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Alternate forms of organisation

  Keith Marcelius suggested an alternate way of organising the company which looks to me like a potential solution to some of the major concerns we all had about the original proposal. It allows us to accommodate people whose financial contribution cannot be commensurate with their time to devote to the venture and it gives a way to reward those who contribute more than their expected share.

Let's assume for the moment that the company is formed as a corporation (this might also work for a limited partnership, but we don't know yet). Suppose we authorize and issue 1 million shares of stock initially (the number is totally irrelevant, but should be large enough so that round-off can be ignored). 600,000 shares of stock are sold to the founders of the company based on their capital contributions; this establishes their initial share. The number of shares purchased would be:

(YourContribution / TotalInitialCapital) * 600000

The remaining 400,000 shares of stock would be held in the corporate treasury. The effect of these shares would be nil as long as they are retained in the treasury; if dividends are distributed they just loop out of the checking account back into the treasury.

Every year, based on people's contributions of work, a stock dividend can be declared to those stockholders who contributed in excess of their share. This means that we take those shares out of the treasury and give them to the person who contributed the extra time. This increases his share at the cost of diluting the shares of those who did not receive the stock dividends. All distribution of stock dividends would be subject to a majority vote of stockholders by shares, so participants' shares could not be watered without their consent. This may have adverse tax consequences and may become more complex to reduce the tax liability of this distribution.

All of this is a very complex way of implementing a simple idea--if one partner wants to work very hard for the company but has no cash at the moment, we can let him earn his share through ``sweat equity'', subject to the approval of the other holders. On the other hand, if a partner does not contribute the work he promised, his share will be gradually reduced as the other participants won't be likely to approve a stock dividend for him. Also, if a participant wants to increase his share by buying additional stock, he may do so at a price agreed to by the shareholders who may agree to sell it to him.

I want to make it clear that this is primarily a way to accommodate cases of hardship where the initial capital contribution is absolutely impossible to obtain at the start, and also to create an incentive for producing work as promised. It is not a way for all partners to avoid contributing capital to the venture--after all, those who do not contribute initially have no guarantee that they will ever be voted a stock dividend--they're trusting those who hold the majority share to compensate them when the time comes.

At this point it looks like if we can do it without adverse tax consequences we will go ahead and incorporate the venture. To avoid the tax disasters, we will remain a ``software manufacturer'' selling discs rather than licensing our products for a per-copy fee. As soon as we begin to generate revenue we want to pay out, we will put all the shareholders on the payroll, thus avoiding a large part of the double taxation of dividends. At this point the final word isn't in on whether we can make a limited partnership do what we want to do, so this decision has not been reached. We will be consulting a lawyer who has formed numerous high-tech ventures and who can presumably tell us what we ought to be doing. I'll send out another letter once we find out. I'm sending out this information at this time so you know what we're thinking at the present moment so you can comment on it.

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Editor: John Walker