Question

QUESTION 1 [Total = 15 marks]

James and Adrian are starting up their own small business, which involves the development and delivery of an online identity verification service, to which other businesses can sign up for a fee.

James has been working on developing the computer program and delivering the service with the support of friends for some time, with some success; having signed up a few businesses based in Brisbane and becoming a well-known figure in the local industry dealing with identity theft after invitations to speak on the topic at several workshops and conferences, trading under the name of IDSolutions. He has a registered business name and an ABN, but has not incorporated.

Adrian has experience in business and marketing and has proposed that they both invest $30,000 each into leasing some commercial space and engaging professional software developers to work with James, with a view to improving the computer program so as to expand its capacity to cope with a larger load as the business grows. Both James and Adrian are planning to give up other employment and work full time in the business. Apart from the computer equipment and premises leased, the assets of the business will likely consist of licence agreements with a number of businesses who have signed up for the service, James’ already- established program and the goodwill he has already built up (as well as any IP (intellectual property) they choose to register, such as trade marks).

Advise James and Adrian regarding the options they have in terms of the legal form their business can take, and any considerations they should take into account in making their choice.

Answer 1

They have many options when it comes to legal forms:

C corp(corporation)-

A corporation is a legal entity that's separate from its owners. Corporations provide protection to their shareholders from personal liability, but the cost to form a corporation is higher than other entities. Corporations also require extensive record-keeping and reporting. Corporations can make a profit, be taxed, and can be held legally liable. Corporations can raise funds through the sale of stock, they a good choice for businesses that need to raise money. James and Adrian can choose this legal form as it is best suited to their needs, it offers limited personal liability and raising money in a corporation is simpler by issuing stock.

S corp(corporation)-

An S corp is a special type of corporation that's designed to avoid the double taxation drawback of regular C corps, it allow profits, and some losses, to be passed through directly to owners personal income. S corps can't have more than 100 shareholders, and all shareholders must be U.S. citizens. S corps also offer limited liability protection and have higher reporting requirements.

LLC(limited liability company)-

An LLC offers the benefits of pass-through taxes(reporting profit and loss on your individual tax returns) and limited liability. In some states an LLC may be dissolved on death of a member, also an LLC cannot issue shares to raise funds. This type of entity is not suitable for businesses which aim to become publicly traded some day.

Considerations: As James and Adrian are starting a new business in the technology sector they will require frequent funding for growth and expansion, and they need limited personal liability since there can be disputes with clients and other people regarding their identity verification service. In order to raise money by issuing shares they will need to start a C corp. In the future if the business becomes very large, a corporation will be suited for their future needs as C corps file their own returns and are not pass through entities.