Legal Structure and FundingCE 2.3: Legal structure and funding

Daniela Axinte and Mary Keany2015/2016

Topics for discussion

• Types of legal structure

• Sources of funding

Types of legal structures

• Sole proprietorship• Limited Partnership• Limited Liability Company• C-Corp

Sole Proprietorship

• Sole Proprietorship - The owner and the business are the same. Business income is treated as personal income and the owner pays individual, self-employment tax on the business income.

• Pros -  Simple to run, inexpensive to start, business expenses can be deducted from taxes, there is no double taxation on profits.

• Cons - The owner is responsible personally liable for any business liabilities, the business has unlimited liability for the owner's personal liabilities, and it is limited to only one person.

• Best for - Small business without excessive liability exposure.

Partnership• Partnerships - The owners are two or more people who share the

assets, profits, and losses. A general partnership can be started by a an oral agreement. As in any legal situations, it is best to put everything in writing, especially things like how much money and time each partner is contributing, the profit sharing percentage, how decisions are made, how long the partnership will last, exit strategy. A limited partnership has one or more general partners, who are liable for the business, and one or more limited partners, who have limited liability. Partnerships have pass-through taxation.

• Pros - Very flexible, allows for ownership of more than one partner, avoids double taxation, has few legal formalities.

• Cons - Partners have unlimited personal liability for business losses, the business cannot be sold without the consent of all partners, and it dissolves when one of the general partners dies.

• Best for - Professional practices, such as accounting, legal, medical.

Corporations

• Corporations -  Most complex structure. As a separate entity, corporations have several distinguishing characteristics including limited liability, easy transferability of shares, and perpetual existence. Corporations also have centralized management who may be different persons from the actual owners. The corporation must pay taxes on its profits and the shareholders must pay taxes on the dividends paid to them from the corporation. The Subchapter S Corporation was created to provide small business with some of the benefits of regular corporations, such as having shareholders (up to 35), offering stock (only one class of stock), and being protected from personal liability and the benefits of sole proprietorship (the income and losses of the company are pass through to the individual shareholders, who file for individual taxes.

• Pros - Provides limited liability to the owners/shareholders, is easy to transfer ownership, it is easy to add new shareholders/investors.

• Cons - It requires a lot more legal work, thus becoming more expensive to run, it requires separate tax returns, and it is subject to the double taxation.

• Best for - Companies looking to raise capital from outside sources in exchange for stock in the company.

Funding options

• Personal investment

• Investment from friends and family

• Investments from investment bankers or venture capital (VC) firms

• Bank loans

• Going public through Initial Public Offering (IPO)

Personal investment

Pros•No investors, nobody to tell you how to run your business

• It’s easy and fast to start your business

Cons•You can run out of your own savings very quickly

•The company might not succeed and you loose all the money

Friends and family

Pros•Easier to convince people to back you up

•Potentially faster to get money

Cons•Remember the “Thanksgiving Rule”

Investment bankers and VC’s

Pros•Large amounts of money

•Accelerated growth

Cons•Larger chucks of the company (and control) you have to give up

Bank loans

Pros• Lower interest rates• They are loans, not investments

Cons• Hard to get• Require significant collateral

IPO

Pros• Raises capital fast

Cons• There is a lot of prep work and compliance documents to file

What type of funding is best for you?

• Short answer: it depends.

• Long answer: it’s complicated.

What others say

1)7 steps to funding your startup2)4 great tips to funding your startup

Flickr tellafotomedia

Video: Funding companies

Assignment: list the sources of funding for your business

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