Lecture 5: Structuring a Corporation


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Startup founders often times just want to focus on building a product, but there are advantages to setting up a corporate structure early on. In this lecture Poornima Vijayashanker covers the various types of corporate structures that exist, and other things to consider such as equity and board of directors.

You can watch the lecture here: http://youtu.be/S7Ov-rsgTdk

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Lecture 5: Structuring a Corporation

  1. 1. Duke ECE 490L: How to Start New Ventures in Electrical and Computer Engineering Poornima Vijayashanker poornima@femgineer.com Jeff Glass jeff.glass@duke.edu Akshay Raut ar118@duke.edu 1
  2. 2. Review • Creativity • Brainstorming • Team Building • IP Duke ECE 490L 2
  3. 3. Announcements • Everyone on the listserv? duke-ece-490l@googlegroups.com • Lab 2 - Quiz on readings from week 1 & 2 • Office Hours on Wednesday 3-4pm • Attendance Duke ECE 490L 3
  4. 4. Resources 4
  5. 5. Agenda • Corporate Structuring • Types of Corporations • Equity, Debt, Assets • Delaware • Board of Directors • Board of Advisors Duke ECE 490L 5
  6. 6. Why do you need a corporate structure if you’re just building a product? Duke ECE 490L 6
  7. 7. Duke ECE 490L • Legal protection - limited liability • Attract investment • Acquisition • Tax haven Benefits of Being a Corporation 7
  8. 8. What are the various corporate structure? Duke ECE 490L 8
  9. 9. Duke ECE 490L • LLC • C-Corp • S-Corp Corporate Structures 9
  10. 10. Duke ECE 490L • Partnership: where owners are members. Members maybe individuals, other LLCs, and foreign entities. • Tax Structure: all LLC income, losses, deductions, and credits flow through to the owner. Earnings are taxed once. • Types of Businesses: any except loans, insurance, and non-profits. • Disadvantages: cannot issue shares fore investment purposes. • Disclaimer: check state requirements and federal tax regulations. LLC 10
  11. 11. Duke ECE 490L • Individual entity: separate from its owners, owners become shareholders. • Shareholders are only liable to the extent of their investment - personal assets are not on the line like in an LLC or sole proprietorship. • Debts are also responsibility of corporation. • Advantages: • Limited liability - instead of purchasing liability insurance. • Raising capital is easier because you issues stocks for sale. Investors like the prospect of earning dividends from profits. • Avoid taking out a loan and paying high interest rates. C-Corp 11
  12. 12. Duke ECE 490L • Advantages: • Also appealing to employees who get stock options. • Company can deduct fringe benefits offered to shareholder employees as a business expense. (Fringe benefit is life insurance, health/disability insurance, medical expenses not paid by insurance). • Disadvantages: • Double taxation: after deducting business expenses, salaries, fringe benefits, and interest payments, C-Corp must pay taxes on profits at corporate level. If distributes profits as dividends, then individuals must pay tax on personal tax return. Can avoid by re-investing profits back into business. C-Corp Continued 12
  13. 13. Duke ECE 490L • Disadvantages: • Bureaucracy and Expenses: stockholders and board of director meetings, must hire lawyer and accountant to handle stock plans. C-Corp Continued 13
  14. 14. Duke ECE 490L • Plan to pay dividends? • Limited liability, income flows through to individual tax returns, and tax-free merger benefits. Limit of 100 shareholders. Don’t pay federal corporate taxes. • Everything is passed through to the owner, can also get assigned losses to report on tax return. • Cannot deduct fringe benefits like a C-Corp but employees who are not shareholders may receive benefits without paying taxes. • Pay vs. profit sharing. Offering a low salary and compensating via profit will raise a flag with IRS. IRS may require payroll taxes to be filed for total income of stockholder. S-Corp 14
  15. 15. Can you convert from a C-Corp to an S-Corp? Duke ECE 490L 15
  16. 16. Yes, but when you convert you become subject to gains tax. This issues comes up in the first 10 years when a C-Corp sells an asset that has built in gains when S election was made. Duke ECE 490L 16
  17. 17. Duke ECE 490L Corporate Structure Advantages Disadvantages LLC Tax benefits for owners. Limited options for raising capital. C-Corp Limited liability, raising capital, and tax deductions on fringe benefits. Double taxation. S-Corp Pass through profits and losses to owners tax return. Cannot deduct fringe benefits. 17
  18. 18. Equit. Debt. Assets. Duke ECE 490L 18
  19. 19. Equity: an ownership interest in a corporation in the form of common stock or preferred stock. Also total assets minus total liabilities also called shareholder’s equity.* Duke ECE 490L * InvestorWords 19
  20. 20. Asset: is any property owned by the corporation. Includes but is not limited to money, real estate, and equipment.* Duke ECE 490L * Law Depot: Corporate Forms FAQS 20
  21. 21. Debt: aka corporate bond, is a bond issued by a corporation to raise money in order to expand its business.* Duke ECE 490L * Wikipedia - Corporate Bond 21
  22. 22. Equity. Duke ECE 490L 22
  23. 23. More to come when we cover fundraising. Duke ECE 490L 23
  24. 24. Cap Table: who owns the startup, outlines shareholders and shares. Duke ECE 490L 24
  25. 25. Duke ECE 490L Founder stock Calculating share price. 25
  26. 26. How much to assign for early employees and founders? Duke ECE 490L 26
  27. 27. Duke ECE 490L 27
  28. 28. Common Stock: A security that represents ownership in a corporation. Holders of common stock exercise control by electing a board of directors and voting on corporate policy. Common stockholders are on the bottom of the priority ladder for ownership structure. In the event of liquidation, common shareholders have rights to a company's assets only after bondholders, preferred shareholders and other debtholders have been paid in full.* Duke ECE 490L * Definition of Common Stock 28
  29. 29. Preferred Shares: A class of ownership in a corporation that has a higher claim on the assets and earnings than common stock. Preferred stock generally has a dividend that must be paid out before dividends to common stockholders and the shares usually do not have voting rights. The precise details as to the structure of preferred stock is specific to each corporation. However, the best way to think of preferred stock is as a financial instrument that has characteristics of both debt (fixed dividends) and equity (potential appreciation). Also known as "preferred shares".* Duke ECE 490L * Definition of Preferred Shares 29
  30. 30. Vesting: period by which an employee earns shares in a corporation. Typically startup employees have a 4-year vesting period. Each new allotment of shares is subject to a new vesting cycle, golden hand-cuffs. Duke ECE 490L 30
  31. 31. Cliff: period of time that a startup employee must serve the company before any of their shares are considered vested. Duke ECE 490L 31
  32. 32. Early exercise option. Duke ECE 490L 32
  33. 33. More to come when we cover fundraising. Duke ECE 490L 33
  34. 34. Delaware. Duke ECE 490L 34
  35. 35. Duke ECE 490L • Cheaper to incorporate. • Well verse in business matters. • The Chancery Court does not use juries, and it’s better because corporations don’t want juries deciding complex business issues. Judges are more capable. • Large body of corporate law to help avoid legal entanglements. • 30% of revenue comes from franchise tax, which the state has invested into technology to keep processes running smoothly and provides timely service. Benefits of Incorporating in Delaware 35
  36. 36. How do you incorporate? Duke ECE 490L 36
  37. 37. Duke ECE 490L • You don’t have to live in Delaware or have your company HQ’s there. • You can have a company with a 1-person executive team and 1 board member. • Even if you are based in Delaware but don’t do business, you don’t have to pay corporate tax. You do have to pay franchise tax. • If you have already incorporated in another state, you can still incorporate there! Incorporating in Delaware 37
  38. 38. What is franchise tax? Duke ECE 490L 38
  39. 39. Franchise tax: domestic stock or non- stock for profit corporation incorporated in the State of Delaware is required to pay annual tax.* Duke ECE 490L * How to Calculate Franchise Taxes 39
  40. 40. How much is franchise tax? Duke ECE 490L 40
  41. 41. Minimum is $75 for using the Authorized Shares method and minimum tax of $350 for corporations using the Assumed Par Value Capital Method. * Duke ECE 490L * How to Calculate Franchise Taxes 41
  42. 42. Board of Directors. Duke ECE 490L 42
  43. 43. Duke ECE 490L • If you have shares! • Responsible for managing corporation’s business and affairs. • Main responsibilities: • Develop strategic planning process • Selecting and directing management team • Protecting shareholders rights’ • Ensuring legal compliance Board of Directors 43
  44. 44. Profitability is often times prioritized. Duke ECE 490L 44
  45. 45. Check on BoD authority? Duke ECE 490L 45
  46. 46. Composition matters. Duke ECE 490L 46
  47. 47. Founder, investor, and independent member. Duke ECE 490L 47
  48. 48. Board of Advisors? Duke ECE 490L 48
  49. 49. Review Duke ECE 490L • Corporate Structuring • Types of Corporations • Equity, Debt, Assets • Delaware • Board of Directors • Board of Advisors 49