Archive for the ‘Startups’ Category

Which Is Better for My Startup, C Corporation or LLC?

Monday, September 13th, 2010

Photo Courtesy NASA’s Marshall Space Flight Center

Startup clients frequently ask– which is the better business entity, a C corporation or a limited liability company (LLC)?

Before answering that question, let’s quickly review the basic differences between C corporations and LLCs. (For more detailed treatment, see here.)

In a corporation, control is held by the shareholders, but they frequently delegate most major decisions to the board of directors and day-to-day control to the officers. The corporate entity shields shareholders from the corporation’s liability and income. But if the corporation’s income is distributed to the shareholders, for example as dividends, the income is effectively taxed twice, once at the corporate level, once at the shareholder level. The corporate entity is especially advantageous for allowing changes in ownership– in the absence of special provisions such as shareholder agreements, existing shareholders can buy and sell stock without restriction to new shareholders.

Pros

  • More “professional” image
  • More attractive to venture capital funding and more flexible for granting options and other incentive compensation
  • Easier to take public

Cons

  • More formalities such as required shareholder and directors meetings, capital maintenance, etc.
  • Income to shareholders is taxed twice

The LLC is a relatively recent creation, within the last 25 years in most states. It is based on the partnership model, where partners share all control, income, and liability personally. Like partners, LLC “members” share control and income, but like corporate shareholders, members are shielded from liability for the acts of the LLC. LLC income is taxed only once, but all profits (and losses as well) are attributed to the members, even if the LLC retains it and does not distribute it to the members, as frequently occurs in the startup stage. (Note that an LLC can make an election with the IRS to be taxed like a corporation, while a corporation can make an election with the IRS to be taxed like a partnership, as a so-called S corporation.) However, as with a partnership, an LLC does not easily release old members or admit new members– the default rule is that normally at least a majority of existing members must approve any change in membership.

Pros

  • Inexpensive and easy to set up and maintain
  • Income to members only taxed once (but all of it is taxed, even if not distributed)

Cons

  • More difficult for old members to leave, and new members to join (may be a pro for some startups)
  • Disfavored by venture capitalists and incentive recipients
  • Must be converted to a C corporation to take public

Bottom Line: if VC funding and/or publicly listed stock is part of your business plan, then a C corporation is your best startup entity. In almost all other cases, an LLC is cheaper, easier, and lower maintenance, but be sure to address your exit strategy, both for individual members and the company as a whole, in your LLC documents at the startup stage. To help you make the correct choice, please consult a knowledgeable business attorney and/or accountant.

Startup Corner: Tips To Protect Your IP

Sunday, April 25th, 2010

Intellectual property and other intangible assets constitute 80% of the market capitalization of S&P 500 companies. Nowadays, it is as critical for companies to properly maintain their patents, copyrights, trademarks, and trade secrets as it is to maintain their plant and equipment.

Below is a quick checklist of eight items your company should follow to protect and preserve its IP.

1. Implement Intellectual Property Ownership Agreements

For most forms of intellectual property, the default rule is that whoever created it, owns it, so have all employees sign employment agreements and independent contractors sign service or consulting agreements that stipulate all intellectual property they create while working for your company is either a work made for hire, or if not, that the creator automatically assigns ownership of its IP to you as of the time of its creation. For similar reasons, on joint projects that could result in patentable inventions, have co-researchers sign agreements assigning ownership of all IP to your company, or if that is not possible, specifying the terms of co-ownership of any patents. Having these agreements in place will save you from a claim that someone else owns valuable IP that you paid for.

2. Put All Licenses and Assignments in Writing

You should not allow other parties to use your inventions, creative content, software, logos, confidential information, etc., nor should you use theirs, without a license agreement in place. If there is a dispute, then at best it would be hard to prove who was allowed to do what for how much money, and at worst, you may lose ownership of your IP in part or in whole. Furthermore, where ownership in patents, copyrights, or trademarks are transferred (an assignment), then often a signed writing is required to make it legally binding.

3. Preserve Confidentiality of Trade Secrets

Trade secrets are valuable commercial information or formulas that maintain their protected status only so long as their owner takes reasonable measures to preserve their confidentiality. Therefore, companies should implement policies that require employees to preserve confidentiality of confidential information, and follow good housekeeping procedures, including: placing “confidential” or “proprietary” stamps on documents; requiring employees to sign nondisclosure agreements; requiring password protection for all computer-stored trade secrets; restricting physical access to areas containing trade secret information and implementing sign-out log procedures; and conducting exit interviews with departing employees. And before release of any valuable confidential information to an outside party, require the recipient to sign a nondisclosure agreement that requires the recipient: 1) to take at least reasonable steps to maintain confidentiality of the information; and 2) to only utilize it for the purposes allowed in the agreement.

4. Register Important Copyrights

Original, creative works such as text, images, music, websites, and software come under copyright as soon as they are fixed in a tangible medium, but in order to get meaningful enforcement capability against infringement, registration with the US Copyright Office is advisable.

5. Register Important Trademarks

Words, logos, or jingles that identify your company’s goods and services often qualify as trademarks. Some degree of protection exists even without registration, under the doctrine of common law trademark. But as with copyrights, in order to receive the maximum degree of protection, registration with the US Patent and Trademark Office is advisable. Furthermore, purchase all domain names that your company is likely to use in the future, including common variations.

6. Challenge Infringing Uses of Your IP

Perform periodic Google and eBay searches to make sure that others are not misappropriating or abusing your company’s copyrights or trademarks. If evidence of infringement is found, consult with your attorney about the advisability of a cease and desist letter or even a lawsuit. Especially in the case of trademarks, ignorance is not bliss — it can lead to forfeit of your IP.

7. Use Copyright and Trademark Notices

Use standard copyright notices, such as “© 2010 Your Company, Inc. All Rights Reserved,” for text, graphics, music, software, websites, and other original creative content, and standard trademark notices, such as “® Your Company, Inc.” or “®” (for registered trademarks) or “™ Your Company, Inc.” or “™” (for common law trademarks) next to words or logos that identify your goods or services. Better yet, have your attorney work with your marketing people to draft comprehensive guidelines for proper use of copyright and trademark notices for all products, product packaging, and company communications. This shows the outside world that you are knowledgeable and vigilant about your intellectual property rights, and also eliminates an “innocent infringement” defense in enforcement litigation. Or as Ali G says when pitching his idea for an ice cream glove to a venture capitalist, “That’s a ©, which means you can’t nick it.”

8. Post Effective Rules for Your Website

Website Terms of Service and Privacy Policies are important means of limiting your company’s legal risk and earning your customers’ trust. Although technically not IP protection devices, they are critical legal safeguards, especially for companies that engage in e-commerce.