Structuring Your Business from Startup Through Growth

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Goals

• Understand Pre-Formation Issues • Learn About Available Entity Forms • Understand Advantages & Disadvantages • Walk Through Real World Application

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Pre-Formation Issues

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Founders’ Agreements

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Founders’ Agreements

• Who Owns the Idea • Roles and Responsibilities • Decision Making and Operations • Ownership and Vesting • Departure and Transfers • Competition with the Business

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What is an Entity?

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Why Form an Entity?

• Limited Liability • Permit Transfers of Economic Interests • Perpetual Existence • Facilitate Investment • Allow Multiple Owners • Enhance Credibility

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Entity Considerations

• Size of Business • Partners and Investors • Transferability and Continuity • Liability • Taxation • Financial Considerations

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Size of Business

• Administrative Ease • Costs of Formation

– Monetary Costs (Filing Fees) – Non-Monetary Costs (Compliance)

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Partners and Investors

• Identity and Number • Management and Control • Divergence of Interests

– Exit Strategies – Growth or Distribution – Life Situation

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Transferability and Continuity

• Effect of Partner Exit • Dissolution of Business • Consider the End at the Beginning

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Liability

Bank Loans Third Parties Product Liability

• Unlimited Personal Liability v. Limited Liability • Exception: Piercing the Veil

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Taxation Pass Through Taxation v. Double Taxation

You Keep $16! Multiply by 10, 100, 1000, etc.

Pass Through Taxation Double Taxation

Income $100 $100 Entity Tax (20%) $0 $20 Distribution $100 $80 Personal Tax (20%) $20 $16 Take Home $80 $64

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Financial Considerations

• Effect of Entity Choice on Capital Raising • Effect of Capital Raising on Entity Choice • Ongoing Compliance Requirements • Consider the Legal Issues and Document

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Available Entity Forms

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Overview of the Entity Choices

• 6 different options: 1. Sole Proprietorship 2. General Partnership 3. Limited Partnership 4. ‘C’ Corporation 5. ‘S’ Corporation 6. Limited Limited Company

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Sole Proprietorships and General Partnerships

Most common form of conducting business • Formation: Easy to incorporate. No

formalities unless a fictitious name is intended to be used

• Personal Liability: No corporate shield • Limited Existence • Tax: All income earned treated as income of

the owner

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Sole Proprietorships and General Partnerships

• Management: Owner free to manage the way he desires

• Low Maintenance Cost: No record keeping • Desirable for businesses with low investment

and limited assets • Not desirable for multiple owners or high

potential liabilities • Partnerships not desirable for spouses as

partners are jointly and severally liable to creditors

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‘C’ Corporations

• State law creation • Independent legal entity • Separate legal existence • Incorporation costs: Statutory compliance • No restrictions of number of stockholders • Administrative formalities – Why is this an issue?

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Management Structure

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Corporate Veil: Provides for liability shield

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Lifting the Corporate Veil

Tax: Double Taxation

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‘S’ Corporations

• An IRS creation for tax purposes

• Hybrid between ‘C’ Corporations and Partnerships

• Same characteristics as a ‘C’ Corporation

• Suited for small businesses

• Form can be changed

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‘S’ Corporations

Differs from ‘C’ Corporation: (i) Ownership Structure: Only up to 100 shareholders. Limited to individual US residents and certain trusts (ii)Tax Treatment: No Double Taxation

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Limited Liability Company

• Hybrid Entity: Corporation and Partnership • One or more partners • No restrictions on the number of owners • Easy formation • Flexible management structure

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Limited Liability Company

• Limited Liability • Piercing the corporate veil • Low Maintenance Cost: Not required to convene

periodic meetings or maintain records • Tax: Flow Through Treatment

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Advantages & Disadvantages

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Introduction Sole Prop GP C Corp S Corp LLC

Owner Numbers & Types

1 ≥ 2 ≥ 1; multiple classes permitted

≤ 100; US residents, certain trusts

≥ 1

Liability Personal liability

Personal liability

Limited liability Limited liability Limited liability

Management Owner No restriction Shhds Board Officers

Shhds Board Officers

Member or Manager (very flexible)

Tax Personal rate Pass-through Double taxation Pass-through; must file IRS election

Pass-through or C-Corp or S-Corp

Formation Issues

Register with State

No filing req File Cert. of Incorp.; Form Board; Issue Stock; Adopt Bylaws

Same as C Corp; Must File IRS election for pass-through tax treatment

File Cert. of Org.; Operating Agreement recommended

Transferability Transfer by selling assets

Consent of all partners (subject to PA)

Flexible; Shhds Agreement Restrictions

Same as C Corp; comply w/ IRS reqs

Flexible; Operating Agreement Restrictions

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Advantages: Easy To Form & Operate! Profits Taxed Only Once Control

Disadvantages: Unlimited Liability Ceiling on Ownership Difficult to Raise Capital

Sole Prop.

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Advantages: Easy/Cheap to Form & Operate! Profits Taxed Only Once

Disadvantages: Floor on Ownership Control Liable for Partners Limited Transferability

General Partnership

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Advantages: Access To Capital Limited Liability Opportunity to “go public” Transferability of Interests

Disadvantages: Taxed Twice Complex & Costly to Form/Operate

C Corporations

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Advantages: Profits Taxed Only Once Limited Liability Transferability of Interests

Disadvantages: Complex & Costly to Form/Operate Limited to 100 shareholders Raising Capital is tougher

S Corporations

100

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Disadvantages: Limited Transferability of Interest

LLCs Advantages: Management & Control Limited Liability Profits Taxed Once Easy To Form & Operate!

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Review Sole Prop GP C Corp S Corp LLC

Owner Numbers & Types

1 ≥ 2 ≥ 1; multiple classes permitted

≤ 100; US residents, certain trusts

≥ 1

Liability Personal liability

Personal liability

Limited liability Limited liability Limited liability

Management Owner No restriction Shhds Board Officers

Shhds Board Officers

Member or Manager (very flexible)

Tax Personal rate Pass-through Double taxation Pass-through; must file IRS election

Pass-through or C-Corp or S-Corp

Formation Issues

Register with State

No filing req File Cert. of Incorp.; Form Board; Issue Stock; Adopt Bylaws

Same as C Corp; Must File IRS election for pass-through tax treatment

File Cert. of Org.; Operating Agreement recommended

Transferability Transfer by selling assets

Consent of all partners (subject to PA)

Flexible; Shhds Agreement Restrictions

Same as C Corp; comply w/ IRS reqs

Flexible; Operating Agreement Restrictions

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Application: LLC vs. Other Forms

Other Form LLC Advantages Sole Prop Limited Liability C Corp Easier to Form;

Pass-through Taxation S Corp Easier to Form;

More Flexible Capital Raising

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Real World Application

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Case Study #1

PAMPERED PUP DOG WALKING Suppose you want to start a dog walking business in Center City, Philadelphia. • Not capital-intensive • Complete control • Center City elite are very protective of their dogs • City of Philadelphia has strict dog laws Which type of entity structure should you choose?

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Case Study #1

Type of Entity for Pampered Pup?

• Sole Proprietorship • General Partnership • S Corporation • C Corporation • Limited Liability Company

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Case Study #1

Type of Entity for Pampered Pup?


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Case Study #2

CUSTOM WOODWORKS Suppose you want to open up an artisan woodworking shop in University City, Philadelphia. • Limited financial resources • A few financial contacts • Ambitions to open many stores Which type of entity should you choose?

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Case Study #2

Type of Entity for Custom Woodworks?


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Case Study #2

Type of Entity for Custom Woodworks?

• Sole Proprietorship • General Partnership • S Corporation • C Corporation ? • Limited Liability Company

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Company Formation

Why Delaware? • Predictability • Delaware General Corporation Law • Delaware courts • Lawyers are more acquainted

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Company Formation

Why not Delaware? • Expensive • Taxes • Corporate agent in Delaware • Lawsuits

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Questions?

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