Monday, March 6, 2017
11 Important Issues Business Partners Should Consider
Many people decide to start their own businesses because they’re intrigued by the idea ofbeing their own boss. All decisions, risks, and rewards are yours and yours alone. This equation changes, however, when you decide to start and run a business in partnership with another person. Many of the freedoms, risks and rewards are similar – but there are unique questions that business partners should ask each other to help ensure the relationship starts and continues smoothly.
Before and during the process of developing a business partnership, it is crucial to ask and answer the questions below.
- What goals do I have for this business? What goals does my partner have? What if one partner wants to create a business that will provide income for his family for several years or decades and the other partner wants to build a company that will grow quickly and sell well? These are not necessarily incompatible goals, but it is important to get these goals onto the table to discuss how to start and run a business that might meet both partners’ goals.
- What is each partner’s level of commitment in terms of time? You can prevent a major source of partner conflict by being explicit about how much time each of you expects to spend working on running and developing the business. Will either of you work full-time for your business at the beginning? Will either of you have other work commitments? If so, are there any situations in which that partner will close out other work or business commitments to focus more energy on this endeavor?
- How will cash invested by partners be treated? Will cash investment be treated as debt to be repaid? Will cash investment buy a higher level of company shares? Will the debt be convertible? These questions and answers also have tax implications, so it may be wise to consult a certified public accountant along with a qualified business law attorney during your start-up phase.
- How comfortable are we with change? Change is the only constant in any business environment, and the most successful businesses are those that are highly adaptable to change – in the market, in the economy, in the personnel, etc. That said, business partners should have a conversation about their “sticking points” – those aspects of the business that one or another partner does not want to change. One partner may be fully committed to the specific product being produced, whereas another partner may be unwaveringly dedicated to a certain market segment. Learn each other’s “sticking points” now to minimize conflict during the inevitable periods of change and adjustment as the business ages and grows.
- How much will we pay ourselves? Who has the authority to change compensation amounts in the future? This issue is related to the question of who is investing how much cash into the business during the start-up phase. Compensation can be a volatile issue. Regardless of how difficult the conversation may be, partners must thoroughly discuss pay structure at the very beginning of a business relationship to minimize conflict down the road.
- Who will own what percentage of the company? In other words, how will we divide the shares? The answer to this question often depends on whether one or both partners provided cash for start-up costs, as well as the time commitment each partner plans to make.
- Who has what kinds of decision-making authority? The answer to this question often is related to the division of shares between the partners, but this is not a requirement. You can designate shares as voting shares or non-voting shares, and you can also choose to set up a board of directors. The partners will have to decide which areas, if any, they each have individual authority over, which areas they must agree on, and which areas the board of directors will control. Common areas of decision making authority include human resources (hiring and firing), capitalization, issuance of shares, and mergers and acquisitions.
- Will we sign contractual terms with the company in addition to the shareholder agreement and partnership agreement? Two common examples of additional contractual terms are the non-compete agreement and the confidentiality or non-disclosure agreement. If founding partners are going to sign such contracts, what will the terms of each agreement be?
- What if one or both of us wants to leave the company? It is better to define exit procedures in the early stages of the business start-up. If no guidelines are in place, one partner’s desire to depart can cause high conflict as formerly aligned partners try to come to agreements about ending their relationship.
- Can either of us be fired? If so, what are the grounds for termination and who has the authority to make that decision? What is the procedure? Discuss and commit to writing your strategy for terminating the operational role of a co-founder if necessary.
- What is our business succession plan? While it is not necessary to have a fully developed and executed business succession plan before starting a business endeavor, it should at least be a topic for discussion in the early stages. Partners may have different ideas about how control over the business will pass to others in the future, and a conversation about succession planning can reveal these differences and give each partner food for thought as a plan is developed.
Have several conversations about these topics, and you will find yourself well prepared when it comes time to put your partnership agreement into writing.
Monday, February 13, 2017
Start-up Business: When is the Best Time to Consult with a Lawyer?
If you are starting a new business venture, it is vital that you assemble your team of advisors immediately. Many entrepreneurs are short on cash during the start-up phase and forego hiring of legal counsel or other professional advisors in order to preserve capital for other aspects of the business venture. But this approach is usually penny-wise and pound-foolish. Especially since many small business start-up lawyers are a lot more affordable than you think.
Your attorney can be an invaluable member of your team of advisors. Business attorneys have seen first-hand the mistakes entrepreneurs make and know how to structure transactions to avoid them. It is best to consult with an attorney early on in the process, before you formally organize the company because the foundational issues are critical to the long-term success of your new venture.
There are many issues to be considered; and the earlier you do so, the better. You’ll want to ensure you choose the most advantageous business structure. From C-Corporations to S-Corporations to Limited Liability Companies and other hybrid entities, you have many options. They must all be carefully considered, in light of your particular situation. How many owners and who they are, liability issues, licensing restrictions, and anticipated profits all play a role in determining what type of entity affords you the most asset protection, and costs you the least in taxes.
During this foundational process, your legal advisors can also help you determine equity splits, which can save you headaches down the road. For example, it is generally advisable to avoid dividing business ownership according to percentages. Doing so can create problems later if additional investors need to be brought in. However, if the appropriate number of shares are authorized at the outset, and issued according to a plan for long-term company growth, you ensure your company can access capital in the future.
Vesting schedules can also be established before stock is issued to the company founders, enabling the initial shareholders to obtain full ownership rights to their shares over a period of time. However, this may not be advantageous in every situation, and must be carefully considered.
Even after your initial formation is complete, there are still a number of legal issues that require your attention. There are agreements to negotiate which may include leases, employment contracts, independent contractor agreements, customer purchase or service agreements and many more.
Steps should be taken early on to protect your intellectual property. Depending on the nature of your business, you may need to obtain and enforce patents and copyrights. If your company has a “brand” you will likely want to obtain a federal or state trademark to protect it for your own exclusive use.
The federal and state employment regulations can be onerous. From verboten interview questions to potential allegations of discriminatory hiring practices, a start-up lawyer can help you avoid the pitfalls and ensure you have a happy, productive work force.
Finally, your attorney can help you identify and secure other professionals and services, such as accountants, recruiters, bankers and even start-up friendly print shops and website development and hosting services.
Sunday, January 22, 2017
Negotiating a Commercial Lease? Be Sure to Address These Issues
When it comes time for your business to move into a new commercial space, make sure you consider the terms of your lease agreement from both business and legal perspectives. While there are some common terms and clauses in many commercial leases, many landlords and property managers incorporate complicated and sometimes unusual terms and conditions. As you review your commercial lease, pay special attention to the following issues which can greatly affect your legal rights and obligations.
The Lease Commencement Date
Commercial leases typically will provide a rent commencement date, which may be the same as the lease commencement date. Or not. If the landlord is performing improvements to ready the space for your arrival, a specific date for the commencement of rent payments could become a problem if that date arrives and you do not yet have possession of the premises because the landlord’s contractors are still working in your space. Nobody wants to be on the hook for rent payments for a space that cannot yet be occupied. A better approach is to avoid including in the lease a specific date for commencement, and instead state that the commencement date will be the date the landlord actually delivers possession of the premises to you. Alternatively, you can negotiate a provision that triggers penalties for the landlord or additional benefits for you, should the property not be available to you on the rent commencement date.
Your initial lease term will likely be a period of three to five years, or perhaps longer. Locking in long terms benefits the landlord, but can be off-putting for a tenant. Instead, you may be able to negotiate a shorter initial term, with the option to extend at a later date. This will afford you the right, but not the obligation to continue with the lease for an additional period of years. Be sure that any notice required to terminate the lease or exercise your option to extend at the end of the initial lease term is clear and not subject to an unfavorable interpretation.
Subletting and Assignment
If you are locked into a long-term lease, you will likely want to preserve some flexibility in the event you outgrow the space or need to vacate the premises for other reasons. An assignment transfers all rights and responsibilities to the new tenant, whereas a sublease leaves you, the original tenant, ultimately responsible for the payments due under the original lease agreement. Tenants generally want to negotiate the right to assign the lease to another business, while landlords typically prefer a provision allowing for a sublease agreement.
Subordination and Non-disturbance Rights
What if the landlord fails to comply with the terms of the lease? If a lender forecloses on your landlord, your commercial lease agreement could be at risk because the landlord’s mortgage agreement can supersede your lease. If the property you are negotiating to rent is subject to claims that will be superior to your lease agreement, consider negotiating a “nondisturbance agreement” stating that if a superior rights holder forecloses the property, your lease agreement will be recognized and honored as long as you fulfill your obligations according to the lease.
Monday, January 9, 2017
Whether you are an owner considering whether or not you should sell your small business or an individual thinking about buying a business that is on the market, it is important to determine how much the business is worth. This can be a daunting task. Every business is different and for that reason no single method can be used in every case. Below are the most common methods used to determine the approximate value of a small business.
The assets a business holds can be used to determine its approximate value. Generally, a business is worth at least as much as its holdings, so looking to tangible and intangible assets can provide a baseline amount. If you choose to use this method, the business’ balance sheet should provide all of the information you need. This method may be too simple to be used for all businesses, especially those that are doing well and generating a lot of profits.
Another way to determine a business’ worth is to look at its revenue. Of course, revenue is not profit a business makes. When using this method, a multiplier is applied to the revenue amount to determine the business value. The multiplier used is dependent upon the industry in which the business is operating. Another method is to apply a multiplier to the business’ earnings or profits, instead of total revenue. This is usually a more accurate way of determining what the business value actually is.
When using these methods, it is important to understand that the market is constantly fluctuating. The value of assets can go up or down depending on the day, and revenue and earnings can change drastically from year to year. Also, when trying to determine what a business is worth, you might consider what the business may be worth if it had better management or more optimal business execution. The current managers may not be taking advantage of various opportunities to make the business more profitable.
Before entering into any purchase or sale agreements, it’s essential that you consult a qualified business law attorney and a business appraiser who can assist in the valuation of a small business and help you understand whether it makes sense to proceed with the transaction.
Monday, November 28, 2016
Overview: Buy-Sell Agreements and Your Small Business
If you co-own a business, you need a buy-sell agreement. Also called a buyout agreement, this document is essentially the business world’s equivalent of a prenup. An effective buy-sell agreement helps prevent conflict between the company’s owners, while also preserving the company’s closely held status. Any business with more than one owner should address this issue upfront, before problems arise.
With a proper buy-sell agreement, all business owners are protected in the event one of the owners wishes to leave the company. The buy-sell agreement establishes clear procedures that must be followed if an owner retires, sells his or her shares, divorces his or her spouse, becomes disabled, or dies. The agreement will establish the price and terms of a buyout, ensuring the company continues in the absence of the departing owner.
A properly drafted buy-sell agreement takes into consideration exactly what the owners wish to happen if one owner departs, whether voluntarily or involuntarily. Do the owners want to permit a new, unknown partner, should the departing owner wish to sell to an uninvolved third party? What happens if an owner’s spouse is involved in the business and that owner gets a divorce or passes away? How are interests valued when a triggering event occurs?
In crafting your buy-sell agreement, consider the following issues:
Triggering Events - What events trigger the provisions of the agreement? These normally include death, disability, bankruptcy, divorce and retirement.
Business Valuation - How will the value of shares being transferred be determined? Owners may determine the value of shares annually, by agreement, appraisal or formula. The agreement may require that the appraisal be performed by a business valuation expert at the time of the triggering event. Some agreements may also include a “shotgun provision” in which one party proposes a price, giving the other party the obligation to accept or counter with a new offer.
Funding - How will the departing owner be paid? Many business owners will obtain insurance coverage, including life, disability, or business continuation insurance on the life or disability of the other owners. With respect to life insurance, the agreement may provide that the company redeem the departing owner’s shares (“redemption”). Alternatively, each of the owners may purchase life insurance on the lives of the other owners to provide the liquidity needed to purchase the departing owner’s shares (“cross purchase agreement”). The agreement may also authorize the company to use it’s cash reserves to buy-out the departing owners.
Wednesday, November 16, 2016
C-Corporation Vs. S-Corporation: Which Structure Provides the Best Tax Advantages for Your Business?
The difference between a C-Corporation and an S-Corporation is in the way each is taxed. Under the law, a corporation is considered to be an artificial person. Shareholders who work for the corporation are employees; they are not “self-employed” as far as the tax authorities are concerned.
In theory, before a C-corporation distributes profits to shareholders, it must pay tax on the income at the corporate rate. Then, leftover profits are distributed to the shareholders as dividends, which are then treated as investment income and taxed to the shareholder. This is the “double taxation” you may have heard about.
C-Corporations enjoy many tax-related advantages :
Income splitting is the division of income between the corporation and its shareholders in a way that lowers overall taxes, and can avoid or significantly reduce the potential impact of “double taxation.” By working with a knowledgeable tax advisor, you can determine exactly how much money the corporation should pay you as an employee to ensure the lowest tax bill at the end of the year.
C-Corporations enjoy a wider range of deductible expenses such as those for healthcare and education.
A shareholder can borrow up to $10,000 from a C-Corporation, interest-free. Tax-free loans are not available to sole proprietors, partners, LLC members or S-Corporation shareholders.
S-Corporations pass income through to their shareholders who pay tax on it according to their individual income tax rates. To qualify for S-Corporation status, the corporation must have less than 100 shareholders; all shareholders must be individual U.S. citizens, resident aliens, other S-Corporations, or an electing small business trust; the corporation may have only one class of stock; and all shareholders must consent in writing to the S-Corporation status.
Depending on your situation, an S-Corporation may be more advantageous:
Electing S-Corporation tax treatment eliminates any possibility of the “double taxation” referenced above. S-Corporations pay no federal corporate income tax, but must file annual tax returns. Because losses also flow through, shareholders who are active in the business can take most business operating losses on their individual tax returns.
S-Corporations must still file and pay employment taxes on employees, as with a C-Corporation. An S-Corporation may not retain earnings for future growth without the shareholders paying tax on them. The taxable profits of an S-Corporation pass through to the shareholders in the year they are earned.
S-Corporations cannot provide the full range of fringe benefits that a C-Corporation can.
Monday, October 17, 2016
Exemption Requirements for Non-Profit Public Benefit Corporations
A public benefit corporation is a type of non-profit organization (NPO) dedicated to tax-exempt purposes set forth in section 501(c)(3) of the Internal Revenue Code which covers: charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals. Public benefit NPOs may not distribute surplus funds to members, owners, shareholders; rather, these funds must be used to pursue the organization’s mission. If all requirements are met, the NPO will be exempt from paying corporate income tax, although informational tax returns must be filed.
Under the rules governing public benefit NPOs, “charitable” purposes is broadly defined, and includes relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erecting or maintaining public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency. These NPOs are typically referred to as “charitable organizations,” and eligible to receive tax-deductible contributions from donors.
To be organized for a charitable purpose and qualify for tax exemption, the NPO must be a corporation, association, community chest, fund or foundation; individuals do not qualify. The NPO’s organizing documents must restrict the organization’s purposes exclusively to exempt purposes. A charitable organization must not be organized or operated for the benefit of any private interests, and absolutely no part of the net earnings may inure to the benefit of any private shareholder or individual.
Additionally, the NPO may not attempt to influence legislation as a substantial part of its activities, and it may not participate in any campaign activity for or against political candidates.
All assets of a public benefit non-profit organization must be permanently and irrevocably dedicated to an exempt purpose. If the charitable organization dissolves, its assets must be distributed for an exempt purpose, to the federal, state or local government, or another charitable organization. To establish that the NPO’s assets will be permanently dedicated to an exempt purpose, the organizing documents should contain a provision ensuring their distribution for an exempt purpose in the event of dissolution. If a specific organization is designated to receive the NPO’s assets upon dissolution, the organizing document must state that the named organization must be a section 501(c)(3) organization at the time the assets are distributed.
If a charitable organization engages in an excess benefit transaction with someone who has substantial influence over the NPO, an excise tax may be imposed on the person and any NPO managers who agreed to the transaction. An excess benefit transaction occurs when an economic benefit is provided by the NPO to a disqualified person, and the value of that benefit is greater than the consideration received by the NPO.
To apply for tax exemption under section 501(c)(3), the NPO must file Form 1023 with the IRS, along with supporting documentation, including organizational documents, details regarding proposed activities and who will carry them out, how funds will be raised, who will receive compensation from the NPO, and financial projections. If approved, the IRS will issue a Letter of Determination. Public charities must also apply for exemption from state taxing authorities, a process which varies from state to state.
Monday, September 19, 2016
Which Business Structure is Right for You?
Which entity is best for your business depends on many factors, and the decision can have a significant impact on both profitability and asset protection afforded to its owners. Below is an overview of the most common business structures.
The sole proprietorship is the simplest and least regulated of all business structures. For legal and tax purposes, the sole proprietorship’s owner and the business are one and the same. The liabilities of the business are personal to the owner, and the business terminates when the owner dies. On the other hand, all of the profits are also personal to the owner and the sole owner has full control of the business.
A partnership consists of two or more persons who agree to share profits and losses. It is simple to establish and maintain; no formal, written document is required in order to create a partnership. If no formal agreement is signed, the partnership will be subject to state laws governing partnerships. However, to clarify the rights and responsibilities of each partner, and to be certain of the tax status of the partnership, it is important to have a written partnership agreement.
Each partner’s personal assets are at risk. Any partner may obligate the partnership, and each individual partner is liable for all of the debts of the partnership. General partners also face potential personal legal liability for the negligence of another partner.
A limited partnership is similar to a general partnership, but has two types of partners: general partners and limited partners. General partners have broad powers to obligate the partnership (as in a general partnership), and are personally liable for the debts of the partnership. If there is more than one general partner, each of them is liable for the acts of the remaining general partners. Limited partners, however, are “limited” to their contribution of capital to the business, and must not become actively involved in running the company. As with a general partnership, limited partnerships are flow-through tax entities.
Limited Liability Company (LLC)
The LLC is a hybrid type of business structure. An LLC consists of one or more owners (“members”) who actively manage the company’s business affairs. The LLC contains elements of both a traditional partnership and a corporation, offering the liability protection of a corporation, with the tax structure of a sole proprietorship (if it has only one member), or a partnership (if the LLC has two or more members). Its important to note that in certain states, single-member LLCs are not afforded limited liability protection.
Corporations are more complex than either a sole proprietorship or partnership and are subject to more state regulations regarding their formation and operation. There are two basic types of corporations: C-corporations and S-corporations. There are significant differences in the tax treatment of these two types of corporations, however, they are both generally organized and operated in a similar manner.
Technical formalities must be strictly observed in order to reap the benefits of corporate existence. For this reason, there is an additional burden of detailed recordkeeping. Corporate decisions must be documented in writing. Corporate meetings, both at the shareholder and director levels, must be formally documented.
Corporations limit the owners’ personal liability for company debts. Depending on your situation, there may be significant tax advantages to incorporating.
Monday, August 22, 2016
Why Should I Incorporate my Small Business?
Not every small business needs to form an LLC in order to function. A child selling lemonade by the side of the road has no use for a Tax ID number. It doesn’t seem practical to set up a new business entity to host a garage sale or a Tupperware party. As a venture starts to grow from a hobby to a full-time job, however, there are questions every business owner should ask to determine whether it is best to incorporate the business into a legal entity.Read more . . .
Tuesday, July 12, 2016
Do You Need Meeting Minutes?
Regardless of the size of the business, corporations (including those organized under Subchapter S) must observe all of the required formalities in order to maximize the benefits of a corporation. Corporate meeting minutes document the decisions made by the company’s board of directors, and are necessary to preserve the “corporate veil” in the event of a lawsuit or other claim against the company. If corporate formalities are not observed, your own personal assets may be at risk.
One such formality is the maintenance of a corporate record book containing minutes of meetings conducted in accordance with the company’s bylaws. Even in a one-person corporation, board resolutions must be drafted, signed and kept in the corporate records.
Read more . . .
Monday, June 13, 2016
Limited Liability Company (LLC): An Overview
The limited liability company (LLC) is a hybrid type of business structure, offering business owners the best of both worlds: the simplicity of a sole proprietorship or partnership, with the liability protection of a corporation. A limited liability company consists of one or more owners (called “members”) who actively manage the company’s business affairs. LLCs are relatively simple to establish and operate, with minimal annual filing requirements in most jurisdictions.
The best form of business structure depends on many factors, and must be determined according to your particular business and overall goals:
LLC members enjoy a limited liability, similar to that of a shareholder in a corporation. In general, your risk is limited to the amount of your investment in the limited liability company. Since none of the members will have personal liability and may not necessarily be required to personally perform any tasks of management, it is easier to attract investors to the limited liability company form of business than to a general partnership.
LLC members share in the profits and in the tax deductions of the limited liability company while limiting the potential financial risks.
LLCs offer a relatively flexible management structure. The business may be managed either by members or by managers. Thus, depending on needs or desires, the limited liability company can be a hands-on, owner-managed company, or a relatively hands-off operation for its members where hired managers actually operate the company.
Because the IRS treats the limited liability company as a pass-through entity, the profits and losses of the company pass directly to each member and are taxed only at the individual level (which may or may not be an advantage to you, depending on the profitability of the LLC and your personal income tax bracket).
Members of an LLC have flexibility in dividing the profits and losses. In a corporation or partnership, profits must be divided according to percentage of ownership. However, with an LLC, special allocations are permitted, so long as they have a “substantial economic effect” (e.g. they must be based upon legitimate economic circumstances, and may not be used to simply reduce one member’s tax liability).
Limited liability companies are, generally, a more complex form of business operation than either the sole proprietorship or the general partnership. They are subject to more paperwork requirements than a simple partnership but less than a corporation. Annual filings typically include statement and nominal filing fee payable to the Secretary of State, informational returns to the IRS, and filing of a state tax return.
In certain jurisdictions, single member LLCs may not be afforded the same level of limited liability protection as that of an incorporated entity.
Also note that in many states, an LLC is prohibited from rendering “professional services” which can include companies providing services that require a license, registration or certification. Such professionals typically have to establish a Professional LLC which does not offer limited liability for professional malpractice.