BUSINESS ORGANIZATION

Technically, capital raising is just one consideration of business organization: whether to stay a sole proprietorship or become a general partnership, limited partnership, limited liability company or corporation. Other considerations are what happens to the Company if a partner wants to sell their share or end the business, if someone wants to buy the Company, or if the Company is operated irresponsibly and incurs debts or lawsuits.The general partnership agreement is one form of business organization with the maximum exposure to these factors.

Investors are typically provided liability protection in partnership agreements by using a form of partnership called a limited partnership, in which there are one or more general partners operating the business, and the investors, who are shielded from mistakes in operation, are called "limited partners." This protection does not exist with general partnerships, theoretically.

At one time I was a big booster of the Limited Liability Company form, and the LLC form seems to have its share of fans among securities lawyers who speak of it in very glowing terms on web sites I have visited. The actual contracts are available online or from the Secretary of State.

Corporations, and limited liability companies (LLC's), which may be partnerships or corporations also provide a form of liability protection to investors. LLC forms, incorporation papers, and sales contract arrangements that shift liability -- all shift responsibility for poor decisions to the people making them. And there is nothing wrong with that. On the other hand, in the Golden Rule, one doesn't really like that if one is the wronged party.

[There are three fine points about incorporation which I really am not going to go into too much detail here: one is "post effective" incorporation, and another is "Delaware" incorporation, and the last is "par" value, as in "no par value" shares. I have read something to the effect that "par value" is a special consideration for tax accounting purposes; and that most shares of stock have no par value.]

[Incorporation in Delaware, if I understand it correctly, is a way of being able to do a number of things: at one time, it may have been a way to sell stock in states which do not allow shares to be sold in their state unless it is expensively registered. Many corporations, when I looked at this ten years ago, were incorporated both in Delaware and in California. There are still many many web sites recommending Delaware incorporation listed in the search engines.There may be other subtleties to this, like having a federal employer identification number but not a state number, and registering in Delaware first. It's the kind of thing that one expects to be straightened out by now, and I believe it is. In California, I believe it is required to register one's stock if it is sold in the state, but that this is not necessary if the transaction is "exempt." Any transaction involving a stockbroker is exempt, because the liability falls on the broker if they present an "unapproved product," as is any transaction in which an investor is accredited, and if no class of "exemption" applies, there is a $100 fee and form that can be filed to make the stock transactable in California. Delaware is also available for tax purposes, but offhand I am unaware of the circumstances where one would need to avoid taxes, if one were charitable and active.]

[And how does one have a corporation when there is no money yet? The subtleties of "post-effective" offerings may be added to a future version of this section. The gist is that one should read the forms one uses, or use one's best judgment if no form is used. Lastly, just because I am not interested in this info, does not mean it is unimportant. It wouldn't hurt to do a little web search in any case.]

I have worked for what seemed to be a corporation which did not file incorporation papers, to my knowledge, though they raised money from a dozen people in their state. I suspect that this may have been a case of "post effective" filing. The individual raising the money was a lawyer, and his investors, to my knowledge, were all business or private associates. A verbal agreement that the capital raised is for a corporation would probably be sufficient for state purposes of post-effective incorporation. I recall that the contributions were logged in a standard ledger and maintained by a professional bookkeeper. The "security" could be something pretty sophisticated, part loan convertible to profit sharing with a sliding scale of equity depending on the total capitalization or just a "share," entrusted to the honor of the promoter.

To recap: it looks like one can raise a great deal of money using verbal agreements and checks, saving "registration" of one's project until it is completely capitalized, as long as one keeps to investors exempted by SEC rules, and stays within the state. Because "general partnership" is less desirable than other business organization forms, it is common practice to either avoid partnership-like arrangements and use loans and receipts, or to opt for a "limited" structure. On principle, one should probably aim to obtain loans if liability ever becomes an issue, and bear the full brunt of responsibility. In this case, one can only reward capital sources with "gifts" and reciprocal lending, but that can be done very effectively.

Let us say that the lawyer never intended to register as a corporation, but was staying a sole proprietorship, intending to pay his investors back their money and then add "gifts" to that amount, tax free up to $10,000. By law, he could not "offer" to give them gifts. But he could give them gifts, just the same.

Let your word be your bond...

So, it is not uncommon to raise money without forms, or to withold submitting these forms to the government branch responsible until full capitalization. It's worth adding that one can always return the money if the capitalization is not proceeeding well enough, though interest may be expected.