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Business Foundations
What everyone should know when starting a new business...
Attorney Anessa Allen Santos
Licensed in Florida
Copyright 2015 All rights reserved.
Anessa Allen SantosAttorney and Business Consultant
Legal & Business Services
Corporations, governance, compliance and taxation
Capital formation, securities and private equity offerings
Licensing of intellectual property
Unified communications & collaboration and other IT matters
General business consulting provided at C-Level and project management
Services provided in English and Spanish
Professional History
Operated in the roles of General Counsel, Chief Operating Officer, Chief Technology Officer & Corporate Secretary
Performed many functions within various corporate departments including finance, marketing, sales, product development & IT
Ass’n of Corporate Counsel (Admitted 2012); Florida Bar Ass’n (Admitted 2003)
Juris Doctorate, Cum Laude, UDSL (2002); B.A. International Studies, Summa Cum Laude, WSU (1997)
Select Your Business Structure
Determine Your Tax Structure
Research Your Business
Name
Register Your Business
Apply For Your Tax ID
Raise Operating
Capital
In this presentation you will learn to…
Topics We Will CoverBusiness Structures
Why form a business entity
Common business structures explained
Corporate Taxation
Four standard tax structures
Business Formation
Where should you incorporate
Trademarks, Domain Names & Business Names
Choosing a business name
How to register your business
How to apply for your tax status
Compliance & Securities
Corporate governance differentiated from business operations
Protecting the corporate veil
Raising capital and securities compliance
Penalties for failure to comply
Exit Strategies
Mergers, acquisitions and other exit doors
Closing
Miscellaneous matters
Resources
Contact Information
Why Form a Business Entity?
Sole Proprietor Personal Liability
• Unincorporated business is owned by a single person operating in their personal name or under a fictitious name
• Owner uses personal SSN to conduct business, but may obtain separate EIN
• Owner is personally liable for the debts and obligations of the business and creditors may claim personal assets to satisfy these debts
• Profits and losses are reported on Schedule C attached to Form 1040
Personal Liability and the Corporate Veil
Corporate Veil Protection
• Corporations are treated as “individuals” for legal purposes
• The “corporate veil” is a legal concept which separates the distinct personalities of its owners from the corporation itself
• Owners are not personally liable for the debts of the corporation
• Veil may be pierced for failure to observe corporate formalities, alter ego, fraud, criminal activities, etc.
Three Common Business Structures
Partnerships
Corporations
Limited Liability Companies
Principles of Partnerships Formed when two or more
individuals work together in a business and share in the profits regardless of intent
Governed by partnership agreement; few formalities required by state.
Owned by General Partners and/or Limited Partners
May be organized for limited purpose and/or duration
General Partners exercise control over the business, personally liable for all business decisions, even other partners.
GP liability may be limited as a limited liability partnership (LLP). Protection varies by state. LLPs often available only to certain professionals.
Limited Partners are usually silent investors with restricted rights. Personal liability limited to amount invested.
Limited Liability Limited Partnership (LLLPs) hybrid of LP and LLP. GPs personal liability limited. LPs personal liability also limited. Not all states recognize.
Joint ventures are often a partnership among incorporated entities
Partners are owners and cannot claim to be employees
Profits and losses of the business flow-through to the partners and are reported by the partners on their individual income tax
Partnership Cheat Sheet*
What to
ConsiderGeneral Partnership Limited Partnership
Limited Liability
Partnership
Limited Liability
Limited Partnership
Ownership 2 or more people, each a
general partner (GP)
At least one GP and
one LP
2 or more people or
entities, each a GP
At least one GP and
one LP
Formation Automatically formed when
GPs begin operations but
should formally register
Only formed when
formally registered
with the state
Formation rules vary
by state, not all states
recognize LLPs
Formation rules vary
by state, not all states
recognize LLLPs
Management
& Control
Each GP controls and
manages per agreed
GPs manage and
control. LPs have
limited input.
Each GP controls
and manages as
agreed
GPs manage and
control. LPs have
limited input
Liability GPs have unlimited,
personal liability for all debts
and obligations jointly and
severally
GPs unlimited joint &
several liability. LPs
liable only for
amount invested.
GPs enjoy limited
liability that varies by
state.
GPs enjoy limited
liability that varies by
state. LPs liable only
for amount invested.
Taxation Pass-through taxation.
Taxed as a partnership
Same as a GP Same as a GP Same as a GP
* Excluding Joint Ventures
Principles of Corporations
☼ Corporations are an alter ego
☼ Formed by filing articles of incorporation (AOI) with the state
☼ Owners are shareholders who own stock/shares. Shareholders rights are set forth by statute and corp organizing documents (AOI and Bylaws)
☼ Shareholders not liable for corp acts or debts
☼ Managed by directors and/or officers
☼ Governed by Statute. Must observe corporate formalities as outlined by state statute with limited flexibility
☼ Must operate for the financial benefit of the shareholders unless organized as a benefit corp
☼ Flexible ownership structure. May issue multiple classes of stock to shareholders with varying rights
☼ “Double Taxation” Corp pays taxes on profits when earned. Shareholders pay taxes on profits when received as dividends.
☼ “Pass through taxation” available with restrictions by filing for subchapter “S”
Corporations Cheat Sheet
Considerations “C” Corporation “S” Corporation “B”enefit Corporation
Ownership Unlimited Shareholders (SH) Structure and shareholder
ownership restricted by IRS
Owned by SHs, but must
also meet social benefits
Formation File Articles of Incorporation
(AOI) with the State where
business operates
Same as C Corp File AOI same as C Corp
State rules vary regarding
recognition
Management &
Control
Board of Directors
Bylaws and State Statute
Board of Directors
Bylaws and State Statute
Board of Directors
Bylaws and State Statute
B Lab standards if certified
Liability SH limited liability. Directors,
officers and management
protected by BJR.
SH limited liability. Directors,
officers and management
protected by BJR.
SH limited liability. Directors,
officers and management
protected by BJR.
Taxation Double taxation. Profits are
taxed to the corp. when
earned, and then taxed to
the shareholders when
distributed as dividends.
Pass-through taxation. Profits
and losses flow-through the
corp. and are reported by
SH who are assessed tax at
individual rate.
Depends on whether
claiming C corp. or S corp.
taxation with the IRS
I’m
New!
Limited Liability Company Principles
Hybrid. Managed like a partnership with limited liability of a corporation. Provides alter ego status
Formed by filing Articles of Organization (AO) with the state
Owners are members who own membership units. Member rights are set forth by statutes and by company organizing documents (AO and Operating Agreement)
Members may own varying proportions of the company whereas partners are equal
Members are not liable for company acts or debts
Managed by members or managers. May establish a board of directors, officers and executives
Governed by Operating Agreement. Very few formalities required by state
statute
Must operate for the financial benefit of the members unless organized as a benefit LLC
Flexible ownership structure. May issue multiple classes of membership units with varying rights
LLC taxed as a partnership by default. May elect treatment as “C” or “S” with accompanying rights and restrictions
Limited Liability Company Cheat Sheet
Considerations Traditional LLCs* Series LLCs Low-profit LLC (L3C)
Ownership Members Members may be different
per series
Members (Good structure to
be a nonprofit subsidiary)
Formation File Articles of Organization
(AO) in the state where the
company operates
One AO filed with state.
Series may be need to be
registered in some form. Not
all states recognize.
File AO with state. May
require social purpose
identified in filing. Not all
states recognize.
Management &
Control
Designate if managed by
members or managers
Each series may be
managed independently
Same as traditional. Must
consider social purpose
Liability Member limited liability.
Managers, Directors,
Officers protected by BJR
which varies by state.
Same as traditional.
Important to document
asset division to achieve
desired protection.
Same as traditional
Taxation IRS treats as a disregarded
entity by default. May file to
claim C or S tax treatment.
Consolidated tax return.
Each series may claim
different status.
Same as traditional
• Single member LLC not permitted in some states. • SLLC May lose limited liability in other states. See charging order rules.
We are new too!
Four Standard Tax Structures
Sole Proprietor• SP / Fictitious Name
• Single Member LLC
Partnership• Partnerships
• Limited Liability Company
C Corp• Corporations
• Limited Liability Company
S Corp• Corporations
• Limited Liability Company
IRSPass
through tax
treatment
Passes
thru to
personal
tax return
Double Tax
of Business
and Owners
Taxation of Sole Proprietors
Ownership Single business owners, fictitious names. Single
member LLCs are treated as a disregarded entity
by the IRS.
Equity The sole proprietor is not incorporated. Without a
business structure there is no equity to offer for a
capital raise. The addition of a business partner,
owner / member converts the business to another
structure and requires notification to the IRS.
Tax ID Owner uses personal social security number or
applies for EIN
Taxation Profits and losses flow thru the business and are
taxed to the owner regardless of whether the
owner actually enjoys the profits.
Reporting Owner files Schedule C to Form 1040
Employees require additional filings
Taxation of Partnerships
Ownership “Partners” Two or more people, businesses, multi-
member LLCs. Also applies to joint ventures
Equity May add and remove partners as needed. Each
partner must contribute together and in equal
part. LLCs may raise capital through the offering of
membership units in one or more series
Tax ID Partnerships should apply for a separate EIN even if
they haven’t formally registered. LLCs taxed as a
partnership should also apply for an EIN.
Taxation Profits and losses flow thru the business and are
taxed to the partner/member regardless of
distribution. “Phantom tax” provisions may be
written into the business management agreement.
Reporting Business files form 1065 and provides form K-1 to
owner/member so they might report their share of
profits and losses with schedule E to their 1040
The IRS states that owners of an
entity taxed as a partnership
are not employees, and thus
are responsible for self-
employment taxes
“C” Corporation Taxation26 USC Chapter 1 Subchapter C
Ownership “Shareholders” Individuals, other businesses, and
multi-member LLCs
Equity “Stock/Shares” May be issued to unlimited
shareholders in multiple classes, each with varying
rights assigned. Equity may be issued for capital
raise and compensation plans.
Tax ID All corporations receive “C” status by default upon
application for an EIN
Taxation Profits are taxed to the corporation when earned
Shareholders pay tax on dividends
Corporations pay taxes for employees
Reporting Profits and losses reported on form 1120
Estimated taxes reported on form 1120W
Employment taxes reported on forms 940/941
Dividends statements reported to shareholders
Double the tax is
heaving lifting!
“S”mall Business Corporation Taxation26 USC Chapter 1 Subchapter S
Formation IRS requires it be “domestic” meaning that it is operating
in the state where it is incorporated
Ownership Maximum of 100 Shareholders who may be individuals,
certain trusts and estates; may not be partnerships,
corporations or non-resident aliens.
Equity Only one class of Stock/Shares may be issued
Tax ID Request EIN, then file form 2553 within two months and 15
days for the tax year the status is desired
Taxation Avoid corp. tax as profits pass thru to shareholders
Corporations pay taxes for employees
Any shareholder who works for the company must be
paid “reasonable compensation” and the remainder
may be paid out as a distribution
Reporting Business files form 1065 and provides form K-1 to
owner/member so they might report their share of profits
and losses with schedule E to their 1040
Employment taxes reported on forms 940/941
Limited Liability CompaniesTax election smorgasbord!
Ownership The owners are called “Members” and are treated
similarly to shareholders of a corporation.
Limitations apply if “S” status is elected.
Equity Multiple classes may be issued unless “S” status
Tax ID After EIN issuance, file form 8832 in order to elect
desired tax status
Taxation Multi-member LLC defaults to partnership status, a
“C” corporation or an “S” corporation. Single
member LLCs automatically treated as a
disregarded entity.
Reporting Company files the forms based upon tax election
Employment taxes reported on forms 940/941
Which tax treatment is best for
the company and its members?
How will taxation affect
potential investment?
Business Structure Advantages Disadvantages
Sole Proprietor • No registration required
• Singleness of control• Economy of Operation• Avoids corporate income tax
• Unlimited personal liability
• Company dies with owner• Difficulty raising capital• Owner’s salary not deductible
Partnerships(GP, LP, LLP, LLLP)
• Flexible options for formation• Operation is by contract• Limited personal liability available• Avoids corporate income tax
• Shared Control• Must pay self-employment taxes• Phantom tax• Partner salary not deductible
Corporationelecting “C” status
• Legal entity totally separate from owners• Limited personal liability for corporate acts• Unlimited number and class of shareholders• Separation of ownership and management• Shareholders may also be employees
• Expensive to form and maintain• Must observe corporate formalities• Operations and purpose inflexible• Government scrutiny and oversight• Double taxation
Corporationelecting “S” status
• Same as with a corporation with exception• Shares may only be issued in a single class• Pass through taxation
• Same as with a corporation with exception• Ownership is restricted • Corporate income tax is avoided
Limited Liability
Company
• Operation is by contract• Flexible management / member / manager• Limited personal liability• May elect any tax structure
• Newer structure / Lack of familiarity• Equity compensation very complex• Integration with other entities complex• Recording capital accounts is complex
Business Entity Comparison Guide
Where should you incorporate?
Consider the following when deciding where to incorporate
♦ When you register with a state, you are subject to that state’s jurisdiction
♦ What are the costs of filing and annual maintenance?
♦ Will the state permit the kind of entity you desire to organize?
♦ Does the state assess corporate income tax? Several states are tax free …
♦ Will the state tax non-resident equity owners as if they were residents in a pass-through tax scenario? (e.g. Ohio)
♦ Is there a sales or use tax on your products or services? (e.g. Mass computer and software services tax which was later repealed)
♦ What sort of privacy protections does the state provide to businesses and their owners?
♦ Will you have sufficient operations (physical presence) in other states which requires you to register as a foreign entity?
Trademarks Domain Names Business Names
Trademarks
A word, phrase, slogan,
symbol or design, or
combination thereof
that identifies the source
of the goods and
services of one owner
from that of another. It is
a brand. To register, you
must file an application
with either the state or
the USPTO.
Domain Names
A web address that
identifies a website.
Registration does not
give you trademark
rights. If the domain
name is used to identify
the sources of goods
and services, it can also
function as a trademark.
It depends on how it is
used. Register with a
domain name registrar.
Business Names
A business name
registration with your
state does not grant you
trademark rights. It can
also be a trademark
depending on how you
use it. Register with the
secretary of state
website where the
business is to be
registered.
1) Search names registered with the
secretary of the state where you will
incorporate
2) Search fictitious names and d/b/a’s with the home state
3) Conduct a common law search on the
internet
4) Search the Whois database to see if the
domain is available
5) Check related domains including newly issued gTLDs …
Choosing a Business Name
How to Register Your Business
Register your business with the Secretary of State
The Secretary of State will have a business division
In Florida this is called the Division of Corporations and can be found at sunbiz.org
Most states permit complete registration online
Registration requirements vary by state and by business entity
Be prepared to pay for registration and any other fees related to your corporate structure, e.g. Delaware charges fees based on shares issued
Annual fees may be required and failure to pay timely may result in costly penalties or involuntary dissolution of your entity
After registering, you will receive many official looking notices in the mail about additional filing requirements and costs. Ignore them unless they are specifically from the state department where you registered. If you aren’t sure, check with your attorney.
How To Apply For Your Tax ID
Compliance and the Regulatory EnvironmentCorporate Governance
What are your house rules?
• Different for each entity structure
• Determined by state statute
• Determined by your governing documents, e.g. Articles of Incorporation/Organization, Bylaws, Partnership/Operating Agreement, etc.
• Governs relationship among owners, managers, directors, officers, investors
• Sets standards for business operations like defines a purpose, tax & accounting standards, dispute resolution, primary office, voting rules, notices, official communication, investor rights etc.
Business Operations
How does the business operate?
• Detailed in the business plan
• Vision and future of the company for product and service development
• IP development and protection
• Marketing, sales and channel management
• Contracts administration
• Financial forecasts, statements and bookkeeping
• Human resources, employment and payroll
• Information technology and information security
Protecting the Corporate Veil
Piercing the Corporate Veil or BJR Immunity
Failure to follow the corporate formalitiesrequired by the state or your own organizational documents
Ultra vires activities – beyond the scope of power or authority of the corporation or that of the actor
Usurping corporate assets – using corporate assets for purposes unrelated to the business
Alter ego – using the corporation as an alter ego for yourself, e.g. in an attempt to defraud creditors
RICO and other criminal actions (e.g. fraud, racketeering, money laundering, etc.)
Fiduciary Duties of Directors and Officers
Duty of loyalty and care is owed by directors
and officers to the company; may be waived if
statutes permit and company documents agree
Business judgment rule states that a director,
officer or other executive shall not be held liable
for their decision as long as it was made in good
faith, with the care of a reasonably prudent
person and with the reasonable belief it was in
the best interest of the corporation
Duty of good faith and fair dealing is implied in
every contract and may not be waived
The corporate veil is your protection from personal liability for the actions and obligations of the
business, regardless of whether such was instituted by you or someone else in the business
Raising Capital & Securities Compliance
“Security” Section 2(a)(1) of the Securities Act of 1933, as amended, (2012)• Any note, stock, future, bond, evidence of indebtedness, certificate of interest or participation in any profit-
sharing agreement, subscription, share, investment contract, or generally any commonly known as a “security”, or any interest in, receipt for, guarantee of, or warrant or right to subscribe to or purchase any of the foregoing
Federal and State “Blue Sky” Laws• When issuing securities, you must comply with two levels of regulation: federal rules when securities for
interstate issuance, and state rules of the issuer and the subscriber
Safe Harbor Rule Regulation D 506(b) and (c)• The SEC is the federal agency that regulates the interstate issuance of securities. The SEC has issued a safe
harbor rule that, if followed, will protect you from allegations of having violated individual state blue sky rules.
Issuer Documents• New owners “subscribe” to the company via a subscription agreement and tender their money in exchange
for shares / units. While not required, it is highly recommended to prepare and distribute an offering memorandum which documents required financial disclosures. This is your insurance policy against claims of failure to disclosure
Securities Filings• As you accept subscriptions for equity, or convert debt to equity, you must file Reg. D, Form D with the SEC,
the issuer’s state and the subscriber’s state in order to maintain Safe Harbor protection. (exception is NY)
Penalties for Failure to Comply
• Involuntary Dissolution of the Corporation – this is most common for failure to follow corporate formalities as mandated by state statute, or by the company’s own governing documents
• Disbursement of Assets – in cases where the business is being used as a sham, or an alter ego, on behalf of the owner(s) to conduct unnecessary risky activities. May also occur pursuant to an involuntary dissolution
• Civil Penalties where the corporate veil is pierced, the owners, directors and/or officer may not only have to pay restitution, but may also be slapped with punitive damages and treble (triple) damages
• Criminal Penalties Especially where the unlawful sale of securities is concerned, it is not uncommon to be sentenced to prison time in addition to receiving civil penalties
Exit Strategies• Caveat! Materials which may affect your exit options include state
statute governing your entity, your organizational document and your governing documents
• Initial Public Offering (IPO) involves a massive reorganization of your business and a highly regulated issuance of securities. I suggest starting with a Reg. A+ offering – a sort of mini IPO – which was authorized under the JOBS Act of 2012. It increases the Reg. A offering limit from $5 million to $50 million and reduces some of the regulatory burdens.
• Merger Two companies combine in order to form one new company usually through a new stock issuance to existing shareholders of both companies (stock swap). Common merger vehicles include horizontal, vertical, forward triangular and reverse triangular mergers.
• Acquisition One company subsumes another company or just its assets usually through the exchange of cash, stock, or a combination. Common vehicles include leveraged buyout (acquisition using a debt instrument), debt/equity swaps, and foreclosure by sale of assets.
• Winding up usually provided for in the statute and/or your governing documents. If it is, you must abide by those rules.
LLCs can go public too!
Closing Thoughts• This presentation is not specific to any state law or business industry, and it does not
address non profit corporations
• Business needs will change over time. At least annually, review your strategy to determine what changes can be made to better your bottom line
• Business environment is rapidly changing. Know your resources and consult them regularly to ensure you do not run afoul of compliance or short your profits
• It’s better to ask for permission than for forgiveness. If you aren’t sure, seek an opinion letter from a qualified advisor or from the agency which governs the issue
• An ounce of prevention is worth a pound of cure… don’t be afraid to pay up front for solid advice rather than paying through the nose for litigation which might have been avoided
• When confronted with an obstacle, don’t worry, there’s usually a way around it. Consult your experts and let them successfully guide you.
• If your expert proves to be an obstacle, get rid of them and find someone better. Don’t waste time trying to turn someone into something they aren’t. There are plenty of alternatives.
Resources and Hyperlinks
Business
• SBA Business Structures
• Florida Division of Corporations
• Whois Domain Registrar
Tax
• IRS EIN
• IRS Business Structures
• Florida Dep’t of Revenue
Securities
• Guide to Small Business & the SEC
• SEC Safe Harbor Reg. D Rule 506
• Florida Division of Securities
Intellectual Property
• USPTO
• U.S. Copyright Office
• Florida Trademark Registry
Contact Information
Anessa Allen Santos
Allen Santos Law PALegal & business consulting services
Orlando FL 34105
USA
T. +1 239.595.3794
W. allensantoslaw.com
Se habla español