gamestartup101: legal: company formation

Game Industry Start Up 101

Workshop #1: LegalBusiness Formation Basics

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Workshop Sponsored by:

Game Industry Start Up 101:Business Formation Basics

Kha DangPerkins Coie, LLP

206.359.6334KDang@perkinscoie.com

The following presentation is intended to assist entrepreneurs in spotting legal issues relevant to new businesses in the State of Washington. The attached is not meant to cover all issues that you may face. There are many factors to be considered in determining which actions and decisions would be most appropriate to any specific situation. This presentation is not intended to substitute for specific legal advice. You should decide which course of action is best after discussing it thoroughly with an attorney.

Choosing a Business Entity

Types of Business Entities

Sole Proprietorship General Partnership Corporation

C Corp S Corp

LLC Limited Partnership; Limited Liability Partnership (not

covered)

Sole Proprietor Simplest and most common

type of entity. Automatically formed when an

individual or married couple goes into business.

Business income is taxed on individual’s tax return.

Unlimited personal liability

Sole Proprietor Simplest and most common

type of entity. Automatically formed when an

individual or married couple goes into business.

Business income is taxed on individual’s tax return.

Unlimited personal liability

General Partnership Formed when two or more unmarried

individuals go into business Partners personally “jointly and

severally” liable (unlimited) for business.

Profits/Losses generally allocated along % of ownership

Each partner’s share of the business income is taxed on her own individual tax return.

General Partnership Formed when two or more unmarried

individuals go into business Partners personally “jointly and

severally” liable (unlimited) for business.

Profits/Losses generally allocated along % of ownership

Each partner’s share of the business income is taxed on her own individual tax return.

Corporation Formed by filing with

Secretary of State. Must keep good records

and comply with management formalities.

Owners (shareholders) are not personally responsible for business debts.

Two different types of corporations “C” and “S” corporations.

“S” Corporation Income not taxed on corporate level (pass

through taxation). Corporate income taxed on an individual level,

whether received by shareholders or not. Must file an “S” election with the IRS and

comply with specific requirements to maintain the “S” status.

S Corp.Difficult to qualify

Common stock only - no preferred (no VC investors)

Individual shareholders (no entities) Limitation on shareholder number Residency requirements

(Very) Basic TaxS Corp

One level of tax on S Corp

$100 earnings($35) shareholder tax $65 net available for distribution    $0 shareholder tax on distribution $65 available for shareholder

“C” Corporation

Double tax: Income of business is taxed on corporate

level. Income (dividends) shareholders receive from

corporation taxed on individual level. Usually not the best choice for a small

business.

(Very) Basic TaxC Corp

Two levels of tax on C Corp

$100 earnings($35) corporate tax $65 distribution ($10) shareholder tax $55 available for shareholder

Limited Liability Company

Formed by filing with Secretary of State

Must keep good records and comply with management formalities.

Limited Liability Can elect to have

pass through tax treatment

(Very) Basic Tax (cont.)

LLC – Like S Corp.

But Preferred Stock and Entity Shareholders OK

LLC Not Pre-Financing Entity

No tax exempt owners Not good for options (but profits interests

available) Expensive if raising investor $

Online filing

Advantages Speed Cheap

Disadvantages Not complete for Corp.

Organizational requirements Contribution of assets Founders relations

Not complete for multiple member LLC Operating Agreement Future investors

Founders' Issues

Founders' Issues

Vesting Voluntary termination of employment Termination for cause; without cause Change in control

Single Trigger Double Trigger

83(b) election

Licensing/PermitsDo I need permission

to do what I do?

Licenses and Permits

Master Business Application: http://access.wa.gov/business/index.aspx

City Specific Licenses (Bellevue on line; Seattle is paper filing)

FEIN: (IRS)

Financing

Financial DilutionDilution in preferred stock rounds often greater

than entrepreneurs realize Series A Round Statistics

Pre Money $6,000,000

Raise $2,000,000

Post Money Value $8,000,000

% Ownership Proceeds On Liquidation

    $5,000,000 $10,000,000

    $ % $ %

Founder 1 30% $900,000 18% $2,400,000 24%

Founder 2 30% $900,000 18% $2,400,000 24%

Employee Plan 15% $450,000 9% $1,200,000 12%

Series A Investors* (fully participating preferred) 25% $2,750,000 55% $4,000,000 40%

Investor Controls

Founders' Majority Ownership ≠ Control of All Decisions

Protective Provisions Class Voting Rights Other Contractual Rights Investor Expectations

Securities Laws

Applies to all issuances of securities Federal and State Laws Accredited Investors

Employees v. Independent Contractors

What is an Employee?

Employees are subject to the employer’s control

Employer must withhold and pay employment taxes on employees, severe penalties for failure to do so.

Employer must comply with labor laws.

What is an Independent Contractor?

Independent contractors are people who perform services for others but who do not have the legal status as employees.

Independent contractors are not subject to the employers control

Employer must file form 1099-MISC if paid more than $600 to an independent contractor

Knowing the Difference

It is very important that a business properly identify a person as an employee or independent contractor.

The burden is on the employer to prove the worker is NOT an employee.

BE CAREFUL….

Classify your workers correctly, if you classify an employee as an independent contractor, you can end up having to pay the employment taxes with interest and penalties!

If in doubt, check with an attorney or with the IRS!!

IRS Guidelines

General standards Behavior Control (tasks, results, training) Financial Control (reimbursements, how

paid,extent of worker’s investment, opportunity for profit and loss)

Type of Relationship (written contract, benefits, permanency, integral to regular business)

Tips to Protect Yourself

Sign a contract with an independent contractor

Arrange a flat fee for the job, not hourly or weekly rate

Independent contractor should be able to hire his own assistants and offer his services to other businesses

Independent contractor should have control over the project and provide his own equipment and materials.

Independent contractor should provide his own insurance, business cards, invoices, etc.

Do not give employee-like benefits (sick days, vacation time) to an independent contractor

Keep a file with the independent contractor’s business card, advertisements, employer ID number, etc.

IRS Employer Publications

Employers Tax Guide: http://www.irs.gov/pub/irs-pdf/p15.pdf

Employers Supplemental Tax Guide (categorization of employee and independent contractors): http://www.irs.gov/pub/irs-pdf/p15a.pdf

Kha DangPerkins Coie LLP

206.359.6334KDang@PerkinsCoie.com