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Startup Companies

Introduction

The lawyers in McCarthy Fingar's Corporate & General Business group have much experience in advising clients on the best ways of organizing a new company. Before any business gets to the start-up phase, the founders of the company have to answer quite a few questions:

When is the right time to form the company?

What is the best choice of entity?

Where should the entity be organized?

How should the company be capitalized?

When and Why to Form the Company

Although a business entity should not be formed until certain preliminary decisions are made, such as determining what the form of entity should be and determining how the equity is to be allocated among the founders, there are good reasons to form the company as early as possible.

Holding Periods: The earlier the company is formed, the sooner the stock can be issued and the capital gains holding period begins to run. Gains on the sale of stock that has been held for one year or more generally results in taxation at the long-term capital gains rate, currently a maximum Federal rate of 15%. Gains on the sale of stock that has been held for less than one year are taxable at an individual's ordinary income tax rate, which can be significantly higher than the long-term capital gains tax rate.

Ability to Contract: The founders may want to establish certain relationships with third parties that require contracts. As an example, the founders may want to enter into a lease. In order for the company to be the tenant, as opposed to the individual founders, a lease contract needs to be signed with the company as the tenant. This obviously cannot be done until the company is formed. Hiring employees, renting equipment, borrowing money, etc. all require that agreements be entered into. Although the individual founders could, and often do, enter into these types of agreements with third parties before the formation of the company, this arrangement is not ideal, and raises issues regarding enforceability and personal liability for the founders.

Limited Liability: Perhaps the most fundamental benefit of incorporating is the protection obtained through the corporate shield. Individual stockholders are generally not liable for the liabilities of the company in which they hold stock. Until a company is formed, the individuals are acting in their personal capacity, and may be personally liable. To enjoy the benefit of the corporate shield, certain corporate formalities must be adhered to, including the maintenance of separate corporate records and accounts, the holding of annual meetings of the stockholders and directors, and the execution of documents in the name of the company.

Choice of Entity

One of the initial decisions founders must make is the form of entity to use for their new company. There are three basic entities to be considered: C Corporation; Limited Liabiliity Company; and S Corporation.

C Corporation: Traditional C corporations are not nearly as common as they were at one time. In general, it is advisable to operate as a C corporation only in those situations where there are going to be outside investors or where the company is to be owned by foreign corporations or individuals. There are good tax reasons to avoid organzing and maintaining a C corporation for most new companies. A C corporation is taxed on its taxable income; and then, if it pays a dividend to its shareholders, the shareholders may be taxed again. Also, if the C corporation sells its assets as part of a liquidity event, the corporation will be taxed on its gain, and then the shareholders may be taxed when the corporation liquidates. For these and other reasons, a C corporation is generally not the preferred method of operation.

Limited Liability Company: If the founders or investors want to be able to deduct early losses from the business on their personal tax returns, they might be tempted to organize the business as an S corporation or limited liability company ("LLC").

S Corporation: S corporation have very strict limitations on who can be stockholders (for example, non-resident aliens, corporations, and partnerships cannot be stockholders in S corporations). However, S corporations offer advantanges that and LLC can not usually provide. For example, LLCs can be cumbersome when it comes to awarding equity participations to employees and consultants.

Where to Organize the Entity

There are two states of incorporation that startups based in New York usually consider: New York and Delaware. If the corporation will be doing business in New York, the entity is generally formed in New York, because it would have to qualify to do business in New York even if it was formed in Delaware. If, however, there will be outside investors, Delaware may be the better choice. There are two primary reasons for this. First, many outside investors are familiar with Delaware corporate law, and thus may be more comfortable with investing in a company organized in that state. Second, it is relatively easy to take stockholder actions in Delaware. For example, Delaware law generally authorizes action by consent with a simple majority of the stockholders' signatures. However, in New York, consents can only be accomplished with the signatures of all of the stockholders. As a result, it is often much easier to obtain stockholder approval of a proposed transaction if the company is based in Delaware.

Capitalization of the Company

Funding a startup company requires important legal and business decisions. At the inception, the shares of each owner of an entity usually depends upon the contributions of capital made by each owner. Every company, new ones and operating ones, must deal with capitaliziation issues, and the owners need legal advice before making decisions on such issues.

The McCarthy Fingar Approach in Advising as to Startup Companies

Whether a client desires to purchase real estate for investment reasons or to form an entity for a different type of new business, the lawyers in McCarthy Fingar's Corporate & General Business group will advise the client as to the best options to consider in making and implementing business and legal decisions. Our attorneys begin the process by collecting all necessary information and documents from the client. Then, we evaluate and present options to the client. After the client has made decisions, our lawyers proceed with our legal work to implement the client's decision.

Contact Us

McCarthy Fingar's Corporate & General Business lawyers are dedicated to our clients' success. If you think you may require our assistance or have any questions regarding options for starting a new company, please contact Howell Bramson by email (hbramson@mccarthyfingar.com) or by phone (914-385-1017) or Robert J. Kiggins by email (rkiggins@mccarthyfingar.com) or by phone (914-385-1024).