©2009 Cooley Godward Kronish LLP. All rights reserved. STARTUP 2009 LEGAL SERIES Topic #2 Forming an Entity

©2009 Cooley Godward Kronish LLP. All rights reserved. 2 Forming an Entity Reasons for forming an entity Corporation Partnership LLC Selecting a form of entity Relevant sample documents

©2009 Cooley Godward Kronish LLP. All rights reserved. 3 Reasons for forming an entity Limited liability—an entity can shield an entrepreneur’s personal assets from liabilities of the business Tax benefits Attracting investors Hiring and providing incentives to employees

©2009 Cooley Godward Kronish LLP. All rights reserved. 4 Corporation Corporation is a distinct legal entity that has: Stockholders—owners of the business Board of Directors—makes important corporate decisions Officers—conducts day to day management Taxed as a separate entity, unless it elects “S corp” status Profits and losses of an S corporation are passed through to the stockholders—meaning there is no “double tax.” However, S corps are subject to limitations that make it difficult to raise venture capital. Stockholders generally enjoy limited liability—creditors cannot pursue stockholders for the debts of the corporation. Companies often organize in Delaware because of advanced corporate law and sophisticated business courts.

©2009 Cooley Godward Kronish LLP. All rights reserved. 5 Partnership Types General Partnership—general partners have unlimited liability. Limited Partnership—limited partners have limited liability; general partners have unlimited liability Limited Liability Partnership—often used for professional service firms (law firms, doctors etc.) Administration Partnership agreement is recommended to address allocation of profits and losses, dissolution, dispute resolution etc. Tax Treatment The entity is not taxed—it is a “flow through” entity. Flexibility in allocating profits and losses among partners. Raising Capital Flow through tax status makes it very difficult to attract capital from venture capital funds.

©2009 Cooley Godward Kronish LLP. All rights reserved. 6 Limited Liability Company Attributes LLCs have become popular because they have benefits of limited liability and flow through tax treatment. Have “members” instead of stockholders. Operating Agreement Operating Agreement is agreement among members that addresses the relative financial rights and obligations and governance matters. Terms of Operating Agreements vary widely—members have great freedom in establishing rights. Raising Capital Flow through tax status makes it difficult to attract capital from venture capital funds. Relatively easy to convert LLC to corporation immediately prior to a financing.

©2009 Cooley Godward Kronish LLP. All rights reserved. 7 Selecting a form of entity Deciding on the proper entity depends on who will own it and how the investors’ capital will be returned Owners Venture backed companies are almost always C corporations because (i) venture capital funds generally cannot invest in flow through vehicles (i.e., S corps, partnerships or LLCs), (ii) it is easier to structure equity incentives in a C corp, (iii) the shares may be widely held or the entity may go public and (iv) corporations have more established corporate governance standards. Return on capital If the business will be paying dividends, a flow through entity may be preferable because there is no double tax. If the business will be incurring losses, a flow through entity may be preferable because the investors can deduct start-up costs against taxable income.

©2009 Cooley Godward Kronish LLP. All rights reserved. 8 Relevant Sample Documents for Delaware Corporation Sample Action of Sole Incorporator Sample Certificate of Incorporation Sample Bylaws Sample Initial Board Resolutions