Business Formation: 10 Strategic Questions
Typically, when a client consults a corporate attorney for help in forming a new company, he will have thought of a rough plan for the company, who the owners will be and generally what the company will do. A good business lawyer will help the client flesh out his ideas and present alternative solutions to potential problems. As a corporate law attorney, I always ask the new business owner the following 10 strategic questions.
1. Owners of the Company
Who are the owners of the company and why are these people owners? Do you need their business acumen, their technical expertise, special skill, funding? It may be possible to limit equity ownership and offer some highly skilled prospective owners an incentive plan, such as phantom stock instead of an equity ownership position. If the company will need funding, it may be possible to attract investors who are willing to loan the company money rather than take an ownership position.
2. Rights of the Owners
What are the relative decision making rights of the owners? Does each owner have equal voting rights or are some limited? Do the owners all have the same percentage interests or is someone a majority owner? Remember that in a 50-50 ownership company, if the owners disagree over a major decision, the business of the company can come to a screeching halt. In severe cases, a strong disagreement between owners with no method of resolving the conflict can literally cause the company to fail.
3. Profits and Losses
How are profits and losses to be allocated? Does each owner have equal distribution rights? Who decides when distributions will be made? Are distributions required to be made when an owner incurs a tax liability? In the event of losses, are owners required to make capital contributions? Are they allowed to make additional capital contributions or loans to the company?
4. Management of the Company
Who conducts the day-to-day management of the company? How much autonomy does management have? How is he paid? Is his salary set by the owners? Are owners who do not work for the company entitled to certain company benefits such as certain stock options or phantom stock entitlement?
5. Buy-Sell Agreement
Does the company plan to adopt a Buy-Sell Agreement to limit transfers of shares in the event an owner leaves the company or becomes unemployed, disabled, divorced or deceased?
6. Type of Business
Exactly what type of business does the company plan to conduct? Some types of business suggest certain types of entities for tax purposes or for ease of management. Has the plan been vocalized or written on paper? Is it backed up by appropriate contracts, including employment agreements and leases?
7. Formation of the Entity
When will the entity begin doing business? Has it already acquired assets? If at all possible, the owner should wait for the official formation of the entity before doing any sort of business without entity protection.
8. Tax Issues
Has the owner consulted with his CPA or tax advisor to be sure he understands the tax issues associated with the business and has mechanisms in place to report and pay all taxes on time?
9. Regulations and Special Permits
Is the business heavily regulated so as to require special permits? Are there governmental restricts on who can be an owner of the company? Are there restrictions on where the company can operate?
10. Exit Strategy
Do you have an exit strategy? Are other family members anticipating taking part in the business at some time? What is the plan to move ownership to them? Is the exit strategy to grow and sell the business to an outsider? Is the business created primarily to provide an income for the owners until retirement or is it primarily an investment vehicle which may be sold in the near future?
Practicing Business Law in Houston
In my years of practicing business law in the greater Houston area, I have seen many new business owners get so excited about their new ventures that they jump in to doing business without thinking through all the ramifications of their decisions. New business is exciting, but new business owners should temper their excitement with a thorough discussion of the details of organization, management and exit strategies with experienced corporate counsel to maximize the company’s chance of success.