There are some traps and gotchas so let’s start with that.Run thru types. Stay away from sole proprietorshipGP can be created inadvertentlyNow explain tax distinction between C Corp and Pass-thru (LLC/S Corp/Sole Proprietorship)Can deduct early lossesExplain Double Taxation – after business profitableDividendsProceeds of Asset SaleBig Pro for pass through – avoiding the double tax upon sale, or at least keeping open the option of asset saleDiscuss problems with S Corporations – one class of stock, no entity owners, no non-U.S. owners, little flexibility in allocating profits and losses – trip over these restrictions can cause conversion to C CorpNote the different advice they may get from accountants and lawyersTradeoff between saving a few thousand now in SE taxes vs. a huge delta upon sale. Note the SE tax benefit is not unlimited – have to pay a reasonable salarymany smaller accounting firms don’t do much partnership taxThere are 2 Cons for LLC (and therefore Pro for C Corp) – Many Financial Investors prefer and/or require themEasier to set up equity compensationFact dependent and context dependentIn my practice, since most of the entrepreneurs that I serve are planning for significant growth/financial investors/possible sale, LLC is almost always what we end up choosing.Lastly, most cost-effective to file in home state. Only need Delaware for public companies or other special purpose reasons. Ignore the gimmicks re other states like Nevada – you still have to qualify and pay franchise and income taxes in your home state.
Recruiting – networking, investor contacts, advisor contacts, Spark and other entrepreneur resourcesEvaluatingDon’t rush itDon’t just look at “technical” qualificationsLook at this as a marriage – long hours, difficult conditions, for hopefully a long timeBe rigorous in the evaluation phaseMultiple layersCheck referencesIncluding social settings, with spouses if applicableCompensationDon’t put cart ahead of the horseCommon mistake is to obsess over how much equityAs you near a decision, you will mutually have a better sense for appropriate compWhen you do want to zero in on an amount of equity – putting pen to paper on possible exit scenarios in however many years and then work backwards into how much would be appropriate nowMust have clear agreements, including Buy-Sell provisions4 D’s Death, Disability, Divorce and DisinterestAlmost always want the equity to vest over time
An active, up-to-speed, engaged board is critical to having a great dialogue
Transcript of "Business Law & Order - March 17, 2014 - Basics of Formation"
Business Law & Order:
Basics of Business Formation
March 17, 2014
California | Illinois | Michigan | Minnesota | North Carolina | Texas | Washington, D.C.
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Business Building Basics
Mark G. Malven
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• Business Formation Choices
– Pros and Cons
• Management Teams
• Advisory Boards (bonus
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• Choice of Entity Pros and Cons
– Sole Proprietorship
– General Partnership
– Contractual Relationship
– C Corporation
– S Corporation
• Relevant Factors
– Taxes – Distributions of (1) Income and (2) Upon Sale
– Financial Investors
– Equity Compensation
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Factors Supporting LLCs for Potential VC
• Members can still agree to corporate-like duties and
• VC can be given preferred interests.
• LLC can easily morph into corporate form.
• Appreciation rights can incentivize employees.
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Why Banks Prefer Corporations
• Tried and true.
• Perception that cash is easily transferable to owners.
• Known collateral classification of ownership interests.
• Operating agreements are not standard.
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– The Trust Factor
– Equity Vesting Over Time
– “Valuing” the Equity
• Clear Agreements, including Buy-Sell Provisions
– Death, Disability, Divorce, Disinterest
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– Compensation – cash and equity
– Managing the meetings, esp. larger boards
– Pet projects (for collaborators)
– Members other projects and roles
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• Best Practices
– Define why you need a AB
– Keep it small
– Avoid pure window dressing
– Watch out for blowhards
– Mix up the backgrounds – e.g. academics and industry
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• More Best Practices – running the meetings
– Send materials early!
– Actively manage the meeting
– Require real work
• Put them on the agenda for short presentations
• Jump right into feedback (requires the pre-reading to
– Include your team in the meetings