how to structure your company and raise the cash …. legally

HOW TO HOW TO STRUCTURE STRUCTURE

YOUR COMPANY YOUR COMPANY AND RAISE THE AND RAISE THE

CASH …. LEGALLYCASH …. LEGALLY

PART I:PART I:HOW TO STRUCTURE HOW TO STRUCTURE

YOUR COMPANYYOUR COMPANY

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

Choose the Right Choose the Right EntityEntity• 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

Sole Proprietorship Sole Proprietorship •Default entity •NO liability protection• Insurance coverage is only option for liability protection

•A DBA filing is NOT entity formation

General Partnership 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

Officers: President, Vice President,

CEO, CFO, Secretary, Treasurer

Employees/Operations/Contracts

Board of Directors

Shareholders Ownership

Strategy/Direction

Implementation/ Signing Authority

Liabilities

CorporationCorporation

ProsPros• Limited liability for

shareholders• Centralized

management • Flexible capital

structure • Most well-known

and easily understood

• Growth-oriented

ConsCons• 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

CorporationCorporation




Board of Directors

Shareholders Ownership

Strategy/Direction


Liabilities




Managers

Members

Limited Liability CompanyLimited Liability Company

Limited Liability Limited Liability CompanyCompany

ProsPros• Flow-through

taxation • Limited liability

for members• Flexibility of

Company Agreement

• Easy to form

ConsCons• Different

terminology (i.e. Managers and Members instead of Board and Shareholders)

• Some investors may insist on corporation structure


General Partner

(LLC/Corp)Limited Partners Ownership

Strategy/Direction


Liabilities

Limited PartnershipLimited Partnership

Limited PartnershipLimited PartnershipProsPros

• Flow-through taxation

• Liability limited for limited partners

• Restricted participation of limited partners in management

ConsCons• 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

Entity TypeEntity Type Fees and Other CostsFees and Other Costs TimingTiming

Corporation Filing Fee: $300Legal Fees: $700-$1200

• SOSDirect•Basic documents (may also do shareholders agreement)

Limited Liability Company

Filing Fee: $200Legal Fee: $1000-$5000

•SOSDirect•Documents can be complex

Limited Partnership

Filing Fee: $750Legal Fees: $2000-$5000

•SOSDirect•Documents can be complex•Requires 2-tier filing

Cost and TimingCost and Timing

Biggest Concerns 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?

TaxationTaxation• 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

http://www.window.state.tx.us/taxinfo/franchise/margin.html

http://www.window.state.tx.us/taxinfo/franchise/margin.html

LiabilityLiability• 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

More Liability 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

ManagementManagement•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

Joint Ownership Joint Ownership Issues 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

Respect the Entity Respect the Entity FormForm• 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

Respect: SignaturesRespect: 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

Respect: Books & Respect: Books & RecordsRecords• Accounting Books: Income

Statement, Balance Sheet, etc.

• Corporate Books: Certificate of Formation, Bylaws, Minutes, Written Consents, Ledger, Partnership Agreement, Company Agreement, etc.

PART II:PART II:RAISING THE RAISING THE

CASHCASH

Debt: LendersDebt: 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

Equity: Stock and Ownership Equity: Stock and Ownership InterestInterest• 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

Equity: Potential Equity: Potential Investors 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

Equity: Potential Investors 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

Securities Law 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

Private Offerings = Private Offerings = ExemptExempt• 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”)

Reg DReg 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

Rule 506Rule 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

““Accredited Investor”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

Why Only Accredited Why Only Accredited Investors?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.

JOBS ACT 2012 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

Title III: Crowdfunding 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

Crowdfunding Crowdfunding Complications 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.

Questions?Questions?

Nicole M. Gewinner, Esq.Nicole M. Gewinner, Esq.Jackson Walker L.L.P.Jackson Walker L.L.P.

[email protected]

100 Congress Avenue, Suite 1100Austin, Texas 78701

www.jw.com