Copyright 2013 Jack M. Kaplan & Anthony C. Warren Setting Up the Company Patterns of...

Copyright 2013 Jack M. Kaplan & Anthony C. Warren

Setting Up the Company

Patterns of Entrepreneurship Management 4th Edition, Chapter 6

Getting Started

Chapter 6

Ownership

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Legal Issues

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Presentation Outline

• What form of Ownership is Best?

• Forms of Doing Business– Setting Up a Proprietorship– Setting Up a “C” Corporation– Setting Up a Sub. S– Partnerships– Setting Up a Limited Liability Company (LLC)

• Legal Issues

• Comparison Organization Charts

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What Form of Ownership is Best?

1. How big can the business potentially become?2. How much control do you need in the decision-making

process of the company? 3. How much capital is needed to start the business?4. What tax considerations are important? 5. In case of failure, to what extent are you willing to be

personally responsible for debts created by the business?

6. Is it important that the business continue in case of the owner’s incapacity or death?

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Ask yourself these questions:


Forms of Doing Business

The legal form of the business is selected from:

•Sole Proprietorship, •C-Corporation,•S-Corporation,•Partnership,•Limited Liability Corporation (LLC)

The form should be determined in light of the business’ short- and long-term needs’

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Sole Proprietorship

Overview:

A Sole Proprietorship has a single owner and only requires local business licenses to open.

Pros:

• Simple to create

• Low start up fees

• No special legal restrictions

Cons:

•Unlimited personal liability

•Limited access to capital

•Lack of Continuity for the Business

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Overview:• Separate legal and tax entity from owners.• Shareholder liability limited to invested capital.• Existence continues after shareholder’s death.• Best form for raising external capital.Pros:• Limited liability.• Most appropriate structure for an IPO.• Certain tax benefits and easy to provide stock option plans.• Ease of transferability of interests.• Structure that a venture capitalist requires.Cons:• Double taxation at the personal and corporate level once

profitable.• High administration compliance costs.• Directors are held personally accountable.• Well defined corporate governance rules and laws to follow.

“C” Corporation

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Registering a “C” Corporation

You must: • Register the name with a state.• Decide on the location of the

company’s principal office.• Obtain a federal employer ID number

SS-4.• Establish the capital structure of the

company.• Open a bank account with the ID

number and acquire a corporation seal.

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Small Business Corporation (Subchapter-S)

Overview:

• A corporation, but with “flow through” tax benefits to owners.• As a corporation, Sub-S is a separate entity and therefore has

limited liability for owners and stockholders.• Limited to 75 owners, only one class of stock allowed, and no

foreign shareholders.Pros:

• Liability protection.• Enjoy corporation status, but owners pay the taxes.Cons:

• Stringent rules necessary to maintain Sub-S status.• Qualification requirements bring administrative and cost

burdens.• Failure to comply with Sub-S rules, may have major tax

consequences.• Not eligible for qualified employee stock options.• Investors cannot receive preferred shares as in a C-

Corporation.

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Partnerships

Overview:

A partnership is usually defined as an association of two or more people carrying on as co-owners of a business for profit.

Pros:– Easy to Establish– Division of Profits– Ability to attract partners– Little Government Regulation

Cons:– Unlimited Liability of at least one Partner– Capital Accumulation not possible– Restrictions of Eliminating General partner– Potential for Personality and Authority Conflict

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Limited Liability Company(LLC)

Overview:• Owned by “members”, not shareholders.• A combination of the best characteristics of

corporations, partnerships, and sole proprietorships.Pros:• Liability protection (a separate legal entity as in a C

Corporation).• LLC is not a tax paying entity (tax benefits to members).• Statute meetings and minutes are not required.Cons:• Unlikely that a venture capitalist would invest.• Cannot take the company public.• Different shareholder interests result in complex

operating agreements.• All members must consent to transfer ownership.• Some states have different management and member

rules.• Often used initially before converting to a C Corporation,

which incurs costs.

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Choosing Legal Counsel

• Law firms handle a variety of legal matters, including corporate, intellectual property, and tax and employment issues.

• Attorneys often specialize in one of these areas.

• Look for firms that are experienced with start- ups from early stage to IPO.

• Avoid firms that deal primarily with large companies.

• Avoid attorneys that do more work with venture capitalists than start-ups.

• Seek recommendations and references.

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Setting Up the Board of Directors - 1

• Set the number of directors.

• Designate the initial board of directors.

• Determine whether the directors will be elected by a plurality of the vote or cumulative voting.

• Cumulative voting entitles each stockholder to cast the total number of votes multiplied by the total number of directors to be elected and insures the minority has representation of the board.

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• Establish a procedure to fill vacancies on the board.

• Designate the executive officers of the company.

• Determine whether the officers should be elected by the stockholders or appointed by the board.

• Determine each officer’s title and responsibilities.

Setting Up the Board of Directors -2

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• Subscription Agreements– Used for initial and subsequent capital contributions.

• Purchase and Sale Agreements– Used for purchase of operating assets.

• Employment Agreements– Given to senior executives.

• Confidentiality Agreements– Used to protect existing and in-process intellectual

property – for employees, and third parties.

• License Agreements– Covers any intellectual property that you use or license.

• Customer Agreements– Basis for delivery of services (service companies only).

Some Legal Agreements You May Require

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Employer –Employee Agreements

• The employee cannot disclose any confidential information about the company either during or subsequent to employment.

• They must return all materials that belong to the company at the time of termination of employment.

• They cannot engage in a new business during the period of employment without the consent of the employer.

• They will not compete with the company for a period of time subsequent to employment.

• Any new ideas they have must be assigned to the employer.

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Business Organizational Structure Comparison Chart

-1Characteristic C-Corp. S-Corp. LLC

Limited liability for all owners Yes Yes Yes

Owners can participate in management without losing liability protection Yes Yes Yes

Easy to form and without maintaining extensive record keeping Yes Yes No

Number of owners 2 or more 1-75 2 or more

Restrictions on ownership No Yes No

Double tax Yes No No

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Business Organizational Structure Comparison Chart

-2Characteristic C-Corp. S-Corp. LLC

Able to deduct business loss on individual return No Yes Yes

YesBasis for loss includes owner’s share of company debt in owner’s tax return No Yes

Can increase basis by “step-up” election Yes Yes Yes

Can specially allocate items of income and expense Yes Yes Yes

Contribute and distribute appreciated property tax free No Yes Yes

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Summary Guidelines

• The key issues to consider are liability, taxation, and corporate governance.

• The structure should be based on your goals and objectives.

• You should consider an LLC or a Sub S for a lifestyle/family business.

• If you plan to go public or raise venture capital, consider a C Corporation.

• Consider the advantages in registering a C Corporation in Delaware.

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Copyright 2013 Jack M. Kaplan & Anthony C. Warren Setting Up the Company Patterns of...

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