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Welcome to Legal Basics for Business Protecting your business & your brand © Casoni Law Group 2009 p 1
Reminders No stupid questions. Listen for things you dont already know. Some things may not be information you need today in your company but by making yourself aware of these issues you will be better prepared if and when they come up for you. These sessions will be recorded and distributed. To have a question or comment edited out of the recording, you must contact me before 6pm PST on the eighth day following the initial call. Please note, your comment will not be deleted from the class version of the call, which is distributed to students within 24 hours of class, but will be deleted before any distribution outside the class. This class will provide information but is not intended to be legal advice. As a student in this class, you have not entered into an Attorney/Client relationship with Dava Casoni. © Casoni Law Group 2009 p 2
Week 1 Review & Questions: Vocabulary Entity: An organization or being that possesses separate existence for tax purposes. DBA: Doing Business As also referred to as Fictitious Name, a DBA must be filed when receiving payment for goods or services in a name other than your legal name. A DBA may be obtained by a sole proprietor, an LLC, a corporation, a partnership – any entity that is doing business under a name that is different from their legal name. If you are filing a DBA for an LLC, you would file the DBA AFTER creating the LLC. You only need to file a DBA if you are operating under a name different from your legal name. LLC: An LLC is a Limited Liability Company. An LLC is created by filing Articles (or Certificate, depending on state) of Organization with the state. An LLC is owned by its member(s) and may be managed by member(s) or a manager. Benefits of an LLC are that the LLC members enjoy limited liability for LLC obligations and the LLC is not taxed at the entity level so there is only one level of federal taxation. © Casoni Law Group 2009 p 3
Vocabulary contd C-Corp: A C-Corp is a regular corporation. It may be called a corporation, a C-Corp, or a Sub- chapter C corp. A corporation is formed by filing Articles (or Certificate, depending on state) of Incorporation with the state. A corporation is owned by shareholders, run by the Board of Directors and managed by Officers. Shareholders in a corporation enjoy limited liability for corporate obligations but the regular corporation is taxed at an entity level and at the shareholder income level. In addition, a corporation must observe corporate formalities in order to retain the limited liability treatment. S-Corp: An S-Corp is a regular corporation which qualifies for and elects to be treated as a partnership for tax purposes. In order to qualify for Subchapter S treatment, a corporation must: (i) have only one class of stock, (ii) have fewer than 100 shareholders all of whom are US citizens or residents and are not corporations and (iii) profits and losses are allocated to shareholders proportionately to their interest. To become an S-corp, you must timely file a Form 2553 (approx 2 months from formation or start of tax year). Non-Profit: A corporation formed under section 501(c)(3) eligible for federal income tax exemptions and certain public and private grants. © Casoni Law Group 2009 p 4
Vocabulary contd General Partnership: A business owned by two or more persons that is not an LLC or a corporation. In a general partnership, partners share profits, losses and management equally and they have unlimited liability for partnership obligations. The partnership itself is not taxed but partner income is taxed. Limited Partnership : A limited partnership (or LP) is a partnership formed by one or more General Partners (each of whom has unlimited liability) and one or more Limited Partners (each of whom has limited liability). It is created when a Certificate of Limited Partnership is filed with the state. Novation : Substitution of a new contract, debt or obligation for an existing one between the same or different parties. If you form an LLC or corporation but have entered into contracts before you form, you must sign a novation for that contract to be adopted by the LLC or corporation and to be subject to limited liability protection. © Casoni Law Group 2009 p 5
Vocabulary contd Registered Agent: A registered agent is a designated person or entity with a physical address within the state to which legal papers may be delivered on behalf of the company. You do not bear any additional exposure as the agent unless you are negligent in handling the documents. If you would prefer to designate a company to be your registered agent, the two credible resources are: Corporate Trust : $335/year, $270 for additional.http://www.ctadvantage.com Ask to set alerts. Corporate Service Company – Small Business group: , includes $50K in veil piercing insurance. Ask to set up My Account for alerts. © Casoni Law Group 2009 p 6
Legal Resources Links to SOS Offices: Lawyer Referrals: California License and Permit Requirements: Other License and Permit Info: Obtaining an EIN: https://sa2.www4.irs.gov/modiein/individual/index.jsphttps://sa2.www4.irs.gov/modiein/individual/index.jsp USC Small Business Clinic: © Casoni Law Group 2009 p 7
Example of Ramifications of Flow Through v. Double Taxation © Casoni Law Group 2009 p 8 C-CorpS-Corp Pre-tax income$1,000,000 Corporate taxes at 40%400,000None Corporate net income distributed600,0001,000,000 Individual taxes at 36%216,000360,000 Net funds available384,000640,000
Piercing the Corporate Veil- does not apply JUST to corporations! Two General Theories to Pierce Alter Ego Theory - The creditor must establish that the business owner failed to separate his financial affairs from the entity's financial affairs, and/or observe statutory formalities regarding division of authority within the entity, required meetings, and recordkeeping. Undercapitalization Theory - The creditor must prove that the owner intentionally underfunded the entity, when it was formed, to defraud the business's creditors. Veil will be pierced automatically if: The LLC or Corporation fails to renew its status annually (or biennally) by filing a report with, and paying a fee to, the state in which they were formed. This failure causes the corporation/LLC to go into "bad standing" with the state. After a certain amount of time, which varies by state, the state will dissolve the entity. If this happens and the owner continues to operate the business, the owner is then operating a sole proprietorship or a general partnership and the owners now have unlimited, personal liability for all of the business's debts. © Casoni Law Group 2009 p 9
© Casoni Law Group 2009 p 10 LLCCORPORATION MANDATORY STATE FILINGS To create File Articles (Certificate) of Organization ($70) File Articles (Certificate) of Incorporation ($100 Within 90 days Statement of Information ($20)Statement of Information ($25) Annual Secretary of State No annual secretary of state filing requirement (unless articles must be amended) Statement of Information ($25) Biennial Statement of Information ($20)No additional biennial requirement Annual State Franchise Tax Minimum $800, due by the 15 th day of the 4 th month after end of tax year, may be waived year 1 in certain circumstances Minimum $800, year 1 may be reduced or waived Dissolution Certificate of dissolutionCertificate of election to wind up and dissolve California Small Business Checklist: What You Need to Do to Create and Maintain an LLC or Corporation in Good Standing* Note: This information is as of May 6, 2009 and is not intended to be relied on as legal advice or authority. Please confirm all filing and fee requirements with your attorney.
© Casoni Law Group 2009 p 11 LLCCORPORATION Additional documents to maintain but not file Operating Agreement Maintain in writing: Current list of full name and business address of each member and holder of economic interest in the LLC in alphabetical order together with their contribution and share in profits & losses of each. Full name/address of each manager Articles of Org & all amendments Fed, State and Local tax returns for 6 most recent years Operating Agreement (if in writing) & amendments Past 6 years financial statements Books and records for past 4 years Bylaws Annual Board Meeting Minutes & any Special Meeting Minutes Annual SH Meeting Minutes & any Special Meeting Minutes May have managers or directors or just manage by membersElect minimum 3 directors (unless 1-2 shareholders) MAY but not required to appoint: Chairman of Board or President (or both), Secretary, and CFO (one person can fill all positions), does not have to be by member or manager Appoint: Chairman of Board or President (or both), Secretary, and CFO (one person can fill all positions). Stock Certificate and Register (unless non-stock corporation)
© Casoni Law Group 2009 p 12 LLCCORPORATION OTHER FILINGS Fictitious Name Filed at county level if operating under a name other than legal name S-Corp Election Not applicableWithin 2 months and 15 days from date of Articles filing Licenses & Permits County level filings – check with county office to determine if your business type requires any license or permits Note: This information is as of May 6, 2009 and is not intended to be relied on as legal advice or authority. Please confirm all filing and fee requirements with your attorney. California Small Business Checklist: What You Need to Do to Create and Maintain an LLC or Corporation in Good Standing contd
Working with Partners and Investors © Casoni Law Group 2009 p 13
Co-Founders/Partners © Casoni Law Group 2009 p 14 I.Founder Agreements II.Employment Agreements (Will cover during Contracts week – technically, should have employment agreements with key management, eventually will want life insurance on key management) III. Common Unit/Stock Option Plans
Founder Agreements © Casoni Law Group 2009 p 15 I. Buy-Sell Agreements A. If one partner desires to sell or is not hitting benchmark, other partner has the right to buy or force the sale of shares B. Can force painful discussions that may not be necessary II. Voting Agreements A. How do you want to handle certain issues, i.e. new partners, sale of company, accepting capital?
Founder Agreements: Pros & Cons © Casoni Law Group 2009 p 16 I. Pros A. Force discussions to ascertain all parties are on the same page B. Resolve disputes before they happen II. Cons A. Lingering resentment B. Cost C. Inability to foresee all circumstance
Partners © Casoni Law Group 2009 p 17 Reduce Legal Costs and Arguments by Discussing: (i)What will each partner contribute to the company financially? (ii)What is each partner responsible for? If possible, be specific about different job responsibilities (eg, is one person responsible for tech, another for finances, another for marketing, or is each person responsible to commit 20 hours per week to company work, etc.) (iii)What percent of profits is each person entitled to? Losses? (note, with LLC, you may structure losses differently) (iv) What happens if one person ends up putting in more or less money or time than you planned – how do you restructure profit & loss split? How often do you re-evaluate? (v) What happens if there is a disagreement among you and one person wants to break off? Does the remaining partner(s) have a right to buy out the departing person? At what price? What if there is no money to buy immediately?
Partners contd © Casoni Law Group 2009 p 18 (vi)What if one partner wants to run the company but no longer wants to work with the other partner? Is there a trigger to remove a partner? (vii)What if one person wants to bring a new person to the group? How do you decide if the person can be admitted? (viii)Are there any big decisions that require both/all partner approval? (ix)Any amounts of money that can only be spent with both/all partner approval? (x)What happens if one partner passes away? You dont have to make decisions on all these matters at the outset, particularly if there are only two partners/members. Where there are several initial owners, it is advisable to be more specific.
Adding Outside Money, New Partners or Strategic Alliances © Casoni Law Group 2009 p 19
Adding Outside Money © Casoni Law Group 2009 p 20 Build business first! Get: Customers Revenue, and Good Team before seeking outside capital
Bringing in Outside Money © Casoni Law Group 2009 p 21 Individual investors Accredited v. Non-accredited Government (small business loans and other government programs) Banks/debt financing Strategic alliances Venture capital
Considerations in Raising Money © Casoni Law Group 2009 p 22 Financial security vs. retained ownership / leverage Once you start raising money, can be a non-stop cycle Early rounds - accredited investors Later rounds - start early before funds get too low Early stage fund raising continues to be difficult
Accredited Investors © Casoni Law Group 2009 p 23 Securities Act of 1933: A company that offers or sells its securities must register the securities with the SEC or find an exemption from the registration requirements. One exemption is the Regulation D Accredited Investor which includes: a director, executive officer, or general partner of the company selling the securities; a business in which all the equity owners are accredited investors; a natural person who has individual net worth, or joint net worth with the persons spouse, that exceeds $1 million at the time of the purchase; a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes. Accredited Investors: When adding a partner, bring them into company as an officer/director first, before taking money.
Friends/Family, Angels, VCs © Casoni Law Group 2009 p 24 Friends and Family: Be careful – make sure they are accredited! Angel Investors: Angel investors are individuals who invest in businesses looking for a higher return than they would see from more traditional investments. Usually angels are the bridge from the self-funded stage of the business to the point that the business needs the level of funding that a venture capitalist would offer. Funding estimates vary, but usually range from $150,000 to $1.5 million. In 2006, angels invested over $25 billion in 51,000 different companies. Small Business Administration estimates that there are at least 250,000 angels active in the country, funding about 30,000 small companies a year. There are about two million people in the United States with the discretionary net worth to make angel investments. Nine out of 10 investors provide personal loans or loan guarantees to the firms they invest in. On average, this increase the available capital by 57%.
Friends/Family, Angels, VCs © Casoni Law Group 2009 p 25 Venture Capitalists: Venture capital firms usually require a high rate of return on their investment (20%+ per annum) and finance provided to the business is typically in the range of $500,000 to many millions of dollars. An angel investor generally wants less control of your company and a slower return on investment, however the criteria for investment are likely to be similar. Consider offering Angels and F&F: Convertible Notes which are debt instruments that can be converted into stock at the option of the holder or the issuer typically at the point when an institutional investor (such as a Venture Capitalist) makes an investment. National Association of Seed and Venture Funds:
Advisory Board v. Board of Directors © Casoni Law Group 2009 p 26 Board of Directors: Considerable Power and Liability (Fiduciary Duties and Obligations) Be careful not to mix Advisory Board with B.O.D.
Compensating Advisors/Setting up Advisory Board © Casoni Law Group 2009 p 27 One percent vesting over four years is at the top end of the range. Advisors typically (although not always) contribute much less value to a company than directors and their equity grant should correspondingly be less. Dont grant equity unless contributing a lot of value. If pay cash compensation, travel expense is often sufficient or nominal cash consideration (approx. $5,000/year). Consider: expectation of what the advisor will provide, how much you value this involvement, existing capital structure of the company (e.g. larger grants if you are younger, smaller grants if you are a more mature company.) Many advisors contribute much of their value early in the life of the relationship so rather than giving a grant that vests over four years, you might consider making an annual grant and then revisiting things in a year to see if the relationship is living up to expectations. A savvy advisor will prefer to get a bigger grant that vests over four years since it will allow them to lock in a strike price at todays fair market value (FMV) of the stock (which - in the success case - will likely be lower than the FMV in the future). An advisory board is a good independent eye. Asks questions beyond just what is on the first line of the profit and loss statement.
How to set up Advisory Board © Casoni Law Group 2009 p 28 Who To Pick Start with who you know and trust (Lawyers and bankers, look at local small business development center, SCORE (Service Corps of Retired Executives) office or industry association.) If you go with customers or vendors who might have good connections in the industry, be careful what you tell them and have them sign confidentiality agreements. Finding a big name or two in the industry will help lend credibility & possibly open doors. Try to find complementary skills: eg, tech person, financial person, etc. How Many Smaller companies with no more than 20 employees typically have up to three advisers, according to the National Federation of Independent Business. How Long Should They Stay on Your Board? Set adviser term limits from 12 to 24 months so that you don't have to deal with sudden, awkward dismissals. You may only hold meetings a handful of times a year, but check in more often than that. You don't want to fall off your mentors' radars. As your business grows, you will need different types of advice and will want option to change.
Strategic Alliances © Casoni Law Group 2009 p 29 How do you feel about the alliance you are considering? Listen to your gut. Do you have compatible values, integrity, personality? Do they get what you are all about? Is your combined offering up-leveled so it is a win-win for both? Strategic Partners Often Invest! Consider convertible notes so you dont have to value your company.
Stock Option I. Company grants the right to purchase a specific number of shares at a pre-set price (generally market value on the date of grant) for a period of time in the future II. Tax requirements to properly structure a plan III. Accounting issues © Casoni Law Group 2009 p 30
Option Plan Requirements I. Board Approval (corporate matter) II. Stockholder Approval (corporate and tax matter) III. Reservation of shares © Casoni Law Group 2009 p 31
Cons of Stock Option Plans I. Dilutive to ownership II. Fairness of administration III. New tax and accounting rules make administration more complex IV. Option value is now an expense and can be difficult to administer V. In public company, if value falls options lose meaning to employees © Casoni Law Group 2009 p 32
Exit Strategies © Casoni Law Group 2009 p 33 Various Types of Exits (the positive kind) Sale of company Initial public offering Redemption of the venture capitalist (rarely occurs)
Sale of Company © Casoni Law Group 2009 p 34 Most common form of exit Even during dot com bubble, over 90% of all successful exits were M&A Cash sale, valuation fixed, no more upside participation Loss of control in a stock sale, no control over the value of consideration Capital gain on sale of company Cheaper than an IPO
Initial Public Offering (IPO) © Casoni Law Group 2009 p 35 The Upside: Higher Profile Additional Financing Currency for Acquisitions Exit Strategy for Venture Investors Potential increased Net Worth The Downside: Loss of Control Heightened Scrutiny Market Pressure Disclosure Requirements Personal Civil and Criminal Liability Expense
Cost of Going Public © Casoni Law Group 2009 p 36 Lawyers Accountants D&O insurance costs Printers Roadshow -It sounds fun, but 20 cities in 10 days isnt Between $1MM and $1.5MM
Types of Initial Public Offerings © Casoni Law Group 2009 p 37 Reverse Merger Find a public shell, merge your company into the shell and gain majority (near total) control of new entity Traditional Select an underwriter, draft a prospectus, sell the shares based on price negotiated with institutional investors
© Casoni Law Group 2009 p 38 For latest tips for entrepreneurs, visit:
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