its business?

A: A 'garage-stage' start-up may be in its primitive stage and does not easily attract outside liability, as transaction volume is pretty small. Therefore, choosing a limited company as a business vehicle may not be necessary. Such a garage business can thus be operated in the form of sole proprietorship or partnership.

Q: How is business risk related to legal structure?

A: Insurable risk can be covered by insurance. The exposure to uninsurable risk is covered, inter alia, by choice of a suitable legal structure. A limited company is a typical choice of vehicle to minimize the risk exposure of the personal liability of the shareholders.

Q: Under what circumstances personal liability of the shareholders or directors will arise?

A: Shareholders who do not take part in the business operation will not be exposed to any further liability risk beyond or over their capital agreed to be paid-up. A limited company serves the purpose of limiting the economic risk of the shareholders. Directors take part in business decision and management. The law imposes obligation on them that they have to exercise reasonable skill and care in operating the business of the company. They also owe to the company the fiduciary duty. This includes the duty not to make secret profit.

Q: What legal structure is preferred if equity financing is required from venture capitalists?

A: A technology start-up aims at obtaining equity financing from parties (like venture capitalist) not currently principals of the business must consider adopting limited company as a legal entity. A legal entity separate from the shareholders and the management provides greater flexibility in dividing its equity. If the business is financed by the principals' own savings or through conventional bank financing such as loans secured on fixed assets, having a separate legal entity is less of a concern. This is because when the borrower is a limited company, a bank requires the directors to enter into personal guarantees in any event.

Q: Should a technology or Internet business always use limited company as its legal structure in operating its business?

A: A business is not necessarily limited to one business entity or one type of legal structure. It can benefit optimally by having a combination of legal structures. For example, its author or inventor can personally own the copyright or patent of a technology start-up. The author or inventor may for a price license the intellectual property rights to a limited company which is owned by the author or inventor in equity. The company then uses the granted rights to have the intellectual property rights commercialised and marketed for profit.

Growth Enterprises Market (GEM) in Hong Kong

Growth Enterprises Market (GEM) in Hong Kong
(Source: GEM, HKSE)

As a gateway to Mainland China and with close trading and business links to other Asian economies, Hong Kong is strategically placed in a high growth region. Over the years, Hong Kong has developed into an internationally recognised financial centre and has provided many Asian and multinational companies with fund-raising opportunities. Growth enterprises particularly those emerging ones, i.e. enterprises that have good business ideas and growth potential, however, may not always be able to take advantage of these opportunities. A great number of them do not fulfil the profitability/track record requirements of the existing market of the Stock Exchange of Hong Kong ( i.e. main board of the Exchange ) and are therefore unable to obtain a listing. The Growth Enterprise Market (GEM) is designed to bridge this gap.

GEM offers growth enterprises an avenue to raise capital. The Growth Enterprise Market does not require growth companies to have achieved a record of profitability as a condition of listing. This removal of entry barrier enables growth enterprises to capitalise on the growth opportunities of the region by raising expansion capital under a well-established market and regulatory infrastructure. Besides the listing of local and regional enterprises, international growth enterprises can enhance their business presence and raise their product profile in China and Asia by listing on GEM.

GEM offers investors an alternative of investing in "high growth, high risk" businesses. The future performance of growth companies particularly those without a profit track record is susceptible to great uncertainty. Because of the higher risks involved, GEM is designed for professional and informed investors. It works on the basis of caveat emptor or buyers beware.

GEM provides a fund raising venue and a strong identity to foster the development of technology industries in Hong Kong and the region. GEM is opened to growth companies big and small engaged in all industries. Technology companies in particular should find it attractive to align themselves with the strong growth theme of the market. In providing a fund raising venue and a strong identity to technology companies, GEM complements and supports the HKSAR Government's initiative to promote the development of technology industries in Hong Kong.

GEM promotes the development of venture capital investments. GEM provides both an exit ground and a venue for further fund raising for investments made by venture capitalists. This facilitates more and earlier investments to be made by the venture capitalists in support of the growth of the industry.

(Source: GEM, HKSE)

NASDAQ in USA

Since its inception in 1971, The NASDAQ Stock Market has been the industry innovator. Introduced as the world's first electronic stock market, Nasdaq long ago set a precedent for technological trading innovation that is unrivaled.

Now poised to become the world's first truly global market, The Nasdaq Stock Market is the market of choice for business industry leaders worldwide. By providing an efficient environment for raising capital, Nasdaq has helped thousands of companies achieve their desired growth and successfully make the leap into public ownership.

www.NASDAQ.COM

Enquiries and Complaints to Equal Opportunities Commission

The Equal Opportunities Commission (EOC) is a statutory body established under the Equal Opportunities Ordinance.

Its operation is funded by the Government. Businesses are entitled to seek advice and consultation with the EOC regarding matters arising from observance or compliance of the discriminatory legislations. 'Prevention is better than Medication' is the best motto when handling discrimination legislations. Looking for advice from the EOC is not subject to any payment of a fee.

Sexual Harassment

Sexual Harassment

Sexual harassment in workplace is governed by the Sex Discrimination Ordinance (SDO).

Harassment

In addition to sexual harassment, other types of harassment have also been found to violate the law. Employees who are harassed because of their disabilities may have a claim under the Disability Discrimination Ordinance.

Types of Sexual Harassment

Employers have an affirmative duty to maintain a workplace free of harassment, including sexual harassment, but are not strictly liable for harassment. Liability depends on what the employer has done to prevent harassment and the remedial measures taken after harassment occurs. An employer's liability will depend upon the facts and circumstances surrounding each claim. The concept of sexual harassment gives rise to two types of unlawful sexual harassment:

When an employee risks losing or not receiving some tangible job benefit based on whether the employee accepts unwelcome sexual advances.

When the working environment is oppressive to an employee because of the actions of coworkers, supervisors or customers.

The SDO has its own definition of sexual harassment. The SDO definition includes unwelcome sexual advances, requests for sexual favors and other verbal or physical conduct of a sexual nature.

Duties of Employers

Employers have a duty to take all necessary steps to prevent sexual harassment and other forms of illegal harassment. This includes affirmatively raising the subject of sexual harassment with management and employees, expressing strong disapproval of it, developing appropriate sanctions for it, informing employees of their rights under the law and sensitizing employees to the problem of harassment. The mere fact that an employer has a policy against harassment in the workplace is not enough. The policy must be communicated to employees, and then management must act to eliminate the harassment when it occurs. When sexual harassment is discovered, effective corrective action must be taken swiftly and decisively by the employer. Effective corrective action restores the victim to a "non-harassed" state, and prevents the misconduct from recurring.

Steps to Prevent Claims

To help ensure your company is not subjected to a claim of sexual harassment, the following steps are recommended:

Establish a clear non-discrimination policy that makes all forms of harassment, including sexual harassment, unacceptable in the workplace. This policy should be regularly reviewed and updated, and disseminated to all current and newly hired employees

Establish a grievance procedure so that employees understand how to bring complaints of harassment to the surface. Make sure than anyone who is alleged to have directly or indirectly participated in the harassment is not involved in the grievance procedure.

The grievance procedure should protect the confidentiality of both the alleged victim and the harasser. It may also be appropriate to provide for a process of appealing the decision of the initial grievance mechanism to some higher management authority.

Fully investigate any allegation of sexual harassment, or any situation where you believe harassment may have occurred. Document the steps taken in your investigation and conclusions that no harassment occurred.

If no disciplinary action is deemed appropriate after the investigation, at a minimum, reestablish a policy against harassment and demonstrate disapproval.

If corrective action is deemed necessary, make sure that it is full and complete and ends the misconduct. Follow-up on the results of the corrective action should be continued until it is clear that the misconduct has been eliminated.

The law on all forms of harassment is sure to evolve over time. Consult your lawyer to make sure that your company manuals, policies, guidelines and practices are adequate to avoid claims of harassment.

Remember that it is not enough just to have these policies, they must be vigorously enforced by management to be meaningful under the law.

Mandatory Provident Fund Schemes (MPF Schemes)

The Mandatory Provident Schemes Ordinance is now effective. An Employer is required to arrange all his relevant employees to join a registered MPF scheme. Please note the legal significance on complying the laws. In some cases, failure to comply is a crimimal offence. Please read the relevant news .

Responsibilities

An Employer is required to make arrangements for relevant employees aged between 18 and 65, who have been employed for 60 days or more, to join a registered MPF scheme (except those who have attained age 64 at the commencement of the exemption provision in the Ordinance).

Employees employed under one employment contract for 60 days or more, whether working full-time or part-time, will be covered by the Ordinance.

An Employer may select one or more MPF schemes available in the market and make arrangements for relevant employees to become scheme members. An Employer is required to display the participation certificate issued by the MPFA.

An Employer is required to calculate individual employee's income and amount of contribution for each contribution period, deduct the relevant mandatory contribution from the employee's relevant income, and pay the employer's contribution, from the Employer's own funds, for the employee's benefit.

An Employer must provide each employee with a monthly pay-record showing the employee's relevant income and the amount of contribution. However, if an Employer is the employer of a casual employee participating in an industry scheme, the Employer does not need to comply with this requirement.

An Employer must pay the total mandatory contributions to the trustee of the scheme on or before the contribution day which is the 10th calendar day after the last day of the relevant contribution period. To put it simply, if an Employer pay monthly wages or salaries to employees on the last day of each month, the contribution day falls on the 10th calendar day following the pay day.

When remitting the payment, An Employer must provide the trustee with a remittance statement showing the relevant income and amount of contribution of each relevant employee.

If an Employer are the employer of a casual employee and an Employer has enrolled the casual employee in an industry scheme, the Employer must pay the total mandatory contributions to the trustee of the scheme on or before the contribution day, i.e., either :

the 10th calendar day after the last day of the relevant contribution period; or

the day on which the relevant income for the relevant contribution period is paid to the casual employee. In other words, the contributions should be paid to the scheme trustee on the pay day. However, when remitting the payment, the Employer does not need to provide the trustee with a remittance statement.

Tax Concession

An Employer MPF contributions are profits tax deductible, provided that the deduction does not exceed 15% of employees' total emolument. Visit the link of Related Tax Implications to know more details.

Cessation of Employment

When an employee ceases employment, an Employer should assist the employee to complete an election form in transferring the accrued benefits derived from mandatory contributions in the MPF scheme to another MPF scheme, or to another account in the same scheme.

An Employer cannot claw back any benefits accrued from the mandatory contributions previously made by an Employer for the employee's benefit.

Offsetting of Severance and Long Service Payments

An Employer can offset the long service payment or severance payment as required under the Employment Ordinance out of the accrued benefits derived from the contribution an Employer have made to the employee in the MPF scheme. An Employer can apply to the trustee to deduct a relevant amount for this purpose for payment to a leaving employee.

For example, if the benefit accrued from the employer's contribution is $55,000 and the amount of long service payment is $80,000, then an Employer can apply to withdraw $55,000 from the employee's MPF account for (partial) payment, and pay $25,000, from an Employer own funds, to the leaving employee.

As a further example, if the long service payment is only $40,000, an Employer can only request the trustee to pay $40,000 to the leaving employee. The remaining accrued benefits, viz., the balance of $15,000 derived from the employer's contributions, together with those derived from the total contribution made by the employee, have to be transferred to the MPF account designated by the employee and preserved until the employee retires.

Please note that in offsetting long service payment or severance payment, an Employer will need to follow other requirements set out in the Employment Ordinance concerning such payments.

Employees' Compensation and Employers' Negligence

To protect employees, Hong Kong has established workers' compensation laws so that employees can receive compensation from the employer for work related injuries. Although the amount that can be is limited, a worker can be compensated regardless of whether the business was negligent. These law (the Employee's Compensation Ordinance) provides that the employee need only prove that the injury arose in the course of employment. This concept is construed very broadly.

Awards to Employees

Worker's compensation rules generally provide that the employee can recover only the cost of medical treatment and lost wages. In serious cases in which the Board of Assessment has assessed that the injured worker has suffered from a certain percentage of loss of earning capacity, the injured workers can collect an amount to compensate for his or her impaired future earning capacity.

Insurance

The Ordinance establishes what an employer must do to provide adequate workers' compensation benefits. The employer is required by law to purchase workers' compensation insurance. The insurance premiums are usually based on factors such as the industry, the types of jobs involved, and the size of the payroll. More "accident prone" employers pay higher rates.

Businesses do not need to purchase workers' compensation coverage for true independent contractors . If you are a sole proprietor, you probably are not covered by your workers' compensation insurance. Workers' compensation does not cover self-employed, name sole proprietors and partners. Sole proprietors and partners therefore have to take out insurance policy normally through a life insurance agent to cover their loss of income due to disability. While it is not necessary for the small business owner to know every workers' compensation rule, care should be taken to work with an insurance agent who is familiar with the laws. An insurance agent can also help determine the appropriate amount of coverage and provide guidance additional employee related coverage that may be necessary in situations not covered by workers' compensation laws.

Negligence Claims on Workplace Injuries

While employees' compensation laws prevent the collection of damages for pain and suffering, loss of amenities, common law allows workers these claims based on the employer's negligence.

An injured worker can sue his or her employer on common law for work related injuries if the business owner was negligent. Common law sets out that the employer owes a duty of care to his fellow employees. This include: safe workplace, safe and proper tools and apparatus, proper co-workers. Compensation paid to the workers out of employees' compensation paid under the Employees Compensation Ordinance will be set-off from the negligence claim. An employee's compensation insurance policy normally covers this area of employer's risk.

Elements to Determine 'Employee' and 'Independent Contractor'

Proper classification of an individual as an "employee" or "independent contractor" is critical. While the ultimate classification is a matter of common law principles as to whether the worker is subject to the control and direction of another only as to the result of his work (an independent contractor) and not as to the means (an employee), the following factors can help to determine the proper classification. Please note that these are for references only and are by no means conclusive:-

1. Instructions to worker - A worker that is subject to instructions about when, where, and how to work is usually an employee.

2. Training - An employee is more likely to be subject to training than an independent contractor.

3. Integration into business operations - The greater the integration of a worker's services into the business, and thus the greater the business' control, tends to reflect an employment relationship.

4. Requirement that services be personally performed - The greater the flexibility given the worker to designate who may perform services favors an independent contractor classification.

5. Hiring, supervising, and paying for a worker's assistants - If the business provides assistants to the worker, as opposed to the worker providing his or her own assistants, this may indicate that the worker is an employee.

6. Continuity of the relationship - Continuing, "on call" or similar long-term relationships, even if part-time, support classification as an employee.

7. Setting the hours of work - An independent contractor usually sets his own work hours.

8. Requirement of full-time work - Independent contractors, unlike employees, do not normally work full-time for one business and are free to work when and for whom they choose.

9. Working on employer premises - If the business requires work to be performed at its offices, this indicates control over the worker (if the work could be done elsewhere).

10. Setting the order or sequence of work - Independent contractors generally enjoy greater freedom to follow their own pattern of work routines and schedules.

11. Requiring oral or written reports - Regularly required oral or written reports usually reflect an employee relationship.

12. Paying worker by hour, week, or month - Employees are normally paid hourly, weekly, or monthly, while independent contractors are usually paid by the job or on a straight commission basis.

13. Payment of worker's business and/or traveling expenses - This factor reflects a business' effort to control its expenses through an employee.

14. Furnishing worker's tools and materials - Employees are normally provided necessary work tools and materials, independent contractors tend to furnish their own.

15. Significant investment by worker - Employees are normally provided the requisite facilities by their employer, while independent contractors usually invest in and maintain their own work facilities.

16. Realization of profit or loss by worker - A worker who can realize a profit or suffer a loss as a result of his services is generally an independent contractor. Of course, some employees may also realize a profit or suffer a loss, as a result of profit sharing plans or investments in the company. In that case, the IRS will examine whether the worker's profit or loss opportunities are different from an employee's.

17. Working for more than one business at a time - Employees usually work for only one company, while independent contractors frequently work for more than one business.

18. Firm's right to discharge worker - An employer exercises control over its employee through the threat of dismissal, while independent contractors normally cannot be dismissed so long as they meet their contractual obligations.

19. Worker's right to terminate relationship- Employees are usually entitled to quit at their leisure, while independent contractors generally must fulfill contractual obligations.

20. Availability of worker's services to the general public - If the worker usually makes himself or herself available to the public to perform services, he or she is more likely an independent contractor.

The penalties for mis-classification under tax and other laws are severe and may, in some cases, create personal liability for the individual that has established the employment relationship or was a responsible party for deducting and withholding contribution to the MPF Scheme. Use caution in making the employee/independent contractor classification, and consult a solicitor for advice.

Other factors should be considered to determine whether an individual should be retrained as an employee or independent contractor. For example, it is much easier to dictate to and control the work of an employee. The employee is usually at the employer's offices throughout the work period and work can be more easily monitored. Also, the employee is more likely to develop some loyalty to the employer and is less likely to leave for another position. However, independent contractors may be freely terminated if the work is not satisfactory. With true independent contractors, there is no cost for employment taxes and fringe benefits.

Caution

If you are considering the hiring of one or more individuals to perform services for your business or organization, you should consider the benefits and features involved in making that individual an employee or, alternatively, an independent contractor. Make sure that if you choose to make someone an independent contractor, that he or she is truly not an employee under the law.

Employees Compensation, Mandatory Provident Schemes Ordinance, Taxation, Employment Ordinance and Discrimination

Under the Employees Compensation Ordinance, an employer is required to purchase an insurance policy for injuries happened in the course of employment. The failure to purchase such a policy is a criminal offence and can lead to criminal prosecution by the Labour Department.

Under the Mandatory Provident Schemes Ordinance, "employers" (which may include for profit and not for profit companies, individuals, schools, government agencies and other entities) are required to deduct and withhold from their "employees" a percentage of wages to be paid to the trustee of the MPF Scheme. The employer is also required to make contribution a certain percentage of the wages out of his own fund for the employee's benefits.

As to taxation, if an employee owes to the Inland Revenue Department any unpaid salary tax, the employer shall upon receipt of a notice of the Commissioner of Inland Revenue deduct and withhold the relevant amount of tax due and unpaid and have the same paid out to the Hong Kong Government. Employers who fail to properly deduct and withhold the appropriate amounts and pay them over to the Commissioner as demanded can be subject to a variety of penalties and interest charges for unpaid amounts.

Classification of an individual as an employee will also affect whether the hiring party is subject to Employment Ordinance which has provisions governing the employer's obligations or responsibilities regarding public holidays, maternity leaves, sick leaves, severance payment, dismissal etc. Other relevant laws include the anti-discrimination statutes under the Equal Opportunity Ordinance, the Disability Discrimination Ordinance, Sex Discrimination Ordinance and Family Status Discrimination Ordinance.

Starting and Running a Business

A start-up has to engage and pay services of others. The service providers can be an individual or a corporation. There are different consequences in respect of the status as an "employee" or an "independent contractor". Basically, the laws impose more onerous burden on an employer on his or her employees.

The obligations of an employer can be found in a number of statutes. A business owner must make himself familiar with provisions under the Employment Ordinance, the Employees Compensation Ordinance, the various anti-discrimination legislations (in particular, provisions regarding sexual harassment in the Sexual Discrimination Ordinance), the Mandatory Provident Fund Schemes Ordinance and an employer's duty of care towards his fellow employees under common law. In addition, there is the Personal Data (Privacy) Ordinance which governs the collection, use, process and access of personal data identifiable with a living individual. The list is by no means exhaustive.