How To Structure Your Company And Raise The Cash …. Legally

1. How To Structure Your Company And Raise The Cash …. Legally

2. Part I:How To Structure Your Company

3. Choose the Right Entity When Should You Form an Entity? • Initiation of Business Operations • Asset Protection • Capital Raising • Multiple other factors ….

4. Choose the Right Entity • Sole Proprietorship • General Partnership (GP) • Corporation • C-Corp • S-Corp • Limited Partnership (LP) • Limited Liability Company (LLC) http://www.sos.state.tx.us/corp/index.shtml

5. Sole Proprietorship • Default entity • NO liability protection • Insurance coverage is only option for liability protection • A DBAfiling is NOT entity formation

6. General Partnership • Definition: Association of 2 or more persons to carry on a business for profit – whether they intend to create a partnership – and whether they call their association a partnership, joint venture or other name • Factors indicating a partnership: • Right to share of profits • Expression of intent • Right to control business • Contribution of money or property • NO liability protection, partners are jointly and severally liable for all partnership liabilities

7. Corporation Shareholders Ownership Strategy/Direction Board of Directors Officers: President, Vice President, CEO, CFO, Secretary, Treasurer Implementation/ Signing Authority Employees/Operations/Contracts Liabilities

8. Corporation Cons • Expense of formation and maintenance • Double taxation for the C-Corporation • S-election restrictions • 100 shareholders or less • One class of stock • Only U.S. residents or citizens • Corporate formalities Pros • Limited liability for shareholders • Centralized management • Flexible capital structure • Most well-known and easily understood • Growth-oriented

9. Limited Liability Company Shareholders Members Ownership Strategy/Direction Board of Directors Managers Officers: President, Vice President, CEO, CFO, Secretary, Treasurer Officers: President, Vice President, CEO, CFO, Secretary, Treasurer Implementation/ Signing Authority Employees/Operations/Contracts Employees/Operations/Contracts Liabilities

10. Limited Liability Company Pros • Flow-through taxation • Limited liability for members • Flexibility of Company Agreement • Easy to form Cons • Different terminology (i.e. Managers and Members instead of Board and Shareholders) • Some investors may insist on corporation structure

11. Limited Partnership Strategy/Direction Implementation/ Signing Authority General Partner (LLC/Corp) Limited Partners Ownership Employees/Operations/Contracts Liabilities

12. Limited Partnership Pros • Flow-through taxation • Liability limited for limited partners • Restricted participation of limited partners in management Cons • Must have a general partner who is liable for all partnership obligations • Limited partners have to agree to no say in management (can be less attractive to investors) • Limited partners who participate in management of business become liable as GPs • Expense of maintaining multiple entities

13. Cost and Timing

14. Biggest Concerns • Taxation: How the entity will be taxed? • Liability: Who will be liable for its obligations? • Management: Who will manage the entity? • Ownership: Who will be the owners of the entity?

15. Taxation • Levels of Taxation: • Federal Tax (IRS) • State Tax (Texas Franchise Tax) • http://www.window.state.tx.us/taxinfo/franchise/margin.html • Taxation by Entity Type: • C-Corp: Double taxation at corporate level and again at shareholder level upon distribution of dividends • S-Corp: No corporate level tax imposed – corporate level income treated as received by shareholders • Limited Partnership: Non-taxable “flow through” entity – taxation imposed only at ownership level • Limited Liability Company: See Limited Partnership above

16. Liability • Entity Liability: Entity will be liable to extent of its assets - question is who will be liable, if anyone, if the entity’s assets are not sufficient to satisfy all claims? • Owner Liability: • Generally shareholders, limited partners and members will not be personally liable for debts and obligations of the entity in excess of their investment • Exceptions • Piercing the Corporate Veil factors include perpetrating fraud, formation to avoid legal obligation or statute, protection for crime • Debt guarantees

17. More Liability • Fiduciary Duties: • Who has them? Directors in corporations, general partners of limited partnerships, managers of limited liability companies • What are they? • Duty of Loyalty: Act in good faith and not allow personal business interests to prevail over interests of corporation. • Duty of Care: Take care that an ordinarily prudent person would exercise under similar circumstances • Duty of Obedience: Obey law and certificate of formation • Indemnification by entity available if so provided

18. Management • Partnerships and LLCs do “not” have Presidents and Directors • Who will have control over/vote on what decisions? Owners or Management? • Generalization: • Corporations = defined by law (modified by agreement) • Partnership and LLC = defined by agreement

19. Joint Ownership Issues • Not only your co-owner, but also your cousin, brother-in-law, roomate… • Shareholder/Company/Partnership Agreements • What if I want to sell? • What if my partner dies? Gets divorced? Files for bankruptcy? • Issues are always easier to resolve before money is a factor

20. Respectthe Entity Form • Keep the Personal Personal • Do not pay personal bills with corporate checks. • Do not pay corporate expenses with personal checks. • Keep Records, “Minutes” or Written Consent • Action taken by owners or management? • Major corporate actions such as voting in management and big transaction • Assets transferred out of the corporation – PAPER IT • Assets transferred by anyone to the corporation – PAPER IT. • Business Operations in Entity Name • Business insurance (e.g. public liability, disability, group medical, hazard) in entity name • Contracts in entity name

21. Respect: Signatures • Corporation or Limited Liability Company MY COMPANY, a Texas ___________ By: ____________________ Name: __________________ Title: ____________________ • Limited Partnership YOUR PARTNERSHIP, L.P., a Texas limited partnership By: ABC CORPORATION, its general partner By: ______________________ Smart E. Entrepreneur, the President

22. Respect: Books & Records • Accounting Books: Income Statement, Balance Sheet, etc. • Corporate Books: Certificate of Formation, Bylaws, Minutes, Written Consents, Ledger, Partnership Agreement, Company Agreement, etc.

23. Part II:Raising The Cash

24. Debt: Lenders • Most major traditional banks do not lend to startups or do so only rarely • Comerica, Square 1 Bank, Silicon Valley Bank lend to entrepreneurial companies • Will want to see accounts receivable, inventory, assets • Very sensitive to market conditions – this last down turn caused them to become risk adverse • Terms may include: fees, collateral, agreement to pay for AR audits, monthly reporting, audited financial statements, financial covenants plus all banking relationships – checking, credit cards, investments, etc. must be with lender

25. Equity: Stock and Ownership Interest • Corporation: Common Stock or Preferred Stock to Stockholders • Understood by typical investors – “Can I buy stock in your company?” • Allows for flexibility (redemption rights, conversion rights, preferences) • Limited Partnerships: Partnership Interest to Limited Partners and General Partner • Limited Liability Companies: Membership Interest to Members • Units v. Percentage Interest • Class A, Class B • Voting Rights • Waterfalls

26. Equity: Potential Investors • Co-owners • Friends and Family • Angel Funding • Wealthy private individuals, with background in business, usually smaller than VC’s ($25K - $250K). • Prefer to deal directly with the entrepreneur • Like local deals • Limited in the number of investments they will do concurrently

27. Equity: Potential Investors • Venture Capital • VC’s often are prepared to invest in continued rounds as the business grows and achieve its milestones • Bring valuable skills, contacts, experience and discipline to your business • Exiting usually in the form of a Public Offering or Sale to a larger business after reaching certain milestones. • Demanding, costly, time consuming. • Due Diligence process can be brutal – background checks, justification of your business plan, legal review, patent review, financial forecasts, etc. • Entrepreneur may lose control after 2nd round of financing to marquee CEO, CFO, etc. • Management reporting to the VC’s is often onerous

28. Securities Law • Starting Place: Registration with the SEC IS required • All securities offerings must be registered with the SEC • Offer triggers compliance requirements - compliance must happen before selling process starts • Unless, that offering is exempt from registration • Doesn’t matter if small private sale or an offering which is immediately listed on the NYSE

29. Private Offerings = Exempt • Privately-negotiated sales • Must not involve any general solicitation or general advertising • Section 4(2)* - the private-offering exemption - “transactions by an issuer not involving any public offering” * Securities Act of 1933(the “Securities Act”)

30. Reg D • Rule 504: Exemption for the offer and sale of up to $1 million of securities in a 12-month period • Rule 505: Exemption for offers and sales of securities totaling up to $5 million in any 12-month period. • Rule 506: Exemption for sales of securities under Section 4(2) with no dollar limit. http://www.sec.gov/answers/regd.htm

31. Rule 506 • Permits unlimited dollar amount of sales • Without a PPM • To Accredited Investors • Preemption from Blue Sky Laws • So long as Offers and Sales are made to Accredited Investors with whom the issuer (or its broker-dealer) has a Substantial Pre-Existing Relationship http://www.sec.gov/answers/rule506.htm

32. “Accredited Investor” • A bank, insurance company, registered investment company, etc. • An employee benefit plan • A charitable organization, corporation or partnership with assets ≥ $5 million • A director, executive officer or general partner of the company selling the securities • A business in which all the equity owners are accredited investors • A natural person with a net worth of at least $1 million (not including house) • A natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 • A trust with assets of at least $5 million

33. Why Only Accredited Investors? • Private placement memorandum that meets Reg D requirements = $$$$$ • If more than $1 million is raised in a 12-month period, Rule 504 is not available • Under Rule 505 and 506, a PPM would be required to offer securities to non-accredited investors • NOTE: Even if not required, delivering a PPM or at least a detailed business plan is probably advisable for liability and marketing reasons, particularly in fulfilling the antifraud requirement.

34. JOBS ACT 2012 • TITLE I—Reopening American Capital Markets To Emerging Growth Companies • TITLE II - Access To Capital For Job Creators • TITLE III — Crowdfunding • TITLE IV — Small Company Capital Formation • TITLE V — Private Company Flexibility And Growth • TITLE VI — Capital Expansion

35. Title III: Crowdfunding • What is it? Issuing small amounts of stock to a large number of investors. • Exemption under Title III • Offering exempt from registration • Through a registered broker or registered funding portal • Allowing sales to accredited and unaccredited investors • Provided that such sales comply with the requirements of the exemption • Benefits of Exemption • Exemption from Blue Sky Laws • Non-accredited investors

36. Crowdfunding Complications • Must file with the SEC and provide to investors: • Description of the offering, business or business plan, financial condition, ownership and capital stock • Risk Factors • Financial statements • Issuer must file with the SEC and provide to investors (at least annually) reports of the issuer’s results of operations and financial statements • Issuer prohibited from advertising • Obligations of intermediaries • File with SEC and FINRA • Obtain questionnaires regarding risks in startups etc.

37. Questions?

38. 512.236.2366 ngewinner@jw.com 100 Congress Avenue, Suite 1100 Austin, Texas 78701 www.jw.com Nicole M. Gewinner, Esq.Jackson Walker L.L.P.