Right Type of Business Formation

Wave -- Business Entity Type Discussion

Read the scenario set out below and discuss the questions that follow it:

Art Fleming is a design engineer with a proven track record in the field of electronic musical instruments. He recently designed a new VLSI (very large scale integrated) chip. This chip is meant to be the heart and soul of a digital sampling keyboard to be called WAVE. Fleming believes the WAVE will set a new industry standard. He wishes to organize a business enterprise to build and market it. He has a meeting with his lawyer and conveys to her the following bits of information:

It will take approximately 2 years to turn the VLSI chip into a marketable product

Given that is true he will have to live on something….whether it be the savings or something else. There obviously wouldn't be any WAVE revenue coming in. He's have to live on income from other ventures or his savings. Also, this would preclude him from doing S-Corp since even owners are paid W-2 wages. This would probably point to a C-Corp/LLC…but we shall continue.

b. Fleming has more than $200,000 in savings from previous ventures. He does not want any of that money to be at risk in this new venture. However, he wants part ownership. He is unsure what percentage he wants.

This also points to a corporation of some sort. Doing a partnership would be a possibility (with limited and full-on partners) but the money of the partners would basically be completely at risk in terms of liability and such. As noted before, an S-Corporation would not be possible (since he can't pay himself from the WAVE due to lack of revenue) so this would all also point to a C-Corp/LLC.

c. Currently, 5 investors are willing to put money into the venture. Only 2 of the 5 want to play an active role in the enterprise. Fleming is willing to give these 2 some limited control.

Another vote for C-Corp/LLC. The non-active people could buy stock and then "cash in" when they feel they've gotten their investment back. The two that want active control could be in management positions that can be decided between them but they would have to be paid if that is done.

d. Fleming knows that he is not qualified to manage the new endeavor. Nevertheless, he wants a significant say in how it proceeds.

He could be the non-paid owner of a C-Corp/LLC…that is really the only way he could do it and not run afoul of the law or expose himself to liability.

e. Five more investors could be attracted to this project, but only if they could be guaranteed some fixed return on their money or could realize immediate tax benefits from investing.

This sort of defeats the purpose of it being an "investment"…which would mean it is not guaranteed to provide any sort of return. Perhaps the biggest tax break the investors could get is the fact that gains on stock (capital gains) are much less than it would be for conventional income. Dividends are also a possibility but the per share amount would be fairly nominal.

http://www.kiplinger.com/article/taxes/T054-C005-S003-10-tax-breaks-geared-to-investors.html

f. Fleming would like Scott Ladd, a manager much in demand in the electronics field, to be his CEO. It would take significant incentives to attract Ladd to the enterprise.

Fleming will need to be attracted on the front end or the back end. It would seem the front end is not doable given the options above (no revenue, not wanting to dip into savings)….but perhaps income from other ventures could fund an incentive package. Again, still looking at a corporation of some sorth.

Fleming is not committed to using any particular type of business organization; he is interested in weighing the alternatives.

What form of organization should Fleming choose for his new venture? Why? What are the advantages and disadvantages of the form you have chosen? Be sure to support your views with the facts and the law of Business Organization.