the very basics - forming the business (series: advising the start-up )
TRANSCRIPT
ADVISING THE START-UPThe Very Basics – Forming the Business
Premiere Date: January 23, 2017This webinar is sponsored by: EisnerAmper 1
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MODERATOR
Jonathan Friedland Sugar Felsenthal Grais & Hammer, LLP
PANELISTS
Brian Judkins Dinsmore & Shohl
David Lallouz Tannenbaum Helpern Syracuse & Hirshtritt
Susan Smith Selloquent LLC
MEET THE FACULTY
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SERIES SPONSOR
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ABOUT THIS WEBINARSo, you are an entrepreneur and want to start your own business (or you are an attorney,
accountant, or other professional advisor working with one).
One of the first decisions required is to choose a legal structure for the business.
What factors should be taken into consideration prior to selecting a legal structure?
Does a sole proprietorship, partnership, limited liability company or corporation (C- or S-corp)
make the most sense?
This webinar focuses on business formation and the pros and cons to the different legal structures,
and includes tips on how to keep one’s personal assets safe from the claims of future creditors of the
business.
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ABOUT THIS SERIESNine out of ten startups will fail. This is the hard and bleak truth.
Advising the Start-Up 2017 is intended to place your startup in the 10% that survive…and hopefully thrive.
Learn from entrepreneurs who have started businesses that have both failed and succeeded. Learn from
professionals who have advised startups from idea, to business formation, to employee no. 1, to successful
startup.
Each episode is delivered in Plain English understandable to business owners and executives without much
background in these areas. Yet, each episode is proven to be valuable to seasoned professionals. As with all
Financial Poise Webinars, each episode in the series brings you into engaging, sometimes humorous,
conversations designed to entertain as it teaches. And, as with all Financial Poise Webinars, each episode in the
series is designed to be viewed independently of the other episodes, so that participants will enhance their
knowledge of this area whether they attend one, some, or all of the episodes.
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EPISODES IN THIS SERIES
EPISODE #1 The Very Basics – Forming the Business 1/23/2017
EPISODE #2 Raising Capital – Negotiating with Potential Investors 3/6/2017
EPISODE #3 HR- 101: Finding, Negotiating With & Retaining Potential Hires 4/17/2017
EPISODE #4 IP – 101: What Every Founder/Entrepreneur Must Know 5/22/2017
Dates shown are premiere dates; all webinars will be available on demand after premiere date
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INTRO
• So…you’ve decided to start a business!
• Which means you have asked and answered the following questions:
What problem am I solving?
Who is my competition?
How am I different than my competition?
• What now?
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FORMING AN ENTITY
• What’s the first thing a new business owner should do?
Form an entity
• Why form an entity?
Limited liability (capped vs. unlimited)
With: The business owner is only at risk for the amount of their investment and none of the other obligations of the business
Without: The business owner is responsible for all of the business’ liabilities
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FORMING AN ENTITY (CONT’D)
More Reasons to Form an Entity:
• Interaction with third parties
Credibility with financing or other sources
May be demanded by third parties as a means of reducing potential liabilities
• Flexibility and structure for management and control
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FORMING AN ENTITY (CONT’D)
What happens if you do NOT form an entity?
• 1 person = sole proprietorship
• 2 or more people = general partnership
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TYPES OF LEGAL ENTITIES
• The two most common forms of legal entities are:
Corporations
C or S-Corps
Limited Liability Companies (or LLCs)
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CORPORATIONS
• Corporations
There are two variations on the corporation (based on the way they are treated for tax purposes)
C-Corp
Unless you plan to raise venture capital or go public, you’ll likely want to stay away from the C-Corp…it’s earnings are taxed twice!
S-Corp
Not subject to double taxation (pass-through entity)
Restrictions include (1) only individuals can be shareholders, (2) no more than 100 shareholders, (3) only U.S. persons can be shareholders, and (4) funds can only be divided between the shareholders “pro rata”
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CORPORATIONS (CONT’D)
• Both types of corporations are owned by their shareholders, whose ownership is evidenced by share certificates.
• Likewise, both types of corporations are largely managed by boards of directors, with day to day responsibilities handled by their officers.
• For both types of corporations, liability is generally limited, subject to adequate capitalization and following corporate formalities, to the amount of the shareholders’ investments in the corporations
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WHY CHOOSE C CORP OVER S CORP?
Given that S corporations generally have a single level of taxation, why would any company want to be a C corporation?
• S corporations have strict limitations on who can be their shareholders (generally, only citizens or resident aliens and most notably, generally not other business entities, although another S corporation may be permissible) and how many shareholders they can have (not more than 100)
• C corporations are generally better for fundraising, because they can have more than one class of stock, which is typically demanded by professional investors and must be used for public companies
• C corporations permit their shareholders to defer taxes until earnings are actually distributed
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OTHER TYPES OF CORPORATIONS
• Professional Corporations
Available, and typically mandatory, if forming a corporation, for certain professions (lawyers, doctors, accountants, etc.)
May not be able to limit individual liability, at least for malpractice actions, even if using
• Statutory close corporations
Limitation on number of shareholders (35)
Flexible management structure such that a shareholder with much less than majority ownership may be able to control management
Fallen into disfavor in the LLC era?
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OTHER TYPES OF CORPORATIONS (CONT’D):
• Non-profit corporations
No profits distributed to shareholders
Limitations on purpose, use of funds, etc.
• Co-operative corporations (consumers, agricultural, etc.)
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LIMITED LIABILITY COMPANIES (LLCs)
• LLCs offer, as their name suggests, limited liability like a corporation, taxation like a S corporation or a partnership, and do not have the restrictions on ownership of a S corporation
• LLCs offer a flexible management structure such that they can either be operated by one, some or all of their members (the LLC equivalent of shareholders) or a manager or managers, who may or may not be members
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LIMITED LIABILITY COMPANIES (CONT’D)
• LLCs are formed by the filing of a certificate (or articles) of organization.
• Their primary governing documents, which are not mandatory but are highly advisable, are known as operating agreements
Operating Agreements are similar to bylaws but often include additional provisions of governance and share transfer which may be included in a shareholder agreement of a corporation.
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LIMITED LIABILITY COMPANIES (CONT’D)
• LLCs have become extremely popular for the advantages and flexibility they offer.
• However, because of their relative newness and largely contractual nature:
LLCs offer less certainty, to both their members and outside entities dealing with them, than do corporations.
While LLCs are permitted to grant stock options, have more than one class of stock and do not generally have limitations on who can become members, there is enough haziness on these issues such that professional investors will generally prefer a C corporation
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SUMMARY OF PRIMARY ENTITY CHOICES
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C-Corporation Limited Liability Corporation/Partnership S-Corporation
Limitation of Liability Yes Yes Yes
Tax Treatment Double-taxation Single-taxation Single-taxation
Permitted Owners Unrestricted Unrestricted • Limited to 100 shareholders• Shareholders cannot be partnerships, corporations or
non-resident aliens• Effectively precludes institutional investors
Equity classifications Common stock; no restrictions on shareholder preferences
Membership or Partnership Interests; distribution preferences permitted
Common Stock (only one class permitted)
Formation Complexity Simple to very complex; options well-established/understood by investors
Complex; LLC/Partnership agreements can become have a wide variety of terms
Simple
Maintenance Complexity/Cost
Simple More complex (requires partnership accounting) Simple (but note close attention to shareholder restrictions to ensure single-level tax treatment)
Ideally Suited For • Start-ups seeking or intending to institutional investors
• Investors wishing to defer personal taxes on investment
• Service partnerships (medical, consulting, law firms)
• Investors wishing to defer personal taxes on investment
• Owners looking for flexible management structure
• Owners looking to allocate assets and losses in a manner not necessarily consistent with ownership percentages
• Small businesses with capital investments from founders (e.g., retailers), and no plans to seek institutional investment
• companies generating significant free cash flow (as a percent of revenues)
FUNDING YOUR BUSINESS
• Sources of Financing Bootstrap
Friends & Family
Government
Angel Investors
Venture Capitalists
Commercial Banks
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FUNDING YOUR BUSINESS (CONT’D)
• Types of Financing
Debt (where you borrow money from a lender that you’ll eventually pay back plus interest)
Pros
Relatively inexpensive form of financing
Control how capital gets allocated (some lenders impose certain restrictions)
No impact on the operations of the business
Cons
Reduces cash flow (diverts capital to principal and interest payments)
Reporting requirements
Potential personal guarantee
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FUNDING YOUR BUSINESS (CONT’D)
• Types of Financing
Equity (where you sell ownership in your business in return for capital)
Pros
No diversion of capital (i.e., no principal or interest payments)
Right investors bring more than capital (experience, industry connections)
Cons
Relatively expensive form of capital
Giving away ownership and possibly control of your business
Raising equity can be a long process
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FUNDING YOUR BUSINESS (CONT’D)
• Types of Financing
Convertible Debt (a loan (a debt obligation) that can be turned into equity (or stock ownership))
Pros
Avoids setting a valuation (eliminates the risk of a “down round”)
No impact on the operations of the business
Cons
Reduces cash flow (diverts capital to principal and interest payments)
Giving away ownership and possibly control of your business
Requires extensive documentation
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FUNDING YOUR BUSINESS (CONT’D)
• Select documents necessary to raise financing
Business Plan
Executive Summary
Management Team + Board of Directors (Advisors)
Market Size
Financial Projections
Business Formation Documents
Confidential Information Memorandum (CIM)
Contracts
Employment Agreements
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RISK MANAGEMENT
• Corporate counsel
• Business licenses & registrations
• Internal controls / policies & procedures
• Insurance
D&O
Key Man
General Liability
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BUILDING A TEAM
• Board of Directors vs. Board of Advisors
• Resources needed (by function)
Business Development
Operations
Finance & Accounting (including Tax)
Legal
Human Resources
• Employee vs. independent contractor (IC)
• Focus on revenue generation (infrastructure lags revenue)
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EXTERNAL PROFESSIONALS
• Corporate counsel
• Accountant / bookkeeper
• Auditor
• Insurance broker
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BUSINESS DEVELOPMENT
• Start Early!
• Business Development vs. Marketing
• Who is responsible for revenue?
• In your head or preferably in a working document Goals
Business Development Strategy
Implementation Plan
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LESSONS LEARNED
• Do something you like and are passionate about
• Understand the problem you are solving, why that problem exists and will customers/clients pay you for the solution
• There are not enough hours in a day – prioritize those tasks that are the highest and best use of your time
• Building infrastructure should lag revenue (i.e., capital should be allocated to revenue generating assets)
• Hire smart, talented employees because you are only as good as your team (if you’re the smartest guy in the room, you’re in the wrong room)
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ABOUT THE FACULTY
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JONATHAN FRIEDLAND
Jonathan Friedland is a partner with Sugar Felsenthal Grais & Hammer, LLP, with offices in Chicago and New York. Jonathan regularly advises private funds in their M&A activity and private companies in their day-to-day affairs. Jonathan has extensive experience in guiding companies and their boards through a variety of challenging situations, including in Chapter 11 and other insolvency regimes.
Jonathan graduated from the SUNY Albany, magna cum laude, in 1991 (after three years of study) and from the University of Pennsylvania Law School in 1994. He clerked for a federal judge before entering private practice. He was an Adjunct Professor of Strategic Management at the University of Chicago’s Graduate School of Business for several years and was the 2006 Clayton Center for Entrepreneurial Law Visiting Professor of Business Law at the University of Tennessee College of Law. Jonathan has been profiled, interviewed, and/or quoted in numerous publications, including Buyouts Magazine; Smart Business Magazine; The M&A Journal; Inside Counsel; LAW360; BusinessWeek.com; The Bankruptcy Strategist; Dow Jones Daily Bankruptcy Review; Bankruptcy Court Decisions; Dow Jones LBO Wire; and The Daily Deal. Jonathan is also lead author and editor of several significant treatises, several chapters in other treatises, and hundreds of articles on law and business. Jonathan holds the highest possible rating from Martindale-Hubbell (AV® Preeminent™) and AVVO (10/10), has been repeatedly recognized as an Illinois “superlawyer” in multiple areas of practice, including Business/Corporate Law and Bankruptcy & Creditor/Debtor Rights, has been named several times as a “Leading Lawyer” by Leading Lawyers Magazine, and has received several other similar distinctions. He is also the founder of DailyDAC/Financial Poise.
ABOUT THE FACULTY
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BRIAN [email protected]
Brian is a partner at Dinsmore & Shohl. His thorough knowledge of corporate law matters, including experience with private and public securities offerings, and mergers and acquisitions of all sizes, enables him to bring efficient results for clients. Having worked with clients in a variety of industries, from health care to software, Brian’s practical approach allows him to learn each client’s operations and objectives before tailoring a strategy to suit their needs.
Brian earns the trust of his clients through his due diligence into exploring every avenue for resolutions. Brian has significant transactional experience with companies of all sizes, representing companies on all sides of middle and small market transactions. He also has extensive experience in working with start-up entities, guiding them through organizations, capital raising and exits.
Brian’s work has led to his recognition in The Legal 500 US 2011 Edition in the areas of middle-market transactions (defined as up to $500 million), where he is described as being “masterful at putting the terms of a deal together, being a subject matter expert in certain areas and pulling the entire acquisition team together to ensure all points are thoroughly considered and implemented.”
ABOUT THE FACULTY
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DAVID [email protected]
David R. Lallouz is a partner in Tannenbaum Helpern Syracuse & Hirschtritt LLP's Corporate, Capital Formation and Securities Law practice where he advises clients on complex corporate transactions. For a decade and a half, David has helped clients creatively structure, negotiate and implement mergers and acquisitions, private equity transactions, venture capital investments and joint ventures. David has successfully negotiated over a hundred M&A and related transactions to date, on the buy-side and sell side, and across a wide range of industries, including, industrial, manufacturing, commercial and retail, banking and financial services, biotech and health sciences, staffing, advertising and talent management, to name a few.
In addition, David regularly advises clients on corporate governance, business formation and capitalization, as well as commercial and contractual relationships. David is a co-founder of Tannenbaum Helpern’s StartMeUp program for entrepreneurs, offering a suite of legal services tailored to the needs of new business owners.
ABOUT THE FACULTY
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SUSAN SMITH
Susan Smith is the founder of Selloquent LLC. Susan speaks at annual leadership retreats, client-appreciation events, and networking events. Since founding Selloquent more than ten years ago, Susan Smith has delivered actionable talks on revenue generation for more than 100 organizations, totaling 2,500+ professionals.
Selloquent, LLC, specializes in revenue growth, accomplished by partnering with clients to adjust structure, process, skill, and by affecting cultural change. Selloquent clients routinely attain increases in profitability, orders, and/or order size.
Visit www.eisneramper.com
EisnerAmper. Let's Get Down to Business®
EisnerAmper LLP is a leading full-service advisory and accounting firm, and is among the largest in the United States. We provide audit, accounting, and tax services, as well as corporate finance, internal audit and risk management, litigation services, consulting, private business services, employee
benefit plan audits, forensic accounting, and other professional advisory services to a broad range of clients across many industries. We work with high net worth individuals, family offices, closely held businesses, start-ups, middle market and Fortune 500 companies. EisnerAmper is PCAOB-registered and provides services to more than 200 public companies and to thousands of entities spanning the hedge, private equity, brokerage and insurance
space in the financial services marketplace. As companies grow we help them reach their goals every step of the way.With offices in New York (NY), New Jersey (NJ), Pennsylvania (PA), California (CA), and the Cayman Islands, and as an independent member of Allinial
Global, EisnerAmper serves clients worldwide.
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