10
THINGS YOU NEED TO DO AS AN ENTREPRENEUR
So
you have perfected the greatest idea since sliced bread and now
you want to turn your idea into a business. Well, this is a
list of 10 big-ticket items that you need to keep in mind in moving
the product from being an idea in the kitchen to being a business. Note
that none of these items works in isolation from the other and that
none of them are static. You’ll need to remake your business
as markets, laws and the commercial environment change.
- Have
a written business plan. Without one you’ll
never know what you’re doing, where you are
going or how you are going to get there.
- Create
a legal form for your business. It can be a corporation,
limited liability company (“LLC”), limited partnership
or even a general partnership. LLC’s are the preferred
form today because (as the name implies) they offer limited liability
(one of the main reasons for doing business as a corporation) with
the income tax benefits enjoyed by partnerships. (Note: one
person LLC’s are now legal in California.)
- Determine
how to finance your venture on a sustainable basis. Will
you use personal savings, the bank of mom and dad, mortgage your
house, an SBA loan, bank loan, venture capital, sale of equity? If
a loan, how you will repay it? If a sale of equity, how much
control will you give up and for what price? Also, don’t
forget about those pesky security laws.
- What
resources will you need to run your business? Which
functions will you outsource: production (e.g., use a co-packer),
storage and delivery (e.g., a logistics firm), advertising, sales,
bookkeeping? If you will be hiring employees, what skills
will they need and how much in wages and benefits will you be able
to afford to pay them? Keep in mind that
carelessly outsourced functions or hired employees
can cause you real grief.
- Protect
your intellectual property rights. Should you patent
it or maintain it as a trade secret? Have you made sure that
employees, business associates, customers, and suppliers sign non-disclosure
agreements whenever necessary. Have you developed a trademark? Do
you want to register your trademark with the United States Patent & Trademark
Office? How about overseas?
- Document
and administer your transactions. Casual agreements
are not a good business practice. Get it in writing may sound
trite, but a little extra work upfront can save you a lot of grief
later especially when dealing with important suppliers and accounts. The
documentation doesn’t have to be elaborate, but it should
be clear and complete so that strangers will agree on its meaning. Also,
don’t forget that agreements are living documents. Refer
to them from time-to-time in order to be sure that both you and
the other party are complying with the terms of the agreement. This
is especially important when circumstances of either
party change and might affect the agreement.
- Have
a working knowledge of the regulations that affect
your business. There are two types of regulations. The first
type is the ubiquitous variety that apply to virtually every business
(e.g. wage and hour laws, worker’s comp., OSHA, business
licenses, zoning, etc.) and then the regulations that are unique
to your business (e.g., FDA, USDA, EPA). Correcting regulatory
problems after the fact can be very expensive.
- Develop
a risk management strategy. What business practices
can you adopt to mitigate potential losses? How much can
you afford to self-insure? What types and
how much insurance will you buy for casualty losses
and liability coverage?
- Be
prepared to delegate. Many entrepreneurs unnecessarily
try to do everything themselves or micromanage the business. Details
are important, but if you spend all of your energy on them, you’ll
never have time to address the big picture items. Furthermore,
many aspects of creating and running a business require technical
skills that can take years to learn and perfect. Therefore,
hiring specialized consultants can offer the best way to get things
done right the first time within a budget. It’s several
times more expensive to do things wrong and then have to hire someone
else to correct it. The cheapest way to do
something right the first time is hire an expert.
- Work
out a tax compliance strategy. Although you and your
business should be separate legal entities, the choice of a legal
form can involve significant tax issues. Furthermore,
failure to comply with our monumentally complex
tax code not only may cost you money in terms of
back taxes but also missed tax saving opportunities.
If you would like more information regarding forming your own business
or maintaining your business, please contact either Allan Zackler
or Steve Weinstein at (510) 834-4400 or by email at azackler@zacklerlaw.com and sweinstein@zacklerlaw.com.
An
Entrepreneur’s Choice of Entity
When
an entrepreneur decides to realize his or her dream of starting a
company, one of the first questions that they typically ask their
legal counsel is which type of legal entity to select for their
business. In most cases, the answer to this question is a Delaware “C” corporation,
particularly if the entrepreneur plans to raise venture capital
to fund the business. This article will discuss the most common
types of legal entities and explain why this conclusion is usually
reached.
The
most common types of legal entities through which a business can
operate are corporations (both “C” and “S” corporations),
general partnerships, limited partnerships, and limited liability
companies (“LLCs”). The designation of a corporation as
a “C” or an “S” corporation refers to the
subchapter of the Internal Revenue Code under which the corporation
is formed. The two most significant factors that affect the choice
of entity are limitation of liability for the owners of the entity
and the tax treatment of the earnings of the business at the entity
level and the owner level.
The
owners of the entity, whether they are founders, investors, or employees,
generally desire to insulate themselves from personal liability for
the obligations of the entity. All of the entities mentioned above
except general partnerships provide some degree of limited liability
for their owners. Under state partnership law, all of the partners
of a general partnership are personally liable for the obligations
of the general partnership. Limited partnerships provide limited liability
for the limited partners, but not for the general partners. As a result,
general partnerships and limited partnerships are not acceptable entities
for venture-backed businesses.
Generally,
the owners of corporations (both “C” and “S” corporations)
and LLCs will not have personal liability for the obligations of
the entity itself. There are certain judicially created and statutory
exceptions to this general rule. For example, if the entity is not
properly formed and operated and the legal formalities of the entity
are not followed, a court may pierce the corporate veil and hold
the owners liable for the obligations of the entity. Also, the owners
of the entity may have personal liability in certain cases that relate
to environmental and products liability.
“C”
corporations are subject to double taxation. The corporation itself
must pay federal and state income tax on its profits. Then, after
these profits are distributed as dividends to the corporation’s
stockholders, each stockholder must pay income taxes on his or her
share of those dividends. Since the corporation cannot claim a deduction
for the distribution of dividends, there is no way to lessen the
impact of this double tax.
Generally,
limited partnerships, general partnerships, “S” corporations,
and LLCs are all treated as pass-through entities for federal and
state income tax purposes. As a result, none of these entities are
subject to federal or state income tax at the entity level. Under
the Internal Revenue Code or the North Carolina tax laws, there is
no partnership income tax, “S” corporation income tax,
or LLC income tax. Rather, the taxable income or loss of these entities
is passed through to the owners. This pass-through effect potentially
could provide numerous benefits to investors including: (a) the ability
to pass through to investors tax deductions and losses that are typically
generated by early stage companies; (b) the ability of investors
to increase their tax basis in their investment through retained
earnings as the business becomes profitable; and (c) the distribution
of earnings to investors without incurring a tax on those earnings
at the entity level. However, if a pass-through entity is generating
net income on which its owners must pay taxes, the entity must be
able to make cash distributions to the owners so that they have will
have funds to pay their tax liabilities.
Notwithstanding
the significant tax benefits of these pass-through entities, most
venture-backed entities are organized as “C” corporations.
The reason is that most venture funds cannot invest in pass-through
entities under the terms of their investment documents. Most venture
funds receive a significant amount of their funding from tax-exempt
organizations such as pension funds. Pension funds and similar
organizations are exempt from taxation on dividends and capital
gains that they receive, but not on pass-through income. As a result,
most venture funds are prohibited from investing in pass-through
entities.
In
addition to being a pass-through entity for tax purposes, “S”
corporations are subject to several other limitations that make them
unattractive entities for venture-backed companies. Among these restrictions
are that: (a) “S” corporations can generally have only
individuals as stockholders; (b) “S” corporations can
only have a single class of stock; and (c) “S” corporations
can only have 75 stockholders.
Once
the decision has been made that the “C” corporation is
the entity of choice for the new company, the next question is in
which state to incorporate. Each state has its own corporate code.
While several national bar organizations have developed a model corporate
code that many states have adopted to some extent, there are significant
differences in the corporate codes of each state. Among the factors
that should be considered in selecting the state of incorporation
are: (a) the depth and predictability of the state’s corporate
law and court system; (b) the nature and extent of the protection
that the state’s corporate law affords to officers and directors
of the corporation; (c) the flexibility and ease of use of the state’s
corporate code; (d) the state’s incorporation fees and annual
franchise taxes; and (e) the efficiency and service of the state’s
corporation agency. Most corporate attorneys agree that Delaware
comes out ahead of all the other states in an analysis of each of
the foregoing factors. In addition, most corporate attorneys are
very familiar with Delaware corporate law. Therefore, if the investor
is represented by out of state counsel, that attorney will probably
already be familiar with Delaware corporate law, thus avoiding the
necessity of educating the attorney on the nuances of the corporate
law of another state. This can help facilitate the closing of a financing
and save transaction costs.
As
a result of all of these factors, the Delaware “C” corporation
generally is the entity of choice for start-up companies. When preparing
to start a new business, Zackler & Associates can help you determine
which type of entity will be best suited for your business and prepare
the necessary documentation and filings.