develop an Operating Agreement that specifies the powers, rights and authorities of the LLC and its Members. Advantages LLCs are advantageous because provide for the combination of limited liability and management ability. They allow for greater flexibility than corporations. The governance is simplified and the tax pass-through status is generally desirable for small and mediumsized companies. Entrepreneurs can retain control by acting as the manager or controlling member while retaining tax flow-through status. Disadvantages LLC are disadvantageous in that they do not provide some of the same tax advantages of a corporation and do not have as well-developed legal standards defined by the long case law. The venture capital firms may also generally want any LLC to convert to a corporation prior to a purchase or public sale. However, doing so merely involves a filing with the State and the development of By-Laws. PARTNERSHIPS Generally There are two types of partnerships: General Partnerships and Limited Partnerships. General Partnerships consist of two or more partners, and each one of those partners has unlimited personal liability for the obligations of the partnership. Each partner has complete and equal managerial control over partnership affairs unless there is a Partnership Agreement stating otherwise. As with LLCs, certain default rules apply in the State laws, but it is better advised for partnerships to be proactive and develop a Partnership Agreement to specifically address its business management and administrative issues. Partnerships resemble LLCs in the respect that tax treatment is a passthrough. In other words, there is no tax at the entity level, but only at the personal level. The partners then pay income tax on the money they received, or that was attributable to them, from the partnership as though that money was personal income. Limited Partnerships A special type of partnership is the limited partnership. Although it is based on the structure of the General
Partnership, the Limited Partnership has some very significant differences. Limited Partnerships do require at least one General Partner. Advantages Limited Partnerships have one very large advantage compared with the General Partnership: Limited Partners are generally not personally liable. A creature of state law, the Limited Liability Partnership and the Limited Liability Limited Partnership are often attractive to entrepreneurs because they can retain control of the business by acting as the General Partner, while still being able to offer limited partner investors the tax benefits of a tax flowthrough entity. They may elect to manage as an officer of a corporation that serves as the partnership’s General Partner. Disadvantages They are expensive and technical rules exist surrounding taxation, partnership formation, duties, and prohibitions against Limited Partners involvement in the business, etc. The personal liability of the General Partner is another disadvantage, which may be reduced by establishing a corporation as the General Partner. CORPORATIONS Generally Corporations have the most developed form of separate business purpose, apart from its owners. While the management may own part of the company, provided the Board of Directors establishes such an ownership plan, the management is traditionally separate from the owners. The corporate governance and process is the most elaborate of the entity forms referenced herein. The tax system allows greater latitude for tax deductions. Advantages A corporation is an autonomous legal entity, existing apart from its shareholders, officers and directors, whereas neither the LLC nor the partnership can truly be considered distinct from the persons creating it. For a start-up company, the most important characteristics of a corporation are the continuity of existence, lack of pass-through tax treatment, limited liability for investors, and the ease of adding investors and selling interests. The day-today management rests with the officers
appointed by the Board of Directors, who are ultimately responsible for the management of the corporation. The Board of Directors is elected by shareholder vote. The exact duties of the Board of Directors and the officers are usually specified in the By-Laws or in the Articles of Incorporation. Disadvantages The drawback of this form of organization is that it tends to be somewhat bureaucratic and process-intensive. For that reason, many small and startup organizations do not begin as a corporation, but convert to one later if their size and exit strategy makes such a change favorable. The separate tax status is a disadvantage for small businesses. With a corporation, there are no ‘pass-through” tax benefits. There is “double taxation” (tax on corporate profits and separate tax on shareholder dividends). Small corporations may avoid the double taxation in certain cases by paying its owners salaries rather than dividends, but the US tax authorities scrutinize such salary payments as possibly impermissible. Initial Investment Capital Now that we have considered the type of entities, we should consider its financing alternatives. Companies initially have a few options in funding their business. First, the owners can invest themselves. Second, they can obtain bank financing. Third, they can seek investors. In my experience, bank financing is the least desirable option for many companies. It is usually more costly and does not provide as much capital as the investment markets. Banks also often require collateral and personal guarantees, especially for start-up companies and smaller companies without sufficient assets or revenue to pledge to the bank. Also, banks may deny funding to companies that have a speculative chance of succeeding. On the contrary, private equity offerings are typically designed for such speculative purposes and, through adequate disclosures and other documentation, such money is raised by the selling efforts of broker/ dealers. Growth or Mezzanine Financing There are broker/dealers in the US that specialize in selling investments in private companies. Because these shares
13 5/2008 • ajan ajantasa tasa