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Copyright 2013 Jack M. Kaplan & Anthony C. Warren
Setting Up the Company
Patterns of Entrepreneurship Management 4th Edition, Chapter 6
Getting Started
Chapter 6
Ownership
Questions
Forms of Ownershi
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Legal Issues
Comparisons
Copyright 2013 Jack M. Kaplan & Anthony C. Warren
Presentation Outline
• What form of Ownership is Best?
• Forms of Doing Business– Setting Up a Proprietorship– Setting Up a “C” Corporation– Setting Up a Sub. S– Partnerships– Setting Up a Limited Liability Company (LLC)
• Legal Issues
• Comparison Organization Charts
Chapter 6
Ownership
Questions
Forms of Ownershi
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Legal Issues
Comparisons
Copyright 2013 Jack M. Kaplan & Anthony C. Warren
What Form of Ownership is Best?
1. How big can the business potentially become?2. How much control do you need in the decision-making
process of the company? 3. How much capital is needed to start the business?4. What tax considerations are important? 5. In case of failure, to what extent are you willing to be
personally responsible for debts created by the business?
6. Is it important that the business continue in case of the owner’s incapacity or death?
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Ask yourself these questions:
Copyright 2013 Jack M. Kaplan & Anthony C. Warren
Forms of Doing Business
The legal form of the business is selected from:
•Sole Proprietorship, •C-Corporation,•S-Corporation,•Partnership,•Limited Liability Corporation (LLC)
The form should be determined in light of the business’ short- and long-term needs’
Chapter 6
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Legal Issues
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Copyright 2013 Jack M. Kaplan & Anthony C. Warren
Sole Proprietorship
Overview:
A Sole Proprietorship has a single owner and only requires local business licenses to open.
Pros:
• Simple to create
• Low start up fees
• No special legal restrictions
Cons:
•Unlimited personal liability
•Limited access to capital
•Lack of Continuity for the Business
Chapter 6
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Copyright 2013 Jack M. Kaplan & Anthony C. Warren
Overview:• Separate legal and tax entity from owners.• Shareholder liability limited to invested capital.• Existence continues after shareholder’s death.• Best form for raising external capital.Pros:• Limited liability.• Most appropriate structure for an IPO.• Certain tax benefits and easy to provide stock option plans.• Ease of transferability of interests.• Structure that a venture capitalist requires.Cons:• Double taxation at the personal and corporate level once
profitable.• High administration compliance costs.• Directors are held personally accountable.• Well defined corporate governance rules and laws to follow.
“C” Corporation
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Copyright 2013 Jack M. Kaplan & Anthony C. Warren
Registering a “C” Corporation
You must: • Register the name with a state.• Decide on the location of the
company’s principal office.• Obtain a federal employer ID number
SS-4.• Establish the capital structure of the
company.• Open a bank account with the ID
number and acquire a corporation seal.
Chapter 6
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Copyright 2013 Jack M. Kaplan & Anthony C. Warren
Small Business Corporation (Subchapter-S)
Overview:
• A corporation, but with “flow through” tax benefits to owners.• As a corporation, Sub-S is a separate entity and therefore has
limited liability for owners and stockholders.• Limited to 75 owners, only one class of stock allowed, and no
foreign shareholders.Pros:
• Liability protection.• Enjoy corporation status, but owners pay the taxes.Cons:
• Stringent rules necessary to maintain Sub-S status.• Qualification requirements bring administrative and cost
burdens.• Failure to comply with Sub-S rules, may have major tax
consequences.• Not eligible for qualified employee stock options.• Investors cannot receive preferred shares as in a C-
Corporation.
Chapter 6
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Copyright 2013 Jack M. Kaplan & Anthony C. Warren
Partnerships
Overview:
A partnership is usually defined as an association of two or more people carrying on as co-owners of a business for profit.
Pros:– Easy to Establish– Division of Profits– Ability to attract partners– Little Government Regulation
Cons:– Unlimited Liability of at least one Partner– Capital Accumulation not possible– Restrictions of Eliminating General partner– Potential for Personality and Authority Conflict
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Copyright 2013 Jack M. Kaplan & Anthony C. Warren
Limited Liability Company(LLC)
Overview:• Owned by “members”, not shareholders.• A combination of the best characteristics of
corporations, partnerships, and sole proprietorships.Pros:• Liability protection (a separate legal entity as in a C
Corporation).• LLC is not a tax paying entity (tax benefits to members).• Statute meetings and minutes are not required.Cons:• Unlikely that a venture capitalist would invest.• Cannot take the company public.• Different shareholder interests result in complex
operating agreements.• All members must consent to transfer ownership.• Some states have different management and member
rules.• Often used initially before converting to a C Corporation,
which incurs costs.
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Copyright 2013 Jack M. Kaplan & Anthony C. Warren
Choosing Legal Counsel
• Law firms handle a variety of legal matters, including corporate, intellectual property, and tax and employment issues.
• Attorneys often specialize in one of these areas.
• Look for firms that are experienced with start- ups from early stage to IPO.
• Avoid firms that deal primarily with large companies.
• Avoid attorneys that do more work with venture capitalists than start-ups.
• Seek recommendations and references.
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Copyright 2013 Jack M. Kaplan & Anthony C. Warren
Setting Up the Board of Directors - 1
• Set the number of directors.
• Designate the initial board of directors.
• Determine whether the directors will be elected by a plurality of the vote or cumulative voting.
• Cumulative voting entitles each stockholder to cast the total number of votes multiplied by the total number of directors to be elected and insures the minority has representation of the board.
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• Establish a procedure to fill vacancies on the board.
• Designate the executive officers of the company.
• Determine whether the officers should be elected by the stockholders or appointed by the board.
• Determine each officer’s title and responsibilities.
Setting Up the Board of Directors -2
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• Subscription Agreements– Used for initial and subsequent capital contributions.
• Purchase and Sale Agreements– Used for purchase of operating assets.
• Employment Agreements– Given to senior executives.
• Confidentiality Agreements– Used to protect existing and in-process intellectual
property – for employees, and third parties.
• License Agreements– Covers any intellectual property that you use or license.
• Customer Agreements– Basis for delivery of services (service companies only).
Some Legal Agreements You May Require
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Copyright 2013 Jack M. Kaplan & Anthony C. Warren
Employer –Employee Agreements
• The employee cannot disclose any confidential information about the company either during or subsequent to employment.
• They must return all materials that belong to the company at the time of termination of employment.
• They cannot engage in a new business during the period of employment without the consent of the employer.
• They will not compete with the company for a period of time subsequent to employment.
• Any new ideas they have must be assigned to the employer.
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Copyright 2013 Jack M. Kaplan & Anthony C. Warren
Business Organizational Structure Comparison Chart
-1Characteristic C-Corp. S-Corp. LLC
Limited liability for all owners Yes Yes Yes
Owners can participate in management without losing liability protection Yes Yes Yes
Easy to form and without maintaining extensive record keeping Yes Yes No
Number of owners 2 or more 1-75 2 or more
Restrictions on ownership No Yes No
Double tax Yes No No
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Copyright 2013 Jack M. Kaplan & Anthony C. Warren
Business Organizational Structure Comparison Chart
-2Characteristic C-Corp. S-Corp. LLC
Able to deduct business loss on individual return No Yes Yes
YesBasis for loss includes owner’s share of company debt in owner’s tax return No Yes
Can increase basis by “step-up” election Yes Yes Yes
Can specially allocate items of income and expense Yes Yes Yes
Contribute and distribute appreciated property tax free No Yes Yes
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Summary Guidelines
• The key issues to consider are liability, taxation, and corporate governance.
• The structure should be based on your goals and objectives.
• You should consider an LLC or a Sub S for a lifestyle/family business.
• If you plan to go public or raise venture capital, consider a C Corporation.
• Consider the advantages in registering a C Corporation in Delaware.
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