Formation Issues: Entity Choice; Entity Venue; Capitalization; Other Out-of-the-Gate Issues

BUSINESS LAW DUMBED DOWNPremiere Date: January 18, 2017

This webinar is sponsored by: EisnerAmper

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MODERATOR

Peter Feinberg Hoge Fenton

PANELISTS

Michele Berdinis Beeline Legal Services

Jonathan Friedland Sugar Felsenthal Grais & Hammer

Steve Gillette Jones Day

MEET THE FACULTY

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SERIES SPONSOR

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ABOUT THIS WEBINARWhen business owners begin operations, they are faced with numerous critical corporate law issues which will continue

to influence their decisions during the business’s lifetime.

Should the business be organized as a corporation, and if so, as a C corporation or an S corporation, a limited liability

company, a partnership or, if only one owner, a sole proprietorship?

Should the company be organized in its home state, Delaware, or somewhere else?

How much money will the business need to be financed and how should it be capitalized?

The answers to these questions will largely determine how profits will be distributed, losses will be allocated, what

taxes will be due and the consequences of a sale for the owners of the business.

Join us for a lively discussion of what considerations need to be kept in mind when making these decisions, the available

choices and the consequences for the business owners.

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ABOUT THIS SERIESThis webinar series holistically considers the dizzying array of choices and issues which individuals (and later, the entities which they

have incorporated or organized) face in corporate and commercial law from the outset of the business until the termination of their

interest in it.

This is done primarily by considering issues of entity choice and locale, capitalization and governance, common and important issues

companies encounter when working with customers, suppliers and other commercial parties, and sales and other exits from business

ownership.

This series will be helpful for those considering starting or purchasing a business for the first time as well as those who already own

existing businesses or are looking to begin another business, in addition to those who advise them on legal, accounting, risk

management and financial issues.

Each episode is delivered in Plain English understandable to business owners and executives without much background in these areas.

Yet, each episode is proven to be valuable to seasoned professionals. As with all Financial Poise Webinars, each episode in the series

brings you into engaging, sometimes humorous, conversations designed to entertain as it teaches. And, as with all Financial Poise

Webinars, each episode in the series is designed to be viewed independently of the other episodes, so that participants will enhance their

knowledge of this area whether they attend one, some, or all of the episodes.

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EPISODES IN THIS SERIES

EPISODE #1 Formation Issues: Entity Choice; Entity Venue; Capitalization; Other Out-of-the-Gate Issues 1/18/2017

EPISODE #2 Governance Issues: Fiduciary Duties, manager v. member management & 2/22/2017

Other Power Sharing Considerations

EPISODE #3 Common Deal Points: Commercially Reasonable v. Best Efforts, Liability limiting Provisions & 4/5/2017

Other Commonly Recurring Negotiation Spots

EPISODE #4 Transition & Exit Planning and Executing a Sale & Other Exit Strategies 5/10/2017

Dates shown are premiere dates; all webinars will be available on demand after premiere date

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WHY FORM A BUSINESS ENTITY?• Limitation of personal liability—all of your assets, even those not related to the

business, are at risk when doing business outside some type of liability limiting entity.

Note, some liabilities cannot be avoided. i.e. payroll taxes; certain intentional acts.

• Continuity of existence—e.g., business terminates with death of sole proprietor or general partner, absent agreement to the contrary

• Formalizes financial and other expectations,

E.g. who is contributing money and/or services to business? How are profictsto be divided?

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WHY FORM A BUSINESS ENTITY? (CONT’D)

• Interaction with third parties

Credibility with financing or other sources

May be demanded by third parties as a means of reducing potential liabilities

• Flexibility and structure for management and control

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WHAT HAPPENS WHEN YOU DON’T FORM A BUSINESS ENTITY?

• 1 person = sole proprietorship

• 2 or more people = general partnership

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SUMMARY OF PRIMARY ENTITY CHOICES

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C-Corporation Limited Liability Corporation/Partnership S-Corporation

Limitation of Liability Yes Yes Yes

Tax Treatment Double-taxation Single-taxation Single-taxation

Permitted Owners Unrestricted Unrestricted • Limited to 100 shareholders• Shareholders cannot be partnerships, corporations or

non-resident aliens• Effectively precludes institutional investors

Equity classifications Common stock; no restrictions on shareholder preferences

Membership or Partnership Interests; distribution preferences permitted

Common Stock (only one class permitted)

Formation Complexity Simple to very complex; options well-established/understood by investors

Complex; LLC/Partnership agreements can become have a wide variety of terms

Simple

Maintenance Complexity/Cost

Simple More complex (requires partnership accounting) Simple (but note close attention to shareholder restrictions to ensure single-level tax treatment)

Ideally Suited For • Start-ups seeking or intending to institutional investors

• Investors wishing to defer personal taxes on investment

• Service partnerships (medical, consulting, law firms)

• Investors wishing to defer personal taxes on investment

• Owners looking for flexible management structure

• Owners looking to allocate assets and losses in a manner not necessarily consistent with ownership percentages

• Small businesses with capital investments from founders (e.g., retailers), and no plans to seek institutional investment

• companies generating significant free cash flow (as a percent of revenues)

CORPORATIONS

• Two primary types of corporations = “C” corporations and “S” corporations.

• These 2 types of corporations have many more types of similarities than differences.

• Both are formed by the filing of a certificate (or articles) of incorporation (see subsequent discussion about the state in which to incorporate or organize) and are largely governed by their bylaws.

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CORPORATIONS (CONT’D)

• Both types of corporations are owned by their shareholders (although see subsequent discussion on who may be a shareholder of a S corporation and its limitation on classes of shares), whose ownership is evidenced by share certificates.

• Likewise, both types of corporations are largely managed by boards of directors, with day to day responsibilities handled by their officers.

• For both types of corporations, liability is generally limited, subject to adequate capitalization and following corporate formalities, to the amount of the shareholders’ investments in the corporations (but see discussion on piercing the corporate veil)

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IMPORTANT DIFFERENCES BETWEEN S AND C CORPORATIONS

• S corporations (as well as partnerships) offer a single level of taxation at the individual level, and are often not taxed at the corporate level

Though certain states, like California, have a “toll keeper” tax of 1.5% on its net income, while C corporations’ earnings are taxed as income (as are any distributions made to their shareholders)

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WHY CHOOSE C CORP OVER S CORP?• Given that S corp generally have a single level of taxation, why would any company want

to be a C corporation?

S corporations have strict limitations on who can be their shareholders (generally, only citizens or resident aliens and most notably, generally not other business entities, although another S corporation may be permissible) and how many shareholders they can have (not more than 100)

C corporations are generally better for fundraising, because they can have more than one class of stock, which is typically demanded by professional investors and must be used for public companies

C corporations permit their shareholders to defer taxes until earnings are actually distributed

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OTHER TYPES OF CORPORATIONS

• Professional Corporations

Available, and typically mandatory, if forming a corporation, for certain professions (lawyers, doctors, accountants, etc.)

May not be able to limit individual liability, at least for malpractice actions, even if using

• Statutory close corporations

Limitation on number of shareholders (35)

Flexible management structure such that a shareholder with much less than majority ownership may be able to control management

Fallen into disfavor in the LLC era?

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OTHER TYPES OF CORPORATIONS (CONT’D):

• Non-profit corporations

No profits distributed to shareholders

Limitations on purpose, use of funds, etc.

• Co-operative corporations (consumers, agricultural, etc.)

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LIMITED LIABILITY COMPANIES (LLCs)

• LLCs offer, as their name suggests, limited liability like a corporation, taxation like a S corporation or a partnership, and do not have the restrictions on ownership of a S corporation

• LLCs offer a flexible management structure such that they can either be operated by one, some or all of their members (the LLC equivalent of shareholders) or a manager or managers, who may or may not be members

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LIMITED LIABILITY COMPANIES (CONT’D)

• LLCs are formed by the filing of a certificate (or articles) of organization.

• Their primary governing documents, which are not mandatory but are highly advisable, are known as operating agreements

Operating Agreements are similar to bylaws but often include additional provisions of governance and share transfer which may be included in a shareholder agreement of a corporation.

• LLCs have become extremely popular for the advantages and flexibility they offer.

• However, because of their relative newness and largely contractual nature:

LLCs offer less certainty, to both their members and outside entities dealing with them, than do corporations.

While LLCs are permitted to grant stock options, have more than one class of stock and do not generally have limitations on who can become members, there is enough haziness on these issues such that professional investors will generally prefer a C corporation

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PARTNERSHIPS

• Two types: General and Limited

• General can be formed as a de facto entity any type a business is owned by more than one person

• Otherwise, may be formed by articles of partnership.

The analogs for bylaws/operating agreements are partnership agreements, which delineate the relationships between the partners

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PARTNERSHIPS (CONT’D)

• GP v. LP

In GP, all of the partners may participate in the governance of the entity and crucially, have unlimited liability.

In LP, the general partner is responsible for the governance of the entity and the limited partners liability is generally limited to their investment in the entity.

• Partnerships are widely used in/by:

Real estate transactions, for family wealth conveyance (family limited partnerships)

Professionals (limited liability partnerships) as an alternative to professional corporations

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FILING AND OPERATIONAL COSTS; FORMALITIES

• Initial filing is the entity’s articles, usually $100-500 depending on state and entity.

• Need to obtain FEIN from IRS

• General corporate/entity documents such as consents, minutes, etc. formalizing capital contributions, assignment of assets, election of officers, etc.

• Preparation of governance documents (bylaws, operating agreement, partnership agreement, shareholders agreement)

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FILING AND OPERATIONAL COSTS; FORMALITIES (CONT’D):

• Employment/consulting agreements, NDAs, Proprietary inventions and assignment agreements, etc.

• Stock option documents

• Trademark name

• Specialized documents for different entities, such as Form 2553 filed with IRS for S corporations

• Ongoing annual meetings/written consents setting appointment of officers and election of directors and approval of other material actions, statements of information, etc.

• Security filings

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JURISDICTION FOR INCORPORATION/ORGANIZATION

• Where to form depends on numerous factors. Factors include:

Tax and filing fees considerations

Where most business is expected to be done

Where fundraising (if any) is expected to be done

Where lenders, etc may prefer

Etc.!

• If company does business where it is not formed then it may need to qualify to do business as a foreign corporation in other states

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JURISDICTION FOR INCORPORATION/ORGANIZATION (CONT’D)

• Corporate income rates vary widely and wildly, from zero (although note that some of the states which have no corporate income tax have a similar gross receipts tax) upward.

• Delaware and New York have well-developed bodies of corporate law which give greater certainty to shareholders, officers and directors.

• Professional investors are most comfortable with certainty

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CAPITALIZATION

• When a company does not have sufficient capital to conduct its operations and pay creditors, it is said to be undercapitalized

• An undercapitalized company is more likely to fail

• The owners of an undercapitalized company may be held personally liable for the company’s debts

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CAPITALIZATION (CONT’D)

• In most instances, initial capitalization of a business can be a relatively small sum

• Owners’ equity is the last money that will be paid back in the event company is dissolved or files bankruptcy.

Owners may put money in as equity or loans (though re-characterization of deb to equity is possible).

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SECURITIES ISSUES

• All securities must be registered or issued pursuant to exemptions, at both the federal and state levels

• What constitutes a “security” is key question, and control is key issue

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NEED FOR ATTORNEY/ACCOUNTANT?

• Some entities are simpler to form that others. Depends on many factors

• In a simple, straightforward scenario, cost for filing and preparation of “basic” documents (Articles, FEIN, basic bylaws/operating agreement and minutes/consents) can be as low as $3000-4000.

• The internet has been a game changer for some business owners by putting most of these documents online, either for free or minimal charge through various services.

• But it can be difficult to discern the quality of the documents available.

• More critically, the role of the attorney/accountant is to spot issues and answer questions about the specific situation and determine best type of entity under the circs.

Using documents found on the internet, even if of high quality, skips this vital step.

It may cost far more later to reverse something which wasn’t done correctly initially.

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ABOUT THE FACULTY

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PETER FEINBERGpeter.feinberg@hogefenton.com

Peter Feinberg has almost 25 years’ experience representing primarily middle market companies in all aspects and many sectors of merger and acquisition transactions.

Mr. Feinberg has successfully closed well over 100 merger and acquisition transactions, representing buyers and sellers, public and privately held companies, multinational firms, family owned businesses and private equity firms.

He practices in Silicon Valley at Hoge Fenton Jones & Appel, a more than 60 year old, 40+ attorney firm. He has previously been a partner at Thelen Reid & Priest and Ferrari Ottoboni and has worked in house at NetApp and Clorox.

ABOUT THE FACULTY

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Michele Berdinis is the President of Beeline Legal Services in New York. Michele graduated from Brown University in 1981 and from the University of San Francisco School of Law in 1985. She spent 18 years representing startups from formation to acquisition. During her years of practice she was a frequent speaker on trademarks and other stuff her clients needed to know. She's had a blast finally doing her own startup and putting almost two decades of trademark practice into a decision tree for this website.

Michele thinks some lawyers aren't always great about knowing how to talk to clients. Clients want help, but some lawyers are too cautious or too busy to give the advice people need. Michele believes a lawyer should just tell clients what's up and then help them find a solution that works for them. Beeline is Michele's way to do that for trademarks.

MICHELE BERDINIS

michele@beelinelegal.com

ABOUT THE FACULTY

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JONATHAN FRIEDLANDjfriedland@sfgh.com

Jonathan Friedland is a partner with Sugar Felsenthal Grais & Hammer, LLP, with offices in Chicago and New York. Jonathan regularly advises private funds in their M&A activity and private companies in their day-to-day affairs. Jonathan has extensive experience in guiding companies and their boards through a variety of challenging situations, including in Chapter 11 and other insolvency regimes.

Jonathan graduated from the SUNY Albany, magna cum laude, in 1991 (after three years of study) and from the University of Pennsylvania Law School in 1994. He clerked for a federal judge before entering private practice. He was an Adjunct Professor of Strategic Management at the University of Chicago’s Graduate School of Business for several years and was the 2006 Clayton Center for Entrepreneurial Law Visiting Professor of Business Law at the University of Tennessee College of Law. Jonathan has been profiled, interviewed, and/or quoted in numerous publications, including Buyouts Magazine; Smart Business Magazine; The M&A Journal; Inside Counsel; LAW360; BusinessWeek.com; The Bankruptcy Strategist; Dow Jones Daily Bankruptcy Review; Bankruptcy Court Decisions; Dow Jones LBO Wire; and The Daily Deal. Jonathan is also lead author and editor of several significant treatises, several chapters in other treatises, and hundreds of articles on law and business. Jonathan holds the highest possible rating from Martindale-Hubbell (AV® Preeminent™) and AVVO (10/10), has been repeatedly recognized as an Illinois “superlawyer” in multiple areas of practice, including Business/Corporate Law and Bankruptcy & Creditor/Debtor Rights, has been named several times as a “Leading Lawyer” by Leading Lawyers Magazine, and has received several other similar distinctions.

ABOUT THE FACULTY

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STEVE GILLETTEsegillette@jonesday.com

Steve Gillette has significant experience representing private equity and other financial sponsors in acquisitions and dispositions of their portfolio companies. He also advises on governance and compliance matters and represents strategic investors in a range of transactions including M&A, securities offerings, and minority and strategic investments. Steve also maintains an active emerging companies practice.

Recent representative transactions include: Riverside’s acquisitions of Momentum Textiles, Soothe, Kasasa, and Health and Safety Institute, and its sale of Baby Jogger; Peterson Partners’ investments in Blue Raven Solar, Si Señor Restaurants, and Whitehaven Partners; BlackBerry’s acquisition of Good Technology ($425 million); SAP’s acquisitions of Roambi and Concur Technologies ($8.3 billion); Lam Research’s acquisition of Novellus ($3.3 billion); Specialists on Call’s sale of control to Warburg Pincus; and several strategic investments by Verizon, Total, AbbVie, Gfk, and Citi Ventures. Steve also acts as outside general counsel to several public and private companies.

Steve regularly speaks at business and legal conferences on private equity, M&A, venture capital, and corporate governance, and has been quoted in The Wall Street Journal as well as in leading industry publications.

Visit www.eisneramper.com

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EisnerAmper LLP is a leading full-service advisory and accounting firm, and is among the largest in the United States. We provide audit, accounting, and tax services, as well as corporate finance, internal audit and risk management, litigation services, consulting, private business services, employee

benefit plan audits, forensic accounting, and other professional advisory services to a broad range of clients across many industries. We work with high net worth individuals, family offices, closely held businesses, start-ups, middle market and Fortune 500 companies. EisnerAmper is PCAOB-registered and provides services to more than 200 public companies and to thousands of entities spanning the hedge, private equity, brokerage and insurance

space in the financial services marketplace. As companies grow we help them reach their goals every step of the way.With offices in New York (NY), New Jersey (NJ), Pennsylvania (PA), California (CA), and the Cayman Islands, and as an independent member of Allinial

Global, EisnerAmper serves clients worldwide.

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