Singapore is well-known for offering a favorable and welcoming environment to startups. Bolstered by supportive government policies and private funding, Singapore has emerged as Asia’s preferred business hub; its position has strengthened with the turmoil in Hong Kong. There are many reasons why foreign entrepreneurs decide to establish their business in Singapore. Read why Singapore has become one of the most desirable places in the world to launch a business. If you are planning to start a business venture in Singapore, see our comprehensive guide on incorporating a Singapore company.
A friendly environment isn’t enough to ensure success, of course. Often, entrepreneurs don’t take the incorporation process seriously and make mistakes that can be very costly in the long-term. By learning about them and planning carefully, you can save yourself a lot of trouble. This article will focus on 5 common mistakes to avoid when starting a new business in Singapore.
1. Not allocating equity equitably
Many businesses with two or more co-founders face the challenge of dividing startup equity fairly among founders. Very often they don’t give this issue much thought and simply divide the founder shares equally. Equity allocation among business partners should not be taken lightly, though there is no one correct formula when deciding how to make the split.
Often, startups divide equity equally to avoid uncomfortable conversations. This approach may no longer be appropriate when your business grows, and not addressing the issue upfront can lead to big problems in the future. An equal split might seem fair at first. But if roles change and the time and effort being devoted to the business by the co-founders differs, it is crucial to ensure that each founder has a stake in the business that matches these contributions. A partner’ role may diminish over time while yours may increase. A 50/50 split then doesn’t make sense if one partner is devoting far more energy to the company than another. The example of Bill Gates and Paul Allen is pertinent; Paul Allen left Microsoft very early and was not involved in its rise to a global powerhouse, yet he held the same equity as Bill Gates.
When launching a new company, you should realize that value doesn’t reside just in the money a partner injects into the enterprise. Their intellectual capital, experience, contributed physical assets, risks and responsibilities taken on, degree of commitment, and time invested in the startup also matter. Truly fair equity allocation may lead to an unequal split favoring the founder who has put the most into getting the new business started successfully. Equity should be split based on contribution to value creation. Therefore, think carefully about the long-term when dividing equity, as each equity percentage point could come at a high cost to those partners who receive less than their fair share.
To avoid an inconvenient situation arising in the future, it’s important to have an honest discussion with your partner(s) to clearly define what each of you brings to the table. Also, it is important to protect your interests using enforceable legal instruments, where you have a chance to clearly state responsibilities, and an equity stake that is equitable to each partner’s role and input.
2. Seeking large amount of funding too early
Seeking external funding for a startup is an exhaustive and time-consuming process. You should assess your funding needs carefully and wisely, and not raise more money than you need.
Seeking too much outside investment too early often means that you end up giving away an unduly large portion of your company’s equity to outside investors. The earlier you are in your company’s life, the lower its valuation will be. If a startup takes less funding at the beginning, then its co-founders will likely own higher percentages of their company when they sell.
Early investors take equity at a stage when your company has low value, so with each invested dollar they buy a larger stake than they would at a later date. Of course, no early startup will be able to forecast its burn rate perfectly, but you should try to carefully estimate your cash needs and raise funding accordingly. Another key strategy is to use debt instead of equity; in other words, borrow money instead of selling your equity. Jeff Bezos is the richest man on earth because he understood this logic very well. He was careful to not sell too much of his company’s equity early on. Instead, he borrowed money i.e. issued corporate bonds which did not dilute his stake.
3. Scaling up too early
Another common mistake is to try to scale up too early. Rapid market expansion, over-hiring, and expanding the marketing and advertising budgets are examples of premature scaling. This happens when your business expands much faster than your product or service is ready for. Scale iteratively in small steps. If your product or service is not quite ready, growing too fast can do serious damage to your brand and your financials.
Keep in mind that rapid growth does not always mean profitability. Early on, most startups sell their products or services at a loss in order to get market share and recognition. This math can go against you very quickly if you scale up your sales because each new sale means more losses! Validate your product or service strategy with a small set of trusted clients, clients who are ready to be beta testers and give you honest feedback. Use them to thoroughly test the thesis that your product or service has actually achieved its product-market fit, and to ensure that your operational and service capabilities are ready for a larger set of customers. Scale up only after that. A good case to learn from is Theranos; it scaled its operations well before its product was ready. To cover up the disconnect, it then had to borrow money, lie to investors, and cheat its customers. No wonder its founders are facing criminal prosecution now.
4. Not planning for tax implications of a successful exit
Founders cann’t time their exit perfectly. But not being prepared for it can be a costly mistake. Most founders do not consider the tax implications of an exit when they are just getting started. Preparing such a strategy will help you maximize your net take home gains from the sale by reducing your tax burden.
Think strategically and for the long term while planning your company incorporation; incorporate in a country that will provide the most efficient tax framework at the moment of exit. Early planning can help you define a business structure that will be the most efficient at the time of exit.
Keep in mind that your exit will result in capital gains. If at the moment of exit you are a tax resident of a country with high income capital gains tax rates, like in the US, your take home payout could be sliced in half. Therefore, consider locating your tax residency in a jurisdiction with low or no tax on capital gains. Singapore is one such country; capital gains are exempt from tax in Singapore. Consider two founders — one a tax resident of Singapore and the other of USA — who hold an equal stake in a company and then sell it for $100 million. The Singapore resident partner will take home $50m while the USA resident partner will take home less than $30m.
However, while planning any relocation you should be aware that some countries have an “exit tax”. This is a tax imposed on taxpayers who move their assets or tax residence out of their current tax jurisdiction. This tax is imposed by the government to ensure that a member state can tax the economic value of capital gains that have been created in its territory, even if the person has not yet realized those gains. For this reason, planning the relocation early is important so that your deemed capital gains taxes are low. In other words, exit when the value of your assets is low.
That is what Eduardo Saverin (one of the Facebook founders) did when he relocated from the USA to Singapore. He renounced his US citizenship, and has lived in Singapore ever since. He did so before Facebook’s IPO. He decided to give up his citizenship at a time when the value of Facebook shares was significantly lower than their post IPO price. Even though he paid millions in exit tax to the USA, the amount he paid was much lower than what he would have paid had he waited until after the IPO. He could have saved those millions too, had he relocated right before founding Facebook! But such clairvoyance is indeed rare.
Saverin has since invested in several Singapore-based startups and he has a strong interest in Asian markets. Any gains he makes from those investments will be completely free of capital gains, which would not have been the case had he remained a tax resident of the USA. Edward D. Kleinbard, a professor at the University of Southern California’s Gould School of Law, was right when he predicted at the time of Saverin’s relocation: “This definitely is going to reduce his tax burdens. He won’t be able to duck all of his taxes, but he will be able to avoid paying some charges he would have picked up if he had stayed a US citizen.”
Singapore is an attractive place for wealthy investors like Saverin, as it offers plenty of tax incentives, no tax on dividends, capital gains, or inheritance, and has one of the lowest corporate tax rates in the world. Singapore’s government has made significant efforts to attract foreign investment and expand the city-state’s extensive network of DTAs to ensure that a company doing cross-border business will not suffer any tax disadvantages.
5. Not considering a proper trust structure
A business structure frequently used by startups is to have co-founders own shares in their own names. However, another savvy strategy is to hold shares through a trust. Accumulating assets in a trust is an effective asset-protection strategy that offers a range of financial benefits in the long run.
A trust is a legal instrument operated by a trustee for the benefit of its beneficiaries. The most common trust structures for startups are a discretionary trust, family trust, unit trust, collective investment trust, irrevocable trust, and asset protection trust. A discretionary trust may be the most advantageous, allowing each founder to maintain shares in the startup without owning them personally. A discretionary trust empowers the trustee to decide on the distribution of the assets (i.e. to whom and when the assets should be distributed, and which portion of the assets are to be distributed). This structure offers great asset protection from creditors in case of a bankruptcy or lawsuit, because the assets of a discretionary trust are considered to be distinct from the assets of the beneficiaries of the trust.
The suitable trust structure depends on whether you’re transferring your shares or granting shares in a trust right at the company outset. Note that establishing a trust at the beginning is easier and less costly than transferring later, when your startup becomes more valuable.
Establishing a family trust and plan for intergenerational wealth transfer is another important consideration for those who may become HNWIx. Often, young founders don’t give enough forethought to late life considerations beforehand. With a forward-looking plan, a founder can ensure a seamless transition of assets to his or her heirs and optimize the tax payments.
Another strategy is to transfer your assets to a special tax-sheltered retirement account. For instance, Peter Thiel, co-founder of PayPal, actually grew his tax sheltered assets to USD $5 billion by investing his PayPal shares at a low value to his Roth individual retirement account (IRA), well before the company had its meteoric rise. Because of the tax-favorable withdrawal policies of a Roth IRA, he will never have to pay a penny of tax on those billions, as long as he waits until after the age of 59 and a half.
Keep in mind, Singapore has no inheritance tax (yes zero!) while the USA has an inheritance tax of 40%, which is likely to rise even further under the new tax plan proposed by the Biden administration.
Final thoughts
Setting up a new business in Singapore is a wise choice. It will automatically mitigate against some of the mistakes described in this article. However, a clear understanding of the likely mistakes founders can make will enable them to come up with mitigation strategies. If you need expert advice or guidance with launching your startup in Singapore, our corporate services team is ready to help you. Contact us.
About CorporateServices.com
Headquartered in Singapore, CorporateServices.com, empowers global entrepreneurs with information and tools necessary to discover Singapore as a destination for launching or relocating their startup venture and offers a complete range of company incorporation, immigration, accounting, tax filing, and compliance services in Singapore. The company combines a cutting-edge online platform with an experienced team of industry veterans to offer high-quality and affordable services to its customers. Contact Us if you need assistance with setting up a new Singapore company or if you would like to transfer the administration of your existing company to us.
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