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If you're looking to start a business then this post is a MUST read. It'll easily walk you through the different types of entity structures available for your business and help you determine which structure makes the most sense for you.
Citation preview
Forming Your Business : A Practical Approach By : Ilana Lubin / Sullivan & Cromwell
April 2015
Forming Your Business: A Practical Approach
March 31, 2015
Why incorporate?
Why incorporate? Limit your personal exposure! Isolate assets Enhance your credibility
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Choosing your entity
Choosing your entity & jurisdiction of formation Rule of Thumb !Delaware Corporation Discuss other alternatives with your lawyer
and/or accountant, considering: Fees (i.e., to incorporate & administer) Your business (i.e., are you a one man shop?) Your goals & timeline
Conversion is an option
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Example of costsCorporation:
Required Organizational Documents
Delaware New YorkCertificate of Incorporation $685 (fee will increase or
decrease based on number and par value of authorized shares; fee includes a registered agent fee of $342.00)
$732 (includes a registered agent fee of $342)
By-Laws N/A N/A
Stockholders Agreement N/A N/AStatement of the Incorporator N/A N/A
Initial Resolutions of the Board of Directors
N/A N/A
Minute Book $84 $84LLC:
Required Organizational Documents
Delaware New YorkCertificate of Formation/Articles of Organization $690 (includes a registered agent
fee of $342) $807 (includes a registered agent fee of $342)
Publication N/A $2199 (as determined based upon the two designated newspapers chosen by the county clerk)
Operating Agreement N/A N/A
Initial Resolutions N/A N/A
Minute Book $84 $84
Types of entities & jurisdictional considerations
Advantages and Disadvantages
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LLC Corporation
Pros Flexibility Sophisticated tax structuring Flow through taxation
Easier to grant equity incentives (options & RSUs) Formalities are straight forward
Cons Complicated tax structuring Complications regarding the grant of equity incentives
Increased corporate formalities 2 levels of taxation
Corporate Entity Types
Sole proprietorship General partnership Limited partnership Corporation Limited Liability Company Limited Liability Partnership
Disregarded Partnership C corporation S corporation
Tax Entity Types
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Choice of entity for corporate purposes does not necessarily dictate how it will be treated for tax purposes. This can change how you complete the SS-4 to obtain an EIN.
A sole proprietorship and any entity other than an Inc. will generally be treated as a disregarded entity for tax purposes by default or can elect to be treated as a disregarded entity, as long as it has only one member. This is also the default classification for single-member LLCs.
Disregarded entity is completely ignored for federal and state income tax purposes. (It is usually regarded for sales and property tax purposes.)
Owner is subject to income tax at his own rates on the income of the disregarded entity.
Disregarded Entity
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Feature S Corporation Partnership/LLCFormation File with state File with stateNumber of Owners Restricted to 100
shareholdersGenerally, unlimited number of members (owners)Corporate Owners Allowed No Yes
Foreign Owners Allowed No YesDifferent Classes of Shares Permitted?
Yes, as long as all of the classes have identical economic rights (rights to dividends and liquidating proceeds). Shares may have
Yes Shares can have both different economic and voting rights.
Liability Protection Yes YesCorporation Formalities (assuming state law corporation)
Many mandated corporate formalities, including, but not limited to: - Annual meetings - Election of Board of
Directors - Election of officers
Few mandated corporate formalities. However, typically members choose to create such formalities through an Operating AgreementManagement (assuming state
law corporation)Board of directors As decided by
membersProfit Sharing Directly proportional to
ownership percentage. All shares must convey equal economic rights.
As decided by members
Annual Accounting Costs May be lower May be higherQuarterly Estimated Tax Payments Made by Members
Yes, with respect to residual profits (corporation withholds on salary because shareholder can be employee).
Yes, with respect to both salary and residual profits (partner cannot be employee)Social Security and Medicare
TaxPaid only on salary (though new 3.8% tax that started in January 2013 applies to passive earnings).
Generally paid on all earnings from LLC (salary and profits)
Side-by-Side Comparison of S Corp vs Partnership/LLC
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Types of entities & jurisdictional considerations
Choose DE Well developed body of corporate law Sophisticated courts Every corporate lawyer, and more importantly,
VC investor is familiar with DE documents and law this is what they want to see. You are making getting funding easier both practically speaking but also by conveying credibility and legitimacy. Another reason, see: NY Business Corporation
Law 630 Liability of Shareholders for Wages Due to Laborers, Servants or Employees
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Types of entities & jurisdictional considerations
The ten largest shareholders.shall jointly and severally be personally liable for all debts, wages or salaries due and owing to any of its laborers, servants or employees other than contractors, for services performed by them for such corporation - N.Y. BSC. LAW Section 630 - This does not apply to a publicly traded
company
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Types of entities & jurisdictional considerations
Remember to apply for authority to do business in the states you are doing business If you are a DE LLC, this will result in publication fees in
NY Conduct name reservations and trademark
clearances if the company name will be consumer facing
A great resource: Delaware Secretary of State website
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Corporation In-A-Box The basic documents that get you up & running brought to you by
C&Ms Corporate Formation Questionnaire can help you organize and focus on initial decisions that need to be made:
Set a number of directors and decide who will be your directors.
Determine how you will divide equity interests? And what is the consideration for each? (i.e., cash, intellectual property, sweat)
Consider a Pre-Nup. Vesting/accelerations schedules
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Corporation In-A-Box The basic documents that get you up & running
Certificate of Incorporation Authorized Number of Shares. (a lower number with a lower par
value (i.e., 0001 will make your annual franchise taxes cheaper (the minimum tax is $175-350; you can always authorize more; on the other hand, think optics when issuing options (a grant of 10 can have the same value as 100 but 100 sounds better)
Action of Incorporator (signs the original certificate, adopts bylaws and elects initial directors)
Bylaws (rules of how the company conducts its affairs, which must be consistent with the DE law and the charter; they cover meetings, voting, officers, directors, indemnification, fiscal year, etc.)
Consent of the Board (adopting Action of Incorporator, COI, Bylaws; electing officers, adopting relevant agreements)
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Corporation in a box The basic documents that get you up & running Founders Common Stock Purchase Agreement (this can also be a
subscription agreement) Typical purchase price at founding is 10 x par value (.0001) = $.001, but if
there is substantial value in the Company at formation then the purchase price could be something different (i.e., book value of assets), and this should be discussed with tax counsel
Can use vesting restrictions here VCs may want to see this for assurance people will stick around Helpful if you have multiple founders because you have pre-negotiated how to deal
with someone leaving or becoming disinterested. A founder divorce is common when you have 3 or more founders.
Transfer limitations (Securities Law; Right of First Refusal) Lock Up Bill of Sale/Assignment and Assumption for non-cash consideration such
as intellectual property or other assets
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Corporation in a box The basic documents that get you up & running
D&O Indemnification Agreement Your VC board representatives will certainly
want this and namely primacy of indemnification
Non-Disclosure Agreement This allows you to start commercial
discussions with companies by protecting your confidential information
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Corporation in a box The basic documents that get you up & running
Employment Agreements Consultant Agreements Confidential Information and Invention
Assignment Agreement Work for hire doctrine Non-Solicits & Non-Competes Mischaracterization Issues
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Other Practical Considerations Protecting Your Assets
Intellectual Property Employees
Real Estate Key Contracts
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Intellectual Property - Types
Patents (Provisional, Design & Utility) Inventions
Copyrights Expression
(GUI, Software, Books, Apps, Website Content)
Trademarks Source Identifier
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Intellectual Property - Patents
Disclosure is a bar to patent protection. Remember to rely on your NDA.
Provisional Patent = A Stake in the Sand Be the first to the patent office & preserve rights
globally Make commercialization easier Obtain the benefit of using patent pending
You will have one year to submit full patent application with claims and proper drawings
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Intellectual Property Patents
Utility Patents Design Patents Provisional
Process, machine, manufacture, or composition matter or improvement thereof
Ornamental Designs Your stake in the sand
20 years from first filing date
14 years from date of grant
1 year from filing date
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Intellectual Property Copyrights & Trademarks
Copyrights Trademarks
Protected on creation Rights inure upon use
Registration is cheap
A U.S. citizen needs a copyright to be registered in
Registration is based on geography
2012 Jane DoeUnregistered Registered
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Trade Secrets
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Information Reasonable measures taken to protect the
information Derives independent economic value from
not being publicly known
Other Practical Considerations Privacy Policies Be clearly posted, with appropriate links Must accurately inform users about a website operators practices
regarding its collection and use of information, including personal information (i.e., social media applications, direct marketing). This is specifically tailored to YOU.
Practices must comply with privacy and data security laws (i.e., COPPA, HIPPA)
Should be consistent with the terms of use
Terms of Use Can minimize liability to site users, protect intellectual property by
prohibiting unauthorized reproduction, and prohibit certain behaviors (i.e., introducing viruses)
Clickwrap
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Other Practical Considerations
Get the insurance policies you will need for your business. One lawsuit could make or break you. Commercial General Liability Cyber Security / Data breaches Industry specific, i.e., Food Contamination
Policy
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Funding Types of Investors Friend & Family Angels (i.e., Jeff Bezos, Paul Graham) Venture Capital Funds Strategic Inventors
(i.e., Peacock Equity Fund (GE/NBC Universal); Simon Venture Group (Simon))
Leasing Companies Banks
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Funding Types of Investments Common Stock Preferred Stock Convertible Promissory Notes Warrants Subordinated Debt (with or without an
equity kicker see above)
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Funding
How much to raise? Rule of Thumb: Raise for 9-18 months Raise enough to get the company off of the
ground Develop a beta version or proto-type Develop your website Generate initial revenues Sign a key contract Hire key management
You will probably need to raise capital more than once
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Funding Securities LawA company should register the offer and sale of securities with the SEC unless there is a corresponding exemption (Securities Act of 1933)
You need an exemption: 4(2) private offering (no filing required)
Used for a limited number of people (think: 10) Insider access to information is key Sophistication (except for founders) Ability to absorb loss Subject to transfer or resale restrictions
Regulation D (Form D filing required)
Blue Sky Laws28
Funding
Think about your end-game:
M&A, IPO, Lifestyle
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Speaker
Ilana Lubin New York [email protected] Phone: +1 212.895.4224
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