Forming Your Business : A Practical Approach

By : Ilana Lubin / Sullivan & Cromwell

April 2015

Forming Your Business:

A Practical Approach

March 31, 2015

Why incorporate?

Why incorporate?
Limit your personal exposure!
Isolate assets
Enhance your credibility

Choosing your entity

Choosing your entity & jurisdiction of
formation
Rule of Thumb !Delaware Corporation
Discuss other alternatives with your lawyer
and/or accountant, considering:
Fees (i.e., to incorporate & administer)
Your business (i.e., are you a one man shop?)
Your goals & timeline
Conversion is an option
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Example of costs
Corporation:

Required Organizational
Documents
Certificate of Incorporation

Delaware

New York

$685

$732

By-Laws

(fee will increase or

decrease based on number and par
value of authorized shares; fee
includes a registered agent fee of
$342.00)
N/A

(includes a registered agent

fee of $342)

Stockholders Agreement
Statement of the Incorporator

N/A
N/A

N/A
N/A

Initial Resolutions of the Board of

Directors

N/A

N/A

Minute Book

$84

$84

Delaware

New York

$690

$807

N/A

LLC:
Required Organizational
Certificate
of Formation/Articles of
Documents
Publication

(includes a registered agent

(includes a registered agent
fee of $342)
fee of $342)
N/A
(as determined based
upon the two designated newspapers
chosen by the county clerk)

Operating Agreement

N/A

N/A

Initial Resolutions

N/A

N/A

Minute Book

$84

$84

Organization

$2199

Types of entities & jurisdictional considerations

Advantages and Disadvantages

LLC

Corporation

Pros

Flexibility
Sophisticated tax
structuring
Flow through taxation

Cons

Complicated tax
structuring
Complications
regarding the grant of
equity incentives

Easier to grant equity

incentives (options &
RSUs)
Formalities are
straight forward
Increased corporate
formalities
2 levels of taxation
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Corporate Entity Types

Sole proprietorship
General partnership
Limited partnership
Corporation
Limited Liability Company
Limited Liability Partnership

Choice of entity for corporate purposes

does not necessarily dictate how it will
be treated for tax purposes. This can
change how you complete the SS-4 to
obtain an EIN.

Tax Entity Types

Disregarded
Partnership
C corporation
S corporation

Disregarded Entity
A sole proprietorship and any entity other than an Inc. will
generally be treated as a disregarded entity for tax
purposes by default or can elect to be treated as a
disregarded entity, as long as it has only one member. This
is also the default classification for single-member LLCs.
Disregarded entity is completely ignored for federal and
state income tax purposes. (It is usually regarded for
sales and property tax purposes.)
Owner is subject to income tax at his own rates on the
income of the disregarded entity.
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Side-by-Side Comparison of S Corp vs Partnership/

LLC
Feature
Formation
Number of Owners
Corporate Owners Allowed
Foreign Owners Allowed
Different Classes of Shares
Permitted?

Liability Protection
Corporation Formalities
(assuming state law
corporation)

Management (assuming state

law corporation)
Profit Sharing

Annual Accounting Costs

Quarterly Estimated Tax
Payments Made by Members

Social Security and Medicare

Tax

S Corporation
File with state
Restricted to 100
shareholders
No
No
Yes, as long as all of the
classes have identical
economic rights (rights to
dividends and liquidating
proceeds).
Shares may have
Yes

Partnership/LLC
File with state
Generally, unlimited
number of members
(owners)
Yes
Yes
Yes Shares can have
both different
economic and voting
rights.

new 3.8% tax that started in

January 2013 applies to
passive earnings).

earnings from LLC

(salary and profits)

Yes
Many mandated corporate
Few mandated
formalities, including, but not corporate formalities.
limited to:
However, typically
Annual meetings
members choose to
Election of Board of
create such
Directors
formalities through an
Election of officers
Operating Agreement
Board of directors
As decided by
members
Directly proportional to
As decided by
ownership percentage. All
members
shares must convey equal
economic
rights.
May
be lower
May be higher
Yes, with respect to residual Yes, with respect to
profits (corporation withholds both salary and
on salary because shareholder residual profits
can be employee).
(partner cannot be
employee)
Paid only on salary (though
Generally paid on all

Types of entities & jurisdictional considerations

Choose DE
Well developed body of corporate law
Sophisticated courts
Every corporate lawyer, and more importantly,
VC investor is familiar with DE documents and
law this is what they want to see. You are
making getting funding easier both practically
speaking but also by conveying credibility and
legitimacy.
Another reason, see: NY Business Corporation
Law 630 Liability of Shareholders for Wages
Due to Laborers, Servants or Employees
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Types of entities & jurisdictional considerations

The ten largest shareholders.shall jointly and

severally be personally liable for all debts, wages
or salaries due and owing to any of its laborers,
servants or employees other than contractors, for
services performed by them for such
corporation
- N.Y. BSC. LAW Section 630
- This does not apply to a publicly traded
company
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Types of entities & jurisdictional considerations

Remember to apply for authority to do business in
the states you are doing business
If you are a DE LLC, this will result in publication fees in
NY

Conduct name reservations and trademark

clearances if the company name will be consumer
facing
A great resource: Delaware Secretary of State
website
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Corporation In-A-Box The basic

documents that get you up & running
brought to you by
C&Ms Corporate Formation Questionnaire can help you
organize and focus on initial decisions that need to be made:
Set a number of directors and decide who will be your
directors.
Determine how you will divide equity interests? And what is
the consideration for each? (i.e., cash, intellectual property,
sweat)
Consider a Pre-Nup.
Vesting/accelerations schedules

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Corporation In-A-Box The basic documents

that get you up & running
Certificate of Incorporation

Authorized Number of Shares. (a lower number with a lower par

value (i.e., 0001 will make your annual franchise taxes cheaper
(the minimum tax is $175-350; you can always authorize more;
on the other hand, think optics when issuing options (a grant of
10 can have the same value as 100 but 100 sounds better)

Action of Incorporator (signs the original certificate,

adopts bylaws and elects initial directors)
Bylaws (rules of how the company conducts its affairs,
which must be consistent with the DE law and the
charter; they cover meetings, voting, officers, directors,
indemnification, fiscal year, etc.)
Consent of the Board (adopting Action of Incorporator,
COI, Bylaws; electing officers, adopting relevant
agreements)
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Corporation in a box The basic documents that get you up

& running

Founders Common Stock Purchase Agreement (this can also be a

subscription agreement)

Typical purchase price at founding is 10 x par value (.0001) = $.001, but if

there is substantial value in the Company at formation then the purchase
price could be something different (i.e., book value of assets), and this
should be discussed with tax counsel
Can use vesting restrictions here

VCs may want to see this for assurance people will stick around
Helpful if you have multiple founders because you have pre-negotiated how to deal
with someone leaving or becoming disinterested. A founder divorce is common
when you have 3 or more founders.

Transfer limitations (Securities Law; Right of First Refusal)

Lock Up
Bill of Sale/Assignment and Assumption for non-cash consideration such
as intellectual property or other assets

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Corporation in a box The basic documents that get you up

& running

D&O Indemnification Agreement

Your VC board representatives will certainly
want this and namely primacy of
indemnification

Non-Disclosure Agreement
This allows you to start commercial
discussions with companies by protecting
your confidential information
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Corporation in a box The basic documents that get you up

& running

Employment Agreements
Consultant Agreements
Confidential Information and Invention
Assignment Agreement
Work for hire doctrine
Non-Solicits & Non-Competes
Mischaracterization Issues
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Other Practical Considerations Protecting Your Assets

Intellectual Property

Employees

Real Estate

Key Contracts

17

Intellectual Property - Types

Patents (Provisional, Design & Utility)
Inventions
Copyrights
Expression
(GUI, Software, Books, Apps, Website Content)

Trademarks
Source Identifier
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Intellectual Property - Patents

Disclosure is a bar to patent protection.
Remember to rely on your NDA.
Provisional Patent = A Stake in the Sand
Be the first to the patent office & preserve rights
globally
Make commercialization easier
Obtain the benefit of using patent pending
You will have one year to submit full patent application
with claims and proper drawings
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Intellectual Property Patents

Utility Patents

Design Patents

Process, machine,
Ornamental Designs
manufacture, or
composition matter or
improvement thereof
20 years from first filing 14 years from date
date
of grant

Provisional

Your stake in the

sand
1 year from filing
date

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Intellectual Property Copyrights & Trademarks

Copyrights

Trademarks

Protected on creation

Rights inure upon use

Registration is cheap

Registration is based on geography

A U.S. citizen needs a

copyright
toDoe
be registered in

2012 Jane

Unregistered
Registered

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Trade Secrets
Information
Reasonable measures taken to protect the
information
Derives independent economic value from
not being publicly known

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Other Practical Considerations

Privacy Policies
Be clearly posted, with appropriate links
Must accurately inform users about a website operators practices
regarding its collection and use of information, including personal
information (i.e., social media applications, direct marketing). This
is specifically tailored to YOU.
Practices must comply with privacy and data security laws (i.e.,
COPPA, HIPPA)
Should be consistent with the terms of use
Terms of Use
Can minimize liability to site users, protect intellectual property by
prohibiting unauthorized reproduction, and prohibit certain
behaviors (i.e., introducing viruses)
Clickwrap
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Other Practical Considerations

Get the insurance policies you will
need for your business. One lawsuit
could make or break you.
Commercial General Liability
Cyber Security / Data breaches
Industry specific, i.e., Food Contamination
Policy
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Funding Types of Investors

Friend & Family
Angels (i.e., Jeff Bezos, Paul Graham)
Venture Capital Funds
Strategic Inventors
(i.e., Peacock Equity Fund (GE/NBC Universal);
Simon Venture Group (Simon))

Leasing Companies
Banks
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Funding Types of Investments

Common Stock
Preferred Stock
Convertible Promissory Notes
Warrants
Subordinated Debt (with or without an
equity
kicker see
above)
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Funding
How much to raise?
Rule of Thumb: Raise for 9-18 months
Raise enough to get the company off of the
ground

Develop a beta version or proto-type

Develop your website
Generate initial revenues
Sign a key contract
Hire key management

You will probably need to raise capital more

than once
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Funding Securities Law

A company should register the
offer and sale of securities
with the SEC unless there is a
corresponding exemption (Securities Act of 1933)
You need an exemption:
4(2) private offering (no filing required)

Used for a limited number of people (think: 10)

Insider access to information is key
Sophistication (except for founders)
Ability to absorb loss
Subject to transfer or resale restrictions

Regulation D (Form D filing required)

Blue Sky Laws
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Funding
Think about your end-game:

M&A, IPO, Lifestyle

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Speaker
Ilana Lubin
New York
ilubin@crowell.com
Phone: +1 212.895.4224

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Starting a new business?

get started at www.lawtrades.com