Chapter 6

1. Chapter 6 Setting up the company

2. Objectives • Best form of ownership • Sole proprietorship and partnership • Incorporating a business • S corporation and limited liability company (LLC) • Registering a business with government entities • Choosing an attorney

3. Introduction • One of the most important decisions is how to legally structure a business. • This is due to the tax laws, liability situation, and ways to attract capital. • Many provide incentives to key employees by offering ownership or equity interest in the company. • The legal form of a business – sole proprietorship, C corporation, S corporation, partnership, or LLC should be determined in light of business needs.

4. Sole proprietorship • Sole proprietorship: A single owner does business himself/herself and requires only a business license to open. • If doing business under a name other than the owner, the business name must be filed as a “doing business as” registration with a state and/or local filing authority. • The business can be terminated anytime and always ends with the death of the owner. • The owner is personally liable for all debts and contracts of the business. • Profits and losses are taxed at individual income tax rates on the owner’s personal tax returns.

5. C corporation • The C corporation is the most common form of business ownership. • A corporation has 3 primary sections: the stockholders, the board of directors, and the officers. • The stockholders are the owners of the business. Each share of stock represents a percentage of ownership. • The board of directors have responsibility for the overall operation of the company. The stockholders elect the board. The board of directors elect the officers • The usual officers in a corporation are president (in charge of day to day operations), secretary (paperwork of the corporation), and treasurer (corporate finances). • Delaware is a popular state for incorporation.

6. Advantages of a C corporation • 1. Limited liability of the stockholders: limited to the total amount of their investment in the corporation. • 2. Ability to attract capital: Venture capitalists demand this form of incorporation. • 3. Ability of the corporation to continue indefinitely: The existence of the corporation does not depend on a single individual. • 4. Transferable ownership: Stockholders can sell their shares. • 5. Skills, expertise, and knowledge: Corporation draws on the skills, expertise, and knowledge of several people (unlike sole proprietorship).

7. Disadvantages of C corporation • 1. Cost and time involved to incorporate: complexity may require involvement of an attorney. • 2. Double taxation: Corporations are taxed on their profits up to 35%. Dividends are also taxed up to 35%.

8. S corporation • To become an S corporation: • 1. The company must be a domestic company. • 2. Only one class of stock is allowed. • 3. Only individuals and certain trusts may own stock. • 4. Shareholders cannot be non resident aliens. • 5. There can be a maximum of 100 shareholders. • 6. The shareholders must elect to become an S corporation at the federal and state level.

9. Advantages and disadvantages of S corporation • Advantages of S corporation: Retains all advantages of a regular corporation. Avoids double taxation (no corporate income tax).Tax status is similar to sole proprietorship or partnership. • Disadvantages: To raise capital from venture capitalists, the company will have to be restructured as a C corporation.

10. Partnerships • General partnership: has unlimited liability, which includes personally owned assets outside the business association. • Limited partnership: limits the liability of the partners to the extent of their capital contribution. • Advantages: Easy to establish. Complementary skills of partners. No restriction on division of profits. Larger pool of capital. Ability to attract limited partners. Avoids double taxation. • Disadvantages: Unlimited liability of at least one partner (at least one general partner). Potential for partner conflicts.

11. Limited liability company • LLC: Blend of best characteristics of corporations, partnerships, and sole proprietorships. • Formed by filing an Article of Organization form with the secretary of state. • Advantages: Owners do not assume liabilities for debt. Not a tax paying entity. No restrictions on classes of memberships or number and types of owners. • Disadvantages: May be difficult for expansion out of state. Transferring ownership is restricted ( varies for different states).

12. Business start up checklist • First 30 days: Name search on Clerks Commission Web site. Check whether web name is available. Modify name till both are available. Determine structure: C corp, S corp, or LLC. Obtain employer ID number from the IRS by completing form SS4. Select a lawyer. Select an accountant. • Need to show: Business license #, federal ID, 2 current IDs for each person authorized to sign checks, SSNs and household location of business owners, business tax ID and SIC code, business location address, business plan, banker, insurance agent, business insurance, by laws adopted, board of directors is elected.

13. Business start up checklist • First 60 days: Establish presence on internet, contact suppliers, for S corp – file form 2553 within 75 days, business insurance (liability, health, workers comp, etc), join a professional organization, some states require list of officers and directors to be filed with state. • By first year end: Federal tax forms, state tax forms, corporate franchise tax, or annual state fees, financing from friends or angel investors, credit line from bank.

14. Selecting your attorney • An attorney can help with: formatting the business, filing necessary documentation, employment contracts, stock ownership agreements, hiring independent contractors, and those for raising capital. • Find one that can competently meet your needs (get recommendations from other business owners). • The attorney has to be knowledgeable in corporate law, securities law, taxation, contract law, employment law, and license or trademark law. • Get estimate of cost of starting your business. • If not satisfied consult another attorney.

15. Selecting your accountant • The accountant should be able to set up the financial control system and offer sound financial advice. • Should be able to: establish accounting and reporting systems, cash projections, financing strategies, tax planning, vendor services and payment options, compensation plan for employees, and accounting software requirements.

16. Name registration, Federal ID #, Insurance issues • Name registration: In most states a corporation’s name must include the word corporation, company, incorporated, limited or an abbreviation. A competent attorney can assist with this. • Federal ID number: from the IRS – except for sole proprietorship. Use form SS-4 (Application for Employer identification number). • Insurance issues: shop for best combination of coverage, service, and price. Insure for fire, employee health and life, crime coverage (burglary), business interruption (cause by fire, etc.), liability, product liability, and directors. • Other Issues: state registration, web site registration, domain name registration.

17. Summary • The legal form of a business – sole proprietorship, C corporation, S corporation, partnership, or LLC should be determined in light of business needs. • Sole proprietorship: A single owner does business himself/herself and requires only a business license to open. • The C corporation is the most common form of business ownership. • A corporation has 3 primary sections: the stockholders, the board of directors, and the officers. • Double taxation: Corporations are taxed on their profits up to 35%. Dividends are also taxed up to 35%. • Advantages of S corporation: Retains all advantages of a regular corporation. Avoids double taxation (no corporate income tax).Tax status is similar to sole proprietorship or partnership. • Limited partnership: limits the liability of the partners to the extent of their capital contribution. • LLC: Blend of best characteristics of corporations, partnerships, and sole proprietorships. • An attorney can help with: formatting the business, filing necessary documentation, employment contracts, stock ownership agreements, hiring independent contractors, and those for raising capital. • The accountant should be able to set up the financial control system and offer sound financial advice. • Insurance issues: shop for best combination of coverage, service, and price.

18. Home Work • 1. Why is it important to decide how to legally structure a business? • 2. What are the different legal forms of a business? • 3. What are the 3 primary sections of a corporation? • 4. What are the advantages of an S corporation? • 5. Why is a limited partnership better than a general partnership? • 6. What are the advantages of a limited liability company (LLC)?