1. Law 514 Corporations Instructor: Dwight Drake
The Start-Up Money Questions
1. How much do we need?
2. What deal can we offer?
3. What money sources are available to us?
4. How do we stay legal?
- Compliance legal
- Mitigate personal liability exposure
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

2. Law 514 Corporations Instructor: Dwight Drake
How Does the Investment Pay
Future Public offering: Big pay day; liquidity. Not a viable hope for most.
Strategic Sale: Establish envied position – then cash in on sale.
Natural Liquidation: Return generated through asset liquidation. Example: real estate development; movie venture.
Inside Buy-Out: Once established, inside management will secure debt financing to take out seed-money investors at profit.
Inside Triggered Buy-Out: Event triggers buy-out under shareholder buy-sell agreement - right of first refusal, showdown clause, death, etc.
Cash Flow Vehicle: Business perpetually throws off cash to shareholders.
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

3. Law 514 Corporations Instructor: Dwight Drake
Common Funding Sources
Closest people - Family and real friends
Acquaintances - Those you know
Private Investors - Angels
Strategic Corporate Partners
Funds – Venture and Vulture
The SMA – No free lunch
Banks and financial institutions – Lousy up front; gold once established, up and running.
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

4. Law 514 Corporations Instructor: Dwight Drake
Some Truisms
The fewer the better.
The smarter the better.
The wealthier the better.
Money loss reactions – prepare for the worse; assume the worse.
Your risk avoidance can be very expensive.
Never count the other guys money.
Never forget the “deal moment”.
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

5. Dividend / Interest Comparison
Investment: $ 1 million
Yield Payment: $ 60,000 (6%)
Corporation’s Income Tax Rate: 34%
Investor’s Marginal Income Tax rate: 33%
Stock Stock Debt
Bush Rate No Bush Rate
Amount Paid Investor , , ,000
Tax Saving to Corporation ,400
Tax Cost to Investor , , ,000
Net Tax Cost – Revenue
to Uncle Sam , , (400)
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

6. Law 514 Corporations Instructor: Dwight Drake
Common Stock
Bottom Line Ownership
Max Upside Potential – Appreciation / Dividends
Ultimate Control
Directors/Officers Primary Focus
Last-in-Line on Liquidation
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

7. Preferred Stock Features
Cumulative / Non-Cumulative
Participating / Non-Participating
Convertible / Non-Convertible
Voting / Non-Voting
Redeemable / Non – Redeemable
Liquidation Preference?
Fixed Terms / Blank Check
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

8. Law 514 Corporations Instructor: Dwight Drake
Basic Bond Terms
Basis Point
Smallest measure used in quoting yields on bonds and notes. One basis point is 0.01% of yield. For example, a bond’s yield that changed from 6.52% to 7.19% would be said to have moved 67 basis points.
Bid
Price at which a buyer is willing to purchase a security.
Bond
(1) The written evidence of debt, bearing a stated rate or stated rates of interest, or stating a formula for determining that rate, and maturing on a date certain, on which date and upon presentation a fixed sum of money plus interest (usually represented by interest coupons attached to the bond) is payable to the holder or owner; (2) For purposes of computations tied in to “per bond,” a $1,000 increment of an issue (no matter what the actual denominations are); (3) Bonds are long-term securities with a maturity of greater than one year.
Bond year
An element in calculating average life of an issue and in calculating net interest cost and net interest rate on an issue. A bond year is the number of 12-month intervals between the dated date of the bond and its maturity date, measured in $1,000 increments. For example, the “bond years” allocable to a $5,000 bond dated April 1, 1980, and maturing June 1, 1981, is [1.166 (14 months divided by 12 months) x 5 (number of $1,000 increments in $5,000 bond)]. Usual computations include “bond years” per maturity or per an interest rate, and total “bond years” for the issue.
Call
Actions taken to pay the principal amount prior to the stated maturity date, in accordance with the provisions for “call” stated in the proceedings and the securities. Another term for call provisions is redemption provisions.
Callable
Subject to payment of the principal amount (and accrued interest) prior to the stated maturity date, with or without payment of a call premium. Bonds can be callable under a number of different circumstances, including at the option of the issuer, or on a mandatory or extraordinary basis.
Call premium
A dollar amount, usually stated as a percentage of the principal amount called, paid as a “penalty” or a “premium” for the exercise of a call provision.
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

9. Law 514 Corporations Instructor: Dwight Drake
Basic Bond Terms
Call price
The specified price at which a bond will be redeemed or called prior to maturity, typically either at a premium (above par value) or at par.
Convertible
Convertible bonds may be converted into shares of another security under stated terms, often into the issuing company's common stock.
Coupon
The rate of interest payable annually. Where the coupon is blank, it can indicate that the bond can be a “ zero-coupon,” a new issue, or that it is a variable-rate bond.
Covenant
The issuer’s pledge, in the financing documents, to do or to avoid from doing certain practices and actions.
Current Yield
The ratio of interest to the actual market price of the bond, stated as a percentage. For example, a bond with a current market price of $1,000 that pays $60 per year in interest would have a current yield of 6%.
Junk bond
A debt obligation with a rating of Ba or BB or lower, generally paying interest above the return on more highly rated bonds, sometimes known as high-yield bonds.
Premium or Discount price
When the dollar price of a bond is above its face value, it is said to be selling at a premium. When the dollar price is below face value, it is said to be selling at a discount.
Yield to maturity
A yield on a security calculated by assuming that interest payments will be made until the final maturity date, at which point the principal will be repaid by the issuer. Yield to maturity is essentially the discount rate at which the present value of future payments (investment income and return of principal) equals the price of the security.
Zero-Coupon Bond
A bond for which no periodic interest payments are made. The investor receives one payment at maturity equal to the principal invested plus interest earned compounded semiannually at the original interest rate to maturity.
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

10. Law 514 Corporations Instructor: Dwight Drake
Corp Bond Ratings
Moody’s S&P Fitch
Prime, Max Safe Aaa AAA AAA
High Grade Quality Aa1 to Aa AA+ to AA AA+ to AA-
Upper Medium Grade A1 to A A+ to A A+ to A-
Lower Medium Grade Baa1 to Baa3 BBB+ to BBB- BBB+ to BBB-
Non Investment Grade Ba BB BB+
Speculative Ba2, Ba BB, BB BB, BB-
Highly Speculative B1 to B B+ to B B+ to B-
Substantial Risk Caa CCC CCC
In Poor Standing Caa2, Caa CCC, CCC-
Extremely Speculative Ca
May Be in Default C
Default D D
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

11. Law 514 Corporations Instructor: Dwight Drake
Sample Bond 10/17/07
Rating Coupon Due Yield Price
Ford B % /20/ %
GE AAA % /11/ %
B of A AA % /15/ %
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

12. Law 514 Corporations Instructor: Dwight Drake
Permissible Stock Consideration
RCW 23B :
“Shares may be issued for consideration consisting of any tangible or intangible property or benefit to the corporation, including cash, promissory notes, services performed, contracts for services to be performed, or other securities of the corporation.”
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

13. Law 514 Corporations Instructor: Dwight Drake
Shareholder Distribution Limitations
RCW 23B : (Applicable to Dividends and Redemptions)
Not permitted if:
Corp would not be able to pay liabilities as they become due in ordinary course (“Equity insolvency test”), or
Corp total assets less than total liabilities plus preferential liquidation rights (“Balance Sheet Test”).
- May value assets per GAAP, fair market value, or “other method reasonable in the circumstances”.
- Articles of Incorporation may exclude preferential rights component of Balance Sheet Test.
Limited Liability Company counterpart provision: RCW
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

14. Law 514 Corporations Instructor: Dwight Drake
Impact of Unlawful Distribution
Directors personally liable to corporation for unlawful distribution. RCW 23B
Shareholder who knew distribution was violation of RCW 23B personally liable to corporation for amount of distribution received. RCW23B
Corporation may not limit liability of director for any unlawful distribution under 23B RCW 23B
Corporation may not indemnify director for unlawful distributions. RCW 23B (b).
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

15. Incentive Stock Options
What it is? Executive given right to buy designated number of shares at designated price over designated time frame.
Advantages:
No income to executive at time of option grant
No income to executive at time of exercise (but tax preference item to extent of excess FMV over cost)
Capital gain at time of sale if not sold within two years of grant or one year of exercise
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

16. Incentive Stock Option Requirements
Plan adopted by shareholders within 12 months of board’s adoption.
Option granted within 10 years of plan adoption.
Option period may not exceed 10 years.
Option price not less than FMV of stock at time of grant.
Option not transferable by executive, except on death.
Executive can not own more than 10% of company.
FMV of all stock first subject to ISOs in same calendar year (determined as of grant date) can’t exceed 100k.
Executive can’t sell within 2 yrs of grant or one year of exercise to get capital gains benefits.
Executive must be employee from time of grant until three months before exercise.
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

17. Nonqualified Stock Options
What are they? Executive given right to buy designated number of shares at designated price over designated time frame.
Tax Impacts:
No income to executive at time of option grant if option not tradable and no readily ascertainable FMV of option.
Yes income to executive at time of exercise – Excess of FMV of stock over option price paid.
Long-term capital gain at time of sale for recognized appreciation post exercise if holding period satisfied.
Yes company gets tax deduction at exercise equal to executive’s tax hit.
A 409A trap if any Value Now factor – to avoid trap, must specify time to exercise (no flexibility)
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

18. Law 514 Corporations Instructor: Dwight Drake
Bonus Stock
What it is: Company just bonuses stock to executive.
Tax Impacts:
Section 83 income to executive based on FMV of stock.
Section 162 deduction to company.
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

19. Law 514 Corporations Instructor: Dwight Drake
Restricted Stock
What it is: Bonus stock with big twist – forfeiture restrictions for executive.
Tax Impacts:
Section 83 income to executive based on FMV of stock when forfeiture restriction lapses.
Section 162 deduction to company.
83(b) election to executive – take lower tax hit at grant to get bigger capital gain break down road. No offsetting benefit if end up forfeiting stock.
No 409A concerns, even with income deferral resulting from forfeiture risks.
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com

20. Two None Real Thing Strategies
Stock Appreciation Rights: Pretend stock where executive is given upside benefit in future growth as deferred compensation.
Phantom Stock or Stock Equivalency: Pretend stock with present “Value Now” and future appreciation for executive, all wrapped in deferred compensation contract. Must comply with 409A. May include gross-up bonus that provides the executive with economic equivalent capital gains benefit.
Law 514 Corporations Instructor: Dwight Drake
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com