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Co-Founder Divorce: Why It’s a Good Idea to Create a Prenup for Your Young Company

Founder disputes are one of the most common risks to a young company, but it doesn’t have to be that way. Whether it is a disagreement over a core issue or the waning interest some experience along the startup road, most companies face turnover in their early days, with key players rotating in and out.

While we know, considering the examples of Facebook and Snapchat, that companies can still go on to greatness despite an early founder breakup, that doesn’t detract from the problems that arise when founders leave while holding onto an equity stake.

Under these circumstances, ex-founders can create problems in one of two ways – either they can insist on maintaining influence in a company when they are no longer wanted or they can surface years down the road and claim a right to a company’s success that they had no part in creating. Either scenario is obviously problematic. But there are a few things companies can do to protect against the type of consequences that can arise due to a founder split:

  1. Don’t Rely On A Handshake: Step one may seem obvious, but it is surprising how often founders ignore the paperwork and barrel down the road in their haste to create the next big thing. The cost of engaging a lawyer to prepare an Operating Agreement for your LLC (or Shareholder Agreement for your corporation) is easily justified considering that you will have a mechanism in place to address issues like key voting decisions, how new members are admitted, or how distributions are divided. Even the task of sitting down with your team members and talking through some of these issues can be critically revealing and bring conflicts to the surface that are better to get out of the way sooner than later.
  2. Company Buy-Back: Especially for early-stage companies, consider a provision in your governing document that allows the company to buy out a member/shareholder upon majority or super-majority vote. This way, if one of the early members is not working out, there is an agreed upon mechanism to facilitate the breakup, with important issues such as the purchase price owed to the exiting member established by a pre-existing formula.
  3. Vesting And Reverse Vesting: Another protection for co-founders is to agree to a vesting schedule pursuant to which founder equity will be granted over time or upon the completion of certain milestones. For example, a founder is granted 16,000 units but she only receives them on quarterly intervals over 4 years, meaning she gets 1,000 shares a quarter. In that way, founders will not fully “own” their equity stake until they stay involved with the company over a certain period of time. A similar concept is known as “reverse vesting,” where a founder is granted his or her total equity allotment upfront, but the company is entitled to repurchase shares if the founder leaves.

If you are interested in more detail related to your situation it is best to speak with an attorney.

Megan K. Johnson is a business lawyer with over 7 years of experience. She helped champion securities crowdfunding at the local level and worked with the first company to successfully close an equity crowdfunding involving everyday investors. She is a partner at Founders Legal and can be reached at [email protected]

megan

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Intellectual Property 102 – Identifying, Securing, Capitalizing, and Early Stage Enforcement

Legal mistakes can doom even the best startup concepts and founding teams. It is important to know who owns the IP, the proper timing for registration, and how to enforce your legal rights. This presentation gives you a legal road map to successfully safeguard your product or idea.

If you are interested in more detail related to your situation it is best to speak with an attorney.

Yuri Eliezer heads the intellectual property practice group at Founders Legal. As an entrepreneur who saw the importance of early-stage patent protection, Yuri founded SmartUp®. Clients he has served include Microsoft, Cisco, Cox, AT&T, General Electric, the Georgia Institute of Technology, and Coca-Cola.

yuri

 

How Is a C-Corporation Different from an S-Corporation?

Both C-Corporations and S-Corporations are, at their core, corporations that are formed at the state level. The formation process, structure, and governance are usually identical for both.  The two big differences are:

  1. The way each entity is taxed at the Federal level;
  2. The restrictions that are placed on the types of equity S-Corporations can issue and the types of shareholders they can have.

Tax law is what sets the differences between C-Corporations and S-Corporations. In fact, the name of each comes from Subchapter ‘C’ and Subchapter ‘S’, respectively, of Chapter 1 of the U.S. Tax Code (26 USC 1).

When a corporation is formed with the state, the C-Corporation is the default. The Corporation can then file an election form with the IRS (Form 2553) to become an S-Corporation. Once accepted, your corporation becomes an S-Corporation.

Click here for more information on the tax benefits of an S-Corporation (over a C-Corporation).

Click here to find out more about restrictions that the IRS places on S-Corporation.

If you are interested in more detail related to your situation it is best to speak with an attorney.

Andrei Tsygankov is the Co-Founder and COO of SmartUp® and a partner at Founders Legal (Bekiares Eliezer LLP). As an attorney, Andrei specializes in corporate, commercial, trademark, and international business matters.

andrei

How an S-Corporation Can Provide Tax Savings

As discussed in an earlier article, an S-Corporation can provide significant Federal income tax savings over a C-Corporation. The question that I am often asked is “if the benefits are so obvious, why aren’t all corporations S-Corps?”

Due to the benefits, the IRS places restrictions on S-Corporation ownership, including the types of shares that the corporation can issue and the types of shareholders who can own them. All restrictions must be met and in place at all times, and they are as follows:

1. The corporation must be a domestic corporation (formed in the United States).

2. The corporation may have only ONE class of stock (although voting and non-voting common stock may be acceptable).

3. The corporation may not have any more than 100 shareholders (certain family trusts can be considered ‘one’ shareholder).

4. Shareholders of the corporation may ONLY be individuals, certain trusts, and estates.

5. Partnerships, non-resident aliens, and other corporations may NOT be shareholders of the corporation (one S-Corp may, however, be a wholly-owned subsidiary of another, if a Q-Sub election is made).

6. The corporation CANNOT be an ineligible corporation (certain types of businesses, including financial institutions, insurance companies and IC-DISCS are excluded from seeking S-Corp status).

The restrictions result in many companies becoming ineligible for S-Corporation status for failing to (or simply not wanting to) adhere to one or more of these rules. If you are considering forming a corporation and are looking into filing the ‘S’ election, discussing the ramifications with knowledgeable legal and accounting professionals can save you significant time, money and heartache down the road.

If you are interested in more detail related to your situation it is best to speak with an attorney.

Andrei Tsygankov is the Co-Founder and COO of SmartUp® and a partner at Founders Legal (Bekiares Eliezer LLP). As an attorney, Andrei specializes in corporate, commercial, trademark, and international business matters.

andrei

How to Avoid Double Taxation | S-Corporation Advantages

Tax law sets the difference between the C-Corporation and an S-Corporation. When a corporation is formed at the state level, the C-Corporation is the default. The C-Corporation can then, voluntarily, file an election form with the IRS (Form 2553) to become an S-Corporation. Once accepted, your corporation becomes an S-Corporation.

Why go through the trouble of making the ‘S’ election? In short, so the corporation would pay no Federal income tax on its profits. Instead, the S-Corporation’s profits are allocated to the shareholders (the ‘owners’) on a pro-rata basis (e.g. if you own 50% of an S-Corporation, 50% of the profits are allocated to you personally).

Each S-Corporation shareholder then includes the appropriate share of the corporation’s profit on his or her personal tax return, and pays income taxes personally on that income. Why is this beneficial? This avoids ‘double taxation’ experienced by C-Corporation shareholders.

For example, a C-Corporation with two equal shareholders has a net profit of $100. At today’s Federal corporate income tax rates, the C-Corporation would pay a maximum rate of 35% on its profit, or $35. If the C-Corporation pays the remaining $65 as dividends to its two shareholders ($32.50 to each), they would each pay a maximum income tax rate on dividends of 20% (today’s top qualified dividend rate for dividends). As a result, each shareholder would pay $6.50 in personal Federal income tax on the dividend received. Altogether, the C-Corporation and the two shareholders paid a grand total of $48 in Federal income tax on the $100 in profit.

If the corporation in the example above was an S-Corporation, it would pay absolutely no Federal income tax. Instead, the entire $100 net profit is allocated to the two equal shareholders ($50 to each). Then, each shareholder would pay a maximum personal income tax of 39.6% (today’s top rate for ordinary income) on the $50 allocated to him or her. As a result, each shareholder would pay $19.80 in personal Federal income tax on the amount allocated. Altogether, the S-Corporation and the two shareholders paid a grand total of $39.6 in Federal income tax on the $100 in profit.

As illustrated by the (very simplistic) examples above, there can be significant tax savings for shareholders of an S-Corporation. Keep in mind, however, that S-Corporation net profits are allocated to its shareholders automatically – even if the shareholders do not receive any distributions (cash) to cover the tax.

If you are interested in more detail related to your situation it is best to speak with an attorney.

Andrei Tsygankov is the Co-Founder and COO of SmartUp® and a partner at Founders Legal (Bekiares Eliezer LLP). As an attorney, Andrei specializes in corporate, commercial, trademark, and international business matters.

andrei

Capital Raising for Small Businesses and Free Lancers: Legal and Practical Aspects

When starting your own business, it is important to keep in mind what makes your company investable, where is your financial support is coming from, and the legal and tax implications in raising capital. You can either go the DIY route or hire a professional who can assist you in cutting through the red tape.

You also need to know the difference between seed funding, traditional and alternative lenders, angel investors, and venture capital to ensure you get the most out of your capital campaign. This presentation provides a great overview of all of this as well as how to design a winning campaign for your new business.

Capital Raising For Small Businesses And Free Lancers

 

If you are interested in more detail related to your situation it is best to speak with an attorney.

Jeffrey Bekiares is a securities lawyer with over 8+ years of experience, and is co-founder at both Founders Legal and SparkMarket. He can be reached at [email protected]

jeff

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LLC or Corporation: What Is Best for Your Startup?

The most significant difference between an LLC and a Corporation is in a) structure and b) governance.

Generally speaking, the way a Corporation is structured and run is well-defined, with little room for variance. An LLC is structured and run by contract between the LLC and its owners (the Members), which makes it very fluid and adaptable.

A Corporation is very rigid – the way in which it is set up and run is defined by law and practice, so there is little room to change things. The benefit of a rigid structure is predictability – everyone involved (investors, lenders, advisors, employees etc.) knows exactly how a Corporation works. This rigid Corporate structure is also highly scalable.

An LLC, however, is a much newer type of entity, and it is designed to be very flexible. The state laws and rules that define LLCs are typically very broad – and purposefully so to allow for variation.

The LLC can be structured, governed and taxed exactly like a Corporation, but can be set up for the Members (owners) to run the LLC directly, without a board. The roles can be defined by contract (Operating Agreement) between the LLC and its Members.

The obvious benefit is that an LLC can be tailored to meet the exact needs of a specific business. There is however, a drawback: Since the baseline laws are broad, the governing documents must be very well done to avoid nasty surprises.

The most important document in an LLC’s toolbox is the Operating Agreement – which is the contract that defines how the company is run.

If you are interested in more detail related to your situation it is best to speak with an attorney.

Andrei Tsygankov is the Co-Founder and COO of SmartUp® and a partner at Founders Legal (Bekiares Eliezer LLP). As an attorney, Andrei specializes in corporate, commercial, trademark, and international business matters.

andrei

How a Corporation Is Set Up

The Corporation is rigid in how it is structured and run.  This is due to laws, rules, and general practices that have existed and worked well for years.

The great thing about a corporate structure is that it scales very well.  From the smallest of companies to the largest enterprises – there is a common truth to how Corporations are set up and run.

A Corporation is typically very rigid in the way that it is structured: 

  1. Shareholders own the corporation (but do nothing else);
  2. Shareholders elect Directors to a Board of Directors;
  3. Board of Directors is responsible for the Corporation and what it does (the Directors owe a fiduciary duty to the Shareholders to run the Corporation well)
  4. The Board then hires Officers (CEO, COO, CTO, etc.) and delegates its authority to them.
  5. Officers run the Corporation on a day-to-day basis and report to the Board;
  6. Officers then hire employees as subordinates, to help run things when needed.

A Corporation’s governance is equally as rigid:

  1. Employees make department-level decisions and propose larger changes to the Officers;
  2. Officers make day-to-day company-level decisions and propose larger, long-term ideas to the Board;
  3. Board of Directors make the big decisions about the Corporation’s business, but propose structural changes to the Shareholders (voting rights, new stock issuances mergers & acquisitions etc.);
  4. Shareholders only vote on matters presented to them by the Board.

If you are interested in more detail related to your situation it is best to speak with an attorney.

Andrei Tsygankov is the Co-Founder and COO of SmartUp® and a partner at Founders Legal (Bekiares Eliezer LLP). As an attorney, Andrei specializes in corporate, commercial, trademark, and international business matters.

andrei

Entity Formation Step by Step Guide – New Georgia Business

How Do I Form My Entity in Georgia?

The following are general, step-by-step instructions on properly forming your Company (Business Entity) in Georgia.

If you have any questions through out the guide please feel free to contact SmartUp.
Consult with an Attorney for Free

REQUIRED ITEMS:

1.) Company NameDecide on the Entity’s Name

  • Consider the following factors:
    • Is the name available in Georgia?
    • Is a suitable internet domain name available?
    • Have others registered Federal or state trademarks with that name?
    • Is anyone else using the name somewhere?

2.) File Online. Register your Entity through the Georgia Secretary of State.

  • http://sos.ga.gov/
    1. Select ‘Corporations’
    2. Select ‘File Online’
  • Register and login to the cGov360 Business Filings system
  • From the cGov360 Filing System Home Screen, select the Entity type, complete the application, and submit payment
  • Make sure that your application appears in the ‘Approved Services’ section of the Filing System.

3.) Receive Confirmation. The Georgia Secretary of State will confirm that your Entity has been formed.

  • 1-2 weeks for processing is typical, unless an expedited option is selected in the application

4.) Publicize the Entity Formation. Contact the County Newspaper (Legal Organ) and ask for a publication.

  • After you receive confirmation from the Georgia Secretary of State that the Entity is formed, contact the publisher of the Legal Organ in the county where the Entity is based.
  • A listing of Legal Organs in each Georgia County can be found here:
  • Ask the publisher for a Notice of Formation (of the Corporation or LLC).
    • Notice needs to be published for two (2) consecutive weeks
    • Notice costs no more than $40.00
    • Publisher should send you confirmation of publication

5.) Obtain an EIN. Request an Employer Identification Number (EIN) from the IRS (also referred to as a Tax ID)  

6.) Obtain GA DOR Tax ID Number. Register the Entity with the Georgia Department of Revenue (GA DOR)

  • Register with the GA DOR after you received the EIN from the IRS.
  • Registration can be accomplished online a http://dor.georgia.gov/tax-registration
  • The most common registrations are:
    • Withholding Tax
      • This should be done BEFORE the Entity hires a W-2 Employee, including owners, if applicable
    • Sales & Use Tax
      •  See the GA DOR webpage to see if your business is subject to the registration

7.) Obtain GA DOL Number. Register the Entity with the Georgia Department of Labor (GA DOL)

  • This should be done BEFORE the Entity hires a W-2 Employee, including owners, if applicable
  • Only a paper application is currently available, and it must be mailed to the GA DOL:

8.) Obtain a Business License. Issued by the County or City.

  • The filing location and procedures depend on the city where the Entity is located

9.) Sign Governing Documents. Obtain, sign and store the documents that govern the Entity.

  • Entity Specific Documents
    • If Corporation:
      • Shareholder Agreement
      • By-Laws
      • Shareholder Resolutions
      • Board Member Resolutions
    • If LLC:
      • Operating Agreement
      • Member Resolutions
      • Manager Resolutions (if applicable)
  • Intellectual Property Assignment Agreement for Founders
    • Transfers IP from individuals to the Entity, and is very important if the Entity’s business has any material that can be Patented or that is a Trade Secret
  • Vesting Agreements for Founders
    • A Restricted Stock Grant Agreement forces a Corporation’s Shareholder to ‘earn’ his or her stock over time of service to the Entity.
      • A Restricted Unit Grant Agreement does the same for an LLC
    • Section 83(b) Election
      • Used to avoid negative tax consequences of vesting
      • Should be filed individually by the Corporate Shareholders or LLC Members
  • If the Entity’s business will be conducted primarily via the Internet:
    • Terms & Conditions
      • For general interaction between the business and its customers
    • Privacy Policy
      • If any data or information is collected by the business
    • End User License Agreement (EULA)
      • If the business offers software that is used by its users
  • Obtain Company Employment Documents
    • Employment Agreements for future Employees
    • Contractor Agreements for future Independent Contractors

OPTIONAL, BUT RECOMMENDED:

1.) Open Bank Accounts. Use the Entity’s full, legal name and EIN.

  • Fund the accounts after opening

2.) Set up Internal Accounting System

  • Bookkeeping software, such as QuickBooks is highly recommended.
  • HIGHLY recommended that it be set up by professional accountant

3.) Secure Intellectual Property

  • Consult a licensed Intellectual Property Attorney about:
  •  Trademarks
    • To protect the Entity’s brand and reputation
  • Patents
    • To secure the Entity’s innovations, ideas

Business Formation 101 from SmartUp Legal

 

If you are interested in more detail related to your situation it is best to speak with an attorney.

Andrei Tsygankov is the Co-Founder and COO of SmartUp® and a partner at Founders Legal (Bekiares Eliezer LLP). As an attorney, Andrei specializes in corporate, commercial, trademark, and international business matters.

andrei

How to Choose a Good Business Name

One of the early defining moments in the life of a startup is choosing a name. It’s generally the first thing the public knows about you – your first business “pitch” when you really think about it. And it serves as the centerpiece of your brand, so it’s important that you select something that you’re proud to put out into the world.

You brainstorm, wait for inspiration, ask for feedback – the process can drag on and on. For a year, my best friend and I devoted the majority of our phone conversations to the all-important topic of what to name the various business ideas we were working to hatch. Finally, after settling on names that suited both of us, the real work began. Could we get the domain?

In today’s era of the Internet and mobile services, the reach of your company is only limited by your customers’ ability to find you. So it makes sense that most startup founders stake the company name on the availability of the domain. But with the ever growing scarcity of good “.com” options, what do you do when a top level domain is not available for your enterprise?

Many startups fall prey to these common pitfalls when forced to think outside the “.com” box.

So how can you choose a good business name?

1. Drop Vowels: Famous internet brands, like Flickr and Twitter (known as Twittr when it first launched), have popularized the trend of dropping the vowels in their company name, which makes it easier to score a .com domain. In fact, Flickr founder, Catarina Fake credits domain acquisition challenges as the driving motivations behind the name: “We tried to buy the domain from the prior owner… He wasn’t interested in selling…. We liked the name “Flicker” so much we dropped the E. It wasn’t very popular on the team, I had to do a lot of persuasion.” While some might argue that a deliberate misspelling makes for an edgier – more distinctive – identity, other founders have faced challenges with this approach. According to Ustav Agarwal, founder and CEO of the gamified music sharing app “nwplying.” “Nowplaying described the product in its simplest form, but it was too common a hashtag for us to possibly differentiate ourselves and create a brand around it – hence the term nwplyng, i.e. ‘nowplaying’ sans vowels,” he says. “Plus, the domain name nwplyng.com was easily available.” But would he recommend this approach to other entrepreneurs? No. “Users misspell it way too often,” he shares, “even the ones using it regularly – and that means you lose out on network effect and app downloads.”

2. Add a Verb: When DropBox wasn’t initially able to acquire DropBox.com, it settled for GetDropBox.com. Same for Atlanta-based startup Gather, which you can find at gatherhere.com. While this is may be a better alternative than abandoning a name you really love just because the .com version is unavailable, there are some practical downsides, explained in detail in this article. In short, be prepared for customer confusion – from lost emails sent to the official owner of the top level domain to less effective marketing campaigns, diluted by the traffic diverted to the domain reflecting your company’s name. Not to mention inevitable questions from investors, anxious to see your company legitimized by securing the straightforward “.com,” sans verb. For customers and potential investors, the “add a verb” approach can often amount to a red flag that begs a larger question – when will your company be legitimate enough to buy the original domain?

3. Choose a Country Code Domain. Enterprising companies like Bit.ly and About.me played the .com scarcity to their advantage, embracing country code domain alternatives to the point that they incorporated the whimsical suffix into their name. This trend is here to stay, with the creation of more and more generic top level domains to choose from (such as “bike,” “food,” and many other common nouns), but keep in mind the reality that customers still have to find you. And a trendy new domain – while it may work for your company name – can cause consumer confusion. As explained here by Eric Bieller, founder of Sqwiggle, “Letsfeast.com used to be found at lesfea.st, which is clever, but extremely difficult to explain to someone audibly.”

With a matter as critical to your company as its name, make sure to consult with a domain attorney before you settle for anything less than the top-level domain of your dreams. A solid understanding of the legal leverage you have – before you try to negotiate with a cybersquatter – can literally translate into a cost savings in the hundreds of thousands. At least that’s what it meant for a recent client.

This is especially true for companies that have expended considerable resources developing brand goodwill. Your hard work should be leveraged to make the acquisition of a top-level domain much easier and more affordable, so you don’t have to settle for the compromises listed above.

 

If you are interested in more detail related to your situation it is best to speak with an attorney.

Megan K. Johnson is a business lawyer with over 7 years of experience. She helped champion securities crowdfunding at the local level and worked with the first company to successfully close an equity crowdfunding involving everyday investors. She is a partner at Founders Legal and can be reached at [email protected]

megan