A legal blog addressing technology and privacy issues
I’m going to be posting a number of posts on the ins and outs of electing and operating a corporation which elects to be taxed as a small business corporation (an “S Corp”) with the IRS. There are many benefits to such an election, but there are also pitfalls that many owners run into that could jeopardize the election.
The first post in this series is simply how to make the election. Read more
First of all, I won’t advise anyone to withdraw their 401(k) funds early as the tax hit the IRS enacts is insane. If you are thinking about doing that, please don’t, or at least don’t do so until you’ve spoken to your accountant.
This post will, however, detail how to use your qualified retirement plan or IRA to start a new, or buy an existing, business. This name given to the process I’ll discuss is rollovers as business startups (“ROBS”). The main gist is that an individual’s current retirement plan is rolled over into a newly established 401(k) plan sponsored by a startup company and then used to purchase the startup company’s stock. The ROBS arrangement allows income taxes and penalties (see IRC Section 72(t))to be avoided because it is a rollover from one qualified plan to another. Read more
If you are one of those people who is tired of having to form seperate entities (LLCs or corporations) for each type of business you operate, or for each piece of real estate that you own, a Series LLC may be useful to you. Nearly a decade ago, the state of Delaware introduced a legal entity that would become known as the Series LLC. Despite its origins in Delaware, several other states have now started to permit the usage of Series LLCs. Read more
It used to be that if you wanted to start a corporation and the end goal was not to maximize shareholder value (or other typical corporate goals), you’d start a not-for-profit corporation. That’s no longer the case. Now in New York (and at least six other states) you can form a Benefit Corporation (a “B-corp”) which has other purposes besides making money. There are also other strategies you can use in a for-profit company to give it more of an egalitarian feel. We’ll discuss below. Read more
I hit on the Hack-a-thon craze in an earlier post. The IP that is created by the hackers in these programs has to be owned by someone, although there are still times where everyone walks away not knowing what everyone’s rights are. If nothing is ever signed by all participants and the hackathon sponsor, its unclear who owns what.
There are a couple different options. The sponsor may want to own everything, or may want to at least have a perpetual paid up license to use the IP created. The hackers should get some rights as well, but its been hard to delineate what and how it should be handled.
A friend of mine and a fellow startup lawyer, Dave Capuccilli of The Capucilli Firm has been working on a solution to this dilemma. Check out his latest iteration to a Hack-a-thon Collaboration Agreement, courtesy of Docracy. Its a great way to ensure all hackers and the sponsor get a fair shot at using the IP created.
I currently represent a few companies that were born at Hack-a-thons and Startup Labs (a similar idea but slightly different format/program), and if they had an agreement like this signed before they came to me it would have made things much smoother.
There are many reasons why LLCs can be great for business owners. For those types of businesses that have revenue and don’t need outside investors or to issue stock options (although LLC profits interests can work), LLCs are a good choice.
For a lot of startup companies, a corporation may be the right choice, especially if it will be seeking investors, plans to be acquired by a larger player in the industry at some point, or would like to have an IPO or other offering. The choice for a lot of companies especially in the high tech sector is the corporation. But if those aren’t your goals, if you have a business plan, target market, product and are ready to sell and make revenue then an LLC may be the right choice for you. Whatever industry you are in, an LLC can be a beneficial entity to use. LLCs can do complex and sophisticated things with respect to splitting profits, can have interesting classes and structures, require less paperwork than would a corporation, and are by far more flexible. (I’ve kind of beat the LLC v. Corp. horse to death earlier so will get to the point now). One of the other great advantages of the LLC form is that it can elect (i.e. choose) to be taxed as either disregarded entity (if one member then a sole proprietorship, and if multiple members than a partnership), an S-corporation or a C-corporation.
In many industries there are opportunities for individuals or companies to team up with one another to accomplish a mutually beneficial goal. This is most commonly accomplished by way of a joint venture.
A joint venture is somewhat amorphous as a concept as there are no bright line legal rules. It is a contractual arrangement, either through an outright joint venture agreement, an oral agreement, an LLC through its operating agreement or something similar. This post gives a broad overview of what it is and why it may be something that would work in your situation. We’ll look at it in more depth in future posts.
This is one of the earliest questions that comes up when an entreprenuer or group of founders want to formalize their company or business relationship. The usual advice is that if you have current income and are not looking for investors and will not have to bring on other owners in the near future, an LLC is usually a good choice. They are flexible, light on required paperwork and are similar to doing business as a sole proprietor, assuming you continue to have the LLC disregarded for tax purposes. Sole member LLC’s are inherently flexible. Multi-member LLC’s are also flexible, but will require a carefully crafted Operating Agreement to cover certain actions each member can take, breakdown of membership interests, profits, and exit options. LLC’s are great vehicles to hold real estate.
Now if your company is seeking investors, especially institutional investors of either angel or VC level, it goes without saying that you will need to be set up as a corporation. Usually the investors will want a Delaware corporation. This will allow the corporation to issue preferred shares with various beneficial provisions in favor of the investors; right to convert to common, liquidation rights, registration rights, anti-dilution provisions, etc. While all of these are technically possible to do in an LLC format, they are not as commonly used. Investors feel more comfortable with the corporation form, notably c-corps, and they are the ones putting up the money so they usually get their way. Also, and more importantly, most investment funds have prohibitions in their organizational documents prohibiting investments in LLC’s to ensure that the fund does not receive any unrelated business income tax (UBIT). While you will hear some buzz around the internet, and maybe directly from some startups that institutional investors invested in their LLC, this is most likely through a “blocker” corporation, which is essentially a sole purpose corporation owned by the fund which holds the interest in the LLC. Most investors do not like this structure as it has its drawbacks, but it is done. Honestly, if you are running a startup, you would rather be negotiating investment terms and trying to get the best deal that you can, so you don’t want to already have one foot in a hole with respect to your entity situation.
Of course, no matter which entity you choose, you can always later either convert (depending on what state your company was formed in) or merge the existing LLC or corporation into another that you have formed. This will of course, require legal assistance, and is not always an easy process, especially if your company has signed certain non-assignable contracts or has other liabilities. But, as with most things, there is a way that it can be done.