Structuring Your Business from Startup Through Growth
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- 2. Goals • Understand Pre-Formation Issues • Learn About Available Entity Forms • Understand Advantages & Disadvantages • Walk Through Real World Application 2
- 5. Founders’ Agreements • Who Owns the Idea • Roles and Responsibilities • Decision Making and Operations • Ownership and Vesting • Departure and Transfers • Competition with the Business 5
- 6. What is an Entity? 6
- 7. Why Form an Entity? • Limited Liability • Permit Transfers of Economic Interests • Perpetual Existence • Facilitate Investment • Allow Multiple Owners • Enhance Credibility 7
- 8. Entity Considerations • Size of Business • Partners and Investors • Transferability and Continuity • Liability • Taxation • Financial Considerations 8
- 9. Size of Business • Administrative Ease • Costs of Formation – Monetary Costs (Filing Fees) – Non-Monetary Costs (Compliance) 9
- 10. Partners and Investors • Identity and Number • Management and Control • Divergence of Interests – Exit Strategies – Growth or Distribution – Life Situation 10
- 11. Transferability and Continuity • Effect of Partner Exit • Dissolution of Business • Consider the End at the Beginning 11
- 12. Liability Bank Loans Third PartiesProduct Liability • Unlimited Personal Liability v. Limited Liability • Exception: Piercing the Veil 12
- 13. 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 13
- 14. 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 14
- 16. 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 16
- 17. 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 17
- 18. 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 18
- 19. ‘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? 19
- 21. ‘C’ Corporations Corporate Veil: Provides for liability shield 21
- 22. ‘C’ Corporations Lifting the Corporate Veil Tax: Double Taxation 22
- 23. ‘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 23
- 24. ‘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 24
- 25. Limited Liability Company • Hybrid Entity: Corporation and Partnership • One or more partners • No restrictions on the number of owners • Easy formation • Flexible management structure 25
- 26. 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 26
- 28. 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 28
- 29. Advantages: Easy To Form & Operate! Profits Taxed Only Once Control Disadvantages: Unlimited Liability Ceiling on Ownership Difficult to Raise Capital Sole Prop. 29
- 30. Advantages: Easy/Cheap to Form & Operate! Profits Taxed Only Once Disadvantages: Floor on Ownership Control Liable for Partners Limited Transferability General Partnership 30
- 31. Advantages: Access To Capital Limited Liability Opportunity to “go public” Transferability of Interests Disadvantages: Taxed Twice Complex & Costly to Form/Operate C Corporations 31
- 32. 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 32
- 33. Disadvantages: Limited Transferability of Interest LLCs Advantages: Management & Control Limited Liability Profits Taxed Once Easy To Form & Operate! 33
- 34. 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 34
- 35. 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 35
- 37. 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? 37
- 38. Case Study #1 Type of Entity for Pampered Pup? • Sole Proprietorship • General Partnership • S Corporation • C Corporation • Limited Liability Company 38
- 39. Case Study #1 Type of Entity for Pampered Pup? • Sole Proprietorship • General Partnership • S Corporation • C Corporation • Limited Liability Company 39
- 40. 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? 40
- 41. Case Study #2 Type of Entity for Custom Woodworks? • Sole Proprietorship • General Partnership • S Corporation • C Corporation • Limited Liability Company 41
- 42. Case Study #2 Type of Entity for Custom Woodworks? • Sole Proprietorship • General Partnership • S Corporation • C Corporation ? • Limited Liability Company 42
- 43. Company Formation Why Delaware? • Predictability • Delaware General Corporation Law • Delaware courts • Lawyers are more acquainted 43
- 44. Company Formation Why not Delaware? • Expensive • Taxes • Corporate agent in Delaware • Lawsuits 44
- 45. Questions? 45