msjdn january webinar - small business formation
TRANSCRIPT
Forming a Small BusinessDONNA HUNEYCUTT, CO-FOUNDER, CO-OWNER, GENERAL COUNSEL, WITTENBERG WEINER CONSULTING, LLC
W W CPutting Good Government Into Practice
Speaker’s Background•Former corporate attorney, clients included GE Capital GMAC, Oxygen media, Tiger Funds
•Observed excellent business management at a small boutique firm
•Interest in finance/business
•Moved to Italy because of surprise PCS
•Helped a friend incorporate, reviewed her contracts
•With same friend, taught almost all of an MBA curriculum
•Accidental entrepreneur
•$7 million company currently employs 60 full time staff around the globe
Obviously, the information presented here is general and should not be deemed legal advice; your situation will vary by fact pattern and state law and may be subject to exceptions.
Do You Want to Run a Business?Are you a self-starter?
Are you organized? Have you observed the operating norms of a well-run business?
Are you prepared to wear many hats?
Are a lot of your personal resources used for business (tax benefits)?
Are you prepared to develop a lot of areas of expertise and assume a lot of liability for getting things right, e.g. employer taxes, insurance, health care, accounting, taxes, etc.
Some personalities are better suited to be employees
If you want to work in a particular field, be careful telling potential employers that you have set up your own company
Choosing a Corporate Form Considerations:
◦ Protection of personal assets◦ Your personal assets can’t be protected against liability for your gross negligence or deliberate malfeasance◦ Your personal assets won’t be protected from liability to pay a personal guarantee
◦ Structure◦ Predictability◦ Taxation◦ Market environment◦ Separate Credit rating
Choosing a Corporate Form: Sole Proprietorship
Pro:
1. You essentially already are a sole proprietorship; no filings or additional tasks required
2. Flow-through taxation
3. One proprietor is sufficient
Cons:
1. No personal liability protection
2. Flow-through taxation at earned income rates
Choosing a Corporate Form: Partnership
1. General Partnership includes joint and several liability by all partners for all partners
2. No personal liability protection
3. Largely replaced by LLCs and LLPs
4. Limited partnership offers limited liability to passive partners, but you still need a fully, personally liable general partner. Good luck finding one!
Choosing a Corporate Form: C Corporation
Pros:
1. Best-developed corporate form = predictability
2. In a C Corporation, you may have different classes of shares
3. Best form to recruit investors and take public; the markets fully understand it; SEC regs written for the Corporation paradigm
4. C Corp is taxed at lower corporate rates (15-35%)
Cons:
1. Highly prescribed structure and reporting
2. “Double” taxation at the corporation level and the shareholder level
3. Expensive filings
4. Not bulletproof
Choosing a Corporate Form: LLC Pros:
1. Flexible – less prescriptive – safe harbor re procedures– flexible allocations of profits and losses
2. Less reporting
3. Pass-through taxation: You can avoid double taxation if you file to be taxed as a Subchapter S
4. Double asset protection (your assets protected from LLC’s liabilities, your LLC’s assets protected from your personal creditors except by charging order)
5. One member MAY be sufficient
6. Harder to pierce the corporate veil than in a corporation, because of the reduced formality
Cons:
7. Less developed caselaw and predictability
8. Different states have different requirements regarding equality of members and fiduciary duties
9. Lesser default structure for how to run things
10. Must structure correctly to optimize asset protection
11. Possible capital values tax/franchise tax
Choosing a Corporate Form: PLLC (PLLP)
1. Some states have a special corporate form for professional services firms
2. To qualify, members may be required to have specific insurance
3. To qualify, members may be required to have specific professional certification
4. Generally eligible for Subchapter S election
5. Otherwise, rules generally follow the rules for LLCs
6. Do not confuse with a limited partnership (where at least one partner is a general partner and the others are passive limited partners)
Choosing a Corporate Form: (Subchapter S) Election
“Subchapter S Corporation” designation is an IRS designation that can be elected by a corporation or an LLC
Pros:
1. Flow-through taxation; no tax paid at the corporation level (except Wash DC state tax)
2. Can elect back to C Corp status at any time
3. Private equity is comfortable with this form (for private placement purposes)
Cons:
1. Only one class of stock permitted
2. Must be “closely held”; Shareholdership limited to 100 owners
3. Generally, shareholders must be natural persons who are US citizens
4. Be careful about deductions and salary (http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/S-Corporation-Compensation-and-Medical-Insurance-Issues)
Closely Held Corporation v. LLC (Both elected Subchapter S)
Closely Held (S) Corporation LLC
Equity Type Stock (limited to 100 holders) Membership Interests
Equity Classes Only common stock Different membership interests may be permitted
Filing Document Articles of Incorporation Articles of Organization
Operating Document By-Laws, Highly prescribed Flexible (Operating Agreement?)
Taxation Flow Through (earned income rates)
Flow through (earned income rates)
Liability Limited Liability * Limited Liability*
Record Keeping Highly-prescribed record keeping and reporting
Minimally-prescribed record keeping and reporting
Cost Generally more expensive Generally less expensive
Daily Management Officers Members or Hired Managers
Piercing the Corporate Veil Corporate veil analysis begins with whether the organization is a real separate structure or whether it’s a “veil” designed to serve as one owner’s alter ego?
1. How many people have equity? The “charging rule” was developed to protect a second equity owner, so it may not apply if there is only one owner
2. Is the corporation a “separate person”? Is it a “legal fiction”
3. Is the owner being paid as an employee at a reasonable rate?
4. Do corporate record demonstrate that the company has a life of its own?
5. Are assets intermingled? Are there personal loans?
6. Is the company sufficiently capitalized?
7. Does the company pay dividends?
Strategic ConsiderationsThink about a business partner
◦ Try before you buy◦ Someone who balances out your skills portfolio◦ Someone you trust◦ Write an exit strategy into your operating agreement so that you can part as friends if it doesn’t work
◦ Buy/sell agreement◦ Company dissolution◦ Notices and periods to cure◦ Duty of loyalty will be in the caselaw
Get a “personal Board of Advisors”
Seek out mentors, but keep in mind how much extra time and energy they have
The best time to start a company is when someone wants you to do a project for them
Where to incorporate
The Logistics1. Do a name search in the state of incorporation and the state of operations
2. Try to come up with something singular – it is not worth using a name in use elsewhere
3. You could trademark your name, but it’s expensive and may not be an issue when you’re a start up or if the name is one others could not use. You have some claim just by using it
4. File your organizing documents
5. Choose an accounting basis (actual or accrual)
6. Get an EIN number
7. Depending on your industry, you may want to get a DUNS number or CAGE code
8. Structure your equity issuances, capitalization, operating norms, and internal controls
Selling Equity/Getting FinancingIn most situations where owners are related or where all owners are involved in the business, equity offerings are exempt from Federal SEC filing requirements
Alternatively, if you’re conducting a private offering to “sophisticated investors”, you can be exempt from any SEC filing requirements as well, depending on a number of other variables
Private placements can be to 35 or fewer “sophisticated investors”, investing for medium term investment and not share flipping, and if you’ve filed an exemption form with the SEC
As you begin, you will not find a lender who will lend to you without a personal guarantee
Think long and hard before taking out a loan for your business
The Day to Day In addition to providing a great Service or product, you will need to…
• Pay employer taxes – IRS.gov website is very helpful and your local state tax website
• Understand labor laws and human capital if you are employing anyone else
• Consider yourself an employer in most cases where you use someone else’s services unless they are truly a vendor or 1099 contractor
• Thoroughly understand the tax requirements that apply to your company
• You may need to pay taxes quarterly in anticipation of profits
• Consider from the beginning that consistency in treating issues is important as you grow bigger
• Field any and all issues that come up
• Do “extra” paperwork above and beyond the actual service or manufacturing that your business creates
• Use reliable accounting software (such as Quickbooks for Small Business)
• Look into whether you need business insurance, professional insurance, etc. See http://www.americanbar.org/groups/gpsolo/resources/insurance.html for attorneys’ professional liability insurance requirements
IMPORTANT, especially for lawyersBusiness is never a zero-risk environment
Lawyers, understand your role as a businessperson, avoid analysis by paralysis
A good attorney finds a way to get to a legitimate objective
But you have to have a good business relationship to weather the bumps in any transaction
Listen to your gut if it lurches
Document the reasons for any non-obvious choices and decisions
Businesspeople, understand your role regarding laws and regulations, and take legal advice seriously
