Business Law Practices
A corporation is established pursuant to state law as a business entity that exists separate and distinct from its individual owner(s), who are called shareholders. Shareholders possess “shares” of ownership in the corporation, which may entitle the shareholder to a distribution in the company’s profits, to certain voting rights in decision-making processes, and to other distributions if the corporate entity were to dissolve.
In addition, shareholders elect directors to serve on a board for a specified term. The board of directors oversees and enacts major decisions on behalf of the corporation. The board, in turn, selects officers to oversee the day-to-day management of the corporate business.
As separate and distinct from its owners, the corporate entity provides a layer of liability protection between the shareholders and the entity itself so long as the entity maintains what are known as “corporate formalities.” These formalities must be strictly adhered to throughout the corporation’s existence to maintain the veil of protection that corporate shareholders expect when investing in a corporation.
The components of the corporate structure highlighted above provide only a general sketch of what it takes to maintain and operate a corporate entity. This process should not be taken lightly and should be entered into with competent tax advice. Our experienced attorneys and tax consultants can provide the advice needed as to the best use of a corporate entity.
LIMITED LIABILITY COMPANY
A limited liability company, or LLC, is somewhat of a hybrid business entity that provides limited liability protection for its owners, called members, yet offers partnership-like tax treatment.
LLC’s have become increasingly popular since their inception in the 1990’s, when state lawmakers across the United States sought to combine the liability protection offered under the corporate entity structure along with partnership-like tax treatment available in other organizational structures. Similar to a corporation, an LLC is formed by filing Articles of Organization with the Secretary of State. After this filing is approved, the LLC must obtain a federal tax identification number, or FEIN, for income reporting purposes.
An LLC is governed by an operating agreement, which is an agreement executed by the members containing the rules and organizational structure needed to sustain the entity. This type of governing structure generally provides more flexibility, particularly in constructing compensation disbursements to the respective members. Additionally, all members of an LLC may agree to participate in the entity’s management and may choose to establish voting rights between managing and non-managing members.
Although a multiple member LLC is required to file a tax return, all tax liability “flows through” to the individual members, resulting in no income tax liability at the entity level.
LLC’s have been popular among real estate investors due to the level of flexibility in structuring management and capital contributions made by the members. Nonetheless, LLC’s have gained wide acceptance among other areas of business.
Our experienced tax consultants can discuss whether establishing an LLC will prove to be a wise investment for your business needs.
A sole proprietor is an individual person who operates a business in his or her own name or under an assumed name. The person’s own social security number serves as the tax identification number of the business and, consequently, the individual simply reports the business’ income on his or her personal return. The sole proprietor pays quarterly estimated taxes, as opposed to filing more complicated payroll tax returns and withholding periodic taxes from money earned.
The advantages of this type of business entity are efficiency and cost. Obviously, the cost and organizational time are minimal. The main disadvantage of this entity choice is lack of liability protection.
Any problems that may arise in the course of business will pass directly to the owner personally, without the ability to insulate personal assets from liability issues. There are also several important tax matters that may arise as the proprietor’s business develops.
Those considering a sole proprietorship need to be advised of the tax implications of conducting business in this manner. Consulting with a tax advisor is highly recommended prior to commencing business activities as a sole proprietor. Our experienced tax consultants can help you determine if a sole proprietorship is right for you.
Overall, there are two types of partnerships: general partnerships and limited partnerships. In both types, the general partners usually manage the business of the partnership. However, various types of partnership entities have recently developed wherein limited partners are allowed to engage in business management activities.
A general partnership is any association of two or more persons (either human beings or other business entities) who carry on a business as co-owners with the expectation of making a profit. A general partnership can come into existence by operation of law, with no formal execution. Nonetheless, it is strongly recommended that the partners enter into a binding legal agreement prior to commencing any business activities. A partnership is always a general partnership unless the owners comply with the special requirements for establishing a limited partnership. A general partnership faces the same advantages and disadvantages as a sole proprietorship, with the primary disadvantage being liability exposure for all general partners.
A limited partnership can only be created by the partners’ execution of a written agreement and the filing of a certificate of limited partnership with the Secretary of State. There are two types of partners in a limited partnership: one (or more) general partner(s) who are each liable for the debts of the partnership and one (or more) limited partner(s) who are liable to the partnership up to the amount of money they have contributed to the business. Partnerships must obtain a federal tax identification number or FEIN. This number is used in place of a personal social security number for tax and identification purposes. Taxes are treated similarly to the sole proprietorship. A partnership must file an annual income tax return; however, any amount owed is “passed through” to each partner’s personal tax return by way of an IRS form K-1.
Generally, the advantages of forming a partnership over other types of entities are lower formation costs, relative ease of partnership setup, and simplicity of management. Like a sole proprietorship, however, the greatest disadvantage of partnerships is the lack of insulation from personal liability in most instances. Our experienced tax consultants can provide solid advice as to the best use of a partnership arrangement.
ENTREPRENEUR FUND RAISING
Raising capital for a new or expanding business venture can be a daunting task. With the downfall of many business ventures over the past several years, asking an outsider to make a significant investment in a start-up or expanding company can be intimidating and oftentimes met with skepticism. However, most traditional sources of financing, such as banks and credit unions, still have stringent requirements for small and start-up companies with little operating experience or credit history. As a result, entrepreneurs looking for capital often find themselves seeking financing by way of private capital raises. Sources for such funds can include family, friends, venture capital groups, so called “angel” investors, and other equity funds. Each category of investor has its own positive and negative attributes. Nonetheless, before seeking funding from any source, the entrepreneur must be prepared. Investors are savvy and they will closely scrutinize any business in which they seek to invest, which may include a thorough analysis of the business’ operations, structure, personnel, and projections. The following bullet points briefly summarize what a company seeking capital must, at a minimum, consider before asking for any money. It is crucial that those seeking to raise capital seek competent legal advice prior to engaging in fund raising activities.
Before seeking capital:
Get your house in order – Make sure that the proper legal entity for the business has been selected and formed pursuant to state law, taking into consideration tax and liability protection issues. Determine whether the capital structure is clearly stated and appropriately structured to bring in outside capital. If the company has any key assets, make sure that they are appropriately titled. Additional questions to consider: Are key employees incentivized sufficiently? Are there any problems with personnel that need to be addressed? Have you protected confidential information?
Bootstrap – Use personal financial resources and those of your family and friends before asking an outside source to invest in your company. This action will demonstrate your commitment to the success of the venture and, consequently, increase its valuation.
Know your business – Raising capital is simply selling a business idea. Like anything else, the salesperson needs to know what he or she is selling before he or she can convince someone else to buy into it. Investors will ask tough questions about the business concept and will want thorough answers. Most investors will expect to see a business plan. The in-depth analysis involved in preparing a business plan will provide the tools to answer competently investors’ questions. At a minimum, be prepared to provide a brief executive summary of the business and, ideally, a power point presentation to share with potential investors. Develop a clear and rational strategy that describes the following: (1) key milestones, (2) succinctly articulated goals, (3) financial projections, (4) a current valuation of the business, (5) realistic capital needs, and (6) a practical exit strategy.
Pitch – Run the concept by experts in the field and practice selling it to others who can ask tough questions about it. Ensure that this question is answered in the presentation: what key feature of the business sets it apart from the competition?
Secure your first customer – Show investors that there is a demand for the company’s products and a viable means of securing income.
When should you begin the process:
Timing – A company’s valuation will be higher if it has been operating long enough to raise revenue and prove its viability. Keep in mind, however, that the fundraising process takes time, so don’t wait until the company is financially exhausted to start looking for outside capital.
Having everything investors need – Investors are looking for the following components in a company: (1) a strong management team, (2) a clear business concept, (3) an exciting and growing market, (4) an estimated time to expect positive cash flow, (5) a reasonable valuation of the company, and (6) clearly articulated capital needs. Have these elements in place before seeking out funding. Always keep in mind this critical concern: investors do not want to see their money being used to pay off debt or personal loans to the founders.
Where to look for funding:
Family and friends – You should utilize this source, as well as your own funds, before looking for outside capital. If your family and friends can’t trust you, who will?
Banks – Banks may offer small business loans to entrepreneurs; however, lender requirements have become stricter over the past several years.
Venture Capitalists – Venture Capitalists manage the money of several investors in a fund from which they can draw to invest in other companies. Venture funding is typically used at a later stage of the business lifecycle than Angel Funding. While larger amounts of funding may be available from Venture Capitalists, this type of investor will most likely expect to share control of your company in return for their investment.
Raising capital for a start-up or growing business can be an exciting and energizing endeavor, both for those involved and for the business entity itself. Nonetheless, seeking investors to raise capital is a very complicated process that has numerous legal implications.
Our experienced tax consultants can provide competent advice at every step in the process, which is crucial to its success.