Business Formation

10 THINGS YOU NEED TO DO AS AN ENTREPRENEUR

So you have perfected the greatest idea since sliced bread and now you want to turn your idea into a business.  Well, this is a list of 10 big-ticket items that you need to keep in mind in moving the product from being an idea in the kitchen to being a business.  Note that none of these items works in isolation from the other and that none of them are static.  You’ll need to remake your business as markets, laws and the commercial environment change.

  1. Have a written business plan.  Without one you’ll never know what you’re doing, where you are going or how you are going to get there.
  2. Create a legal form for your business.  It can be a corporation, limited liability company (“LLC”), limited partnership or even a general partnership.  LLC’s are the preferred form today because (as the name implies) they offer limited liability (one of the main reasons for doing business as a corporation) with the income tax benefits enjoyed by partnerships.  (Note: one person LLC’s are now legal in California.)
  3. Determine how to finance your venture on a sustainable basis.  Will you use personal savings, the bank of mom and dad, mortgage your house, an SBA loan, bank loan, venture capital, sale of equity?  If a loan, how you will repay it?  If a sale of equity, how much control will you give up and for what price?  Also, don’t forget about those pesky security laws.
  4. What resources will you need to run your business?  Which functions will you outsource: production (e.g., use a co-packer), storage and delivery (e.g., a logistics firm), advertising, sales, bookkeeping?  If you will be hiring employees, what skills will they need and how much in wages and benefits will you be able to afford to pay them?  Keep in mind that carelessly outsourced functions or hired employees can cause you real grief.
  5. Protect your intellectual property rights.  Should you patent it or maintain it as a trade secret?  Have you made sure that employees, business associates, customers, and suppliers sign non-disclosure agreements whenever necessary.  Have you developed a trademark?  Do you want to register your trademark with the United States Patent & Trademark Office?  How about overseas?
  6. Document and administer your transactions.  Casual agreements are not a good business practice.  Get it in writing may sound trite, but a little extra work upfront can save you a lot of grief later especially when dealing with important suppliers and accounts.  The documentation doesn’t have to be elaborate, but it should be clear and complete so that strangers will agree on its meaning.  Also, don’t forget that agreements are living documents.  Refer to them from time-to-time in order to be sure that both you and the other party are complying with the terms of the agreement.  This is especially important when circumstances of either party change and might affect the agreement.
  7. Have a working knowledge of the regulations that affect your business.  There are two types of regulations.  The first type is the ubiquitous variety that apply to virtually every business (e.g. wage and hour laws, worker’s comp., OSHA, business licenses, zoning, etc.) and then the regulations that are unique to your business (e.g., FDA, USDA, EPA).  Correcting regulatory problems after the fact can be very expensive.    
  8. Develop a risk management strategy.  What business practices can you adopt to mitigate potential losses?  How much can you afford to self-insure?  What types and how much insurance will you buy for casualty losses and liability coverage? 
  9. Be prepared to delegate.  Many entrepreneurs unnecessarily try to do everything themselves or micromanage the business.  Details are important, but if you spend all of your energy on them, you’ll never have time to address the big picture items.  Furthermore, many aspects of creating and running a business require technical skills that can take years to learn and perfect.  Therefore, hiring specialized consultants can offer the best way to get things done right the first time within a budget.  It’s several times more expensive to do things wrong and then have to hire someone else to correct it.  The cheapest way to do something right the first time is hire an expert.
  10. Work out a tax compliance strategy.  Although you and your business should be separate legal entities, the choice of a legal form can involve significant tax issues.  Furthermore, failure to comply with our monumentally complex tax code not only may cost you money in terms of back taxes but also missed tax saving opportunities.

If you would like more information regarding forming your own business or maintaining your business, please contact either Allan Zackler or Steve Weinstein at (510) 834-4400 or by email at azackler@zacklerlaw.com and sweinstein@zacklerlaw.com.  

 

An Entrepreneur’s Choice of Entity

When an entrepreneur decides to realize his or her dream of starting a company, one of the first questions that they typically ask their legal counsel is which type of legal entity to select for their business. In most cases, the answer to this question is a Delaware “C” corporation, particularly if the entrepreneur plans to raise venture capital to fund the business. This article will discuss the most common types of legal entities and explain why this conclusion is usually reached.

The most common types of legal entities through which a business can operate are corporations (both “C” and “S” corporations), general partnerships, limited partnerships, and limited liability companies (“LLCs”). The designation of a corporation as a “C” or an “S” corporation refers to the subchapter of the Internal Revenue Code under which the corporation is formed. The two most significant factors that affect the choice of entity are limitation of liability for the owners of the entity and the tax treatment of the earnings of the business at the entity level and the owner level.

The owners of the entity, whether they are founders, investors, or employees, generally desire to insulate themselves from personal liability for the obligations of the entity. All of the entities mentioned above except general partnerships provide some degree of limited liability for their owners. Under state partnership law, all of the partners of a general partnership are personally liable for the obligations of the general partnership. Limited partnerships provide limited liability for the limited partners, but not for the general partners. As a result, general partnerships and limited partnerships are not acceptable entities for venture-backed businesses.

Generally, the owners of corporations (both “C” and “S” corporations) and LLCs will not have personal liability for the obligations of the entity itself. There are certain judicially created and statutory exceptions to this general rule. For example, if the entity is not properly formed and operated and the legal formalities of the entity are not followed, a court may pierce the corporate veil and hold the owners liable for the obligations of the entity. Also, the owners of the entity may have personal liability in certain cases that relate to environmental and products liability.

“C” corporations are subject to double taxation. The corporation itself must pay federal and state income tax on its profits. Then, after these profits are distributed as dividends to the corporation’s stockholders, each stockholder must pay income taxes on his or her share of those dividends. Since the corporation cannot claim a deduction for the distribution of dividends, there is no way to lessen the impact of this double tax.

Generally, limited partnerships, general partnerships, “S” corporations, and LLCs are all treated as pass-through entities for federal and state income tax purposes. As a result, none of these entities are subject to federal or state income tax at the entity level. Under the Internal Revenue Code or the North Carolina tax laws, there is no partnership income tax, “S” corporation income tax, or LLC income tax. Rather, the taxable income or loss of these entities is passed through to the owners. This pass-through effect potentially could provide numerous benefits to investors including: (a) the ability to pass through to investors tax deductions and losses that are typically generated by early stage companies; (b) the ability of investors to increase their tax basis in their investment through retained earnings as the business becomes profitable; and (c) the distribution of earnings to investors without incurring a tax on those earnings at the entity level. However, if a pass-through entity is generating net income on which its owners must pay taxes, the entity must be able to make cash distributions to the owners so that they have will have funds to pay their tax liabilities.

Notwithstanding the significant tax benefits of these pass-through entities, most venture-backed entities are organized as “C” corporations. The reason is that most venture funds cannot invest in pass-through entities under the terms of their investment documents. Most venture funds receive a significant amount of their funding from tax-exempt organizations such as pension funds. Pension funds and similar organizations are exempt from taxation on dividends and capital gains that they receive, but not on pass-through income. As a result, most venture funds are prohibited from investing in pass-through entities.

In addition to being a pass-through entity for tax purposes, “S” corporations are subject to several other limitations that make them unattractive entities for venture-backed companies. Among these restrictions are that: (a) “S” corporations can generally have only individuals as stockholders; (b) “S” corporations can only have a single class of stock; and (c) “S” corporations can only have 75 stockholders.

Once the decision has been made that the “C” corporation is the entity of choice for the new company, the next question is in which state to incorporate. Each state has its own corporate code. While several national bar organizations have developed a model corporate code that many states have adopted to some extent, there are significant differences in the corporate codes of each state. Among the factors that should be considered in selecting the state of incorporation are: (a) the depth and predictability of the state’s corporate law and court system; (b) the nature and extent of the protection that the state’s corporate law affords to officers and directors of the corporation; (c) the flexibility and ease of use of the state’s corporate code; (d) the state’s incorporation fees and annual franchise taxes; and (e) the efficiency and service of the state’s corporation agency. Most corporate attorneys agree that Delaware comes out ahead of all the other states in an analysis of each of the foregoing factors. In addition, most corporate attorneys are very familiar with Delaware corporate law. Therefore, if the investor is represented by out of state counsel, that attorney will probably already be familiar with Delaware corporate law, thus avoiding the necessity of educating the attorney on the nuances of the corporate law of another state. This can help facilitate the closing of a financing and save transaction costs.

As a result of all of these factors, the Delaware “C” corporation generally is the entity of choice for start-up companies. When preparing to start a new business, Zackler & Associates can help you determine which type of entity will be best suited for your business and prepare the necessary documentation and filings.

 

Phone: (510) 834-4400
Facsimile: (510) 834-9185