HARTFORD | STAMFORD | WASHINGTON, DC | GREENWICH | LAKEVILLE Incorporation 101 January 30, 2015 James C. Schulwolf Matthew J. Monteith

When to Incorporate Does IP exist? How many founders? Are you selling a product or performing services? Are you engaging third parties (vendors) or hiring employees?

Why to Incorporate Limited liability!! Tax implications Formally divide ownership Attract investors “House” IP and confidential information Assign roles and responsibilities

Types of Entities Limited Liability Company C-Corporation S-Corporation

LLC Overview One or more persons, called members, may form a limited liability company—they are analogous to shareholders in corporations Members can manage the company’s affairs, or can delegate management powers to managers—they are analogous to officers or directors in corporations Very flexible as to management and decision- making Management Structure

LLC Overview Limited liability (significant advantage over partnerships/sole proprietorships) Single level of taxation – income and expenses are passed through the limited liability company to the members and taxed only at the member level (significant advantage over C-corporations) ► C-corporation is treated for federal tax purposes as separate entity subject to tax at maximum federal tax rate of 35% and state rate of 7.5%. Dividends and liquidating distributions are subject to second tax at shareholder level, currently at 15-20%. ► Connecticut corporate tax (7.5%) does not apply to LLCs. Instead, each member’s share of LLC income will be subject to Connecticut’s 6.7% personal income tax. Advantages

LLC Overview Investors may require corporate entity; may require conversion to a corporation No IPO Certain specialized businesses may not be eligible for LLC treatment (i.e. banks, insurance companies, utilities) Less developed body of law Disadvantages

C-Corporation Overview Stockholders Directors Officers Required formation documents ► Certificate of Incorporation ► Bylaws Other documents ► Stockholders agreement is very common Management Structure

C-Corporation Overview Limited liability Almost always accepted by investors Very well-developed body of law Good vehicle for an IPO Advantages

C-Corporation Overview More corporate formalities than LLCs Double taxation – income is taxed to the corporation (highest federal rate is 35%, highest CT rate is 7.5%) and then taxed to shareholders as dividend income when distributed (15-20%) May be unwieldy for small management/ownership groups Disadvantages

S-Corporation Overview Pass-through taxes, but limited to 100 shareholders, one class of stock and, in general, only individuals (rather than entities) can be shareholders. ► Limited markets for capital – since S-Corporations cannot have shareholders who are not U.S. individuals, institutional investors cannot be shareholders, therefore markets for capital are limited—generally to “angel” investors and mezzanine debt/options financing ► Little economic flexibility – S-Corporations cannot give preferred returns on capital and priority distributions to shareholders due to single class of stock rule.

Ownership Issues Founders’ Stock ► To vest or not to vest… ► Reverse vesting ► Milestones for vesting ► Voting or Non-voting What about future employees? ► Equity incentives

Governance Issues Shareholders Agreement or Buy-Sell Agreement ► What happens to your shares if you leave the company? ► Death or disability? ► ROFR (first, the company, then the other shareholders) ► At what price? ► Can you voluntarily transfer to a third party?

Board of Directors Directors are responsible for overseeing general management and control of the business and affairs of the company and promoting best interests of company and its shareholders (big picture issues) ► Officers control day to day operation (“little picture” issues) Elected by the shareholders How many members should serve on a board? Who are typical board members?

Boards, Boards, Boards Board of Directors vs Board of Advisors – what is the difference? ► “Must” have a Board of Directors (even if just one person) ► “May” have a Board of Advisors (if it makes sense for the company) Can I be a shareholder, and a board member, and an officer? ► Yes, but wearing multiple hats may cause conflicts Compensation issues

IP Issues Need to ensure that the corporation, and NOT the individual shareholders, owns all intellectual property related to the business Invention Assignment Agreement ► University context – make sure that university licenses the appropriate rights to the corporation, even if the actual IP remains property of the university Non-Disclosure Agreement Non-Compete Agreement???

Beware: An Investor Changes Everything! Institutional investors will almost certainly require significant changes to corporate structure and organizational documents Properly prepared documents, clear ownership structure, and evidence that the entity owns all key assets and information reflect well on the company and improve investment prospects Takeaway: Do not get bogged down in the minutiae early on. Things will change once the company raises money.

Questions? THANK YOU!