StarTec’s Lindsay agrees: “I’m not clear or comfortable with preferential membership units. The whole setup is a lot cleaner if it’s preferred stock.”
Yet, an LLC is attractive to buyers, Rummel says. “Buyers tend to like to purchase LLC units, because they can take advantage of a step-up basis [the fair-market value rather than the initial price paid] in the entity’s assets. That allows them to amortize those assets over time and take associated tax deductions,” she says. “You don’t get the stepped-up basis when you buy the stock of a C corporation.”
Companies that can’t decide between a C corporation and an LLC should try the LLC first, Rummel says. “It’s often advantageous to start with an LLC and then convert to an C corporation,” she says. “But if you establish a C corporation, it can be costly from a tax perspective to convert to an LLC.”
“At the end of the day, all of these structures have the ability for the parties to reach an economic agreement that makes sense,” Gorman says. Choose the structure that works for all of your company’s goals—including your fundraising and exit strategies.
Careful How You Spend That Equity
Most new businesses have more equity than cash, and it can be tempting to swap equity for the professional services your startup firm needs. Careful how you trade, says Michael Schley, a partner at Bloomington-based law firm Larkin Hoffman Daly & Lindgren, Ltd.
“When you barter that equity, it will have a cost to you later on, and you need to weigh that cost,” Schley says. All the stock that leaves your hands dilutes your equity stake, and that may be a problem for future investors. “The venture capitalists will still get their 40 percent, and they want management very involved in the company, with enough stake that it’s harder for them to walk away or pay less attention,” he cautions.
On the other hand, trading shares or options is sometimes a fledgling firm’s only choice. In that case, Schley suggests trading shares only for services you need immediately, and making sure that you get top-notch value. “There are some consultants that are worth their weight in gold, and I would give them shares all day long. Others are helpful, but maybe not as valuable,” Schley says.
Some consultants are exempt from a requirement that you register the securities you give them. Others—particularly those involved with fundraising—are not. Check with your lawyer before you make a deal. |
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