By Bill Daly / Guest Column
Entrepreneurs typically start businesses because they believe the product or service they are offering is either unique in the marketplace or they can provide it better than existing providers. In this process, entrepreneurs often recognize the need to establish a formal business entity, but don’t always appreciate that their initial choice in selecting and forming an entity can have a wide-ranging effect on how the company operates and grows.
Here are a few variables for entrepreneurs to consider as they set up their new venture:
Multiple owners and decision-making
If a company is founded by multiple individuals, they should have honest and direct conversations with each other about how decisions will be made, and who is needed to make both operational and larger, fundamental decisions.
Decisions can vary in significance from deciding who to hire and what to offer that person in compensation to whether the company wants to take investment from an outside investor or wants to sell all of its assets in an acquisition. These scenarios are on opposite ends of the spectrum in terms of magnitude, but co-founders should have discussions regarding these possibilities. More “operational” and simple decisions may only need a simple majority while larger, fundamental decisions may need a larger vote.
Similarly, co-founders should have discussions on the buy-sell provisions or transfer restrictions they want to impose on themselves or other owners of the business. These provisions can vary in how restrictive they are; having the conversations with an experienced attorney to help guide you through the choices is important.
Tax efficiency
Although it was true before, it is even more so now in light of federal tax reform: The selection of an entity and how such entity is taxed (e.g., a partnership versus a S-corp versus a C-corp) can have significant ramifications in the year-to-year operation the business, but also if the business is sold. The selection of an entity and its taxation structure is often dependent on what the business does and what the long-term growth plans are by the owners.
Structuring for growth, investment
Depending on what the business intends to do and whether it will be seeking outside investment, this variable can either be the least or most important. To those entrepreneurs looking to form a small business without any outside equity investment, aside from some bank loans, this discussion is often pretty short. However, if you are a scalable startup looking to raise multiple rounds of outside investment, this discussion is often lengthy and nuanced.
Each scenario is unique but factors that are significant in this discussion are 1) when does the company intend to raise money, 2) who are the first potential investors (individual friends and family, angels or venture capital funds) and how much are they intending to raise, and 3) where do they intend to raise money (i.e., locally, regionally or nationally)?
The discussion with a group of co-founders that intend to raise significant capital from venture capital funds or sophisticated angel investors within the next 6-12 months is different than a group that intends to raise a small amount of capital from local friends and family, and do not intend to raise capital from angel or venture capital investors for over a year.
These topics are just the tip of the iceberg when it comes to the topics that are often discussed with clients ahead of formally establishing a business. Having these discussions early is often extremely beneficial, and makes entrepreneurs more knowledgeable and confident that their legal affairs are in order so they can focus on growing their business.
Bill Daly is an attorney, vice president and co-chair of the Startup & Innovators Practice group at Shuttleworth & Ingersoll P.L.C.
