Product Overview

An important decision in starting a business is the choice of legal entity. This case provides a realistic, yet stylized, setting to facilitate a discussion of factors to consider in the entity choice decision, emphasizing legal and tax issues. Two MBA graduates have raised $5.2 million in equity from a small group of investors to buy a company. Upon deciding to buy assets from another company to start their business venture, they must determine the legal entity that best meets the needs of management and the investors. There are three alternative versions of this case, with the only difference being the allocation of profits to the investors. In this B case, the allocations of profits are not allowed for an S corporation given the restriction limiting the entity to one class of stock. This B case provides for a non–pro rata allocation of profits, which equates to management receiving a 20% profit (i.e., carried) interest.

Learning Objectives

1) To consider the optimal legal entity structure for a new venture with investors who have competing interests. 2) To examine the benefits and costs of common entities under state law in the United States. 3) To formulate a series of questions to consider when establishing the legal entity for a business in any country. 4) To compute financial measures attributable to various investors from investing in a pass-through legal entity and to compare these to the financial measures from investing in a C corporation.