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

How To Structure Your Company And Raise The Cash …. Legally. Part I: How To Structure Your Company. Choose the Right Entity. When Should You Form an Entity? Initiation of Business Operations Asset Protection Capital Raising Multiple other factors …. Choose the Right Entity.

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

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  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.

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