Corporate/Formation Matters Start With a Sound Basic Structure   By Thomas K. Crowe, Esq.   The first task for a startup telecommunications business is to address corporate formation issues. This is the case whether the business model is prepaid card, wireless, MVNO, or postpaid toll.  These upfront decisions are important since they can determine whether owners have personal liability for the debts of the business, whether there will be double taxation if profits are withdrawn from the business, and generally whether there is a sound legal entity through which the business can smoothly operate and grow. The following provides a general overview of some of the basic formation issues.   Formation A threshold issue is whether the new venture should be incorporated and, if so, which form of corporate entity should be selected. A corporation is a legal entity separate from its owners and generally can have an unlimited number of shareholders. A major advantage of any corporate entity is that it limits the personal liability of the owners for claims against the corporation. Creation of a corporation generally occurs when properly completed Articles of Incorporation are filed with the appropriate state authority and all fees are paid. Some small businesses are operated as sole proprietorships. The major disadvantage of a sole proprietorship is that the owner of the business is personally liable for debts or obligations of the business. For this reason, very few telecommunications businesses are operated as sole proprietorships. The following provides a brief overview of the legal forms most widely used in the current environment to establish a new telecommunications business. Regular Corporation The primary advantage of a regular corporation, of course, is that it limits the personal liability of the stockholders for debts or obligations of the corporation. Notwithstanding this, a number of disadvantages are associated with corporations. First, federal income taxation of business profits is at rates higher than those applied to individual taxpayers. Second, if profits are withdrawn from the business, those profits are effectively “double taxed.” Finally, regular corporations entail relatively more complexity and expense than most other forms of doing business. S Corporation An S corporation is an entity that has elected a special tax status with the IRS. This tax treatment allows the income of the corporation to be “passed through” to the shareholders. Thus, shareholders’ individual tax returns report the income or loss generated by the S corporation, meaning that business profits are taxed at individual tax rates, not higher corporate rates. In general, there is no double taxation on profits withdrawn from the business. Like a regular corporation, stockholders generally have no personal liability for debts or obligations of the corporation. One of the major disadvantages of an S corporation is that, in addition to the complexity that a regular corporation entails, it requires the close oversight of a tax legal advisor. Limited Liability Company   Limited Liability Companies, or LLCs, are increasingly being considered as an alternative form of doing business. This corporate form is available in many but not all states. Essentially, LLCs are hybrid entities that combine the favorable flow-through tax treatment of S corporations with the limitation of liability enjoyed by corporations. Like the stockholders of an S corporation, LLC members are generally not liable for debts and liabilities of the business. Significantly, federal income taxation of business profits is assessed at individual tax rates and there is no double taxation if profits are withdrawn from the business. While LLCs entail a moderate level of complexity and expense, LLC laws tend to vary among states in their requirements. Business Name In selecting a legal form that the business will take, careful consideration should be paid to the business name. Generally speaking, a corporate name cannot be the same as or deceptively similar to the name of any other corporation incorporated, or registered to do business, in the same state as your company. Before deciding upon a corporate name, it should be carefully checked to determine whether the name is available for use. At a minimum, such a check should be made with the jurisdiction in which your business will be incorporated and each jurisdiction in which the corporation will likely be registered as an out-of-state corporation. Even if a business incorporates successfully under a given business name, this does not necessarily mean that absolute rights to that name are obtained. A separate check should be undertaken against registered federal trademarks or trade or fictitious business names to avoid business name conflicts. In addition to a trademark search, an expanded search might entail reviewing local telephone directory listings and conducting an internet search for similar business names. It is not uncommon in the telecommunications industry for startup companies to face lawsuits brought by competitors with identical or similar business names, so these steps should not be overlooked. In addition, state-specific requirements need to be carefully followed as many state laws require that the corporate name contain the word “corporation,” “company,” “incorporated” or other similar words or abbreviations. EIN   Upon formation, a new corporation should apply immediately for an employer identification number, or EIN, from the IRS using Form SS-4. The EIN that the IRS will issue is then used in all correspondence with the IRS.   Out-Of-State Registration Once the legal entity has been formed, consideration should be given to where services will be offered. This step will enable a new business to determine in which states it will need to register as an out-of-state corporation, possibly apply for authorizations to operate as a telecommunications provider(see http://www.tkcrowe.com/telecommunications_ licensing.html), as well as obtain other permits or authorizations. While a new business will incorporate under the laws of a given state, it will need to register as an out-of-state corporation in all other states in which it intends to offer service and transact business. Major telecommunications providers operating nationwide, for example, typically are registered as an out-of-state corporation in all fifty states. Filing for authority to transact business as an out-of-state corporation generally involves a fee. Fees vary from state to state but generally range from $50 to as much as several hundred dollars. Processing time also varies from state to state, from as little as two days to several weeks. For an additional fee, many states offer expedited processing services, which can reduce the processing time to 24 hours or less. Because obtaining authority to transact business is a prerequisite to applying for authority before the state public utilities commission to provide telecommunications service, a new business should begin the process of obtaining these registrations well in advance of the date on which it intends to begin offering service.   Ongoing Corporate Formalities Once incorporated, it is important that ongoing corporate formalities be observed. For example, personal funds should not be commingled with corporate funds; the full and correct name and address of the corporation should be shown on all stationery, websites, business cards, contracts, etc.; and all significant corporate actions should be reflected in appropriate minutes authorizing those actions. Annual meetings of the stockholders and the board of directors should be held at such time and place as provided in the corporate bylaws. It is important that corporate reporting requirements and ongoing fees be paid by applicable deadlines. Further, each corporation must have a registered agent in the state in which it is incorporated, and the correct address of the registered agent must be kept current with the appropriate state regulator. To the extent that these and other corporate legal formalities are not observed, the possibility exists that the “corporate veil” could be pierced. This essentially means that the business runs the risk of being determined not to have maintained its legal corporate status. Were such a determination to be reached by a court, the corporate form of the business is essentially viewed as being defective or void. In other words, the stockholders may have personal liability for corporate acts, debts or obligations and that the other benefits of that corporate form may not apply.   The author is a Washington, D.C.-based attorney specializing in communications, VoIP, wireless and prepaid legal/regulatory matters. To obtain additional information regarding any of the issues covered above, please contact Thomas K. Crowe at (202) 263-3640 or visit our website at www.tkcrowe.com. The foregoing is intended to provide a general overview only and should not be viewed as a substitute for conferring with qualified legal counsel. Each new business will have unique requirements that should be analyzed by counsel. Please note that these materials were last updated on June 15, 2007, and do not include developments occurring after that date.