Boulder Business Law Advisor

I just read Inc.com's Norm Brodsky's The Right Way To Approach A Start-up - a short but insightful article on a recent experience he had with one of his startups.  What I found to be the most interesting item in his story was that among his business partners, he retained "a veto over the location" of the business (Kobeyaki Restaurants in NYC). 

This brings up a great question: "How does one get a veto in a startup?" Well, like anything else you agree on with your partners, you negotiate.  But then what do you do? ... Write it down!  Yesterday, we wrote about some things all startups should not avoid doing early on.  Number one on the list was choice of business entity.  It is during this process that you will best be able to make and memorialize agreements as to how the business will be run.  In a Limited Liability Company (LLC), for example, it will come in the form of an Operating Agreement.  An operating agreement is the governing document of the company, which, while similar in many respects to a stock corporation’s by-laws, contains the agreement of the members as to how the LLC will conduct its day-to-day business.  It is in the operating agreement you could include a provision providing for a "veto" much like Mr. Brodsky had in his startup. 

Q: How does one get a veto in a startup?

A: Negotiate.

It is best to memorialize any (and all) such agreements early on in the startup to avoid (or at least minimize) disputes at critical points.  An agreement for a veto may not be necessary in your situation, but there may be something else you want - or are asked to give.  In Mr. Brodsky's situation, the location of the business was a critical decision to him - so much so that he used his veto a couple of times.  I would venture a guess that when Mr. Brosky exercised his veto power, his business partners were at least a little annoyed.  But having a solid agreement will help in such situations as reasonable minds can simply point to the agreement and move on. 

Certainly, agreements are always up for interpretations, so be as clear and forthright when drafting them.  Drafting an operating agreement should be done by a lawyer or even lawyers depending on its scope and the parties involved.   If you are asked to give something up, it is always a good idea to consult your own lawyer - i.e., one who represents you and your interests, not the business itself.

Laszlo & Associates' Boulder StartUp Lawyers provide legal counsel to businesses on a variety of business needs including startup and corporate formation, employment law, risk management, corporate protection and legal compliance.

While there are many forms your startup can take, in reality, there are only three forms a startup will consider: C Corp, S Corp, or LLC.  Deciding what corporate form a startup should take is one of the most critical early decisions a startup will make.  But, making an informed decision and laying the proper foundation will save many headaches down the road. 

The C Corp:  The C Corp is a separate legal entity and is a separate tax payer, i.e., it pays its own state and federal taxes and if it distributes dividends to shareholders, those dividends are taxed (and paid by the shareholders).  This is commonly referred to a “double taxation.”  But does it make sense for a startup to organize as a C Corp?  Maybe … maybe not.  The most important scenario for startups to organize as a C Corp is where it plans on raising venture capital – in this instance it has to be a C Corp.  Another reason to be a C Corp would be where the startup plans to retain money in the company.

The S Corp: If you are not sure whether your startup will need to be a C Corp down the road, but it remains a possibility, the S Corp offers very good flexibility and can be easily converted to a C Corp should the need arise.  Perhaps the most attractive feature of the S Corp is the pass through taxation and ease with which it can be converted back to a C Corp (I say “back” because you first organize as a C Corp, then elect S status by filing Form 2553 with the IRS).  There are key drawbacks to the S Corp however.  An S Corp must adhere to all C Corp formalities including recordkeeping, shareholder meetings, file annual reports, etc.  Also, S Corps cannot have more than 100 shareholders – which would essentially eliminate the possibility of crowdfunding – LLCs cannot be shareholders and all individual shareholders in an S Corp must be US citizens or permanently reside in the US.  Finally, the S Corp is far less flexible in terms of division of profits and classes of stock – for example, as an S Corp, your startup cannot have common and preferred classes of stock. 

The LLC: Which brings us to the darling of the small business world – the LLC.  If your startup does not plan to raise venture capital and seeks flexibility in ownership structure, the LLC is a very desirable corporate form.  Like the S Corp, the LLC provides for pass through taxation and will protect personal assets from liability (when corporate formalities are observed).  One of the most convenient aspects of the LLC is that owners of an LLC operate the business pursuant to an “Operating Agreement.”  Please do not mistake this to mean an Operating Agreement is a simple document – generally, they are not.  However, LLC Operating Agreements can be drafted to address very specific items unique to a given business’ needs.  Further, division of profits and losses are easily dealt with in the LLC – whereas in an S Corp, any division must strictly conform with one’s percentage ownership of the company.  It is important to note that not all states permit conversion of an LLC to a C Corp – thus, an LLC may not be the best option if you need to be a C Corp down the road.

The above is a very general overview of the three main types of corporate structures utilized by startups.  It is paramount that any startup fully understands its current position with an eye toward the future when deciding what form to take.

The Boulder Business Lawyers of LaszloLaw provide legal counsel to startups, for-profit and non-profit businesses on a variety of business needs including corporate formation, risk management, corporate protection and legal compliance.

There is a lot of discussion lately about a new and growing corporate charter, the "Benefit Corporation."  This was the topic of a recent well written article in the Wall Street Journal by Angus Loten “With New Law, Profits Take a Back Seat.”   Currently, seven states have passed laws providing for companies to designate as Benefit Corporations: Maryland, Vermont, New Jersey, Virginia, Hawaii, California and New York – with bills introduced in four other states – one of which is Colorado. 

Currently before the Colorado Legislature is SB 11-005, concerning Benefit Corporations.  The Bill would permit Colorado corporations to set forth a primary “purpose of promoting general public benefit” as opposed to maximizing their profit.  Designation as a “Benefit Corporation” does not create non-profit corporation, nor is it a tax-exempt status.  Simply, the Benefit Corporation is a new legal structure that facilitates the growing interest in “social entrepreneurship.”

Existing Colorado corporations seeking to become Benefit Corporations would, by minimum status vote, amend their existing articles of incorporation to include a statement that the corporation is a benefit corporation.  Not yet formed corporations would incorporate in accordance with the Colorado Business Corporation Act and also state in their articles of incorporation that they are a Benefit Corporation. 

Further, the Benefit Corporation would have the purpose of promoting “General Public Benefit”, which, under the Bill, “means a material, positive impact on society and the environment, taken as a whole, as measured by a third-party standard, from the business and operations of a benefit corporation.” 7-138-102(4) … and may identify a “Specific Public Benefit” that the corporation intends to promote, such as:  “Providing low-income or underserved individuals or communities with beneficial products or services; promoting economic opportunity for individuals or communities beyond the creation of jobs in the normal course of business; preserving the environment; improving human health; promoting the arts, sciences, or the advancement of knowledge; increasing the flow of capital to entities with a public benefit purpose; and conferring any other particular benefit on society or the environment.” 7-138-102(7)(a)-(g).

Additionally, the Colorado law would require heightened oversight in the form of an “Independent” designated benefit director who must prepare to be included in the required Annual Benefit Report an opinion regarding whether the corporation acted in accordance with its stated General and Specific public benefit purpose; complied with or failed to comply with the terms and provisions of the statute.

Benefit Corporation status is essentially an “add-on” to existing corporate forms that seek to act as a shield from investor allegations that the company is not maximizing shareholder value – thus, allowing the Corporation to put the benefit ahead of profits.  It is important to note that a Benefit Corporation is not a "B Corp" certification - that is a privately administered label and not a legal status.  (For more information on B Corp Certification, go HERE.)

“For an investor, this is a terrible idea … The structure creates a lack of accountability … if the management of a benefit corporation makes a bad decision, there’s very little you can do about it as a shareholder.”  - Charles Elson, a teacher of corporate governance at the University of Delaware, as quoted in the Loten article.

Because the Benefit Corporate form is not yet available in Colorado (earliest it could appear on the ballot would be November, 2012), we have not seen how it will be received by Colorado businesses nor do we know how it will stand up against investor challenges such as those suggested by Mr. Elson.  One can certainly foresee such situations where bad decisions are defended under the banner of the Benefit Corporation form.  Moreover, it is not out of the realm of possibility that corporations may seek Benefit Corporation status solely for protection from investors.  Until the form is tested, it may be a better option to add specific goals in existing corporate documents, by-laws and corporate codes – thus rendering the need for Benefit Status unnecessary.

Laszlo & Associates, a Boulder, Colorado based lawfirm provides legal counsel to for-profit and non-profit businesses on a variety of business needs including corporate formation, risk management, corporate protection and legal compliance.