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

E. aallensantos@gmail.com

W. allensantoslaw.com

Se habla español