DOCSLIB.ORG

Start Ups and Emerging Companies – 101: Choice of Entity

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
Start Ups and Emerging Companies – 101: Choice of Entity JANUARY 14, 2013 | HANSON BRIDGETT CORPORATE PRACTICE GROUP What type of corporate entity is best for my business? Start Ups and As a founder/entrepreneur, you (and your partners) have an idea Emerging for a new venture are willing to invest your time and money in the start-up of a new business. Selecting the right corporate vehicle Companies – 101: for your business is critical to your success. The goal of the Choice of Entity founder is to choose an entity that (1) "fits the business model" for the venture, and (2) makes the company "attractive" to investors. How do you know what entity is the best fit? A good starting point for making this determination is to ask yourself: "How am I going to fund my company?" Many founders start their company with their own funds on a "shoe string", focusing their resources on developing the "big idea" and bringing the product to market. However, after your "founder funds" are exhausted (self-funding), you will need to either sell your company, or seek investment from one or more of the following Private Equity sources: • Friends and Family • Angel Funds • Venture Capital by Derek A. Ridgway The investment path you choose will pay a significant role in the corporate vehicle you select for your company. What are the typical corporate entities to choose from? Generally, there are three main types of entities to choose from: Corporations, Limited Liability Companies and Partnerships. Corporations: A Corporation is owned by its shareholders, who buy stock or shares in the company in exchange for consideration. The corporation is governed by a set of bylaws which states how the corporation is to be operated. The shareholders may decide to define the rights between them through a shareholder agreement. Limited Liability Company (LLC): A Limited Liability Company (LLC) is owned by its members (as opposed to shareholders) who have a membership interest (as opposed to stock) in the PG 2 company. The LLC is governed by an operating agreement which states how the company is to be operated. The operating agreement also provides for the rights of the members with respect to the company, and in particular, the members' respective exit rights. Partnership: A Partnership is owned by the partners, who have a "partnership interest" in the partnership. The partnership is governed by a partnership agreement which states how the partnership is to be operated. The partnership agreement also provides for the rights of the partners with respect to the company. So what is the best entity for me? First, a little bit about corporate entities. All corporate entities are recognized as a separate legal entity. This means that they exist as a separate "person", that can, for example, buy and sell goods, employ people, enter into contracts, and take any other action that any person can do. Just like you and me, the liabilities of the corporate entity are limited to its own assets. The founders are generally not liable for the debts of the company. Also, like any person, the company pays taxes. With this background, consider the following specific types of entities for your business. This is not an exhaustive list, but are the most common business entities used for start-up ventures. C-Corporation: A C-Corporation is a type of corporation. If you are seeking Venture Capital funding, a C- Corporation may be the best fit for your business. Most corporations (and practically every large company) are organized as C-Corporations because they appeal to a larger group of investors. Venture Capital firms generally favor C-Corporations because only C-Corporations may issue preferred stock and have stockholders other than individuals. C-Corporations tend to be more formal and more expensive to operate than other forms of corporate entities. The most significant drawback to a C-Corporation is the potential for negative tax treatment. This "double tax", as it were, means that the corporation pays tax on its profits at the end of the year (reported on the company's income tax return), and when the corporation makes a distribution to the founders (and/or other shareholders), the founders/shareholders also pay tax (hence, a "double tax") on the distributed amount on their personal income tax return. Many entrepreneurs want to avoid this "double tax" exposure. There are ways to avoid "double tax" exposure for a period of time, but as your company grows, "double tax" will be inevitable for the successful C-Corporation. Limited Liability Company (LLC): If you are seeking funding from Friends and Family or from Angels, an LLC may be the best fit for your business. Many companies are formed as an LLC because an LLC not subject to "double tax", and it has the same limited liability protection as a Corporation. In addition, an LLC may issue preferred membership units with the same privileges and rights as preferred stock. Also, ownership in an LLC is not limited to individuals, but may include other corporate entities as members (owners) of the LLC. While an LLC may be ideal for most Private Equity investors, Venture Capital firms typically avoid LLCs because they are taxed as a "pass-through" entity. This means that the members pay the tax owed by the company directly on their personal income tax return. The company is not separately taxed. Venture Capital firms typically do not invest in LLCs because this "pass-through" taxing mechanism may require that the firm (as a member of the LLC) report the company's losses to the firm's investors (which VCs don't like to do), or may require the firm's foreign investors to file a US tax return. PG 3 LLCs, however, are frequently used for non-venture capital funding, such as Friends and Family, Angel Funding and other Private Equity (e.g. Series A) rounds. There are some additional cost considerations associated with LLCs which should be considered as part of your entity selection decision. S-Corporation: Similar to an LLC, an S-Corporation is a "pass-through" entity. S-Corporations are somewhat limited, however, because the number of shareholders that the company may have at one given time is capped, and, importantly, the shareholders generally must be individuals. Also, an S-Corporation may only have one class of shares, called common shares. These features may be acceptable for a Friends and Family round of financing, but is generally not favorable for other types of Private Equity funding. Partnership: Partnerships are rarely used because they, for the most part, expose the partners to unlimited liability for the partnership's debts. Enough said. Bottom line: If you have the next "twitter" or "you tube", then you may want to form a C-Corporation at the outset and position the company for substantial funding (and eventually an IPO). However, if what you are looking for is flexibility, and an entity that is easy to use and easy to invest in for most Private Equity investors, an LLC may be your best bet. If you decide (or an investor requires) that you later convert to a C-Corporation, the process to convert is relatively easy and generally not cost-prohibitive to accomplish. For more information, please contact: Derek A. Ridgway, Partner 925-746-8484 [email protected] DISCLAIMER: This publication does not constitute legal advice. Readers should consult with their own legal counsel for the most current information and to obtain professional advice before acting on any of the information presented. Copyright © Hanson Bridgett LLP.
Load more

Recommended publications
  • Website: Friend Or Foe?
    VENTURE CAPITAL & PRIVATE EQUITY FUNDS DESKBOOK SERIES Website: Friend or Foe? Many venture capital firms and private equity firms create and maintain websites—usually eponymous— to achieve such far-ranging goals as building brand recognition, communicating with their existing investors, and creating channels of information with existing and potential portfolio companies. It is appropriate to use a website for such purposes and others, such as describing the industry sectors of interest to a venture capital or private equity firm, provided that certain precautions are taken as described in this article. Caution is warranted when establishing a website because there may be unintended legal consequences lurking within seemingly harmless web content. A scrubbed website can be a true friend for a venture capital or private equity firm. A neglected or carelessly composed website can be a terrible foe. Do Not Solicit Investors When engaged in a private offering (i.e., raising a fund), it is important that venture capital firms and private equity firms keep in mind that many of their funds are relying on exemptions to a number of different securities laws that all have one common requirement: there must be no public offering of securities by or on behalf of any of such private funds managed by such firms. Websites are generally viewed as being publicly available. Regulatory authorities, such as the Securities and Exchange Commission (SEC), have adopted very broad views of what constitutes an offering. As such, any materials on a website that could be viewed as a general solicitation or general advertisement may be considered a public offering by the SEC or other regulatory authorities.
    [Show full text]
  • Walker Report
    WALKER REPORT NOVEMBER 2018 Our Support of the Walker Report Over the past several years, Kohlberg Kravis Roberts & Co. L.P. Overview of KKR and our private equity business (together with its affiliates, “KKR,” “we” or “us”) has been KKR is a leading global investment firm that manages multiple working to increase the transparency of our investment activities alternative asset classes, including private equity, energy, and processes, both through formal compliance with guidelines infrastructure, real estate and credit, with strategic partners recommending increased levels of disclosure as well as through that manage hedge funds. KKR aims to generate attractive voluntary initiatives with our clients, partners, portfolio investment returns for its fund investors by following a patient companies and the public at large. and disciplined investment approach, employing world-class In November 2007, a working group formed by The British people, and driving growth and value creation with KKR portfolio Private Equity and Venture Capital Association (“BVCA”) and companies. KKR invests its own capital alongside the capital it led by Sir David Walker issued the Guidelines for Disclosure manages for fund investors and provides financing solutions and Transparency in Private Equity. That publication, which is and investment opportunities through its capital markets also known as the “Walker Report,” makes specific business. References to KKR’s investments may include the recommendations for improving the level of public disclosure activities of its sponsored funds. For additional information by private equity firms operating in the United Kingdom. about KKR & Co. Inc. (NYSE: KKR), please visit KKR’s website at www.kkr.com and on Twitter @KKR_Co.
    [Show full text]
  • FREQUENTLY ASKED QUESTIONS: Commission
    Louisville Metro Fre Revenue FREQUENTLY ASKED QUESTIONS: Commission Venture Capital Funds and Family Limited Partnerships WHICH BUSINESS ENTITIES QUALIFY FOR THE VENTURE CAPITAL FUND OL TAX EXEMPTION? The occupational license taxes do not apply to venture capital funds business entities as defined in LMCO 110.03(A)(12). To qualify for the exemption, the venture capital fund must be a limited liability company, limited liability partnership, or limited partnership formed and operated for the exclusive purpose of buying, holding and/or selling securities (including debt Are business entities that qualify for securities), on its own behalf and not as a broker, primarily in non- publicly traded companies, and the capital of the fund is primarily the Venture Capital Funds or Family derived from investments by entities and/or individuals which are Limited Partnerships tax exemptions neither related to nor affiliated with the fund. See LMCO required to file an annual OL return? 110.03(A)(12) for additional information and definitions. So long as the entity files an annual informational return along with the required WHICH BUSINESS ENTITIES QUALIFY FOR THE documentation, the entity is not responsible FAMILY LIMITED PARTNERSHIP OL TAX for filing an occupational license return. EXEMPTION? The occupational license taxes do not apply to family limited partnership business entities as defined in LMCO 110.03(A)(13). To qualify for the exemption, the income received by family limited partnerships must be from a family-owned non-corporate entity where the sole activity of such entity is the production of investment income not derived from tangible or real property and at least 95% of the equity of the family limited partnership is owned by members of the family.
    [Show full text]
  • Private Equity in the 2000S 1 Private Equity in the 2000S
    Private equity in the 2000s 1 Private equity in the 2000s Private equity in the 2000s relates to one of the major periods in the history of private equity and venture capital. Within the broader private equity industry, two distinct sub-industries, leveraged buyouts and venture capital experienced growth along parallel although interrelated tracks. The development of the private equity and venture capital asset classes has occurred through a series of boom and bust cycles since the middle of the 20th century. As the 20th century ended, so, too, did the dot-com bubble and the tremendous growth in venture capital that had marked the previous five years. In the wake of the collapse of the dot-com bubble, a new "Golden Age" of private equity ensued, as leveraged buyouts reach unparalleled size and the private equity firms achieved new levels of scale and institutionalization, exemplified by the initial public offering of the Blackstone Group in 2007. Bursting the Internet Bubble and the private equity crash (2000–2003) The Nasdaq crash and technology slump that started in March 2000 shook virtually the entire venture capital industry as valuations for startup technology companies collapsed. Over the next two years, many venture firms had been forced to write-off large proportions of their investments and many funds were significantly "under water" (the values of the fund's investments were below the amount of capital invested). Venture capital investors sought to reduce size of commitments they had made to venture capital funds and in numerous instances, investors sought to unload existing commitments for cents on the dollar in the secondary market.
    [Show full text]
  • NVCA 2021 YEARBOOK Data Provided by Dear Readers
    YEARBOOK Data provided by Credits & Contact National Venture Capital Association NVCA Board of Directors 2020-2021 (NVCA) EXECUTIVE COMMITTEE Washington, DC | San Francisco, CA nvca.org | [email protected] | 202-864-5920 BARRY EGGERS Lightspeed Venture Partners, Venture Forward Chair Washington, DC | San Francisco, CA MICHAEL BROWN Battery Ventures, Chair-Elect ventureforward.org | [email protected] JILL JARRETT Benchmark, Treasurer ANDY SCHWAB 5AM Ventures, Secretary BOBBY FRANKLIN President and CEO PATRICIA NAKACHE Trinity Ventures, At-Large JEFF FARRAH General Counsel EMILY MELTON Threshold Ventures, At-Large JUSTIN FIELD Senior Vice President of Government MOHAMAD MAKHZOUMI NEA, At-Large Affairs MARYAM HAQUE Executive Director, Venture AT-LARGE Forward MICHAEL CHOW Research Director, NVCA and PETER CHUNG Summit Partner Venture Forward DIANE DAYCH Granite Growth Health Partners STEPHANIE VOLK Vice President of Development BYRON DEETER Bessemer Venture Partners RHIANON ANDERSON Programs Director, Venture SCOTT DORSEY High Alpha Forward RYAN DRANT Questa Capital CHARLOTTE SAVERCOOL Senior Director of PATRICK ENRIGHT Longitude Capital Government Affairs STEVE FREDRICK Grotech Ventures MICHELE SOLOMON Director of Administration CHRIS GIRGENTI Pritzker Group Venture Capital DEVIN MILLER Manager of Communications and JOE HOROWITZ Icon Ventures Digital Strategy GEORGE HOYEM In-Q-Tel JASON VITA, Director of Programming and CHARLES HUDSON Precursor Ventures Industry Relations JILL JARRETT Benchmark JONAS MURPHY Manager of Government Affairs
    [Show full text]
  • Venture Capital, Private Equity and Hedge Funds: an Introduction
    Venture Capital, Private Equity and Hedge Funds: An Introduction UGBA 195T, 2 units Course Overview: This course will provide a high level introduction to venture capital, private equity, and hedge funds. In the course, students will learn: • What are venture capital, private equity, and hedge funds? • What types of investments do they make? • How do they generate superior investment returns? • What do the professionals in these firms do? • How are these firms organized, structured and managed? • What are the career paths in these firms? • What are the risks and rewards experienced by these firms? Teaching Method: The course will use Harvard Business School case studies written for MBA students. There will be some lectures to introduce core concepts. The course syllabus will focus approximately 50% on venture capital, 25% on private equity and 25% on hedge funds. Prerequisites / Grading / Homework: • Course is best suited for UC Berkeley seniors with extensive prior course work in business. First preference to seniors enrolled in Haas School of Business. • Some interest or experience in start-ups, investing or finance will be helpful. • Homework will include reading and analyzing one business case per week of approximately 15- 20 pages in length. • Grading will be based on classroom participation (25%), pop quizzes (25%) and a final project (50%). Instructor: Rob Chandra serves on the Haas School of Business faculty where he teaches an undergraduate course on alternative investing and co-teaches an MBA course on entrepreneurship. He is a general partner with Avid Park Ventures, a San Francisco based venture capital firm. His current or prior investments include Alibaba, CrowdStrike, Dropbox, Lending Club, MongoDB, Nutanix, Robinhood, Snap, Twitter and Uber.
    [Show full text]
  • Evolution of Japanese Venture Capital
    Evolution of Japanese Venture Capital April 24, 2008 Michael Korver Managing Partner Global Venture Capital Some Observations • Both “high-growth expectation” entrepreneurial activity and VC funding levels in Japan are much lower than in the US (even when adjusted for population and size of economy). Also lower than in Europe. • According to the Global Entrepreneurship Monitor (GEM), Japan ranked second from last among high-income countries surveyed in terms of the prevalence rate of high- growth expectation early-stage entrepreneurship during 2000 – 2006. • Venture capital is available in Japan, but much of it comes from organizations affiliated with large financial institutions. • Most VC-backed companies in Japan target domestic market exclusively. According to GEM, Japan ranks last among high-income countries surveyed in terms of the prevalence rate of the international orientation of its entrepreneurial ventures. • According to GEM, Japanese have the lowest perceptions of the positive attributes about entrepreneurship activity in the world. • Japanese VC’s depend heavily on a handful of Japanese stock exchanges for exits (and performance) of their domestic portfolio companies. • Japan is a technologically sophisticated country with large domestic early-adopter markets and global companies generating significant amounts of technology innovation. What is the role of entrepreneurship and venture capital in driving this innovation? International Comparisons • U.S. venture capitalists invested $29.4B in 3,813 deals in 2007 – marking the highest yearly investment since 2001 (MoneyTree Report) • According to preliminary figures released by the EVCA, European venture capitalists invested €11.5B in 2007 • Japanese VCs invested ¥2,800 hundred million in 2,773 companies in the year ended Mar.
    [Show full text]
  • Venture Capital Industry: Evidence from Two Randomized Controlled Trials∗
    Discrimination in the Venture Capital Industry: Evidence from Two Randomized Controlled Trials∗ Ye Zhang † October 30, 2020 Abstract This paper examines discrimination based on startup founders' gender, race, and age by early-stage investors, using two randomized controlled trials with real venture capitalists. The first experiment invites U.S. investors to evaluate multiple randomly generated startup profiles, which they know to be hypothetical, in order to be matched with real, high-quality startups from collaborating incubators. Investors can also donate money to randomly displayed startup teams to show their anonymous support during the COVID-19 pandemic. The second experiment sends hypothetical pitch emails with randomized startups' information to global venture capitalists and compares their email responses by utilizing a new email technology that tracks investors' detailed information acquisition behav- iors. I find three main results: (i) Investors are biased towards female, Asian, and older founders in \lower contact interest" situations; while biased against female, Asian, and older founders in \higher contact interest" situations. (ii) These two experiments identify multiple coexisting sources of bias. Specifically, statistical discrimination is an important reason for \anti-minority" investors' contact and investment decisions, which was proved by a newly de- veloped consistent decision-based heterogeneous effect estimator. (iii) There was a temporary, stronger bias against Asian founders during the COVID-19 outbreak, which started to fade in April 2020. Key Words: Venture Capital, Entrepreneurship, Discrimination, Field Experiments JEL Classification: C93, D83, G24, G40, J15, J16, J71 ∗I would like to express my deepest appreciation to Jack Willis, Harrison Hong, and Wei Jiang for their guidance, support, and profound belief in the value of my work.
    [Show full text]
  • The Wisdom of Compounding Capital the Wisdom of Compounding Capital
    INSIGHTS GLOBAL MACRO TRENDS VOLUME 11.1 • FEBRUARY 2021 The Wisdom of Compounding Capital The Wisdom of Compounding Capital Ultra High Net Worth investors have increasingly become more influential leaders in the global asset management industry, leveraging a more sizeable base of assets under KKR GLOBAL MACRO & ASSET management to participate in more complex transactions, ALLOCATION TEAM all while broadening their global reach. In an effort to Henry H. McVey Head of Global Macro & Asset Allocation better understand this growth opportunity, we recently +1 (212) 519.1628 [email protected] engaged with around 50 CIOs from leading Ultra High Frances B. Lim Net Worth family offices with whom KKR does business. +1 (212) 401.0451 [email protected] Most families with whom we spoke are also led by self- Rebecca J. Ramsey made entrepreneurs, which dovetails closely with the +1 (212) 519.1631 [email protected] way founders Henry R. Kravis and George R. Roberts have been building KKR for the last forty five years. Their Special thanks to Eric Mogelof, Jim Burns, investment profiles also mesh well with KKR and its Monica Mandelli, Blake Shorthouse, Stanley Ho, Jeff Schachter, Dan Parant, balance sheet heavy strategy, given the Ultra HNW’s focus Doug Krupa, Elizabeth Di Cioccio, on capital appreciation as well as their commitment to a Mohamed Attar, Shannon Rutter, Ryan McGrath, George Stephan, long-term investment horizon via private investments. Alice Chung, and Junaid Arefeen. While underlying fundamentals are robust in this sector of the market, many CIOs are looking to further refine their business models.
    [Show full text]
  • Press Release David Stepp FINAL
    Media Contact: Nicole Pack 650-475-3721 [email protected] FOR IMMEDIATE RELEASE Venrock Promotes David Stepp to Partner Palo Alto, Calif., July 31, 2013 – Venrock, a pioneering venture capital firm established in 1969 by the Rockefeller family, today announced the promotion of David Stepp to partner. In addition to helping shape firm strategy, Stepp oversees the firm’s operations and administration, including structuring of fundraisings, investor relations, human resources, and the finance and legal functions. Stepp advises portfolio companies and actively participates in the structuring and implementation of portfolio investments, exits and significant transactions. Stepp is also responsible for the regulatory and compliance functions of the firm and serves as chief compliance officer. “David Stepp has been a key contributor across all dimensions of our business over the last six years,” said Bryan Roberts, partner at Venrock. “David’s promotion is a recognition of his commitment to our firm, its limited partners and our entrepreneurs. He is a terrific colleague and richly deserves this recognition.” Stepp joined Venrock as general counsel in 2007 from Cooley LLP. At Cooley, his practice focused on the formation and representation of venture capital partnerships and the representation of emerging growth and small-cap public technology companies. Stepp earned his B.S. in Molecular and Cellular Biology from the University of Arizona and his J.D. from Harvard Law School. About Venrock Originally established as the venture capital arm of the Rockefeller family in 1969, Venrock continues a tradition of partnering with entrepreneurs to establish successful, enduring companies. With a primary focus on technology and healthcare, portfolio companies have included Adify, Apple Computer, Athenahealth, Centocor, Check Point Software, DoubleClick, Endeca, Gilead Sciences, Idec Pharma, Imperva, Illumina, Intel, Millennium Pharma, SlideShare and Tudou.
    [Show full text]
  • VENTURE CAPITAL, ENTREPRENEURSHIP, and ECONOMIC GROWTH Sampsa Samila and Olav Sorenson*
    VENTURE CAPITAL, ENTREPRENEURSHIP, AND ECONOMIC GROWTH Sampsa Samila and Olav Sorenson* Abstract—Using a panel of U.S. metropolitan areas, we find that increases in macrolevel relationships among the supply of venture capi- the supply of venture capital positively affect firm starts, employment, and aggregate income. Our results remain robust to a variety of specifications, tal, entrepreneurship, and economic growth therefore remain including ones that address endogeneity. The estimated magnitudes imply open questions. that venture capital stimulates the creation of more firms than it funds, which To determine whether the availability of venture capital appears consistent with two mechanisms: First, would-be entrepreneurs anticipating financing needs more likely start firms when the supply of stimulates the formation of new firms, and in turn con- capital expands. Second, funded companies may transfer know-how to their tributes positively to economic growth, we exploited both employees, thereby enabling spin-offs, and may encourage others to become cross-sectional and longitudinal variation in the supply of entrepreneurs through demonstration effects. venture capital across and within Metropolitan Statistical Areas (MSAs). We estimated the local effects of venture cap- I. Introduction ital activity—measured in terms of the number of companies funded, the number of investments made, and the aggregate NALYSTS, bureaucrats, business leaders, politicians, dollars invested—on the number of firms established and on A and pundits have widely pointed to venture capital (VC) employment and aggregate income. Since the supply of ven- as an important factor underlying the economic growth of ture capital itself may depend in part on the demand for certain regions within the United States, such as Silicon Val- it—that is, on the availability of high-potential businesses ley, as well as of the country as a whole (Bottazzi & Rin, in which to invest—we also used endowment returns as an 2002).
    [Show full text]
  • Sherrie Quinn
    Sherrie Quinn Associate Corporate and M&A, Financing and capital markets Primary practice Corporate and M&A, Financing and capital markets 27/09/2021 Sherrie Quinn | Freshfields Bruckhaus Deringer About Sherrie Quinn <p style="margin: 0in; margin-bottom: .0001pt;">Sherrie is a corporate associate in Silicon Valley. She represents leading technology and life sciences companies in the software/SaaS, hardware, digital media, biotech, and internet industries. Her representation of companies spans the corporate lifecycle, with a focus on mergers, acquisitions, public offerings, divestitures, financings, and other strategic transactions.</p> <p style="margin: 0in; margin-bottom: .0001pt;">&nbsp;</p> <p style="margin: 0in; margin-bottom: .0001pt;">Prior to joining Freshfields, Sherrie was an associate in the San Francisco office of Goodwin Procter, where she represented iconic venture capital firms and<span style="color: red;">&nbsp;</span>emerging and later-stage companies in the software, technology, and life sciences industries throughout their corporate life cycle, including pre-incorporation planning, general corporate representation and counseling, venture capital financings, and mergers and acquisitions.</p> Recent work <h3>Capital Markets</h3> <ul> <li><a href="http://news.freshfields.com/profiles/Global/r/6105/freshfields_serves_as_issuer_s_counsel_to_zymergen_on_its">Zymergen on its Initial Public Offering as a public benefit corporation valued over $4bn</a></li> <li><a href="http://news.freshfields.com/en/Global/r/5938/freshfields_advises_goldman_sachs___co__llc_in_connection">Goldman
    [Show full text]