Legal Insights

When starting a business, most founders are primarily concerned with products, markets, funding, and customers. Relatively few spend much time considering which legal form of company they should establish. However, based on our experience handling corporate governance and shareholder disputes, the choice made at the time of incorporation can affect the company’s management structure, investment arrangements, and even the way future disputes between shareholders are handled for many years.

Many businesses focus only on completing the registration process at the beginning and simply adopt a standard form of articles of incorporation and company structure prepared by a registration agent. Problems often arise later, when the company begins to generate profits, brings in outside investors, or faces disagreements among its shareholders. At that stage, the original structure may no longer be suitable, and the dispute may eventually develop into lengthy litigation.

For this reason, understanding the legal consequences of different company structures before incorporation is often more important than the registration process itself.

What Types of Companies Are Available Under Taiwan’s Company Act?

Article 2 of Taiwan’s Company Act recognizes four types of companies:

1. Unlimited companies
2. Limited companies
3. Unlimited companies with limited liability shareholders
4. Companies limited by shares

In current Taiwanese business practice, however, the two structures most commonly used are the limited company and the company limited by shares.

This is because shareholders of an unlimited company, and certain shareholders of an unlimited company with limited liability shareholders, may still bear unlimited liability for company debts. These structures are therefore relatively uncommon in modern commercial practice. This article focuses on limited companies and companies limited by shares.

Limited Companies: Generally Suitable for Smaller Businesses with a High Degree of Shareholder Trust

A limited company is commonly used by:

• Family businesses
• Small and medium-sized enterprises
• Professional service firms
• Founders who intend to operate the business together during its early stages

One of the main characteristics of a limited company is limited shareholder liability.

Article 99 of the Company Act provides that each shareholder is liable to the company only up to the amount of his or her capital contribution. In other words, company debts are, in principle, payable from the company’s assets, and shareholders are not required to use all of their personal assets to satisfy those debts.

Another important feature of a limited company is its strong personal character. In practical terms, the identity of the shareholder matters, rather than only the percentage of ownership held.

For this reason, Article 111 of the Company Act provides that a shareholder who wishes to transfer his or her capital contribution to a person who is not already a shareholder must, in principle, obtain the consent of a majority of the other shareholders.

This arrangement has both advantages and disadvantages.

The advantage is that an unfamiliar outsider cannot easily become a shareholder, which helps preserve the stability of the existing management team and the relationship of trust among shareholders.

The disadvantage is that, when a dispute arises, a shareholder who wishes to leave the company may be unable to transfer his or her interest if the other shareholders do not agree. The shareholder may then remain trapped in a company that he or she no longer wishes to participate in.

In practice, many disputes involving limited companies arise precisely because a shareholder wishes to leave but has no effective way to exit.

Companies Limited by Shares: More Suitable for Fundraising, Expansion, and Business Growth

A company limited by shares may provide greater flexibility where a business intends to:

• Bring in outside investors
• Establish employee share ownership arrangements
• Obtain venture capital investment
• Increase the number of shareholders
• Pursue a future public listing

The main feature of a company limited by shares is that shareholders hold shares rather than capital contributions.

Article 154 of the Company Act provides that shareholders are liable to the company only up to the amount payable for the shares they have subscribed.

In addition, Article 163, paragraph 1 of the Company Act provides that the transfer of shares may not be prohibited or restricted by the articles of incorporation.

Shares are therefore, in principle, freely transferable. This gives a company limited by shares greater flexibility in the circulation of equity and makes the structure more suitable for investment and capital market transactions.

For this reason, many medium-sized and large enterprises, start-ups, and companies planning future fundraising or a public listing choose to operate as companies limited by shares.

Is a Limited Company Always More Suitable for a Start-up?

At the early stage of a business, many founders establish a limited company simply to avoid additional procedures, assuming that the structure can be changed later if necessary.

That approach is not necessarily wrong, but it is not suitable for every business.

For example, a company may originally have only two founders and therefore be established as a limited company. Several years later, the company may wish to bring in an outside investor, only to discover that the rules concerning equity transfers, capital increases, and corporate governance no longer meet its commercial needs. The company may then have to undergo a formal reorganization.

By contrast, some technology companies and start-ups establish a company limited by shares from the beginning, even when their operations remain small, because that structure is more suitable for future fundraising and equity incentive arrangements.

The choice of company structure should therefore not be based solely on the company’s present size. Founders should also consider the expected direction of the business over the next three to five years.

Can a Company Change Its Legal Structure?

Yes, but the process is not always as simple as expected.

The Company Act permits a company to reorganize its legal structure, such as by converting a limited company into a company limited by shares. However, the process involves more than obtaining the required corporate approvals and registering the change with the competent authority.

In practice, the conversion may also require:

• Adjustment of shareholder rights
• Changes to the roles of directors and managers
• Comprehensive amendments to the articles of incorporation
• Review of investment agreements
• Modification of bank financing documents
• Reassessment of tax arrangements

Where the company already has outside investors, loans, or important commercial agreements, a change in legal structure may also affect existing contractual relationships. All related legal documents should therefore be reviewed together, rather than treating the matter as a simple registration procedure.

Company Structure Is Only the First Step; Corporate Governance Is More Important

In practice, companies rarely enter into litigation solely because they selected the wrong legal structure.

More commonly, disputes arise over questions such as:

• How should ownership percentages be allocated?
• Who should serve as a director?
• What powers should the directors have?
• Must company profits be distributed?
• What happens when a shareholder wishes to leave?
• Should non-compete obligations apply?
• Can a shareholder require the company or other shareholders to purchase his or her interest?
• What happens to the shares when a shareholder dies?

Even where the company structure itself is appropriate, a failure to address these matters at the time of incorporation may later lead to disputes concerning the validity of shareholder resolutions, directors’ liability, ownership of shares, or control of the company.

For this reason, the articles of incorporation, shareholders’ agreement, and overall governance structure are often more important than the choice of company form itself.

Common Legal Disputes in Company Operations

A company is a separate legal person. Its organization, the rights and obligations of its shareholders, and the operation of its corporate bodies must comply with the Company Act and its articles of incorporation.

When courts review shareholder rights or corporate governance disputes, they will examine whether shareholder resolutions and board resolutions comply with the Company Act, the company’s articles of incorporation, and relevant administrative interpretations issued by Taiwan’s Ministry of Economic Affairs.

The fact that the shareholders believe a meeting was held, or that no one objected at the time, does not necessarily mean that the procedure complied with the law.

Accordingly, the articles of incorporation should be lawful and workable from the beginning. The company should also continue to observe the applicable corporate rules throughout its operations. If a dispute later proceeds to court, proper compliance and documentation will be essential for the company or shareholder to defend its position effectively.

Lawyer’s Perspective

Incorporating a company is not merely a registration exercise. It is the starting point for the company’s entire legal structure.

The Company Act provides different frameworks for limited companies and companies limited by shares. Each has a different governance structure, method of equity transfer, and legal effect. Neither is automatically better than the other. The real question is whether the chosen structure fits the company’s operational needs and future development.

In many shareholder disputes, the underlying problem is not that the business itself failed. Rather, the founders did not properly address ownership allocation, directors’ authority, shareholder exit arrangements, or the contents of the articles of incorporation at the outset.

Once the company becomes profitable, or the relationship among shareholders deteriorates, issues that initially appeared minor may develop into disputes over management control, directors’ liability, or litigation lasting several years.

Before establishing a company, founders should therefore not only select the appropriate legal structure, but also review the articles of incorporation, shareholders’ agreement, and governance arrangements as a whole. Early legal planning is generally far more effective than attempting to repair an unsuitable structure after a dispute has already arisen.