Corporate Law for Start-ups – Raising Funds from Multiple Investors in Malaysia
In a start-up’s life cycle, fundraising often involves the start-up company raising money by offering its shares to multiple investors including family and friends or even groups of angel investors, and not just once but over several subsequent rounds.
Issuing shares directly to multiple investors could very quickly result in scores of individuals being admitted as shareholders of the company. As Malaysia’s Companies Act 2016 restricts the number of shareholders of a private limited company to maximum of 50 members, a direct ownership in the company by early stage investors may inadvertently result in an ‘over-crowding’ of the members’ register.
Such over-crowding could result in logistical challenges of having to circulate documents to multiple signatories (who may be located all over the world), just to pass a members’ resolution. Also, an over-crowded members’ register may turn off prospective venture capital investors who may eventually insist for a restructuring of the company in order to ‘clean up’ the register.
In this article, we explore the different methods or vehicles that can be used by start-ups in Malaysia for multiple investors to invest into the company.
- Using a Public Company (known as a “Berhad”)
A Berhad is typically preferred for mid-sized to larger businesses which have plans to or are already preparing to offer shares to the wider public by listing on the stock market or otherwise. Unlike the usual private limited company, a public limited company has the advantage of having no maximum number of shareholders. Similar to a private limited company, the shareholders’ liability are also limited to the amount of unpaid capital in the Berhad.
However, using a public company either as the main business operating entity or an investment holding entity also means more stringent legal and administrative requirements apply. Among others, a public company must lodge a statement in lieu of a prospectus, have at least 2 directors, the director’s fees must be approved at the company’s general meetings, must hold annual general meeting (“AGM”) every year and must lodge the financial statements and statutory reports with the Companies Commission of Malaysia, which may not apply to a private limited company. The public company’s auditor must also attend the AGM where the financial statements of the company are being laid, so as to address any relevant questions arising.
In the long run, the ongoing costs required to administer a public company can potentially add up to a substantial amount, and may not be the most ideal option given that most start-ups are tight on cash flow at the early stage. The Companies Act 2016 also allows a private limited company to convert into a public company by way of a special resolution, but requires the leave of Court for a public company to convert into a private one.
- Using a Special Purpose Holding Entity
Alternatively, a separate entity can be incorporated as a special purpose vehicle (“SPV”) with its sole function being to subscribe, hold and deal with the shares of the startup company (ie, the main operational entity), on behalf of all the individual investors. The SPV may take the form of either a private limited company (Sdn Bhd under the Companies Act 2016) or perhaps a Limited Liability Partnership (LLP under the Limited Liability Partnership Act 2012). More information on these two types of entities can be found in this article.
When using an SPV as a holding entity, having a separate shareholders’ agreement at the SPV level is crucial to govern the rights of the various investors in the SPV, and also the exercise of their rights via the SPV as indirect shareholders of the start-up company. The shareholders’ agreement of the SPV should therefore provide for procedures and thresholds required for the investors to appoint a corporate representative, to regulate dealings in shares of the SPV or the start-up, decision making on matters relating to both the SPV and the start-up company (e.g, when pre-emption or tag along rights are triggered), access to information in the start-up company, rights to attend and vote at shareholders’ meetings of the start-up company and other matters.
A downside in using an SPV will be the administrative costs incurred by the investors as the SPV will also need to comply with the statutory requirements, such as filing of the annual returns and financial statements. Furthermore, some individual investors may also be reluctant to hold shares alongside other investors that they do not know, and to only owning an indirect stake in the company they wish to invest in.
- Using a Trust / Nominee Structure
The company may also consider setting up a nominee or a trustee arrangement to hold shares in the company on trust for multiple investors. However, this option may require the involvement of a professional trust company registered under the Trust Companies Act OR the appointment of an independent individual to act as the trustee.
Unlike the above option of incorporating an SPV to hold shares, there is no separate entity that needs to be created or maintained under a trust structure. Each investor enters into a trust agreement with the trustee, which records the investor’s beneficial ownership, rights and liabilities in the company’s shares (being the trust asset) held in the trustee’s name as the legal owner. Under a trust arrangement, the trustee will have the fiduciary duty to deliver the information in relation to the company to the investors, vote on behalf of the investors, account for all benefits and gains arising from the trust property, and safeguard the interests of the investors. In consideration of the services rendered by the trustee, a professional fee is usually charged.
- Equity Crowdfunding (“ECF”) Licensed by the Securities Commission of Malaysia
A start-up company can now raise funds from the general public through a licensed ECF operator, of which there were 6 such registered market operators in Malaysia at the end of 2018. After undergoing a due diligence exercise with the selected ECF operator, the start-up will create a fundraising campaign which has the benefit (over a private placement exercise) of a wider reach to a public audience once the ECF campaign goes live. Usually, the investee company would have pre-agreed with the ECF platform the terms of the issuance, such as the allocated equity (subject to a maximum of 30%), the minimum investment amount or ticket size (which could go as low as RM 10 per investment), as well as the duration of the fundraising campaign (a maximum window of 12 months is allowed).
Generally speaking, each licensed ECF operator will have its own arrangement which allows the investors to own an indirect interest in the investee company, be it through a trust agreement / professional nominee arrangement, a limited liability partnership or a special purpose company to hold shares of the investee company. In any event, the founders should familiarize themselves with the legal documents to have a better understanding on the underlying structure and the corresponding benefits that the investors can enjoy in the investee company, which will in turn help in managing the prospective investor’s expectations.
This article was written by Shawn Ho and Ee Lyne Chong. Shawn leads the corporate practice group of Donovan & Ho, which has been recognised as a recommended firm for Corporate, Mergers & Acquisitions by the Legal 500 Asia Pacific 2018. IFLR1000 has also ranked us a Notable Firm 2019.
Our corporate practice group advises on corporate acquisitions, restructuring exercises, joint venture arrangements, shareholder agreements, employee share options and franchise businesses, Malaysia start-up founders and can assist with venture capital funds in Seed, Series A & B funding rounds. Feel free to contact us if you have any queries.