Transition from Sole proprietorship to C-Corp
Transition from Sole proprietorship to C-Corp
Business and Money > Finance
28 Oct 2006 00:16 PDT
31 Oct 2006 00:53 PST
I have started the business since 2001 under as a sole proprietorship
(the ?Old COMPANY?), have developed the product and acquired a small
set of clients (>20). My current total monthly revenue is about $8000.
The business is still losing money as the revenue is not enough to
cover the expense. The business has a $20K loan from my family member.
Along the way, I have recruited a few key individuals who contributed
significantly to the business either with very low pay or no pay. I
have certain verbal agreements but do not have formal signed agreement
with these core team members to share the future business success with
Expansion Need and Objectives
My business has reached a point that I need to have a structure
allowing me to achieve the following objectives:
1) Incur no unnecessary tax liability for myself and the other core
team member and allow future stock gain to be taxed as long-term
capital gain instead of ordinary income.
2) Get personal liability protection as the business is growing.
3) Establish a company structure that I can offer shares to the core
team members, hire employees, and issue stock option to motivate
4) Create a structure to allow future investment to expand the business.
We are thinking to take the following actions:
1) Form a new C corporation (the ?New COMPANY?) that allows us to
issue founder shares to the core team. The New COMPANY will hire all
members and conduct business from this point on. The New COMPANY will
sign a business agreement with the Old COMPANY to allow it continue
the business development based on what Old COMPANY has developed.
2) The New COMPANY will issue a total of 10 million of common shares
immediately to the 5 founders at a price of $0.0001 per share.
Founder will pay for these shares at the $0.0001 price. 3 are US
citizens and 2 are non-US citizens.
3) Sign a Founder Share Purchase Agreement by each founder with buy
back clause, if founder can not continue to provide service to New
COMPANY in the event of resignation, involuntary termination and
death/disablement with a predefine percentage and price.
4) File 83(b) election so future stock gain will be taxed at capital gain.
5) Create a stock option plan with initial allocation of 2 million
shares. The plan has a straight-line 4-year vesting period.
6) Sign a business agreement between the Old COMPANY and New COMPANY
with the following terms:
a. Exclusive distributor - the New COMPANY will be the exclusive
distributor for the product developed under Old COMPANY. Under this
term, New COMPANY will be the only party to recruit new clients and
provide services to clients. The Old COMPANY shall transfer all its
clients to sign a new service agreement directly with New COMPANY.
b. Future product development ? New COMPANY will continue the product
development from this point on.
c. Compensation ? New COMPANY has to pay Old COMPANY $3000 (three
thousand) monthly fee.
d. Option to acquire the Intellectual Property(IP) ? The New COMPANY
has an option to pay Old COMPANY of $200,000 (two hundred thousand) to
acquire the IP from Old COMPANY within five years.
1) Is this a viable approach? If not, why not?
2) Are there other good alternative to achieve the stated objectives?
3) Any obvious holes in this approach that might not stand up against
future IRS scrutiny?
4) Have you seen this done before?
5) Does the Old COMPANY (my sole proprietorship) still have legal
liability exposure under such arrangement?
6) Does the option to acquire the IP in the future constitutes an
arm-length transaction? The objective of this option is to defer the
transaction between old and new Company to a future date so there is
no tax implication at this time.
7) What is the significant of the current stated value? Assuming the
New Company exercises the option to buy the IP, I as the sole
proprietorship will have to pay ordinary income from the proceed.
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