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Eric A Koester

Eric Koester’s Answers

7 total

  • Two friends are working on starting up a business. What is/are the best legal forms for the business?

    This will be a manufacturing/distribution business involved with consumer chemicals. A leased space with no other employees other than the two partners. Should we go Partnership, LLC, Inc or what? Once we have the best direction to go how do we...

    Eric’s Answer

    This is a tough question to answer without more information -- so my first piece of advice is to talk to your lawyer and your accountant to get a better sense of what would make the most sense from a structural, accounting, and tax perspective. There isn't a one-sized-fits-all approach to the structure -- so it is worthwhile to take the time to give more details about your ultimate goals, how you plan to capitalize the business, and the likely financial performance of the business. Spend the time to have that conversation -- it is worth it to save you a headache down the road.

    That said, I recently wrote a short article on some "Rules of Thumb" related to entity selection: http://www.myhightechstartup.com/2009/01/13/rules-of-thumb-matching-the-right-business-entity-to-your-business/#more-126 Take a look at see if this provides you further insights (I'd encourage you to read the whole post -- this is just a summary below):

    RULE ONE
    If your business is a one-man or one-woman company and you are making a profit that is in line with what your salary would be if you were not working for yourself, consider forming a single member LLC.

    RULE TWO
    If your business is a one-man or one-woman company and you are making big profits (in excess of a typical salary you’d earn working for someone else), consider forming an S-corporation.

    RULE THREE
    If you are unsure if you’ll ever pursue venture capital financing and, if you were to pursue it, believe you’ll wait a couple of years, consider forming either an S-corporation or an LLC.

    RULE FOUR
    If your business growth strategy involves raising money from investors in the upcoming 6-24 months, consider forming a C-corporation (but remember, you can form a C-Corporation and make an S-Corporation election with the IRS until you are ready to raise funding).

    RULE FOUR (PART II)
    The second part of this Rule is the S-Corporation. Let’s assume you fall under Rule Four, and plan to raise funds in the next 6-24 months, but you’ve got nothing certain at this point. So what should you do?

    Herein is why the S-Corporation can be ideal compared to forming an LLC. If you are planning to raise funds, you can form a C-Corporation (let’s say in Delaware, which is probably the most common place for high-tech companies to form). To make that C-Corporation into an S-Corporation and have pass-through taxation, you simply need to file an S election with the IRS and follow the rules related to S-Corporations. That’s it. And then, when you are ready to take funding and issue preferred stock, you simply with forgo the S Election with the IRS, and you’ll automatically convert back into the C-Corporation. (You will need to handle some tax issues related to the change, but you’d have to do that if you were an LLC.) So for ease of operations, S-Corporation can be ideal.

    RULE FIVE

    If you are planning to create a high growth company in need of substantial outside funding, consider incorporating in Delaware.

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  • If I copywrite a business plan, will it offer the same as protection as a patent on the new product idea covered in the plan?

    So I write a business plan on a product concept to seek funding. A patent search on that new invention is very expensive. I want to perform the search later, but not at the onset of the business plan. Will copywriting the business plan be as ef...

    Eric’s Answer

    Unfortunately, a copyright won't protect your business idea -- it just protects the words themselves (such as prohibiting someone from copying a chapter of a book and claiming it is their own). And, you can't even patent the 'new product idea' in your business plan anyways. A patent requires you to "reduce the invention to practice," which means you can't get protection for just an idea. You have to actually make/build/create/design your product to get patent protection. For many people at a 'business plan' stage of their business, patents are cost-prohibitive anyways.

    So, the better question is, how can your do your best to keep your business plan confidential and proprietary?

    The first thing to remember -- consider limiting any disclosure of proprietary information in a business plan, especially in an executive summary business plan you are sharing with potential investors initially. No need to disclose the 'secret sauce' if you don't have to. If these investors like the general picture and want to dig under the hood further, then you can consider sharing more proprietary information.

    One of the common practices to protect confidential/proprietary information being discussed is getting people who you plan to discuss or show your business plan to sign a nondisclosure agreement (NDA). Many professional investors will not sign NDAs to view a business plan since they tend to see so many similar business plans. So getting potential investors or others to sign an NDA may not always be an option, but you should still take steps to provide some protection on your business plan itself.

    What about putting words like 'confidential' or 'proprietary' on the cover? Use of the language “confidential and proprietary” may not provide the same level of protection as a non-disclosure agreement, but some courts have held that in a scenario where a person or persons were aware that they had been exposed to a trade secret, they would be barred from using it or disclosing it to others without permission. Is it lock-tight protection -- no, but it is something. Take steps where possible to protect your proprietary information, and remember that when you cannot get an NDA signed to trust your gut — make sure to ask around before disclosing to a potential investor if you are wary of their reputation.

    One tip -- On the cover page of your business plan, state (in bold text) that the business plan is confidential and proprietary. This doesn't automatically provide you any formal protections (other than potentially some trade secrets if they are disclosed), but it can make people think twice about disclosing key information from you business plan.

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  • Not For Profit Organization

    We would like to start an animal rescue group, not-for-profit, in the state of California.We will be taking dogs from the shelters, getting them medical attention, rehabilitating them and then placing them in good homes. I have tried to navigate t...

    Eric’s Answer

    Hello Morgan,

    The process can be fairly difficult, but there are a number of useful resources online that can help you out. Below is a summary of the steps involved for forming a nonprofit in California, taken from the Citizens Media Law Project (link attached below). Walk through the steps below, including the additional details in the full post. Once you've gotten the California corporate entity formed, then you can work on getting 501(c)(3) status (link attached below).

    Usually the 501(c)(3) status will take several months to prepare and to hear back from the IRS. So if you plan to raise funds in the meantime, you may consider approaching another 501(c)(3) (perhaps another animal-related organization) who can possibly act as a fiscal sponsor.

    Good luck! It can be a long and tedious process. But when you are preparing your 501(c)(3) application (or receive correspondence from the IRS after filing), be sure to call the IRS and walk through things on the telephone. It can be much simpler that trying to guess or figure it out on your own.

    Best of luck.
    - Eric Koester

    1. Choose a business name and check for availability
    2. Recruit and/or appoint directors
    3. Incorporate your Nonprofit Organization
    a. Prepare and file articles of incorporation with the Secretary of State
    b. Create the bylaws
    c. Prepare and file a Statement of Information with the Secretary of State
    d. Hold an organizational meeting
    e. Create a Records Book
    4. Get your Employer Identification Number
    a. Federal
    b. State
    5. Register with the Office of the Attorney General
    6. Apply for tax exemptions
    a. Federal
    b. State
    c. Local

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  • Converting LLC to C Corp prior to raising money.

    The business is currently a simple WA LLC with 3 Co-Founders each owning 33% of the company. We have a termsheet for a VC investment that will require us to convert the LLC into a C Corp (the termsheet says Delaware, but the other investment part...

    Eric’s Answer

    First, congrats on getting a term sheet from a VC. Times are tight out there, so just getting one in the door is a good accomplishment. Second, these basic terms you've mentioned are very common in a VC investment -- converting into a C-corp and putting 3-4 year vesting on the four founders. Nothing unusual from my experience. I've published a couple legal guides on Avvo that have some common term sheet terms we've seen on recent deals -- that could be a helpful guide as you negotiate the term sheet.

    To your questions -- again, there are lots of things in this question, but here are a couple basic thoughts:

    (1) The conversion process can be done in a couple of ways, the most common are either (a) a merger of your WA LLC into a DE or WA c-corporation, (b) a type of share exchange where you would give your member interests in the LLC in exchange for your common stock of the new C-corporation. The most common approach would probably be a merger in this case. Unfortunately, Washington doesn't have a conversion mechanism (like Delaware does), so the merger approach is the most common process (which is too bad, since the process is simpler/cheaper). The process of doing the merger into a C-corporation is fairly straightforward -- probably no more than a couple weeks all in. But the issue will come down to timing the tax issues. So be sure to talk with your tax advisors who should be able to help ensure your tax liability is minimized or zero.

    (2) With respect to the tax consequences, I'll defer to a tax expert on that topic, but generally, a merger/conversion from an LLC to a c-corp is a taxable transaction. That said, depending on your balance sheet (the amount of liabilities compared to assets), there are oftentimes ways to structure it as a tax-free transaction. For this, talk to a tax attorney (I can recommend a good one if you need) and the money spent talking to a tax person is well worth it and your VC may actually require it. The key is the amount of debt on your books, so if you have a great deal of outstanding debt you may have some taxes to pay. Even so, depending on the balance sheet of corporation and the tax basis of each of you have, the taxes you each owe could be minimal. But in order to make any determination, see your balance sheet would be key -- particularly understanding your assets and liabilities.

    (3) As far as the time/cost required to do the conversion, I'll start with the answer every lawyer loves to use: it depends. It can be a complicated transaction, but if you've done them before, you know what problems to avoid. Ultimately, it will largely depend on how much of the tax work is done by your attorneys and how much you can have your accountants and tax advisors handle. In deals I've worked on that are lower costs, the accountants will handle the tax piece of the transaction (providing comfort and assurances on the tax compliance of the conversion). So I would talk to an attorney that has done a conversion, pre-VC funding. Then, connect your attorney and your tax/accounting people together. Usually, your accountant will be cheaper, so as much of the tax side of things you can put in the hands of your tax advisor, the better. Pitch the work to a couple attorneys and ask for an estimate. They should be able to help once they see the balance sheet.

    And finally, I have had at least one client do a Series A investment (from angels rather than a VC) where the investors receive Series A Preferred Units and didn't do a conversion first. So consider that as an option if the VC will consider it. Probably fairly unlikely, but at least a point of discussion if you uncover big tax issues.

    If I can give you any further insights into the other conversions I've worked on or a referral of a good tax attorney that has worked on some WA LLC merger/conversions, happy to do so. Good luck.

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  • Loan payback

    What is the best way for me to protect my $25,000 investment in my friends invention? How do I make sure I get the money plus some profit back?

    Eric’s Answer

    Investing in a startup is risky business -- even if you are making a loan versus taking equity in the company. Therefore, you should always consider your money at risk if you make an investment into a startup company. There is really no way to "guarantee" anything when it comes to a business that has a relatively low likelihood of becoming a big success.

    However, I think there are really two important things here to protect your investment.

    (1) Get to the front of the line. This means you need to structure your investment in such a way as you receive an interest in the assets of the startup or in the personal assets of your friend.

    (2) Be active in the company. If you can take a role in the company as a board member, executive or adviser, you may be able to help ensure that your friend makes decisions in the best interest of you as an investor, as well as in the company.

    In the end, remember that you should be an accredited investor to purchase any security that is privately issued (such as a promissory note in a startup company). Check with a lawyer to be sure that your investment complies with Federal and Washington securities laws. Good luck.

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  • Capital losses

    When itimizing gains and losses from stocks and mutual funds what is the limit on losses?

    Eric’s Answer

    If you have capital losses, you can offset your capital gains by those losses. The limits on deducting your capital losses come in when your losses exceed your gains. If you capital losses exceed your capital gains, you are able to deduct up to $3000 (or $1,500 if married filing separately). If your net capital loss is more than this limit, you can carry the loss forward to later years.

    I recommend using a software like TurboTax for your personal filings (if you are planning to prepare your taxes yourself). The software is under $100 for most filers, and can be free if you use certain forms (for itemizing deductions, you will need to pay for the software). However, these software programs usually will help with items like deduction caps and spots deductions you may have missed.

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  • Merger / Aqusisition

    Hello Avvo community, I'm currently the ceo of 3 year old company that has grown significantly over the last 3 years--oh yeah, also the 100% shareholder. We are now considering a merger with another small, privatley held company owned by 1 m...

    Eric’s Answer

    A merger usually brings with it some challenges. So if you decide to jump in, remember that there will be some challenges, likely some personality conflicts and maybe some attrition. But a well-done merger can also take your business to places you could never have gotten alone.

    I usually encourage a client to consider a merger or acquisition in two steps. The first step is deciding whether it makes business sense to merge. Once you've made that determination, the next step is to decide the big deal points and go-forward business terms. In most cases, the first step is usually best left without the lawyers -- or perhaps with some high level consultation. The second step is good to involve both your lawyer and your accountant to help discuss questions -- but don't get bogged on details too early. Consensus on big items; leave details for later.

    So, the first point of analysis -- Should you do it?

    The first question is do you really need to merge to accomplish your goal here? In some cases, perhaps you aren't looking for a merger, but you are looking for a partnership of some sort. Maybe it makes sense to enter into some type of agreement -- a partnership agreement, distribution agreement, or even to form a separate joint venture and keep your existing businesses. In each of these alternative structures, you retain your current business and gain something from the partner, from a preferred pricing scheme, steady supply, talent, etc. The downside is you lose control and the synergies that come from a combined business are lost. The key question to ask yourself -- can I reach my ultimate goal without combining the company? If your answer is no, then you should really consider trying to make the merger work.

    If you've decided that a merger or acquisition makes sense and you can't accomplish the goal without combining the company, then you should decide if this party is the right merger partner. In your case, with a small business and limited people, the real key is making it a good cultural fit. Do you believe you will work well together? Perhaps you can try it out first by working on a discrete project with the businesses. Perhaps you can co-consult on a customer. See if you work well together because you are forming a partnership and no matter how much the structure might work, without a personal fit, it ain't worth the extra headaches.

    Second point of analysis -- How to do it?

    This question is very fact-specific. But what I can tell you is that if you are very committed to doing the merger after point one -- your lawyers and accountants usually can help you create a structure that will work and address some of the key challenges -- including integration issues, taxes, asset contributions, employment issues, intellectual property, decision-making, etc.

    To accomplish this stage, I think the best approach is asking each of the parties to draft a set of deal points independent of one another. Then, come together and discuss those deal points to see where you stand. Again, these shouldn't be nitty gritty points like the structure of the transaction, but should more consider broader goals, operational styles, employment strategies, decision-making authority, etc. Hammering out those points will help you to find out what is truly important and how the business can be run.

    And finally, prepare a basic term sheet laying out those points. Who is contributing what, who will be responsible for what decisions, what will the business look like after it is combined, etc.? Ultimately, your lawyers and accountants can help with some of the details like deal structure, tax consequences, intellectual property, etc.

    For a CEO, your job is deciding whether you really need to merge and then getting consensus on the big issues of how to do it. Once the parties are all behind the deal, documenting the deal and handling deal points is where a good lawyer and accountant can earn their keep.

    Good luck!

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