structuring your business from startup through growth
DESCRIPTION
Follow up slides from PENN LAW ENTREPRENEURSHIP LEGAL CLINIC AT NEXTFAB http://nextfab.ticketleap.com/penn-law-entrepreneurial-legal-clinic-at-nextfab/detailsTRANSCRIPT
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Goals
• Understand Pre-Formation Issues • Learn About Available Entity Forms • Understand Advantages & Disadvantages • Walk Through Real World Application
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Pre-Formation Issues
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Founders’ Agreements
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Founders’ Agreements
• Who Owns the Idea • Roles and Responsibilities • Decision Making and Operations • Ownership and Vesting • Departure and Transfers • Competition with the Business
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What is an Entity?
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Why Form an Entity?
• Limited Liability • Permit Transfers of Economic Interests • Perpetual Existence • Facilitate Investment • Allow Multiple Owners • Enhance Credibility
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Entity Considerations
• Size of Business • Partners and Investors • Transferability and Continuity • Liability • Taxation • Financial Considerations
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Size of Business
• Administrative Ease • Costs of Formation
– Monetary Costs (Filing Fees) – Non-Monetary Costs (Compliance)
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Partners and Investors
• Identity and Number • Management and Control • Divergence of Interests
– Exit Strategies – Growth or Distribution – Life Situation
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Transferability and Continuity
• Effect of Partner Exit • Dissolution of Business • Consider the End at the Beginning
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Liability
Bank Loans Third Parties Product Liability
• Unlimited Personal Liability v. Limited Liability • Exception: Piercing the Veil
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Taxation Pass Through Taxation v. Double Taxation
You Keep $16! Multiply by 10, 100, 1000, etc.
Pass Through Taxation Double Taxation
Income $100 $100 Entity Tax (20%) $0 $20 Distribution $100 $80 Personal Tax (20%) $20 $16 Take Home $80 $64
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Financial Considerations
• Effect of Entity Choice on Capital Raising • Effect of Capital Raising on Entity Choice • Ongoing Compliance Requirements • Consider the Legal Issues and Document
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Available Entity Forms
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Overview of the Entity Choices
• 6 different options: 1. Sole Proprietorship 2. General Partnership 3. Limited Partnership 4. ‘C’ Corporation 5. ‘S’ Corporation 6. Limited Limited Company
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Sole Proprietorships and General Partnerships
Most common form of conducting business • Formation: Easy to incorporate. No
formalities unless a fictitious name is intended to be used
• Personal Liability: No corporate shield • Limited Existence • Tax: All income earned treated as income of
the owner
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Sole Proprietorships and General Partnerships
• Management: Owner free to manage the way he desires
• Low Maintenance Cost: No record keeping • Desirable for businesses with low investment
and limited assets • Not desirable for multiple owners or high
potential liabilities • Partnerships not desirable for spouses as
partners are jointly and severally liable to creditors
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‘C’ Corporations
• State law creation • Independent legal entity • Separate legal existence • Incorporation costs: Statutory compliance • No restrictions of number of stockholders • Administrative formalities – Why is this an issue?
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‘C’ Corporations
Management Structure
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‘C’ Corporations
Corporate Veil: Provides for liability shield
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‘C’ Corporations
Lifting the Corporate Veil
Tax: Double Taxation
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‘S’ Corporations
• An IRS creation for tax purposes
• Hybrid between ‘C’ Corporations and Partnerships
• Same characteristics as a ‘C’ Corporation
• Suited for small businesses
• Form can be changed
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‘S’ Corporations
Differs from ‘C’ Corporation: (i) Ownership Structure: Only up to 100 shareholders. Limited to individual US residents and certain trusts (ii)Tax Treatment: No Double Taxation
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Limited Liability Company
• Hybrid Entity: Corporation and Partnership • One or more partners • No restrictions on the number of owners • Easy formation • Flexible management structure
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Limited Liability Company
• Limited Liability • Piercing the corporate veil • Low Maintenance Cost: Not required to convene
periodic meetings or maintain records • Tax: Flow Through Treatment
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Advantages & Disadvantages
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Introduction Sole Prop GP C Corp S Corp LLC
Owner Numbers & Types
1 ≥ 2 ≥ 1; multiple classes permitted
≤ 100; US residents, certain trusts
≥ 1
Liability Personal liability
Personal liability
Limited liability Limited liability Limited liability
Management Owner No restriction Shhds Board Officers
Shhds Board Officers
Member or Manager (very flexible)
Tax Personal rate Pass-through Double taxation Pass-through; must file IRS election
Pass-through or C-Corp or S-Corp
Formation Issues
Register with State
No filing req File Cert. of Incorp.; Form Board; Issue Stock; Adopt Bylaws
Same as C Corp; Must File IRS election for pass-through tax treatment
File Cert. of Org.; Operating Agreement recommended
Transferability Transfer by selling assets
Consent of all partners (subject to PA)
Flexible; Shhds Agreement Restrictions
Same as C Corp; comply w/ IRS reqs
Flexible; Operating Agreement Restrictions
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Advantages: Easy To Form & Operate! Profits Taxed Only Once Control
Disadvantages: Unlimited Liability Ceiling on Ownership Difficult to Raise Capital
Sole Prop.
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Advantages: Easy/Cheap to Form & Operate! Profits Taxed Only Once
Disadvantages: Floor on Ownership Control Liable for Partners Limited Transferability
General Partnership
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Advantages: Access To Capital Limited Liability Opportunity to “go public” Transferability of Interests
Disadvantages: Taxed Twice Complex & Costly to Form/Operate
C Corporations
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Advantages: Profits Taxed Only Once Limited Liability Transferability of Interests
Disadvantages: Complex & Costly to Form/Operate Limited to 100 shareholders Raising Capital is tougher
S Corporations
100
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Disadvantages: Limited Transferability of Interest
LLCs Advantages: Management & Control Limited Liability Profits Taxed Once Easy To Form & Operate!
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Review Sole Prop GP C Corp S Corp LLC
Owner Numbers & Types
1 ≥ 2 ≥ 1; multiple classes permitted
≤ 100; US residents, certain trusts
≥ 1
Liability Personal liability
Personal liability
Limited liability Limited liability Limited liability
Management Owner No restriction Shhds Board Officers
Shhds Board Officers
Member or Manager (very flexible)
Tax Personal rate Pass-through Double taxation Pass-through; must file IRS election
Pass-through or C-Corp or S-Corp
Formation Issues
Register with State
No filing req File Cert. of Incorp.; Form Board; Issue Stock; Adopt Bylaws
Same as C Corp; Must File IRS election for pass-through tax treatment
File Cert. of Org.; Operating Agreement recommended
Transferability Transfer by selling assets
Consent of all partners (subject to PA)
Flexible; Shhds Agreement Restrictions
Same as C Corp; comply w/ IRS reqs
Flexible; Operating Agreement Restrictions
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Application: LLC vs. Other Forms
Other Form LLC Advantages Sole Prop Limited Liability C Corp Easier to Form;
Pass-through Taxation S Corp Easier to Form;
More Flexible Capital Raising
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Real World Application
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Case Study #1
PAMPERED PUP DOG WALKING Suppose you want to start a dog walking business in Center City, Philadelphia. • Not capital-intensive • Complete control • Center City elite are very protective of their dogs • City of Philadelphia has strict dog laws Which type of entity structure should you choose?
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Case Study #1
Type of Entity for Pampered Pup?
• Sole Proprietorship • General Partnership • S Corporation • C Corporation • Limited Liability Company
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Case Study #1
Type of Entity for Pampered Pup?
• Sole Proprietorship • General Partnership • S Corporation • C Corporation • Limited Liability Company
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Case Study #2
CUSTOM WOODWORKS Suppose you want to open up an artisan woodworking shop in University City, Philadelphia. • Limited financial resources • A few financial contacts • Ambitions to open many stores Which type of entity should you choose?
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Case Study #2
Type of Entity for Custom Woodworks?
• Sole Proprietorship • General Partnership • S Corporation • C Corporation • Limited Liability Company
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Case Study #2
Type of Entity for Custom Woodworks?
• Sole Proprietorship • General Partnership • S Corporation • C Corporation ? • Limited Liability Company
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Company Formation
Why Delaware? • Predictability • Delaware General Corporation Law • Delaware courts • Lawyers are more acquainted
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Company Formation
Why not Delaware? • Expensive • Taxes • Corporate agent in Delaware • Lawsuits
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Questions?
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