h ow t o s tructure y our c ompany a nd r aise t he c ash …. l egally
TRANSCRIPT
HOW TO HOW TO STRUCTURE STRUCTURE
YOUR COMPANY YOUR COMPANY AND RAISE THE AND RAISE THE
CASH …. LEGALLYCASH …. LEGALLY
PART I:PART I:HOW TO STRUCTURE HOW TO STRUCTURE
YOUR COMPANYYOUR COMPANY
Choose the Right Choose the Right EntityEntityWhen Should You Form an Entity?•Initiation of Business Operations•Asset Protection•Capital Raising•Multiple other factors ….
Choose the Right Choose the Right EntityEntity• Sole Proprietorship• General Partnership (GP)• Corporation
– C-Corp– S-Corp
• Limited Partnership (LP) • Limited Liability Company (LLC)
http://www.sos.state.tx.us/corp/index.shtml
Sole Proprietorship Sole Proprietorship •Default entity •NO liability protection• Insurance coverage is only option for liability protection
•A DBA filing is NOT entity formation
General Partnership General Partnership • Definition: Association of 2 or more persons
to carry on a business for profit – whether they intend to create a partnership – and whether they call their association a partnership, joint venture or other name
• Factors indicating a partnership:• Right to share of profits• Expression of intent• Right to control business• Contribution of money or property
• NO liability protection, partners are jointly and severally liable for all partnership liabilities
Officers: President, Vice President,
CEO, CFO, Secretary, Treasurer
Employees/Operations/Contracts
Board of Directors
Shareholders Ownership
Strategy/Direction
Implementation/ Signing Authority
Liabilities
CorporationCorporation
ProsPros• Limited liability for
shareholders• Centralized
management • Flexible capital
structure • Most well-known
and easily understood
• Growth-oriented
ConsCons• Expense of formation
and maintenance• Double taxation for
the C-Corporation • S-election restrictions
– 100 shareholders or less
– One class of stock– Only U.S. residents or
citizens
• Corporate formalities
CorporationCorporation
Officers: President, Vice President,
CEO, CFO, Secretary, Treasurer
Employees/Operations/Contracts
Board of Directors
Shareholders Ownership
Strategy/Direction
Implementation/ Signing Authority
Liabilities
Officers: President, Vice President,
CEO, CFO, Secretary, Treasurer
Employees/Operations/Contracts
Managers
Members
Limited Liability CompanyLimited Liability Company
Limited Liability Limited Liability CompanyCompany
ProsPros• Flow-through
taxation • Limited liability
for members• Flexibility of
Company Agreement
• Easy to form
ConsCons• Different
terminology (i.e. Managers and Members instead of Board and Shareholders)
• Some investors may insist on corporation structure
Employees/Operations/Contracts
General Partner
(LLC/Corp)Limited Partners Ownership
Strategy/Direction
Implementation/ Signing Authority
Liabilities
Limited PartnershipLimited Partnership
Limited PartnershipLimited PartnershipProsPros
• Flow-through taxation
• Liability limited for limited partners
• Restricted participation of limited partners in management
ConsCons• Must have a general
partner who is liable for all partnership obligations
• Limited partners have to agree to no say in management (can be less attractive to investors)
• Limited partners who participate in management of business become liable as GPs
• Expense of maintaining multiple entities
Entity TypeEntity Type Fees and Other CostsFees and Other Costs TimingTiming
Corporation Filing Fee: $300Legal Fees: $700-$1200
• SOSDirect•Basic documents (may also do shareholders agreement)
Limited Liability Company
Filing Fee: $200Legal Fee: $1000-$5000
•SOSDirect•Documents can be complex
Limited Partnership
Filing Fee: $750Legal Fees: $2000-$5000
•SOSDirect•Documents can be complex•Requires 2-tier filing
Cost and TimingCost and Timing
Biggest Concerns Biggest Concerns • Taxation: How the entity will
be taxed?• Liability: Who will be liable for
its obligations?• Management: Who will manage
the entity?• Ownership: Who will be the
owners of the entity?
TaxationTaxation• Levels of Taxation:
– Federal Tax (IRS)– State Tax (Texas Franchise Tax)
• http://www.window.state.tx.us/taxinfo/franchise/margin.html
• Taxation by Entity Type:– C-Corp: Double taxation at corporate level and again
at shareholder level upon distribution of dividends – S-Corp: No corporate level tax imposed – corporate
level income treated as received by shareholders– Limited Partnership: Non-taxable “flow through”
entity – taxation imposed only at ownership level– Limited Liability Company: See Limited Partnership
above
LiabilityLiability• Entity Liability: Entity will be liable to extent of its
assets - question is who will be liable, if anyone, if the entity’s assets are not sufficient to satisfy all claims?
• Owner Liability: – Generally shareholders, limited partners and
members will not be personally liable for debts and obligations of the entity in excess of their investment
– Exceptions • Piercing the Corporate Veil factors include
perpetrating fraud, formation to avoid legal obligation or statute, protection for crime
• Debt guarantees
More Liability More Liability • Fiduciary Duties:
• Who has them? Directors in corporations, general partners of limited partnerships, managers of limited liability companies
• What are they? • Duty of Loyalty: Act in good faith and not allow
personal business interests to prevail over interests of corporation.
• Duty of Care: Take care that an ordinarily prudent person would exercise under similar circumstances
• Duty of Obedience: Obey law and certificate of formation
• Indemnification by entity available if so provided
ManagementManagement•Partnerships and LLCs do “not”
have Presidents and Directors
•Who will have control over/vote on what decisions? Owners or Management?
•Generalization:– Corporations = defined by law (modified by
agreement)
– Partnership and LLC = defined by agreement
Joint Ownership Joint Ownership Issues Issues • Not only your co-owner, but also your
cousin, brother-in-law, roomate… • Shareholder/Company/Partnership
Agreements – What if I want to sell? – What if my partner dies? Gets divorced?
Files for bankruptcy?
• Issues are always easier to resolve before money is a factor
Respect the Entity Respect the Entity FormForm• Keep the Personal Personal
– Do not pay personal bills with corporate checks. – Do not pay corporate expenses with personal
checks. • Keep Records, “Minutes” or Written Consent
– Action taken by owners or management?– Major corporate actions such as voting in
management and big transaction • Assets transferred out of the corporation – PAPER
IT• Assets transferred by anyone to the corporation –
PAPER IT.• Business Operations in Entity Name
– Business insurance (e.g. public liability, disability, group medical, hazard) in entity name
– Contracts in entity name
Respect: SignaturesRespect: Signatures• Corporation or Limited Liability Company
MY COMPANY, a Texas ___________
By: ____________________Name: __________________Title: ____________________
• Limited Partnership
YOUR PARTNERSHIP, L.P., a Texas limited partnership
By: ABC CORPORATION, its general partner
By: ______________________Smart E. Entrepreneur, the President
Respect: Books & Respect: Books & RecordsRecords• Accounting Books: Income
Statement, Balance Sheet, etc.
• Corporate Books: Certificate of Formation, Bylaws, Minutes, Written Consents, Ledger, Partnership Agreement, Company Agreement, etc.
PART II:PART II:RAISING THE RAISING THE
CASHCASH
Debt: LendersDebt: Lenders
• Most major traditional banks do not lend to startups or do so only rarely
• Comerica, Square 1 Bank, Silicon Valley Bank lend to entrepreneurial companies
• Will want to see accounts receivable, inventory, assets
• Very sensitive to market conditions – this last down turn caused them to become risk adverse
• Terms may include: fees, collateral, agreement to pay for AR audits, monthly reporting, audited financial statements, financial covenants plus all banking relationships – checking, credit cards, investments, etc. must be with lender
Equity: Stock and Ownership Equity: Stock and Ownership InterestInterest• Corporation: Common Stock or Preferred Stock to
Stockholders
– Understood by typical investors – “Can I buy stock in your company?”
– Allows for flexibility (redemption rights, conversion rights, preferences)
• Limited Partnerships: Partnership Interest to Limited Partners and General Partner
• Limited Liability Companies: Membership Interest to Members
– Units v. Percentage Interest
– Class A, Class B
• Voting Rights
• Waterfalls
Equity: Potential Equity: Potential Investors Investors • Co-owners • Friends and Family• Angel Funding
– Wealthy private individuals, with background in business, usually smaller than VC’s ($25K - $250K).
– Prefer to deal directly with the entrepreneur
– Like local deals– Limited in the number of investments they
will do concurrently
Equity: Potential Investors Equity: Potential Investors • Venture Capital
– VC’s often are prepared to invest in continued rounds as the business grows and achieve its milestones
– Bring valuable skills, contacts, experience and discipline to your business
– Exiting usually in the form of a Public Offering or Sale to a larger business after reaching certain milestones.
– Demanding, costly, time consuming.– Due Diligence process can be brutal – background
checks, justification of your business plan, legal review, patent review, financial forecasts, etc.
– Entrepreneur may lose control after 2nd round of financing to marquee CEO, CFO, etc.
– Management reporting to the VC’s is often onerous
Securities Law Securities Law • Starting Place: Registration with the SEC IS
required • All securities offerings must be registered with
the SEC– Offer triggers compliance requirements -
compliance must happen before selling process starts
• Unless, that offering is exempt from registration
• Doesn’t matter if small private sale or an offering which is immediately listed on the NYSE
Private Offerings = Private Offerings = ExemptExempt• Privately-
negotiated sales
• Must not involve any general solicitation or general advertising
• Section 4(2)* - the private-offering exemption - “transactions by an issuer not involving any public offering”
* Securities Act of 1933(the “Securities Act”)
Reg DReg D• Rule 504: Exemption for the offer and
sale of up to $1 million of securities in a 12-month period
• Rule 505: Exemption for offers and sales of securities totaling up to $5 million in any 12-month period.
• Rule 506: Exemption for sales of securities under Section 4(2) with no dollar limit.
http://www.sec.gov/answers/regd.htm
Rule 506Rule 506• Permits unlimited dollar amount of
sales• Without a PPM• To Accredited Investors• Preemption from Blue Sky Laws• So long as Offers and Sales are made to
Accredited Investors with whom the issuer (or its broker-dealer) has a Substantial Pre-Existing Relationship
http://www.sec.gov/answers/rule506.htm
““Accredited Investor”Accredited Investor”• A bank, insurance company, registered
investment company, etc.• An employee benefit plan• A charitable organization, corporation or
partnership with assets ≥ $5 million• A director, executive officer or general partner of
the company selling the securities• A business in which all the equity owners are
accredited investors• A natural person with a net worth of at least $1
million (not including house)• A natural person with income exceeding $200,000
in each of the two most recent years or joint income with a spouse exceeding $300,000
• A trust with assets of at least $5 million
Why Only Accredited Why Only Accredited Investors?Investors?• Private placement memorandum that meets Reg
D requirements = $$$$$
• If more than $1 million is raised in a 12-month period, Rule 504 is not available
• Under Rule 505 and 506, a PPM would be required to offer securities to non-accredited investors
• NOTE: Even if not required, delivering a PPM or at least a detailed business plan is probably advisable for liability and marketing reasons, particularly in fulfilling the antifraud requirement.
JOBS ACT 2012 JOBS ACT 2012 • TITLE I—Reopening American Capital Markets
To Emerging Growth Companies • TITLE II - Access To Capital For Job Creators • TITLE III — Crowdfunding• TITLE IV — Small Company Capital Formation • TITLE V — Private Company Flexibility And
Growth• TITLE VI — Capital Expansion
Title III: Crowdfunding Title III: Crowdfunding • What is it? Issuing small amounts of stock to a large
number of investors.• Exemption under Title III
– Offering exempt from registration – Through a registered broker or registered funding
portal– Allowing sales to accredited and unaccredited
investors– Provided that such sales comply with the
requirements of the exemption• Benefits of Exemption
– Exemption from Blue Sky Laws– Non-accredited investors
Crowdfunding Crowdfunding Complications Complications • Must file with the SEC and provide to investors:
– Description of the offering, business or business plan, financial condition, ownership and capital stock
– Risk Factors– Financial statements
• Issuer must file with the SEC and provide to investors (at least annually) reports of the issuer’s results of operations and financial statements
• Issuer prohibited from advertising
• Obligations of intermediaries – File with SEC and FINRA– Obtain questionnaires regarding risks in startups etc.
Questions?Questions?
Nicole M. Gewinner, Esq.Nicole M. Gewinner, Esq.Jackson Walker L.L.P.Jackson Walker L.L.P.
100 Congress Avenue, Suite 1100Austin, Texas 78701
www.jw.com