HARTFORD | STAMFORD | WASHINGTON, DC | GREENWICH | LAKEVILLE Incorporation 101 January 30, 2015 James C. Schulwolf Matthew J. Monteith

HARTFORD | STAMFORD | WASHINGTON, DC | GREENWICH | LAKEVILLE

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Incorporation 101

January 30, 2015

James C. Schulwolf Matthew J. Monteith


When to Incorporate

• Does IP exist?

• How many founders?

• Are you selling a product or performing services?

• Are you engaging third parties (vendors) or hiring employees?


Why to Incorporate

• Limited liability!!

• Tax implications

• Formally divide ownership

• Attract investors

• “House” IP and confidential information

• Assign roles and responsibilities


Types of Entities

Limited Liability Company

C-Corporation

S-Corporation


LLC Overview

• One or more persons, called members, may form a limited liability company—they are analogous to shareholders in corporations

• Members can manage the company’s affairs, or can delegate management powers to managers—they are analogous to officers or directors in corporations

• Very flexible as to management and decision-making

Management Structure


LLC Overview

• Limited liability (significant advantage over partnerships/sole proprietorships)

• Single level of taxation – income and expenses are passed through the limited liability company to the members and taxed only at the member level (significant advantage over C-corporations)

► C-corporation is treated for federal tax purposes as separate entity subject to tax at maximum federal tax rate of 35% and state rate of 7.5%. Dividends and liquidating distributions are subject to second tax at shareholder level, currently at 15-20%.

► Connecticut corporate tax (7.5%) does not apply to LLCs. Instead, each member’s share of LLC income will be subject to Connecticut’s 6.7% personal income tax.

Advantages


LLC Overview

• Investors may require corporate entity; may require conversion to a corporation

• No IPO

• Certain specialized businesses may not be eligible for LLC treatment (i.e. banks, insurance companies, utilities)

• Less developed body of law

Disadvantages


C-Corporation Overview

• Stockholders

• Directors

• Officers

• Required formation documents

► Certificate of Incorporation

► Bylaws

• Other documents

► Stockholders agreement is very common

Management Structure



• Limited liability

• Almost always accepted by investors

• Very well-developed body of law

• Good vehicle for an IPO

Advantages



• More corporate formalities than LLCs

• Double taxation – income is taxed to the corporation (highest federal rate is 35%, highest CT rate is 7.5%) and then taxed to shareholders as dividend income when distributed (15-20%)

• May be unwieldy for small management/ownership groups

Disadvantages


S-Corporation Overview

• Pass-through taxes, but limited to 100 shareholders, one class of stock and, in general, only individuals (rather than entities) can be shareholders.

► Limited markets for capital – since S-Corporations cannot have shareholders who are not U.S. individuals, institutional investors cannot be shareholders, therefore markets for capital are limited—generally to “angel” investors and mezzanine debt/options financing

► Little economic flexibility – S-Corporations cannot give preferred returns on capital and priority distributions to shareholders due to single class of stock rule.


Ownership Issues

• Founders’ Stock

► To vest or not to vest…

► Reverse vesting

► Milestones for vesting

► Voting or Non-voting

• What about future employees?

► Equity incentives


Governance Issues

• Shareholders Agreement or Buy-Sell Agreement

► What happens to your shares if you leave the company?

► Death or disability?

► ROFR (first, the company, then the other shareholders)

► At what price?

► Can you voluntarily transfer to a third party?


Board of Directors

• Directors are responsible for overseeing general management and control of the business and affairs of the company and promoting best interests of company and its shareholders (big picture issues)

► Officers control day to day operation (“little picture” issues)

• Elected by the shareholders

• How many members should serve on a board?

• Who are typical board members?


Boards, Boards, Boards

• Board of Directors vs Board of Advisors – what is the difference?

► “Must” have a Board of Directors (even if just one person)

► “May” have a Board of Advisors (if it makes sense for the company)

• Can I be a shareholder, and a board member, and an officer?

► Yes, but wearing multiple hats may cause conflicts

• Compensation issues


IP Issues

• Need to ensure that the corporation, and NOT the individual shareholders, owns all intellectual property related to the business

• Invention Assignment Agreement

► University context – make sure that university licenses the appropriate rights to the corporation, even if the actual IP remains property of the university

• Non-Disclosure Agreement

• Non-Compete Agreement???


Beware: An Investor Changes Everything!

• Institutional investors will almost certainly require significant changes to corporate structure and organizational documents

• Properly prepared documents, clear ownership structure, and evidence that the entity owns all key assets and information reflect well on the company and improve investment prospects

• Takeaway: Do not get bogged down in the minutiae early on. Things will change once the company raises money.


Questions?

THANK YOU!

Documents

HARTFORD | STAMFORD | WASHINGTON, DC | GREENWICH | LAKEVILLE Incorporation 101 January 30, 2015 James C. Schulwolf Matthew J. Monteith