Patterns of Entrepreneurship Setting Up the Company Patterns of Entrepreneurship Chapter 5

copyright 2003 Jack M. Kaplan Session Outline What form of Ownership is Best Forms of Doing Business Setting Up a Proprietorship Setting Up a “C” Corporation Getting Registered Choosing Legal Counsel Setting Up a Limited Liability Company(LLC) Setting Up a Sub. S Setting Up the Board of Directors Comparison Organization Charts copyright 2003 Jack M. Kaplan

What form of Ownership is Best 1.How big can this 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 owner capacity or death?    copyright 2003 Jack M. Kaplan

Forms of Doing Business The legal form of the business: Sole Proprietorship, C-Corporation, S-Corporation, Partnership, or LLC) should be determined in light of the business’ short- and long-term needs copyright 2003 Jack M. Kaplan

copyright 2003 Jack M. Kaplan Proprietorship A sole Proprietorship is a form of business that has a single owner and only requires local business licenses to open. Advantages: . Simple to create .Low cost start up fees .No special legal restrictions copyright 2003 Jack M. Kaplan

copyright 2003 Jack M. Kaplan Proprietorship Disadvantages: Unlimited Personal liability Limited access to capital Lack of Continuity for the Business copyright 2003 Jack M. Kaplan

Setting Up a “C” Corporation Choose the name of the business. 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. To open a bank account, ID number and corporation seal are required. copyright 2003 Jack M. Kaplan

copyright 2003 Jack M. Kaplan Getting Registered Check on state availability of name call (609) 530-6400 Costs $15.00 for one name Costs $20.00 for two names Reserve a name for $60.00 for 60 days Get an ID number call (800) 829-1040 copyright 2003 Jack M. Kaplan

Setting Up a Corporation (C) Overview: Separate legal and tax entity. Shareholder liability limited to invested capital. Existence continues after shareholder’s death. Easier to raise capital. Pros: Limited liability. Most appropriate structure for IPO. Tax benefits and stock option plans. Ease of transferability of interests. Structure that a venture capitalist requires. Cons: Double taxation. High administration compliance costs. Directors are held accountable. Well defined corporate governance rules and laws to follow. copyright 2003 Jack M. Kaplan

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 attorneys that do more work with venture capitalists than start-ups. copyright 2003 Jack M. Kaplan

Setting Up a Small Business Corporation (Sub S) Overview: A corporation, but with “flow through” tax benefits. 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 necessitate administrative and cost burdens. If failure to comply with Sub S rules, tax consequences can be disastrous. Not eligible for qualified employee stock options. Investors cannot receive preferred shares as in a C Corporation.

Setting Up a Limited Liability Company (LLC) Overview: Relatively new form of doing business. 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.

Setting Up a Partnership A partnership is usually defined as an association of two or more people carrying on as co-owners of a business for profit. Advantages: Easy to Establish Division of Profits Ability to attract partners Little Government Regulation copyright 2003 Jack M. Kaplan

Setting Up a Partnership Disadvantages: Unlimited Liability of at least one Partner Capital Accumulation Restrictions of Eliminating General partner Potential for Personality and Authority Conflict copyright 2003 Jack M. Kaplan

copyright 2003 Jack M. Kaplan Choosing Counsel Problems are different - possibility of mixed loyalties for the entrepreneur. A friend is a poor choice. Investors want to deal with experienced lawyers. Avoid using the largest firm. Biggest is not necessarily better. Select a firm that provides the basics and a hands-on approach. Check the experience and credentials of the attorney handling your matter. copyright 2003 Jack M. Kaplan

Setting Up the Board of Directors 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. copyright 2003 Jack M. Kaplan

Setting Up the Board of Directors 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. copyright 2003 Jack M. Kaplan

copyright 2003 Jack M. Kaplan Legal Agreements 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. License Agreements Covers any intellectual property that you use or license. Customer Agreements Basis for delivery of services (service companies only). copyright 2003 Jack M. Kaplan

Business Organizational Structure Comparison Chart Characteristic 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 copyright 2003 Jack M. Kaplan

Business Organizational Structure Comparison Chart Characteristic C-Corp. S-Corp. LLC Able to deduct business loss on individual return No Yes Yes Basis for loss includes owner’s share of company debt in owner’s tax return No Yes 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 copyright 2003 Jack M. Kaplan

copyright 2003 Jack M. Kaplan 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. copyright 2003 Jack M. Kaplan

Setting Up 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. ·         copyright 2003 Jack M. Kaplan