DEC Education: DEC Education: Setting up a Business StructureSeptember 10, 2013p ,

Robert A. Schroeder1

DEC Education: Setting up a Business Structure

Agenda• Introductions

• Overview

• Business StructuresBusiness Structures

• Forming a Business Entity

• Founder and Investor Agreements• Founder and Investor Agreements

• Intellectual Property

Q&A• Q&A

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DEC Education: Setting up a Business Structure

Overview – What is a Business?

Founders

Intangible Assets (ideas

Physical Assets (equipment,

inventory, etc.)Cash

Investors

BusinessLenders

Assets (ideas, patents, etc.)

inventory, etc.)

Employees BusinessEmployees

ServicesProducts

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DEC Education: Setting up a Business Structure

Overview – Why Establish a Business?• Launching a product or serviceg p

• Creating intellectual property

• Having more than one founder/investorHaving more than one founder/investor

• Hiring employees

• Obtaining financing• Obtaining financing

• Starting a capital gains holding period

Establishing ownership rights and governance• Establishing ownership rights and governance procedures

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DEC Education: Setting up a Business Structure

Overview – Primary Business Types• Sole Proprietorship (no entity)p p ( y)

• Partnership (general or limited)

• Limited Liability CompanyLimited Liability Company

• Corporation (C-corp or S-corp)

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DEC Education: Setting up a Business Structure

Sole Proprietorship• Simple, no formation paperworkp , p p

• Single decision-maker

• No protection against personal liability; personalNo protection against personal liability; personal assets at risk; consider good umbrella insurance policy

• No ability to grant equity interests; hard to raise or borrow money

A id d bl i i /l i d• Avoids double taxation; income/losses incorporated into your personal tax return; must withhold and periodically pay employment and income taxesp y p y p y

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DEC Education: Setting up a Business Structure

Partnership• Multiple owners (partners); shared financial p (p );

commitment

• Generally simple to establish

• Avoids double taxation; respective portions of partnership profits and losses passed through to partnerspartners

• Partnership files informational return; partners responsible for taxesresponsible for taxes

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DEC Education: Setting up a Business Structure

Partnership• General Partnershipp

• Joint liability; liable for partners’ actions

• Personal assets at riskPersonal assets at risk

• May be established accidentally

• Limited Partnership• Limited Partnership

• General partner is personally at risk

Limited partners have limited liability• Limited partners have limited liability

• Established by filing certificate of formation

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DEC Education: Setting up a Business Structure

Partnership• Partnership agreement establishes ownership and p g p

decision-making procedures

• Partnership agreement may range in complexity

• Comprehensive agreement can reduce risk of partner disagreements and disputes

• May be hard to raise money from investors

• Complicated to grant equity interests to employees

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DEC Education: Setting up a Business Structure

Limited Liability Company • Permits one or more owners (members); shared ( );

financial commitment

• Provides limited liability exposure to members

• Generally simple to establish with state filing

• Can avoid double taxation by electing to be treated y gas a partnership for tax purposes

• LLC files informational tax return; members ibl fresponsible for taxes

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DEC Education: Setting up a Business Structure

Limited Liability Company• LLC/Operating agreement establishes ownership p g g p

and decision-making procedures

• LLC agreement may range in complexity; but flexible

• Comprehensive agreement can reduce risk of member disagreements and disputes

• May be hard to raise money from investors

• Somewhat complicated to grant equity interests to lemployees

• Requires annual state filings

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DEC Education: Setting up a Business Structure

Corporation• Permits one or more owners (stockholders); shared ( );

financial commitment

• Provides limited liability exposure to stockholders

• Can be simple to establish with state filing

• Requires annual state filingsq g

• Documentation can become complex

• Must maintain state prescribed procedures (board ofMust maintain state prescribed procedures (board of directors, officers, meeting minutes, etc.)

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DEC Education: Setting up a Business Structure

Corporation• “S-Corp” Electionp

• Available if less than 100 stockholders

• All stockholders must be U S individuals (orAll stockholders must be U.S. individuals (or certain trusts and estates)

• Restricted to one class of stock; does not permit ppreferred stock

• Treated as a partnership for tax purposes

• Employee-owner should receive reasonable comp or earnings may be taxed as wages

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DEC Education: Setting up a Business Structure

Corporation• Considered a “C-Corp” if not an “S-Corp”p p

• Permits multiple classes of stock

• Subject to taxation at corporate level and onSubject to taxation at corporate level and on distributions

• Typical entity structure expected by venture yp y p ycapital and other institutional investors

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DEC Education: Setting up a Business Structure

Corporation• Certificate of incorporation and bylaws establishes p y

ownership rights and decision-making procedures

• Provides well recognized governance structure (board of directors and officers)

• Comprehensive documentation can reduce risk of stockholder disagreements and disp tesstockholder disagreements and disputes

• Investors are familiar with and expect to invest in corporationscorporations

• Stock options are available to provide to employees

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DEC Education: Setting up a Business Structure

Entity Related Considerations• Do you expect to have investors? If so, what type of y p , yp

investors (family, angel, VC, etc.)?

• Do you expect to have employees?

• Will you issue equity to employees or consultants?

• Do you expect to sell the business?y p

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DEC Education: Setting up a Business Structure

Entity Related Considerations• Tax pass-through versus corporationp g p

• Will the business generate net income soon or are losses expected?

• Will you have personal income from other sources to offset losses against?

• Will the business retain earning or distribute them to the owners?

C id i l l• Consider corporate tax rates at income levels expected; consider reasonable compensation from corporation to shareholders as employees.p p y

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DEC Education: Setting up a Business Structure

Forming a Business Entity – Where?• Delaware

• Most common state for incorporation/formation

• Well established case law including with respectWell established case law, including with respect to director and officer fiduciary duties

• Efficient formation and annual report processesp p

• Investors often insist on Delaware

• Need to establish an agent for service of processNeed to establish an agent for service of process

• Become qualified to do business in Texas (and other states where operating)

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DEC Education: Setting up a Business Structure

Forming a Business Entity – Where?• Texas

• If operating in Texas, may be simpler to deal with only one state (no need for an out-of-state agent, no out-of state franchise taxes, etc.)

• Investors not as familiar with Texas law; but similar to Dela are la in man respectssimilar to Delaware law in many respects

• Other states or countries

J i di i h b i i l d• Jurisdiction where business is located

• Cayman Islands

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DEC Education: Setting up a Business Structure

Forming a Business Entity – How?• Choose a name

• Check Secretary of State for availability (Texas and, if applicable, Delaware and any other states you plan to operate)

• Preliminary screening for intellectual property (trademark) infringement search(trademark) infringement search

• In-depth infringement analysis if preliminary screen seems clearscreen seems clear

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DEC Education: Setting up a Business Structure

Forming a Business Entity – How?• Create and file certificate of incorporation/formationp

• Pay incorporation/formation fees

• Identify and engage agent (for forming an entityIdentify and engage agent (for forming an entity outside your business location and in-state if desired)

• Create partnership agreement, limited liability p p g ycompany agreement or bylaws

• Establish record keeping (initial board and h h ld l i k ifi )shareholder resolutions, stock certificates, etc.)

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DEC Education: Setting up a Business Structure

Forming a Business Entity – Who?• Legal counselg

• Experienced attorney can address specific concerns (suitability of structure; founder or investor protections; IP; stock options; etc.)

• Caution regarding online providers

• Very low price

• Generic documents

• Limited or no advice on suitability of structure and related matters

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DEC Education: Setting up a Business Structure

Founder and Investor Agreements• Ownership Arrangementsp g

• Dividend/distribution/liquidation allocations

• Preemptive Rights to maintain ownership levelPreemptive Rights to maintain ownership level

• Transfer restrictions

Right of First Refusal for co investors– Right of First Refusal for co-investors

– Co-Sale Rights to tag along in sales

Drag Along Rights to facilitate sale of company– Drag-Along Rights to facilitate sale of company

• Information Rights

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DEC Education: Setting up a Business Structure

Founder and Investor Agreements• Governance Matters

• Rights to appoint directors/managers

• Indemnification rights for activity performed asIndemnification rights for activity performed as director, manager, partner, officer, etc.

• Protective provisions requiring consent to take p q gcertain company actions (e.g., incurring debt, sale of company, major acquisitions, changing line of business etc )business, etc.)

• Non-compete provisions

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DEC Education: Setting up a Business Structure

Founder and Investor Agreements• Documented in a variety of documentsy

• Certificate of Incorporation or Bylaws (Corp)

• Shareholder Agreements (Corp usually)Shareholder Agreements (Corp usually)

• Limited Liability Company Agreement (LLC)

• Partnership Agreement (Partnership)• Partnership Agreement (Partnership)

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DEC Education: Setting up a Business Structure

Issuing Debt and Equity to Investors• Subscription Agreement / Stock Purchase p g

Agreement

• Securities Laws

• Limitations on advertising and soliciting investors

• Accredited Investors

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DEC Education: Setting up a Business Structure

Intellectual Property• Considerations Before Setting up a Business

• Ownership of your intellectual property

– Universities, existing/prior employers, g p p y

– Friends, mentors, advisors

• Existing employment agreementsExisting employment agreements

– Employment and confidentiality agreements

– Proprietary information agreements -– Proprietary information agreements -assignment of inventions / right to IP

– Non-competition / non-solicitation agreementsp g

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DEC Education: Setting up a Business Structure

Intellectual Property• Transferring IP to your businessg y

• Technology assignments from founders

• Developing new IP within your businessDeveloping new IP within your business

• Proprietary information agreements with employeesp y

• Consulting agreements with IP assignments

• Licensing IP to and from othersLicensing IP to and from others

• University IP policies

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DEC Education: Setting up a Business Structure

Intellectual Property• Protecting Intellectual Propertyg p y

• Use confidentiality agreements

• Mark confidential material as “confidential”Mark confidential material as confidential

• Enforce registered intellectual property

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DEC Education: Setting up a Business Structure

Intellectual Property• Registering Intellectual Propertyg g p y

• Patents

• TrademarksTrademarks

• Copyrights

• US Patent and Trademark Office• US Patent and Trademark Office

• US Copyright Office

Non US Agencies• Non-US Agencies

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DEC Education: Setting up a Business Structure

Thank you

• IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Di l i Thi J D t ti id t d i f ti l l i d d l t f• Disclaimer: This Jones Day presentation provides comments and information on legal issues and developments of interest to our clients and friends. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Participants should seek specific legal advice before taking any action with respect to the matters discussed herein.

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