tag:blogger.com,1999:blog-2614804625749844252024-02-25T02:29:16.835-05:00My Biz LawyerJeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.comBlogger75125tag:blogger.com,1999:blog-261480462574984425.post-87834933638102812482016-01-19T15:11:00.004-05:002016-01-19T15:41:22.998-05:00Issues to Consider When Offered Stock Options<div style="text-align: justify;">
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It is commonplace for start-ups and emerging companies to offer stock option to employees, consultants and service providers in conjunction with, or often in lieu of, cash compensation. For the employee, consultant or service provider, the offer of stock options can be an opportunity to share in the potential success of the company, but a potential recipient of stock options should be aware of certain important considerations before simply accepting stock options in a start-up or emerging companies. This discussion summarizes key aspects of stock options and issues you should consider when negotiating terms relating to the possible grant of stock options in a privately-held company.</div>
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<b>1. Stock Options</b>.</div>
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Before discussing the implications of receiving a grant of stock options as an employee or service provider, it is essential to understand the differences between stock options and other forms of equity -- such as Restricted Stock and Warrants. Stock options are issued to key employees, directors, and other service providers in exchange for services rendered to the company. Options are a compensatory vehicle intended to increase the compensation of the recipient through an appreciation (hopefully) in the value of the company. The recipient of the Options is given a right to acquire stock in the issuing company (the "issuer" or "grantor"). It differs from the actual grant of stock as the recipient (the "grantee", "optionee" or "option holder") does not actually acquire any stock in the issuer as a result of the grant, but only the right to acquire stock based on the terms and conditions set forth in the instrument granting the options. </div>
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The instrument granting the Option, often titled the Option Grant or Notice, provides the terms upon which the recipient of the Option has a right to actually acquire stock in the Issuer. The key components of any Option are as follows:</div>
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•<span class="Apple-tab-span" style="white-space: pre;"> </span>Date of Grant: date upon which the grant is made to the Optionee</div>
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•<span class="Apple-tab-span" style="white-space: pre;"> </span>Type of Grant: Incentive Stock Options versus Non-Statutory Options</div>
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•<span class="Apple-tab-span" style="white-space: pre;"> </span>Number of Shares: the number of shares that can be potentially be acquired by Optionee</div>
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•<span class="Apple-tab-span" style="white-space: pre;"> </span>Exercise Price: the amount per share, if any, that the Optionee must pay to acquire the shares</div>
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•<span class="Apple-tab-span" style="white-space: pre;"> </span>Vesting Schedule: the point(s) upon which all or a portion of the grant can be exercised </div>
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•<span class="Apple-tab-span" style="white-space: pre;"> </span>Term: the length of the options/expiration period, which is often 10 years</div>
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In addition, if an Option Plan has been adopted by the Company, the Notice of Option will state that the terms of the Plan are deemed incorporated in the Notice of Option. The Plan (which may also cover other forms of equity grants authorized by the Company in addition to Options), will address important administrative and tax issues as well as issues relating to (i) the types of equity authorized for issuance, including the nature of the Options (Incentive Stock Options and Non-Statutory Options), (ii) the effect of the death, disability, termination for cause of the option holder, (iii) the right, if any, of the Company to clawback vested options upon certain events, (iv) the effect if a corporate restructuring or similar event; and (v) the treatment of grants upon a change-in-control or similar corporate transaction. If the Issuer has not adopted a Plan, then these concepts should be addressed in the Option Grant or the Option Agreement -- which will also Option exercise procedure.</div>
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<b>2. How Restricted Stock and Warrants Differ from Options.</b></div>
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In contrast to Stock Options, <u>Restricted Stock</u> gives the grantee the right to purchase shares at fair market value or a discount, or at no cost. While the grantee acquires the shares at the time of the grant (subject to payment of the purchase price, if any) the grantee cannot actually take possession of the stock until the specified restrictions lapse, otherwise referred to as vesting. The vesting requirements can be based on the lapse of a period of time, the occurrence of a defined event or based on any other terms. Even after the vesting occurs, the company may still have a right to repurchase the shares from the grantee upon the occurrence of specified events (such as termination of employment or a "for cause" event). </div>
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<u>Warrants</u> are often confused with or seen as interchangeable with Stock Options, primarily because warrants have many of the features of Stock Options. A Stock Warrant gives the recipient the right to acquire stock in the Company either immediately or at a future date at a specified price. However, unlike options, warrants are not intended as compensation for services; instead, they are granted in the connection with a capital raise (equity or debt) as an added benefit to induce the investor/lender to provide the capital to the company. Options and Warrants may look similar, but they have markedly different tax treatments, you should always consult a tax advisor, but in the simplest terms:</div>
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<li style="text-align: justify;">Upon the exercise of an option, the employee/service provider is taxed at ordinary income tax rates on the spread between the exercise price (i.e., price paid) and then fair market value of the stock on the date of exercise and ton a sale of the stock, the appreciation is taxed at capital gains rates;</li>
<li style="text-align: justify;">There is no tax at the time of exercise of a warrant and only capital gains on the appreciation in the value of the stock</li>
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As a serious admonition, you cannot avoid the tax liabilities relating to options by simply labeling the grant as warrants. If the grant is compensatory in nature, namely given to an employee or service provider as compensation for services, it will be deemed an Option and taxed accordingly.</div>
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<b>3. Key Considerations and Possible Terms to Negotiate When Offered Stock Options.</b></div>
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If you are offered stock options, do not just accept them until you fully understand the Option terms. This means discuss the offer with a lawyer and your accountant so you understand the option terms and potential tax implications. The company may argue that the terms are non-negotiable, but this is generally not the case for two reasons: (i) even if the options are issued pursuant to a Plan, the company generally has the authority to set the option terms, is not required to offer all option holders the same terms, and can even deviate from the Plan as long the terms do not negatively affect other participants or create tax issues for the company, and (ii) if a Plan has not been adopted, the company may argue it is constraint by terms offered other option holders, but unless there is a contractual restriction or tax concern, the company has broad authority when setting the terms of the options.</div>
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The review of the option terms should the following topics.</div>
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A. <u>Type of Options</u> -- Are they Incentive Stock Options (ISOs) or Non-Statutory Options (NSOs). ISOs can only be offered to employees/directors and non consultants and other service providers. ISOs generally have a more favorable tax treatment since only the profit on the sale of the shares is taxed at capital gains rates the requisite holding periods are satisfied (as opposed to an NSOs, as to which the spread between the exercise price and fair market value on exercise is taxed as ordinary income and any profit on a subsequent sale is then taxed again at capital gains rates). Again, there are nuances, including application of the AMT to ISOs, and thus the tax treatment of the grant should be reviewed with an accountant.</div>
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B. <u>Amount of Shares</u> -- The amount of shares offered can be stated as an exact number or as a percentage of the outstanding shares. If the offer is for a specified percentage, there are two questions: (i) as of what date is the percentage calculated -- the date of the grant or at the time of exercise, understanding that your ownership percentage will be diluted if additional shares are subsequently issued by the company; and (ii) how is the number of outstanding shares calculated -- if not on a fully-diluted basis (which would include the total potential option pool, warrants, convertible notes, other rights convertible into stock), then be prepared to be significantly diluted.</div>
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C. <u>Vesting</u> -- While for employees, vesting is usually tied to continued employment, with a portion often vesting upon hire and the remainder vesting over time (often 3 or 4 years), it can be based on on certain events or milestones. For example, revenues, profit, growth in area of the business (such as number of customers, opening of new locations) and a wide-variety of other business metrics. If the vesting is based on continued employment, the terms should address issues with respect to temporary interruptions of employment, termination for reasons other than "cause," and termination (by the employee) "for good reason". If vesting is tied to conditions other than continued employment, the conditions should be clearly defined -- for example, how will "revenue" or "profit" be calculated or what if the milestones are not met due to changes in company business strategy or policies. </div>
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D. <u>Death and Disability</u> -- The terms of any option grant should address how any unvested options are treated in the event of death or disability of the option holder. A Plan or the grating instrument can state that the options terminate or that the company has the right to determine how they will be treated. Of course, as the option holder, you would want accelerated vesting, but a partial vesting may be a way to compromise.</div>
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E. <u>Change-in-Control</u> -- What happens to unvested options if the company is sold? In a word, it depends. If there is an option plan, does it provide for acceleration of vesting and, if so, under what circumstances? Is accelerated vesting left to the discretion of the company? If there isn't a plan, then the granting instrument may or may not address the matter. You may hear that there is a "Single Trigger" or "Double Trigger" acceleration, and you need to understand those terms and which one applies. A Single Trigger means that unvested options automatically vest upon the change-in-control whereas a Double Trigger adds the requirement of a termination within a period of time after the change-in-control. Other important issues include, to state a few, how is a "change-in-control" defined (f.e., not only sale of a controlling interest but also sale of all or substantially all of the assets of the company), what if the corporate transaction is a cash buy-out (and there is no surviving ore replacement stock in an acquisition) and there is a Double Trigger acceleration requirement, and what if there aren't specified terms addressing change-in-control or if acceleration is at the discretion of the company.</div>
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F. <u>Term</u>. Most options have a ten-year term, but make sure it isn't a shorter period.</div>
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G. <u>Right of First Refusal/Repurchase Rights </u>-- The ultimate goal is that you will want to exercise the option (assuming the exercise is not simply in the course of a liquidity event, like an acquisition) and become a shareholder because the increase in the valuation of the company. While you will not be a shareholder upon at the time of the grant, you need to be aware of any restrictions on the shares upon becoming a shareholder. The rights and obligations of a shareholder in a company are usually set forth in a Shareholder's Agreement (or, they can be in the Plan document, Company's Certificate of Incorporation or in the Option Agreement). Often the Company (and/or the shareholders) will have a right of first refusal in the event a shareholder seeks to sell its shares to a third party. Separately, the Company may have a right to repurchase the shares upon termination of an employee-shareholder or of any shareholder upon the occurrence of certain events (such as death, divorce or a "for cause" event). A Voting Agreement may also be a condition to becoming a shareholder. The simple point is that due diligence is necessary before deciding to accept options as a component of the compensation.</div>
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Disclaimer: The discussions in this Blog are for informational purposes and do not constitute legal advice nor create an attorney-client relationship. You are urged to seek the advise of an experienced lawyer who can provide counsel with respect to your corporate/business law matters.</div>
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Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-73779014719391635272014-11-22T13:10:00.000-05:002014-11-22T13:10:55.910-05:00The Essentials of a Good Shareholders' Agreement (Part II): Right of First RefusalI recently received a kind email regarding a post I did some time ago regarding the importance of the Shareholders Agreement: <u>http://mybizlawyer.blogspot.com/2012/12/why-you-need-shareholders-agreement.html</u>. The comment noted, however, that I had indicated there would be subsequent entries discussing key components of a good Shareholders' Agreement. In the vein of better late than never, the next several posts will focus on the key provisions of a Shareholders/ Agreement. The focus of this post is the <b>Right of First Refusal</b>.<br />
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1. <u>Why is a Right of First Refusal Important</u>?<br />
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A well-drafted Shareholders' Agreement should include a Right of First Refusal, granting the right of the corporation and/or other shareholders to purchase the shares of a selling shareholder before those shares can be legally sold to a third party. Absent the right, a selling shareholder can simply sell the shares to a third party -- which in theory does not sound like an issue, but in reality can be a nightmare for the business. Consider the issues that can arise when a shareholder is not restricted from selling its shares to whomever it wishes on whatever terms: the shares could be sold to someone you do not want to be in business with at a price that is substantially below the value of the business. Moreover, what if the selling shareholder is a founder or selling a controlling stake in the corporation -- regardless of the person's character, you may not see the purchaser as the right person to be holding the reigns of the business. Shareholders in a privately held company invest in a business because of a belief in the founders, and if a founder can just sell its interests to anyone without restriction, the very reason for owning the shares can be at risk. On the other side of the coin, as a founder, you often take in investments from others not only because of financial needs but also the expertise, reputation or relationships that an investor may bring to the business. When an investor sells without the restrictions of a Right of First Refusal, the founders should be concerned whether the purchaser is an appropriate partner for the business, and should not overlook the fact that as controlling shareholders the founders will owe a fiduciary duty to this new shareholder. Thus, the Right of First Refusal is essential to protect the interests of both the founders and investors.<br />
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2. <u>Who Can Have the Right of First Refusal?</u><br />
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The Right of First Refusal can be granted to the corporation, the shareholders or both. Often, the corporation will be granted the option to purchase the shares before they are required to be offered to the non-selling shareholders. Vesting the initial right in the corporation has the following advantages: <br />
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(i) it allows the corporation to "clean up" the capitalization table; in other words, reduce the number of shareholders and outstanding shares. By reducing the number of outstanding shares, the other shareholders benefit because their percentage of ownership will increase (i.e., if there are 200 outstanding shares, four shareholders each with 50 shares, they thereby each own 25% of the corporation; if a shareholder sells 50 shares to the corporation, the total outstanding shares drops to 150, and the three remaining shareholders would then each own 33% of the company);<br />
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(ii) the corporation now has additional shares it can offer to existing or a new investor, without diluting the existing shareholders, and<br />
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(iii) the corporation can prevent an existing shareholder from increasing its stake to a level that may not be viewed as ideal for the business.<br />
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If the Right of First is not given to, or exercised by, the corporation then the existing shareholders will have a right to purchase the shares. Note, that in a more complex structure where there are different classes of stock, holders of a particular series of stock (for example, Class A Preferred Shares) may be granted the Right of First Refusal in priority to, or exclusive of, other classes of stock). Again, giving the Right to the shareholders allows them to prevent a third-party buyer from becoming a shareholder and affords an opportunity to increase ownership in the business.<br />
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3. <u>When is the Right of First Refusal Triggered?</u><br />
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Of course, the Right of First Refusal is triggered upon a "sale" of the shares by an existing shareholder; however, what constitutes a "sale" or triggering event? Obviously, the Right should arise if a shareholder has an offer from a third party to purchase all or a portion of the shares owned by the selling shareholder. Other events can also trigger the obligation, such as an involuntary sale that is triggered by the occurrence of an event set forth in the Shareholders Agreement. These involuntary events can include the death, disability or retirement of a shareholder or for "cause" events like conviction of a crime, fraud, misappropriation, violation of non-compete or confidentiality requirements or breach of material company policies. In some circumstances, the selling shareholder may hold a particular license, and the suspension or loss of the license would jeopardize the status of the company as a professional services corporation, requiring the sale of the person's shares in the company. When drafting the Right of First Refusal, consider not only the events that, aside from a voluntary sale, should trigger the right, but also when is a triggering event deemed to occur -- f.e., what constitutes and who determines if a "disability" or a material breach of corporate policies has occurred.<br />
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4. <u>What are the Key Aspects of the Right of First Refusal?</u><br />
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<li>First, as noted above, identify who has the right: the corporation, the shareholders, and which shareholders (if any).</li>
<li>Second, detail when the right is triggered: (i) for a voluntary sale it is typically upon an offer to a third party and (ii) for an involuntary sale, the clause should explain what constitutes an (involuntary) triggering event and who will make the determination that it has occurred. For example, will a physician make the decision about whether a shareholder has a "disability" and if so how will that physician be selected.</li>
<li>Third, provide clear notice provisions: consider what details must be included in the<i> bona fide </i>third party offer, how long does the corporation/non-selling shareholder have to exercise its rights, and include a clear statement that the failure to exercise within a defined time period constitutes a waiver of the right.</li>
<li>Fourth, if the corporation does not purchase any or all of the offered shares, what are the rights of the non-selling shareholders, and if one or more non-selling shareholder does not exercise the right, can the others who exercised the right purchase a greater portion of the offered shares.</li>
<li>Fifth, in the case of an involuntary sale, how is the purchase price to be determined: this is the most difficult aspect of drafting a Right of First Refusal, requiring terms that address who makes the determination (such as an accountant, investment bank or other person with a particular expertise relating to the business) and what formula should be used (such as a multiple of gross or net revenues, net profit, discounted cash flow, book value or a host of other valuation procedures),</li>
<li>Sixth, if the right is exercised, what are the terms for closing the sale: (i) when must the corporation or non-selling shareholders close on the purchase of the shares; and (ii) is there a defined structure for payment of the purchase price (such as partial payment at closing and the remainder as a loan or are the proceeds of a Buy-Sell Insurance policy available).</li>
<li>Seventh, if the third party does not close the sale by a certain time period, must the shares be re-offered to the corporation/non-selling shareholders.</li>
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5. <u>A Word about Buy-Sell Insurance.</u><br />
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A dilemma can arise if the corporation or non-selling shareholders want to exercise the right but do not have the financial ability to do so at the time. As noted above, one way to address the issue is by including provisions for structuring the purchase through installment payments or a loan, alleviating the issue that arises when the corporation/non-selling shareholders want to exercise the right but lack the funds. Another mechanism that should strongly be considered is obtaining Buy-Sell Insurance. With Buy-Sell Insurance, the corporation (and the shareholders, if they obtain a policy as well), can fund the purchase the insurance proceeds of the policy. The insurance proceeds are used to purchase the shares upon defined events, which are usually death or disability of a shareholder (but can include other events). In the course of drafting the Shareholders' Agreement, the shareholders should consider the option of purchasing a Buy-Sell Insurance policy. If the company/shareholders are not in the position to do so, then the Right of First Refusal should include a provision that if a policy is obtained down the road, it will in the first instance be used to fund the purchase of the shares from the departing shareholder.<br />
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Needless to say, a well-drafted Right of First Refusal clause is an essential component of the Shareholders Agreement. As a word of caution, however, make sure the provision addresses the specific interests of the company and the shareholders rather than simply relying on a one-size-fits all approach. Considering who can exercise the right, when it is deemed triggered, how valuation is determined, and the options for funding the buy-out are crucial when drafting the provisions of a Right of First Refusal. <br />
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<i>Disclaimer: The discussions in this Blog are for informational purposes and do not constitute legal advice nor create an attorney-client relationship. You are urged to seek the advise of an experienced lawyer who can provide counsel with respect to your corporate/business law matters.</i>Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com1tag:blogger.com,1999:blog-261480462574984425.post-43161728705689308462014-08-12T13:41:00.001-04:002014-08-12T13:42:58.467-04:00Valuation Terms for a Buy/Sell, Operating Agreement and Shareholder AgreementIn prior posts, I stressed the importance for business owners to enter into an agreement that sets forth the right to require a redemption or buy-out of a owner's equity interest upon the occurrence of certain triggering events. Ideally, business owners should have a well-drafted document that addresses the buy-out rights as well as a number of other key issues relating to management and control, financial terms, restrictions on transfer of interests, and a number of other matters. Whether in the form of an Operating Agreement (for an LLC), a Shareholder Agreement (for a Corporation), the Partnership Agreement or in a separate Buy-Sell, it is imperative that the owner's of a business address these fundamental issues in writing. A major area of concern is the right to buy-out a partner upon the occurrence of certain triggering events, including death, disability, and "for cause" termination. Now let's say the partners have agreed that upon defined triggering events either the company (through a redemption of the interests) or the other partners can force a buy-out/termination of a partner or the partner's legal interests, the questions becomes how is that interest valued? Below are some thoughts about how to address the difficult issue regarding valuation in the context of a partner "buy-out."<div>
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1. <u>Include a Valuation Method in the Governing Agreement Between Business Partners.</u></div>
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Before examining how valuation should be addressed in the governing document among the partners, it is important to state what may be obvious but is often overlooked in these agreements: actually include provisions that detail the method or procedure for determining valuation. On many occasions, the governing agreement will only go half way -- it will include a redemption and/or buy-out right but not include how to value the departing owner's interest. As you can imagine, this invariably leads to costly litigation over the proper valuation of the business. Avoid creating a problem by including the valuation method in the governing document.</div>
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2. <u>There is no Single Valuation Method that is Appropriate for all Businesses.</u></div>
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The next question is what is the appropriate valuation method. The bottom line is there is no single correct answer, as it depends on a number of factors, including (i) the nature of the business, (ii) the operating history and status, and (iii) the perception of the partners. The nature of the business matters because, for example, you would not value a real estate holding company in the same way you would an online retailer. The operating history/status of the business is significant because it may not make sense to apply the same valuation method to a mature company with an established operating history and revenues to a pre-revenue start-up. Finally, there is the perception of the partners, which can create some of the biggest issues in determining valuation. For example, the partners of an early stage company may believe that even without any current revenues, they have a new technology or concept that will attract substantial investment and eventually substantial revenues, requiring the valuation to take into account their understanding of the potential market for their product.</div>
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3. <u>What are the Possible Valuation Methods or Procedures?</u></div>
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So, if no single method of valuation applies, how is the issue then addressed in the governing document? The answer is really a matter of the partners agreeing on the appropriate method. In some cases, the agreement will actually state a formula for calculating the valuation: whether it is book value, a multiple of gross or net income, an income multiple that looks at historical earnings, or a calculation based on discounted cash flow. In other circumstances, the partners may recognize that they are cannot determine the appropriate methodology or feel it may need to adjust as the company develops, and instead would rather leave it to a third party to determine the valuation. If the parties decide that engaging a professional to determine the valuation upon the triggering event, then they must next decide who would be engaged: obvious choices include a CPA, investment bank, or a company specializing in business valuations. Assuming a professional is to be engaged, the next question is how is that person/firm chosen? One possibility is to specifically name them in the agreement, but what if they are no longer in business at the time the valuation is needed. The parties can instead state that they will mutually agree who should be retained at the time of the triggering event, but what if they don't agree? An alternative which is often utilized is to set a time by which the parties have to agree, barring which they each choose a person to conduct the valuation, and subject to the reasonableness of the issued valuation opinions the final valuation is the average. Or, the agreement can provide that each party chooses their expert and the two experts then choose a third, with average of the three constituting the final valuation. Recognize, however, that engaging three experts can be costly, and the parties need to set forth how the fees will be paid (likely, they each pay their own expert and share the cost of the third one).</div>
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Lastly, the governing agreement should include provisions about timing -- in other words, when the valuation must be completed if the methodology is set forth in the agreement or when the experts must be chosen and their valuation opinion issued. Without clear deadlines, the process can drag-on without a timely resolution.</div>
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Disclaimer: The above does not create any attorney-client relationship and is for informational purposes only. It is important to retain a knowledgeable business lawyer before entering into any business relationship .</div>
Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-79937218477658085062014-05-13T09:03:00.002-04:002014-05-13T09:08:07.332-04:00Recovering Lost Profits In Business Litigation <div class="MsoNormal">
Today's post features a guest entry by James T. Hunt, Jr., <span style="background-color: #fff9ee; color: #222222; font-family: Georgia; font-size: 11.5pt; line-height: 17.633333206176758px;">a business litigator and a partner at Slater, Tenaglia, Fritz & Hunt, P.A.</span></div>
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Business lawsuits involving the claim of “lost profits” as
damages can present unique challenges, especially if your business cannot
identify specific transactions or deals that were lost due to the defendant’s
wrongful conduct or breach of a contract. Some states have strict guidelines
governing the ability to recover lost profits, while others actually prohibit
lost profit recovery in certain circumstances.</div>
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<b>A Tale Of Two States:
<st1:state w:st="on">New York</st1:state> vs. <st1:state w:st="on"><st1:place w:st="on">New Jersey</st1:place></st1:state><o:p></o:p></b></div>
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Despite their proximity and the similarity in contract
caselaw, <st1:state w:st="on">New York</st1:state> and <st1:state w:st="on">New Jersey</st1:state> have somewhat different standards
regarding recovery of lost profits. In <st1:state w:st="on">New
York</st1:state>, any business can recover its lost profits in a
lawsuit, regardless of how long the company has been operating. In fact, lost profits are somewhat treated the
same way as any other type of damages. <st1:state w:st="on">New Jersey</st1:state> courts,
however, have steadfastly refused to permit recovery of lost profits in cases
involving a new business, which known as the “new business rule.” Only an established business with a history
of revenue and profits can recover lost profits. </div>
<div class="MsoNormal">
<st1:state w:st="on"><st1:place w:st="on"><b><br /></b></st1:place></st1:state></div>
<div class="MsoNormal">
<st1:state w:st="on"><st1:place w:st="on"><b>New York</b></st1:place></st1:state><b><o:p></o:p></b></div>
<div class="MsoNormal">
<st1:state w:st="on"><br /></st1:state></div>
<div class="MsoNormal">
<st1:state w:st="on">New York</st1:state>
courts require a plaintiff to prove its lost profits in the same manner as any
other damages. Lost profits, therefore, must be proven with a “reasonable
certainty.” This does not mean that
absolute precise mathematical accuracy is required. Rather, courts are mindful
that a prediction of future profit is inevitably speculative to some
degree. </div>
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<br /></div>
<div class="MsoNormal">
In essence, there must be some rational basis on which to
support an award of lost profits. But a
request based on pure speculation will most certainly be rejected. Generally, three criteria need to be
satisfied to obtain an award of lost profits: (1) the damages were actually
caused by the breach, (2) the particular damages were fairly within the
contemplation of the parties to the contract at the time it was made, (in other
words, the damages were foreseeable), and (3) that the alleged loss is capable
of proof with reasonable certainty. <st1:state w:st="on">New York</st1:state> falls in the
majority of states that permit recovery of lost profits even if it is a new
business with no track record of profitability. A new business endeavor is held to the same
standard – it must prove lost profits with reasonable certainty. At the same time, however, a <st1:state w:st="on">New York</st1:state> court will not
allow an award to be based on pure conjecture or speculation. While the
standard is the same for an existing business or new business, in the case of a
new business a stricter standard is imposed because there is no experience from
which lost profits may be estimated with reasonable certainty and other methods
of evaluation may be too speculative. The more risky and speculative the
industry, the less likely a new business could prove lost profits with such
certainty. </div>
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<br /></div>
<div class="MsoNormal">
What constitutes “reasonable certainty” can be nebulous and
difficult to pin down. For example, in a leading <st1:state w:st="on">New York</st1:state> case, the court rejected a claim
for lost profits arising from a domed stadium that was never constructed. The
court concluded that the multitude of assumptions required to quantify the lost
profits award contained an impermissible level of “speculation and conjecture.”
Some of these questionable assumptions
included that the facility would be completed, available for use, and operating
profitably for over 20 years. In another federal <st1:state w:st="on">New York</st1:state> case, the court rejected as
speculative a lost profit calculation that assumed the occurrence of numerous
successive hypothetical transactions. The court found this constituted
precisely the sort of conjecture that the reasonable certainty standard
prohibits. </div>
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<br /></div>
<div class="MsoNormal">
In a Second Circuit Court of Appeals case, <u>Trademark
Research Corp. v. Maxwell Online, Inc.</u>,
a trademark search service brought suit against a software design firm
for alleged breach of a contract that required the defendant to create for the
plaintiff a trademark database and search system. The Second Circuit held that
plaintiff's claim for future profits from in-house trademark searches and sales
of disks providing direct access to plaintiff's database should not have been
presented to the jury because it was incapable of proof with reasonable
certainty as a matter of law. For
example, the plaintiff's accounting expert had assumed an abrupt expansion of the
market for trademark search services, assumed that plaintiff would reverse the
long decline in its market share, assumed that plaintiff's historically
aggressive competitors would take no measures to counter plaintiff's
ascendancy, and predicted which choices customers would make among a variety of
new and old search technologies. To cap it off, all of these assumptions were reduced
to speculative exact dollar amounts and spun out to the year 1998. Even though
there was a significant amount of evidence submitted, the court found that it
consisted of a “network of conjecture.”</div>
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<br /></div>
<div class="MsoNormal">
By contrast, an established business often is in a good
position to offer evidence of past experience as a reasonable basis from which
a jury may determine lost profits with the requisite degree of certainty. For
example, in a case involving a sidewalk café seeking lost profits for breach of
contract, the New York Court of Appeals upheld a jury award for lost profits.
The Court of Appeals held that the evidence of the past experience and profits
of the established restaurant to which the cafe would be attached was
sufficient “to remove plaintiff's lost profit claim from the realm of
impermissible speculation.” In a federal
<st1:state w:st="on">New York</st1:state>
case, a company in the business of selling costume jewelry through the mail
brought suit for breach of contract to distribute 8,000,000 advertising
supplements in newspapers. The company had been in business for over forty
years. The company offered statistical
evidence of its past performance in a remarkably similar advertising program. The
court found this evidence was sufficient to prove its lost profits with
reasonable certainty. </div>
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<st1:state w:st="on"><st1:place w:st="on"><b><br /></b></st1:place></st1:state></div>
<div class="MsoNormal">
<st1:state w:st="on"><st1:place w:st="on"><b>New Jersey</b></st1:place></st1:state><b><o:p></o:p></b></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
Just across the river, <st1:state w:st="on">New Jersey</st1:state> courts allow recovery of lost
profits but not if the business is new and has no history of generating
revenue. This rule is called the “new
business rule,” and is the law in a minority of states. Generally, profits lost
by reason of breach of contract may be recovered if there are any criteria by
which probable profits can be estimated with reasonable certainty. Indeed, <st1:state w:st="on">New Jersey</st1:state> courts do permit
considerable speculation by the trier of fact as to damages. As one court has
stated, “[t]he rule relating to the uncertainty of damages applies to the
uncertainty as to the fact of damage and not as to its amount, and where it is
certain that damage has resulted, mere uncertainty as to the amount will not
preclude the right of recovery.” Courts
have pointed out that the mere fact a plaintiff cannot pinpoint its damages
with laser preciseness should not get a breaching party off the hook, since the
breaching party caused the problem in the first place. Accordingly,
<span class="informationalsmall">the fact that a plaintiff may not be able to fix
its damages with precision will not preclude recovery of damages. But a request
for damages that is based on pure speculation and on mere opinion evidence
without factual support will not succeed. Again, “reasonable certainty” is the
touchstone. <o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
A lack of past performance is why <st1:state w:st="on">New Jersey</st1:state> continues to apply the New
Business Rule, which prohibits a new business from recovering lost profits. The
reasoning behind the new business rule is that lost profits cannot be
determined with a reasonable degree of certainty because there is not an
established history of revenue and profits. Under the New Business Rule, prospective profits of a new business are
considered per se too remote and speculative to meet the legal standard of
reasonable certainty. The short existence
of the entity makes a determination of lost profits too speculative. A <st1:state w:st="on">New Jersey</st1:state> appellate
court acknowledged it is in the minority of states that preclude lost profits
in new business cases, and conceded that it was without any power to award such
damages unless the New Jersey Supreme Court changed the law. </div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
So what constitutes a “new business”? The answer is decided upon a case-by-case
analysis of the individual factual circumstances involved and the type of
industry in which the business operates. For example, in one case an appellate
court deemed a 2 ½ year old business to be “new.” The business offered
educational, recreational and entertainment services for children, teens, and
adults in one modern community center.
In so doing, the court deemed the business “new and unproved.” Under
other circumstances, courts have permitted an award of lost profits where the
business had operated only two years (from 1996 to 1998). In fact, the Third
Circuit Court of Appeals has permitted lost profits for a business operating
for only 1 ½ years. Obviously, the more risky and speculative the industry, the
less likely a newer business could prove lost profits. </div>
<div class="MsoNormal">
<b><br /></b></div>
<div class="MsoNormal">
<b>Past Is Prologue<o:p></o:p></b></div>
<div class="MsoNormal">
<span class="informationalsmall"><br /></span></div>
<div class="MsoNormal">
<span class="informationalsmall">So how important is it to
demonstrate past performance? In fact it is the key to recovering lost profits.
Past experience of an ongoing, successful business can provide a reasonable
basis for the computation of lost profits with a satisfactory degree of
definiteness. Past profit experience on
other projects is widely accepted as relevant to a determination of damages
based on lost profits. Courts have held
that evidence of such a past performance may form the basis for a reasonable
prediction as to the future. In
addition, courts have accepted other evidence of the profitability of a
business, such as industry-wide information and projections and even revenue
data of a competitor. While a newer business with no track record may
ultimately be able to recover lost profits, it will be a much more difficult
task than a business with a solid, several-years record of profitable
performance. </span></div>
<div class="MsoNormal">
<b><br /></b></div>
<div class="MsoNormal">
<b>Proving Your Damages:
The <st1:city w:st="on"><st1:place w:st="on">Battle</st1:place></st1:city> of
the Experts<o:p></o:p></b></div>
<div class="MsoNormal">
Proving a company’s lost profits to a reasonable degree of
certainty will most likely require expert testimony. In most cases, if the
stakes are high, a battle of the experts will ensue, where both parties retain
experts who submit differing and contradictory expert opinions. Victory will then hinge on which side
retained the most convincing expert. While
it is possible to use the owner of the business as a sort of “expert” given his
or her deep knowledge of the business and the industry, it is far too risky to
go it alone without a qualified expert. Experts will have to analyze the
company’s operating and revenue history, its costs and expenses, and forecast a
lost profit figure that can pass muster. Retaining a highly competent, qualified,
and trial-experienced accountant as your expert is a necessity. </div>
<div class="MsoNormal">
<b><br /></b></div>
<div class="MsoNormal">
<b>Jurisdiction is
Important<o:p></o:p></b></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
If you have the option to file a lawsuit in several
different jurisdictions, it is always important to confer with an experienced
business law attorney to determine which jurisdiction will be most beneficial
to you. This is especially true if you have a new business that intends to
claim lost profits as part of the damages suffered. Certain factors may dictate
where you can sue and what state law applies to the case. For example, if the
matter involves an inter-state transaction across jurisdictional lines,
determining “where” the transactions occurred as a legal matter will impact
your case. Further, your contract may contain a choice of law provision that requires
application of the law of a particular state.
You need an experienced business lawyer to assess the ramifications of
such a provision and the hurdles the applicable state’s law would raise in your
case. </div>
<br />
<div class="MsoNormal">
<span style="background: #FFF9EE; color: #222222; font-family: Georgia; font-size: 11.5pt; line-height: 115%;"><br /></span></div>
<div class="MsoNormal">
<span style="background: #FFF9EE; color: #222222; font-family: Georgia; font-size: 11.5pt; line-height: 115%;"><span style="font-size: 11.5pt; line-height: 115%;">About the author:<span class="apple-converted-space"> </span></span><span style="background-color: transparent; font-family: Calibri; font-size: 11pt; line-height: 115%;"><a href="http://www.stfhlaw.com/our-people/james-t-hunt-jr/" target="_blank"><span style="background-position: initial initial; background-repeat: initial initial; color: #888888; font-family: Georgia; font-size: 11.5pt; line-height: 115%;">James Hunt</span></a></span><span class="apple-converted-space" style="background-color: transparent;"><span style="background-position: initial initial; background-repeat: initial initial; font-size: 11.5pt; line-height: 115%;"> </span></span><span style="font-size: 11.5pt; line-height: 115%;">is
a business litigator and a partner at </span><span style="background-color: transparent; font-family: Calibri; font-size: 11pt; line-height: 115%;"><a href="http://www.stfhlaw.com/" target="_blank"><span style="background-position: initial initial; background-repeat: initial initial; color: #888888; font-family: Georgia; font-size: 11.5pt; line-height: 115%;">Slater, Tenaglia, Fritz & Hunt, P.A.</span></a></span><span style="font-size: 11.5pt; line-height: 115%;">, a
commercial and business litigation firm with offices in NY and NJ. </span><span style="background-color: transparent; font-family: Calibri; font-size: 11pt; line-height: 115%;">To learn more about
claiming lost profits, contact <a href="http://www.stfhlaw.com/" target="_blank"><span style="background-position: initial initial; background-repeat: initial initial; color: #888888; font-family: Georgia; font-size: 11.5pt; line-height: 115%;">Slater, Tenaglia, Fritz & Hunt, P.A.</span></a></span><span style="font-size: 11.5pt; line-height: 115%;">, </span><span style="background-color: transparent; font-family: Calibri; font-size: 11pt; line-height: 115%;">to schedule a free initial
consultation</span></span></div>
Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-77562457929738425722014-03-28T11:54:00.001-04:002014-03-28T11:54:13.759-04:00My Biz Lawyer: Due Diligence and the Business Transaction: Making...<a href="http://mybizlawyer.blogspot.com/2014/03/due-diligence-and-business-transaction.html?spref=bl">My Biz Lawyer: Due Diligence and the Business Transaction: Making...</a>: Even fledgling entrepreneurs are aware of the importance of conducting due diligence in a business transaction, but possessing a true und...Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-60207433847435482002014-03-28T11:51:00.002-04:002014-03-28T11:51:28.562-04:00 Due Diligence and the Business Transaction: Making the Examination Fit the Deal <div class="MsoBodyText" style="margin-bottom: 6.0pt; margin-left: .3in; margin-right: .3in; margin-top: 0in;">
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
<div class="MsoNormal" style="line-height: 115%; text-align: justify;">
<span style="font-family: Arial, Helvetica, sans-serif;">Even fledgling entrepreneurs are aware of the importance of conducting due diligence in a business transaction, but possessing a true understanding of the process is another story. <span lang="X-NONE">A simple dictionary definition of the
meaning will generally focus on analyzing a company in the context of corporate mergers or a stock purchase. However, as with any simple definition, reducing an understanding of </span>a <span lang="X-NONE">due diligence </span>investigation <span lang="X-NONE">to a few
words paints a woefully incomplete picture of </span>its <span lang="X-NONE">significance </span>in <span lang="X-NONE">a business transaction. If there is any one concept
that should be emphasized before entering into any business transaction</span>,<span lang="X-NONE"> it is this: </span></span><span style="font-family: Arial, Helvetica, sans-serif;"><i>Do not engage in any
important business transaction until a due diligence investigation that is tailored
to the the nature, scope, and terms of the transaction has been completed. </i></span></div>
<div style="text-align: justify;">
<span style="font-family: Arial, Helvetica, sans-serif;"><br /></span></div>
<div style="text-align: justify;">
<span style="font-family: Arial, Helvetica, sans-serif;">We conduct due diligence all of the time in our daily lives. We make decisions about purchasing
goods or engaging someone's services based on certain considerations with or without consciously
realizing that what we are actually doing is a form of due diligence. It is common for us to conduct due diligence and make
decisions about familiar and not-so-familiar transactions—such as trying a new
restaurant, downloading a smartphone application, buying the latest high-definition
television, hiring a lawyer, and so on— and although we might not
realize it, we routinely engage in legal, financial, technology, personal, and other forms of due diligence depending on
the product or service we are considering buying. the legwork required to be a well-informed consumer and to ensure you are getting
the right product or service at the right price is simply a less structured and
less detailed form of the due diligence an entrepreneur should perform before entering
into a business transaction.</span></div>
<div style="text-align: justify;">
<span style="font-family: Arial, Helvetica, sans-serif;"><br /></span></div>
<div style="text-align: justify;">
<span style="font-family: Arial, Helvetica, sans-serif;">Before purchasing a product or engaging a service,
diligent consumers research the company/service provider, research the product
or the services, try to determine the value of the product or services being
offered, and, sometimes, conduct a background check or investigation of potential
hires. Parties to a potential business transaction apply due diligence criteria similar
to those precautions consumers perform before buying products or hiring professional
services: they will investigate the company and its business operations, research the
products or services offered by the company, determine the appropriate
valuation of the target business, examine
management capabilities and perform background checks and investigations of
founders and key personnel. D</span><span lang="X-NONE" style="font-family: Arial, Helvetica, sans-serif;">ue diligence<i> </i>therefore<i> </i>involves the process of examining and developing the necessary level of understanding of (i) </span><span style="font-family: Arial, Helvetica, sans-serif;">the </span><i style="font-family: Arial, Helvetica, sans-serif;"><span lang="X-NONE"><b>company</b></span></i><span lang="X-NONE" style="font-family: Arial, Helvetica, sans-serif;"> and (ii) its<i> <b>business operations</b></i> (</span><span style="font-family: Arial, Helvetica, sans-serif;">in other words,</span><span lang="X-NONE" style="font-family: Arial, Helvetica, sans-serif;"> its products, assets</span><span style="font-family: Arial, Helvetica, sans-serif;">,</span><span lang="X-NONE" style="font-family: Arial, Helvetica, sans-serif;"> and/or services and how the company functions)</span><span style="font-family: Arial, Helvetica, sans-serif;">;</span><span style="font-family: Arial, Helvetica, sans-serif;"> (iii) </span><span lang="X-NONE" style="font-family: Arial, Helvetica, sans-serif;">determining an appropriate <b><i>valuation</i> </b>of a business</span><span lang="X-NONE" style="font-family: Arial, Helvetica, sans-serif;"> and the transaction</span><span style="font-family: Arial, Helvetica, sans-serif;">;</span><span lang="X-NONE" style="font-family: Arial, Helvetica, sans-serif;"> and (iv) vetting <i style="font-weight: bold;">personnel </i><i>(</i>management capabilities, key personnel and employment matters) before entering into a business transaction with, investing in, licensing assets or services </span><span style="font-family: Arial, Helvetica, sans-serif;">of, </span><span lang="X-NONE" style="font-family: Arial, Helvetica, sans-serif;">or purchasing all or part of a business or its assets</span><span style="font-family: Arial, Helvetica, sans-serif;">.</span><span style="font-family: Arial, Helvetica, sans-serif;"> </span><span style="font-family: Arial, Helvetica, sans-serif;">I call these four aspects of any business the</span><span style="font-family: Arial, Helvetica, sans-serif;"> </span><i style="font-family: Arial, Helvetica, sans-serif;">business cornerstones</i><span style="font-family: Arial, Helvetica, sans-serif;">.</span></div>
<div>
<br /></div>
<div style="text-align: justify;">
<span style="font-family: Arial, Helvetica, sans-serif;"><span lang="X-NONE">Whether you are buying or investing in a business, entering into a joint venture or partnership, considering making a business loan, or entering into a variety of other business transactions, you should focus on these business cornerstones before entering into any type of transaction</span>. While <span lang="X-NONE">the
amount of focus given </span>to <span lang="X-NONE">each of these areas var</span>ies<span lang="X-NONE"> greatly depending on the nature of the transaction and the goals
of the parties, </span><span lang="X-NONE">these four aspects of
any business should comprise the basis for the due diligence investigation. </span></span><span lang="X-NONE" style="font-family: Arial, Helvetica, sans-serif;">What should you learn from your
examination of the cornerstones?</span><span lang="X-NONE" style="font-family: Arial, Helvetica, sans-serif;"> The </span><span lang="X-NONE" style="font-family: Arial, Helvetica, sans-serif;">goals of a due diligence examination
corresponding to each of the four business cornerstones are shown in the Table below:</span></div>
<div>
<div class="MsoBodyText">
<br /></div>
<div class="TableCaption">
<span style="font-family: Arial, Helvetica, sans-serif;"><b>Table: </b>Due
Diligence Goals<o:p></o:p></span></div>
<table border="1" cellpadding="0" cellspacing="0" class="MsoNormalTable" style="border-collapse: collapse; border: none; mso-border-alt: solid windowtext .5pt; mso-border-insideh: .5pt solid windowtext; mso-border-insidev: .5pt solid windowtext; mso-padding-alt: 0in 5.4pt 0in 5.4pt; mso-yfti-tbllook: 480;">
<tbody>
<tr>
<td style="border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 203.4pt;" valign="top" width="271"><div class="TableHead">
<span style="font-family: Arial, Helvetica, sans-serif;">The Business Cornerstone<o:p></o:p></span></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="TableHead">
<span style="font-family: Arial, Helvetica, sans-serif;">The Due Diligence Goal<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 203.4pt;" valign="top" width="271"><div class="TableText">
<span style="font-family: Arial, Helvetica, sans-serif;">The Company<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="TableText">
<span style="font-family: Arial, Helvetica, sans-serif;">To understand the
legal and financial structure of the company and identify potential
organizational or structural risks<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 203.4pt;" valign="top" width="271"><div class="TableText">
<span style="font-family: Arial, Helvetica, sans-serif;">The Business Operations<o:p></o:p></span></div>
<div class="TableText">
<br /></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="TableText">
<span style="font-family: Arial, Helvetica, sans-serif;">To understand the
nature of the business and its products, assets, and services; the
operational aspect of the business, and to identify potential legal,
financial, and business risks<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 203.4pt;" valign="top" width="271"><div class="TableText">
<span style="font-family: Arial, Helvetica, sans-serif;">Valuation<o:p></o:p></span></div>
<div class="TableText">
<br /></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="TableText">
<span style="font-family: Arial, Helvetica, sans-serif;">To determine an appropriate valuation of
the company and/or the transaction and identify potential financial risks<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 203.4pt;" valign="top" width="271"><div class="TableText">
<span style="font-family: Arial, Helvetica, sans-serif;">Personnel<o:p></o:p></span></div>
<div class="TableText">
<br /></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="TableText">
<span style="font-family: Arial, Helvetica, sans-serif;">To identify the
key personnel and ascertain whether they are capable of operating the
business, executing business plans, and/or fulfilling post-closing obligations<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
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<span style="line-height: 115%;"><span style="font-family: Arial, Helvetica, sans-serif;"><br />The common
denominator of these four goals is that the due diligence process impart to you
a level of understanding of the company, its business and operations that is sufficient
to enable you to decide whether to engage in the contemplated transaction. To
achieve this appreciation, the due diligence investigation necessarily involves,
not only examining materials and data provided
by the company or your potential business partner but also information obtained from various sources, including public and private information and the advice of
professional consultants. </span></span></div>
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<span style="font-family: Arial, Helvetica, sans-serif; line-height: 115%;">Simply put, think of due diligence as a
process of first hearing the company’s business story—as it may have been
provided in an investment presentation or business plan—and then conducting an
investigation to corroborate the story. </span><span style="font-family: Arial, Helvetica, sans-serif; line-height: 115%;">A proper due diligence examination will focus on the four business cornerstones, and includes not only broad-based legal and financial questions, but also requires
that you identify the critical areas of the business and thereby gear your inquiries
to the specific business and the nature of the transaction involved. It is not enough rely on the standard due diligence set of questions; instead, tailoring the due diligence to the target company’s business operations and </span><span style="font-family: Arial, Helvetica, sans-serif;">the underlying facts of the transaction</span><span style="font-family: Arial, Helvetica, sans-serif; line-height: 115%;"> is essential to conducting a productive due
diligence examination. </span></div>
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<span style="line-height: 16.866666793823242px;"><span style="font-family: Arial, Helvetica, sans-serif;">For a a comprehensive discussion of the role of due diligence in a wide variety of business transactions, please see <u style="font-weight: bold;">Due Diligence and the Business Transaction: Getting a Deal Done</u>, by Jeffrey W. Berkman (Apress 2013) (available on Amazon and Barnes & Noble) </span></span></div>
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<span style="line-height: 16.866666793823242px;"><span style="font-family: Arial, Helvetica, sans-serif; font-size: x-small;">Disclaimer: The above is for informational purposes only and does not constitute legal advice. You are advised to consult an experienced business lawyer before entering into any business transaction.</span></span></div>
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Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-8270014386526396752013-12-05T09:10:00.001-05:002013-12-05T09:20:48.103-05:00Due Diligence is Important in a Variety of Business Transactions.The due diligence process should not be limited to buying or investing in a business. It should be conducted in a variety of business transactions, including if you are becoming a partner in a new or existing business, licensing intellectual property, or a taking on a new business partner. And, if you are considering selling your business or taking on new investors, conduct due diligence on your business first so that potential issues can be resolved before they are discovered by a potential purchaser or investor.<br />
<br />
<b><u>Due Diligence and the Business Transaction: Getting a Deal Done (Apress 2013)</u> </b>is a practical guide to due diligence for anyone buying or selling a privately held business or entering into a major agreement with another company or business partner. The book will help you understand when to conduct due diligence, whom to include, and how to spot the red flags that signal danger. In addition, you will learn:<br />
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· How to conduct due diligence when contemplating a variety of business transactions, including a business loan, purchase of a business, investment, commercial real estate transaction, franchise opportunity, or licensing deal<br />
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· How to calibrate the correct scope and breadth of the due diligence investigation depending on your situation<br />
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· How the results of due diligence may and often will change the elements of the final deal<br />
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· How to draft due diligence documents so they protect your interests.<br />
<br />
The book is available at <a href="http://www.apress.com/9781430250869">http://www.apress.com/9781430250869</a> or on Amazon.Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-47900443675171453942013-02-15T10:11:00.001-05:002013-02-15T10:11:44.473-05:00Crowdfunding: When Will the SEC Finally Enact the Implementing Rules?<div class="normal" style="margin: 0pt;">
<span style="font-family: Arial;">The below was released in conjunction with Sequel Technology & IP Law (SequelTech), which is Of Counsel to The Berkman Law Firm, PLLC</span></div>
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<span style="font-family: Arial;"><span style="mso-tab-count: 8;"> </span>Media Contact:</span></div>
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<span style="font-family: Arial;"><span style="mso-tab-count: 8;"> </span>Dan Shafer, Shafer Media</span></div>
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<span style="font-family: Arial;"><span style="mso-tab-count: 8;"> </span>831-531-4679</span></div>
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<span style="font-family: Arial;"><span style="mso-tab-count: 8;"> </span>dan@shafermedia.com</span></div>
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<a href="http://www.blogger.com/null" name="h.fidvbhye02om"></a><span style="font-family: Arial;">Crowdfunding: A Hot Potato </span></h2>
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<a href="http://www.blogger.com/null" name="h.p3w6q7nwmu8g"></a><span style="font-family: Arial;">on Which the SEC Must Make Decisions Soon</span></h2>
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<span style="font-family: Arial;">WASHINGTON, D.C., Feb. 13, 2013 -- Attorneys at Sequel Technology & IP Law, PLLC (Sequeltech), a well-known intellectual property firm based in Washington, D.C., are calling for the Securities and Exchange Commission (SEC) to move the process of regulating so-called “crowdfunding” Web sites closer to its front burner.</span></div>
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<span style="font-family: Arial;"><i style="mso-bidi-font-style: normal;">W</i>hen President Obama signed into law the Jump Start Our Business Startups (JOBS) legislation in April, 2012, he and Congress took official notice of the existence for the preceding few years of a fund-raising technique for small and startup businesses called “crowdfunding.” The law established a broad framework for crowdfunding Web services like Project Kickstarter (</span><a href="http://www.kickstarter.com/"><span style="color: #1155cc;"><span style="font-family: Arial;">http://www.kickstarter.com</span></span></a><span style="font-family: Arial;">), Indiegogo (</span><a href="http://www.indiegogo.com/"><span style="color: #1155cc;"><span style="font-family: Arial;">http://www.indiegogo.com</span></span></a><span style="font-family: Arial;">) and EquityNet (</span><a href="https://www.equitynet.com/"><span style="color: #1155cc;"><span style="font-family: Arial;">https://www.equitynet.com/</span></span></a><span style="font-family: Arial;">), which actually pioneered the field.</span></div>
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<span style="font-family: Arial;">“Up to now, crowdfunding services have been acting as mostly passive intermediaries between companies seeking funding for projects and products and large numbers of individuals who are interested in providing small-dollar donations to help them along,” says Jeffrey W. Berkman, Of Counsel to SequelTech.</span></div>
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<span style="font-family: Arial;">Companies who use crowdfunding sites to raise capital do not offer securities in return. Rather, they provide themed give-aways, credits on a movie, a chance to get a pre-release or free copy of the product, and the like.</span></div>
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<span style="font-family: Arial;">From the start, crowdfunding sites have been viewed with suspicion and wariness by traditional securities brokers and salespeople. They clearly operate outside any framework of SEC regulations. However, in the current economic climate, many government officials see these sites as providing a much-needed service for companies that need to raise capital but can’t afford the sometimes staggering fees associated with registering a stock offering with the government </span><span style="font-family: Calibri; font-size: 12pt; line-height: 150%; mso-bidi-font-family: Calibri; mso-bidi-font-size: 11.0pt;">or raising funds through the current framework of a private placement.</span></div>
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<span style="font-family: Arial;">With the passage of the JOBS Act, the SEC was given authority over these unconventional funding services. A few broad guidelines were included in the legislation:</span></div>
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<span style="mso-fareast-font-family: Arial;"><span style="mso-list: Ignore;"><span style="font-family: Arial;">○</span><span style="font: 7pt 'Times New Roman';"> </span></span></span><span style="font-family: Arial;">Businesses wishing to avail themselves of crowdfunding must not raise more than $1 million per year through the mechanism.</span></div>
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<span style="mso-fareast-font-family: Arial;"><span style="mso-list: Ignore;"><span style="font-family: Arial;">○</span><span style="font: 7pt 'Times New Roman';"> </span></span></span><span style="font-family: Arial;">Crowdfunding sites will be required to be registered with a self-regulatory organization and regulated by the SEC.</span></div>
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<span style="mso-fareast-font-family: Arial;"><span style="mso-list: Ignore;"><span style="font-family: Arial;">○</span><span style="font: 7pt 'Times New Roman';"> </span></span></span><span style="font-family: Arial;">There will be some sort of means test to insure investors are qualified in the sense that investors in other, more traditional, private placement offerings are qualified, albeit with perhaps fewer restrictions.</span></div>
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<span style="mso-fareast-font-family: Arial;"><span style="mso-list: Ignore;"><span style="font-family: Arial;">○</span><span style="font: 7pt 'Times New Roman';"> </span></span></span><span style="font-family: Arial;">The firm behind the crowdfunding site </span><span style="font-family: Calibri; font-size: 12pt; line-height: 150%; mso-bidi-font-family: Calibri; mso-bidi-font-size: 11.0pt;">must be a broker or can be a non-broker but it still must be registered with the</span><span style="font-family: Arial;"> SEC.</span></div>
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<span style="mso-fareast-font-family: Arial;"><span style="mso-list: Ignore;"><span style="font-family: Arial;">○</span><span style="font: 7pt 'Times New Roman';"> </span></span></span><span style="font-family: Calibri; font-size: 12pt; line-height: 150%; mso-bidi-font-family: Calibri; mso-bidi-font-size: 11.0pt;">Significantly, crowdfunding will allow general advertising and solicitation to accredited investors in a non-registered offering, which is prohibited under securities law.</span></div>
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<span style="font-family: Arial;">But the passage of the JOBS Act didn’t have the immediate effect of clarifying the rules and regulations which would govern crowdfunding. </span><span style="font-family: Calibri; font-size: 12pt; line-height: 150%; mso-bidi-font-family: Calibri; mso-bidi-font-size: 11.0pt;">Rather, the JOBS Act placed the obligation on the SEC to adopt the required rules and regulations for implementation.</span></div>
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<span style="font-family: Calibri; font-size: 12pt; line-height: 150%; mso-bidi-font-family: Calibri; mso-bidi-font-size: 11.0pt;">“Unfortunately, up to now the SEC has failed to enact the implementing rules and regulations governing crowdfunding,” SequelTech Founder and Managing Partner Melise Blakeslee points out.<span style="mso-spacerun: yes;"> </span>There is speculation as to why the outgoing SEC Chairman failed to act by the January 31, 2013 deadline.<span style="mso-spacerun: yes;"> </span>However, with the appointment of Mary Jo White as SEC Chairman, Berkman sees the dawning of a new era at the SEC. “</span><span style="font-family: Arial;">Chairman White,” he says, “has a reputation for being tough and getting things done, so many observers who want to see crowdfunding clarified and properly regulated are expressing hope that the time may now come soon.”</span></div>
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<span style="font-family: Arial;">It will soon be a year since the JOBS Act was signed into law. The crowdfunding industry has continued to grow and prosper. Thousands of companies, projects and non-profit organizations have received funding. But so long as the SEC fails to issue the needed regulations spelling out in detail the restrictions it will impose on these Websites, crowdfunding, which is hailed by many start-ups and emerging companies as a game-changing opportunity to raise funds, remains unavailable.</span></div>
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<span style="font-family: Arial;">What does this mean if you’re interested in funding a product or project via a crowdfunding site? It means you’ll want your attorneys to keep a close eye on the SEC regulatory process so that you can make timely adjustments to your plans and fund-raising tactics as needed without losing out on the enormous potential of crowdfunding. “And if you’re thinking about starting a new business to get in on the ground floor of crowdfunding, you should pay close attention to the news about the forthcoming SEC regulations,” warns Blakeslee.</span></div>
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<span style="font-family: Arial;">ABOUT SEQUEL TECHNOLOGY & IP LAW PLLC</span></div>
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<span style="font-family: Arial;"><span style="mso-tab-count: 1;"> </span>Sequel Technology & IP Law (SequelTech) is a Washington, D.C.-based law firm specializing in intellectual property and high-technology law. Founded in 2009, the firm is headed by Managing Partner Melise Blakeslee. <em>Melise Blakeslee and Jeffrey W. Berkman work together as "of counsel" on various business law, IP and high-technology law matters for clients in a variety of industries. </em></span></div>
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<span style="font-size: xx-small;">Disclaimer: The discussions in this Blog do not constitute legal advice nor create an attorney-client relationship. You are urged to seek the advise of an experienced lawyer who can provide counsel with respect to your corporate/business law matters.</span>Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-34407263667843317622012-12-18T11:31:00.001-05:002012-12-18T11:31:18.752-05:00Why You Need a Shareholders Agreement (Part I)If you are forming a corporation with a partner, regardless of whether it is with your best friend that you have known since birth or a new business relationship, executing a well-crafted Shareholders Agreement is essential. Too often, partners mistakenly believe that the corporate By Laws answer all the questions and will adequately set the parameters for the relationship between shareholders. While the By-laws address day-to-day operations of the corporation, the Shareholder Agreement is where a number of specific rights and obligations of the shareholders are set forth. Common provisions of a Shareholders Agreement will address such issues as voting rights, restrictions on voluntary and involuntary transfers of stock, buy-out clause, non-competition obligations, death, incapacity or divorce of a shareholder, and limitations on Board of Directors powers. The next several posts will address the importance of the Shareholders Agreement, some of the common provisions, as well as several issues that are often overlooked in drafting the Agreement.<br />
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1. <u>Do Not Confuse the Articles, By-laws and Shareholders Agreement</u>.<br />
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Entrepreneurs forming a corporation for the first time may find that they are unclear as to the differences between the Certificate of Incorporation (or Articles of Incorporation), By-laws and the Shareholders Agreement:<br />
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A. <i>Certificate of Incorporation</i>: This document (which often have a different name outside of New York, such as Articles of Incorporation), is the only document that must be filed in New York to form a corporation. As with many states, New York provides a simple form requiring only limited information to be included in the Certificate (name of the entity, purpose, county where located, number of authorized shares, and name of registered agent). While you may draft your own form, the simple New York form is all that is required to incorporate. There are siutations where you might draft your own Certificate of Incorporation, as where there are different classes stock, and the Certificate of Incorporation will be more complex. However, the basic Certificate of Incorporation is a bare-bones document that does not address any issues relating to corporate governance, authority of the Board of Directors, or the rights and obligations of the shareholders. <br />
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B. <i>By-laws of a Corporation</i>. The By-laws serve the purpose of setting forth important terms relating to the governance of the corporation. Thus, the By-laws establish important aspects for day-to-day operation of the corporation:<br />
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(i) Board of Directors: the number of members of the Board of Directors, meetings of the Board, voting, removal, vacancies, and powers of the Board of Directors;<br />
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(ii) Shareholders: Annual and Special Meetings of Shareholders, including notice, voting, and general procedures;<br />
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(iii) Officers: election/appointment and removal procedures and authority of officers;<br />
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(iv) Indemnification: indemnification of Directors, officers, employees of the corporation; and<br />
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(v) Miscellaneous: Stock, Maintaining Books and Records, Seal of the Corporation, Amendments to the By Laws. <br />
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C. <i>The Shareholders Agreement</i>. The Shareholders Agreement is the document among the Shareholders and the Corporation where a number of specific rights and obligations of the shareholders and the corporation are detailed. The Shareholder Agreement is a contract, and can include essentially any terms that do not violate the New York Business Corporation Law (or any other applicable law). Typical provisions can include voting agreements or rights among the shareholders, restrictions on voluntary transfers of stock (i.e., selling stock to a third-party) and involuntary transfers (death, bankruptcy or divorce of a shareholder), a buy-out clause, non-competition obligations, information rights of shareholders, and limitations on authority of the Board of Directors and dispute mechanisms.<br />
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2. <u>Why the Shareholder Agreement is Essential</u>.<br />
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The Shareholder Agreement is essential as it clarifies the rights and obligations of the Shareholders between each other as well as certain obligations of the corporation to the shareholders that are not otherwise included in the By-laws. Too often entrepreneurs, to their peril, are willing to rely on the relationship with their friend (now business partner) or believe they lack the negotiating position to ask for certain rights as a condition of an investment or becoming a minority partner in a business. A well-drafted Shareholders Agreement not only helps delineate the rights of the business partners, but it will in most cases resolve any disputes before they arise because the issue will have been addressed in the Agreement. <br />
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Below are some typical disputes that will be alleviated with a Shareholders Agreement:<br />
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<li>Deadlock in a 50/50 corporation</li>
<li>The sale of shares by your business partner to his undesirable friend</li>
<li>The transfer of shares to the free-loading son of your deceased business partner</li>
<li>The transfer of shares to your business partner's spouse in a divorce</li>
<li>A decision by the Board to hire an employee at a ridiculously high salary </li>
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If the business partners have a Shareholders Agreement, all of the above can be dealt with before they become issues.<br />
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3. <u>What are some of the Key Provisions to Include in a Shareholders Agreement</u>?<br />
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Important provisions in a Shareholder Agreement will, at a minimum, include:<br />
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A. Restrictions on voluntary and involuntary transfers of a shareholder's stock;<br />
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(i) Right of First Refusal<br />
(ii) Co-Sale (Tag Along) Rights<br />
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B. Resolution mechanism/buy-out clause in case of a deadlock;<br />
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C. Voting rights and obligations among shareholders;<br />
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D. Limitations on Board of Directors powers; and<br />
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E. Several Miscellaneous Rights<br />
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(i) Restrictive Covenants<br />
(ii) Drag-Along Obligations in the event of sale of the company<br />
(iii) Information Rights<br />
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The next several posts will discuss the above typical clauses of a Shareholders Agreement, including important drafting tips.<br />
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<span style="font-size: x-small;"><br /></span><span style="font-size: xx-small;">Disclaimer: The discussions in this Blog do not constitute legal advice nor create an attorney-client relationship. You are urged to seek the advise of an experienced lawyer who can provide counsel with respect to your corporate/business law matters.</span>Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com1tag:blogger.com,1999:blog-261480462574984425.post-27442815508800862232012-11-27T14:43:00.001-05:002012-11-27T14:46:55.239-05:00Private Placements: The Friends and Family Exemption and Other MisconceptionsThere is a common misconception among start-ups and emerging companies seeking to raise capital that the securities laws don't apply to them simply because the company is small, or they are not raising millions of dollars or the purchasers are "friends and family". While all of these may seem logical reasons not to incur the expenses and involve the resources that are required to prepare for a private placement, the fact remains that these are not valid legal excuses for avoiding the application of the securities laws. <br />
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Notwithstanding the desire of the small, private company to avoid the expense and time of complying with the securities laws, if you are considering raising even a small amount, the following principles apply:<br />
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1. <u>Securities Laws Apply to Private Companies</u>. The fact that a company is private, or is not seeking to do an initial public offering (IPO) to become public, does not mean the securities laws don't apply. The simple rule to follow is that if you are raising capital through an equity (i.e., stock, LLC interests, partnership interests) or debt (loan, convertible notes) offering, assume that the securities laws apply even for private, closely held companies.<br />
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2. <u>An Offering Must Be Registered with the SEC Absent an Exemption</u>. If you are a small or emerging private company, don't assume that an offering need not be registered with the Securities Exchange Commission (SEC). <em>The law is actually the opposite: an offering of securities must be registered unless there is an exemption available under the securities rules.</em><br />
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3. <u>The Securities Laws Apply to More than Stock Offerings</u>. Don't fall into the trap that the securities laws only apply to stock offerings. The definition of a "security" is very broad under the securities rules, meaning that not only stock, but LLC, partnership interests, debt, notes and other forms of raising capital will generally fall under the definition. You should start with the assumption that registration is required and look for an exemption rather than believing the securities laws are inapplicable because your company is only selling a small amount of LLC interests in your private company.<br />
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4. <u>The "Friends and Family" Round is Still an Offering</u>. The fact that your investors are friends or relatives is not a valid exemption from application of the securities laws. While there are a number of exemptions from registration of an offering (as opposed to application of the securities laws), you won't find a "friends and family" exemption. If an exemption applies to the offering (such as sales to accredited investors, under Rule 506 of Regulation D), you can substantially reduce the expenses and time associated with the private placement, but you cannot avoid application of the securities laws. <br />
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5. <u>An Exemption from Registration Is Not the Same as Ignoring the Securities Laws</u>. Even if an exemption from registration is applicable, the securities laws still must be followed when doing the offering otherwise the exemption will be lost and the offering will be in violation of the securities laws. One common exemption from registering the offering is the right to sell securities to an unlimited number of "accredited investors" and 35 non-accredited investors who must have sufficient financial knowledge and experience to understand the risks relating to the investment. However, the sale of securities to even one person who does not meet these investor criteria will result in a loss of the exemption, and render the offering in violation of the securities laws. The lesson is that while there are several types of exemptions, if a company is relying on one of them, they need to be sure to comply or risk substantial legal exposure.<br />
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6. <u>A Private Placement Memorandum (PPM) is Advisable Even for Rule 506 Offerings</u>. Under Rule 506 of Regulation D, securities can be offered in an exemption from registration to "accredited investors". These investors must meet certain annual income (in excess of $200,000, or $300,000 with a spouse) or net worth (in excess of $1,000,000) thresholds before they are deemed "accredited". The good news is that an offering to an accredited investor means no information has to be provided to the investor, but the reality is that while a full-blown PPM can be avoided, it is prudent to provide at least an investment letter or scaled-down PPM detailing the risks associated with the investment. This document will go a long way to defending any claims by a disgruntled investor if the company later has financial or operational difficulties.<br />
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7. <u>The PPM is Not a Shield from All Liability</u>. Even if you find an exemption from the registration requirements, and even if you provide a PPM, the anti-fraud rules still apply. The offering materials cannot mislead investors with false or insufficient information. The PPM can be a significant tool for defending against claims that may be asserted later by a dissatisfied investor, but it needs to be properly drafted, and include sufficient disclosures regarding the risks of the investment as well as warnings about the suitability of the investment. <br />
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8. <u>Blue Sky (State) Laws Apply</u>. Even if the offering qualifies for an exemption from registration, state Blue Sky laws still apply. For many states, the availability of a federal exemption from registration is sufficient, requiring only a notice filing (and, of course, payment of a fee) within a prescribed period after the offering. However, New York, for example, requires the filing of a Form 99 and the payment of a significant fee prior to the first sale. So, don't ignore the state laws simply because the offering is exempt under the federal securities laws.<br />
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9. <u>The JOBS Act Eliminates Ban on Solicitation Only as to Accredited Investors</u>. The Jumpstart Our Business Startups Act ("JOBS Act") will eliminate the previous ban on general advertising or solicitation for offerings under Rule 506 of Reg. D, but only if the purchasers are accredited investors. The issuer will need to take reasonable steps to verify the purchaser is an accredited investor, and what satisfies this "reasonableness" requirement is unclear. The main point is that companies should not misunderstand the JOBS Act as allowing general advertising and solicitation to anyone unless the issuer can reasonably verify the accredited investor status. <br />
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10. <u>Violations of the Securities Laws Can Result in Substantial Liability</u>. If you take the risk of avoiding compliance with securities laws on the theory that offering is small or the investors are friends (for example), be aware that a disgruntled investor could lead to liability in the form of rescission of the sale, civil and criminal liability.<br />
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<strong>The Take Away: If Your Company is Raising Money, You Will Need to Ensure Compliance with the Securities Laws Regardless of the Size of the Offering or Nature of the Investors. </strong><br />
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Disclaimer: <span style="font-size: xx-small;">The discussions in this blog do not constitute legal advice nor create any attorney-client relationship. You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters</span> Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-59895828246360633192012-11-15T11:16:00.003-05:002012-11-15T11:16:30.529-05:00Disaster Preparation for Businesses: Legal IssuesIn the aftermath of Hurricane Sandy, all businesses should consider how to prepare a disaster that strikes your business. In considering the legal issues that can arise, it is important recognize that disaster preparation should not only take into account possible future weather or other events that cause damage to a business, but also the loss of a key employee, the death or incapacity of a business partner or even the loss of a key supplier. <br />
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I recently gave an interview on Image Talk, a blog talk radio interview presented by YPI Consultants (<a href="http://www.ypiconsultants.com/"><span style="color: #ffcc77;">http://www.ypiconsultants.com/</span></a>), discussing disaster preparation and related legal issues. You can listen to the interview at <a href="http://www.blogtalkradio.com/ypiconsultants/2012/11/13/image-talk" title="blocked::http://www.blogtalkradio.com/ypiconsultants/2012/11/13/image-talk">www.blogtalkradio.com/ypiconsultants/2012/11/13/image-talk</a><br />
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Disclaimer: <span style="font-size: xx-small;">The discussions in this blog do not constitute legal advice nor create any attorney-client relationship. You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters</span> Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-54468828145763286052012-09-11T08:55:00.000-04:002012-09-11T08:59:46.781-04:00Financial and Legal Issues You Need to Consider Before Buying a Franchise or Small Business.<div style="text-align: justify;">
If you are considering buying a franchise or a business, there are many business and legal issues you need to address. I recently gave an interview on Image Talk, a blog talk radio interview presented by YPI Consultants (<a href="http://www.ypiconsultants.com/"><span style="color: #ffcc77;">http://www.ypiconsultants.com/</span></a>), discussing issues faced by enterpreneurs when buying a business. The importance of proper financial and legl due diligence, understanding the franchise agreement/purchase contract, business and legal risks, and business continuity/transition are among the key topics discussed.</div>
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You can listen to the interview at:</div>
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<a href="http://www.blogtalkradio.com/ypiconsultants/2012/09/11/image-talk">http://www.blogtalkradio.com/ypiconsultants/2012/09/11/image-talk</a></div>
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Disclaimer: <span style="font-size: xx-small;">The discussions in this blog do not constitute legal advice nor create any attorney-client relationship. You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters</span> </div>
Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-28511624016189349642012-08-09T15:13:00.000-04:002012-08-09T15:13:39.693-04:00Issues Overlooked by Start-Ups: A Live Blog Chat (Part II)<br />
This is Part II of a recent interview I gave August 7 on Image Talk, a blog talk radio interview presented by YPI Consultants (<a href="http://www.ypiconsultants.com/">http://www.ypiconsultants.com/</a>). In this interview I discuss several legal issues that small businesses and start-ups often overlook, including those relating to ownership of intellectual property rights, invention assignment agreements, website development and website policies. <br />
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You can listen to the interview at:<br />
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<a href="http://www.blogtalkradio.com/ypiconsultants/2012/08/07/image-talk">http://www.blogtalkradio.com/ypiconsultants/2012/08/07/image-talk</a><br />
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Disclaimer: <span style="font-size: x-small;">The discussions in this blog do not constitute legal advice nor create any attorney-client relationship. You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters</span><br />
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<br />Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-28971085298743711852012-08-06T17:04:00.002-04:002012-08-06T17:15:46.908-04:00Board-Level Attention to Trademarks is EssentialThis Article is authored by Melise Blakeslee, of counsel.*<br />
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The protection of intellectual property may seem like a day-to-day operations task with which senior executives and Board members need not concern themselves in the absence of a crisis. But in today’s world of rapid expansion, particularly into the international realm, keeping a close eye on some aspects of trademark protection is sufficiently essential that it warrants high-level attention.<br />
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As the Board of Directors begins to explore expansion into international markets, it is important that they ensure that the appropriate product marketing people as well as the company’s trademark counsel be brought into the discussion early. It is too easy to lose valuable trademark protection during international expansion. Many nations have what are called “first to file” trademark laws that assign a trademark to the first person to file for it. If third parties, including your own distribution and manufacturing partners, get wind of your expansion plans before you have secured your trademark rights, difficult and expensive situations can arise.<br />
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It is also important that members of the Board monitor senior management to ensure that distribution agreements include appropriate trademark protection language. Too often, these agreements are silent on the subject and in this case silence is clearly not golden. In the absence of clear protection language, a distributor may pre-empt your trademark rights innocently or intentionally. Determining the right person or company to secure particularly international trademarks is a function of the company’s long-term goals. And these goals are most often best understood by members of the Board.<br />
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Recent experience leads me to guess that nowadays many marketing departments are “clearing” new trademarks by simply doing a Google search on the Internet. This is a mistake. Conducting only an informal search opens the door to a charge of willful infringement and doesn’t give you any insight whatsoever as to the ability to move into other related product lines using the new brand. It is vital that proper searches be conducted in accordance with best trademark practices to ensure legally binding protection and avoidance of litigation.<br />
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Staying on top of possible infringements of your trademarks is another place Board members can play a key role. Insisting on constant monitoring and vigilance of the Internet for mentions of your brands can save significant amounts of money and time by nipping even innocent infringement in the bud. Management should ask for regular reports about what particular trends are impacting the company’s brands on the Internet. Using these reports, management should be giving guidance as to what should be pursued and how. This task is endless, unfortunately. The good news is that consistent enforcement with careful prioritization and smart strategies will help in the long run.<br />
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<em>Melise provides advice to clients of The Berkman Law Firm on a vareity of matters including the intricacies of protecting, licensing and enforcing intellectual property rights, and brand protection, Internet-related problems, and data security. She is the author of Internet Crimes, Torts and Scams: Investigation & Remedies, published by Oxford University Press, 2012.</em><br />
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Disclaimer: <span style="font-size: x-small;">The discussions in this blog do not constitute legal advice nor create any attorney-client relationship. You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters</span>Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-67788334136507740432012-07-27T09:06:00.000-04:002012-07-27T09:06:09.381-04:00Issues Overlooked by Start-Ups: A Live Blog ChatI was recently the featured guest on Image Talk, a blog talk radio interview presented by YPI Consultants (<a href="http://www.ypiconsultants.com/">http://www.ypiconsultants.com/</a>), discussing some of the legal issues that small businesses and start-ups often overlook. <br />
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You can listen to the interview at:<br />
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<span style="font-family: "Georgia", "serif";"><a href="http://www.blogtalkradio.com/ypiconsultants/2012/07/24/image-talk">http://www.blogtalkradio.com/ypiconsultants/2012/07/24/image-talk</a></span></div>
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<span style="font-family: "Georgia", "serif";">Disclaimer: <span style="font-family: Times; font-size: xx-small;">The discussions in this blog do not constitute legal advice nor create any attorney-client relationship. You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters</span><br /><br /><br /> </span></div>Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-34626499357862301662012-07-23T10:54:00.000-04:002012-07-23T10:54:57.809-04:00Business Entities: Structures, Characteristics and Choosing the Right One for Your Business (Part IV)Below is a link to Part IVof a four-part continuing legal education seminar I recently gave on business structures, characteristics and choosing the right one for your business.<br />
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Please see: <a href="http://vimeo.com/44119420">http://vimeo.com/44119420</a><br />
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<span style="background-color: white; color: black; font-size: x-small;">Disclaimer: The discussions in this blog do not constitute legal advice nor create any attorney-client relationship. You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters</span>Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-68937820797210789072012-07-16T12:20:00.000-04:002012-07-16T12:20:01.106-04:00Business Entities: Structures, Characteristics and Choosing the Right One for Your Business (Part III)Below is a link to Part III of a four-part continuing legal education seminar I recently gave on business structures, characteristics and choosing the right one for your business.<br />
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Please see: <a href="http://vimeo.com/44119419">http://vimeo.com/44119419</a><br />
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Part IV will be made avaialble in the next blog post.<br />
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<span style="background-color: white; color: black; font-size: x-small;">Disclaimer: The discussions in this blog do not constitute legal advice nor create any attorney-client relationship. You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters</span>Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-32791372795701291902012-07-11T12:29:00.001-04:002012-07-11T12:29:40.501-04:00Business Entities: Structures, Characteristics and Choosing the Right One for Your Business (Part II)Below is a link to Part II of a four-part continuing legal education seminar I recently gave on business structures, characteristics and choosing the right one for your business.<br />
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Please see: <a href="https://vimeo.com/44118815" title="blocked::https://vimeo.com/44118815">https://vimeo.com/44118815</a><br />
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Parts III and IV will be made avaialble in the next several blog posts.<br />
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<span style="background-color: white; color: black; font-size: x-small;">Disclaimer: The discussions in this blog do not constitute legal advice nor create any attorney-client relationship. You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters</span>Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-84006996633899404942012-07-05T14:27:00.003-04:002012-07-05T14:42:00.377-04:00Business Entities: Structures, Characteristics and Choosing the Right One for Your Business (Part I)Below is a link to Part I of a four-part continuing legal education seminar I recently gave on business structures, characteristics and choosing the right one for your business.<br />
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Please see: <a href="https://vimeo.com/44118492">https://vimeo.com/44118492</a><br />
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Parts II, III and IV will be made avaialble in the next several blog posts.<br />
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<span style="background-color: white; color: black; font-size: x-small;">Disclaimer: The discussions in this blog do not constitute legal advice nor create any attorney-client relationship. You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters</span>Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-71701150701689278822012-06-26T09:00:00.000-04:002012-06-26T09:18:19.619-04:00Legal Issues When Buying a Business: Don't Overlook These Provisions in the Purchase Agreement.As discussed in prior installments of this series on buying a business, there are a number important legal issues you need to consider before signing the purchase agreement. The first installment discussed the role of the Exclusivity Agreement, the second installment examined the differences between structuring the transaction as stock purchase as opposed to a purchase of assets, the third examined the importance of escrowing a portion of the purchase price to cover any issues that may arise post closing, and the fourth discussed important aspects of due diligence and how to address legal or financial issues in the purchase agreement. This fifth installment examines several key provisions that should be incorporated in the purchase agreement but are otherwise often overlooked.<br />
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The Purchase Agreement is a very flexible instrument giving the parties substantial flexibility not only as to the structure the transaction but with respect to the representations, warranties, disclosures and covenants that the parties can negotiate to include (or for that matter exclude) from the Agreement. There are a number of standard provisions relating to such matters as legal ownership of/title to the assets, representations as to the corporate status and authority, disclosures as to litigation, financial and tax related representations, environmental issues and post closing obligations. First, while these provisions may be part of a standard purchase agreement they by no means should be viewed as boilerplate. Even a slight variation in language can alter the meaning and scope of these sections, and thus all representations, warranties and covenants, no matter how standard, need to be reviewed carefully. Second, below are a number of provisions which are often overlooked but you should consider incorporating in the Purchase Agreement.<br />
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<strong>1. </strong> <u><strong>Intellectual Property</strong></u>.<br />
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Of course it is standard to include representations regarding the seller's title and ownership of the intellectual property, but make sure the Agreement:<br />
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(a) Covers licensed rights as well as often the seller does not own but licenses key IP. In the same vein, confirm the licenses are assignable and if consent of the licensor is required that the Seller obtain the consent as a condition of closing.<br />
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(b) Addresses rights to the domain names and company websites and requires transfer of these rights to the buyer as a condition of closing. It is not unusual for the buyer to forgot about the transfer of the domain and then have to coax the seller into compliance after the sale.<br />
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(c) IP rights should include not only registered marks or issued patents, but pending applications, unregistered rights, royalties, licenses and, significantly, awards, damages or pending claims and litigation.<br />
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(d) Incorporates provisions relating to software, requires the turn over of source code, manuals, passwords, license keys and all other documentation.<br />
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<strong>2. <u>Litigation</u></strong><br />
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Representations relating to pending or threatened litigation are typical in a Purchase Agreement, but be sure:<br />
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(a) There are sufficient disclosures about pending and threatened litigation, including the status of such matters.<br />
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(b) Decide how litigation is to be handled post-closing. Will your lawyer take over the matter or will the Seller's lawyer continue to handle it; who will be responsible for the legal fees and costs; include a right to periodic updates as to the status of any legal matters; and set forth any rights as to damages, awards, insurance proceeds and to settle the matter and any indemnification in the event of an unfavorable outcome.<br />
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<strong>3. <u>Financial/Tax Matters</u></strong><br />
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In addition to the typical representations and warranties concerning financial and tax issues, include:<br />
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(a) <em>Financial</em><br />
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<em> </em>(i) Require that the seller update the financial statements on or prior to Closing;<br />
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(ii) Include a formula for adjusting the purchase price if there are material changes to the financial statement;<br />
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(iii) Although often used, try to avoid using an earn-out (post-closing payment contingent on certain financial milestones) as they are difficult to negotiate, document and manage once the buyer assumes the reins of the business, and as a result they are a major source of post-closing disputes. If an earn-out cannot be avoided, make sure you have counsel who has experience negotiating and drafting earn-outs.<br />
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(b) <em> Taxes</em><br />
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(i) The representations and warranties should not only cover federal and state taxes, but sales and any other applicable taxes for all relevant jurisdictions.<br />
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(ii) The seller should provide all filings and disclose any past, pending or threatened audits/assessments.<br />
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(iii) Require the seller provide post-closing assistance for any filings relating to periods of time the seller controlled the business.<br />
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(iv) Include appropriate indemnifications for tax liabilities.<br />
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<strong>4. <u>Transition</u></strong><br />
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Is there a switch in your house that you have no idea what it does, and since the seller is long gone you have no way of finding out? Well, think how that issue is magnified exponentially if you purchase a business and don't have the seller to assist with the transition. The assistance is important not only as to obvious issues, like computer systems, financial records, and where the keys to the third floor supply closet are located, but making a smooth transition as far as clients/customers, introduction to vendors/suppliers, establishing a good relationship with employees/consultants, ensuring an understanding of business processes and procedures that are essential for operation of the business. Therefore, the Purchase Agreement can require the meaningful assistance of the seller or even include compensation to the seller for post-closing assistance and continued employment with the company for a reasonable period of time.<br />
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<strong>5. <u>Material Adverse Change</u></strong> <br />
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Undoubtedly the Purchase Agreement will include a Material Adverse Change clause essentially providing the buyer with certain rights and remedies (including possibly termination of the transaction) in the event of a material adverse change with respect to the business. The clause is one of those tricky provisions which, if not properly drafted, can result in substantial disputes. The key is to avoid ambiguity by incorporating specific criteria as to when the Material Adverse Change clause is implicated, such as decline in sales, the loss of certain amount of or even specifically named customers, a decrease in EBITDA or termination of a manufacturing or supplier relationship.<br />
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<strong>6. <u>Employment/Labor Matters</u></strong> <br />
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Provisions relating to Employment and Labor matters are standard, but also make sure the representations and warranties include:<br />
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(a) Existence of confidentiality, invention assignment and non-competes, and get copies for each employee and consultant.<br />
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(b) Confirmation that consultants are truly consultants and not employees (which can give rise to substantial tax liabilities).<br />
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(c) Details and disclosures regarding any employee plans (stock, pension, etc.) and vesting status f each employee.<br />
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(d) Disclosures with respect to any collective bargaining any other labor matters.<br />
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<strong>7. <u>Operations in Foreign Countries</u></strong><br />
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Establishing the right of the company to operate in any foreign jurisdictions where it does business should be obvious, but compliance with the Foreign Corrupt Practices Act is far less familiar to most people. The FCPA prohibits various behavior relating to operating in foreign jurisdictions, including paying bribes to obtain contracts, business, etc. Violation of the FCPA carries substantial civil and criminal liability. As a buyer, you might not think much about the FCPA, but if you manufacture in China, for example, you better pay attention and therefore incorporate a representation that no unlawful payments have been made by seller or its agents.<br />
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<strong>8. <u>Covenants</u></strong><br />
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The Purchase Agreement should contain covenants relating to:<br />
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(a) Non-solicitation of employees, customers and clients and non-interference with existing vendor/supplier relationships.<br />
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(b) In certain circumstances, a Non-Compete that complies with the narrow limitations imposed by applicable state law.<br />
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(c) As discussed in prior posts, clear indemnification and escrow terms to address post-closing liabilities.<br />
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(d) Confidentiality.<br />
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(e) Obligation of the Seller to notify the buyer upon the occurrence of material events arising at any time prior to closing.<br />
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(f) Resignations of officers, directors, responsibility of the seller as to termination of some or all employees/consultants.<br />
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<strong>9. <u>Termination</u></strong><br />
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There will be grounds for either party to terminate the Agreement prior to closing. The termination provisions should not only provide specifics as to when the right can be invoked by a party, but also the liabilities, if any, resulting from termination and the effect of termination.<br />
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<strong>10. <u>Survival</u></strong><br />
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Give careful consideration to how long any of the representations, warranties and covenants will survive avter closing. The seller will push for no or a very short period while the buyer will want them to survive until the chance of any liability no longer exists. A compromise will almost always be necessary, and remember not all of the provisions need to survive for the same period of time<br />
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The above are by no means an exhaustive list of key provisions in a purchase agreement, and they will certainly vary depending on the nature of the business involved -- for example, if you are buying a gas station the environmental disclosures, reps and warranties will be substantial. What is obvious that you cannot accept a boilerplate purchase agreement and instead the provisions need to be tailored to the particular transaction.<br />
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Disclaimer: <span style="font-family: Times; font-size: xx-small;">The discussions in this blog do not constitute legal advice nor create any attorney-client relationship. You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters</span><br />
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<br />Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-85856985695829803192012-05-24T10:06:00.001-04:002012-05-24T10:10:17.989-04:00Legal Issues When Buying a Business: Due DiligenceAs discussed in prior installments of this series on buying a business, there are a number important legal issues you need to consider before signing the purchase agreement. The first installment discussed the role of the Exclusivity Agreement, the second installment examined the differences between structuring the transaction as stock purchase as opposed to a purchase of assets, and the third examined the importance of escrowing a portion of the purchase price to cover any issues that may arise post closing. Part IV of this series explores important aspects of due diligence and how to address legal or financial issues in the purchase agreement.<br />
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Due diligence is a fundamental part of any purchase transaction as its purpose is to verify valuation assumptions (i.e., if the purchase price makes sense) and identify risks (whether they are legal, financial or operational).<br />
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1. <u>Conducting Legal Due Diligence</u>.<br />
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The purchaser will obviously want to conduct due diligence of the business or assets being purchased. The legal due diligence will examine an an array of legal issues, including:<br />
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(a) <em>Business Entity.</em> <br />
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<li>Are the company's organizational documents and records are in order and the entity in good standing.</li>
<li>Are there any obstacles to the transaction such as a right of first refusal held by a shareholder or third party.</li>
<li>Is there anything in the By Laws/Operating Agreement mandating a super majority or even unanimous approval of a sale.</li>
<li>If the purchaser is buying the entity rather than the assets it is important to ensure there are no liens and that there aren't any third party's with rights with respect to the ownership interests.</li>
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(b) <em>Permits/Compliance with Laws/Regulatory Matters.</em><br />
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<li>Are any permits, licenses or governmental approvals required by any jurisdiction where the business operates. </li>
<li>If permits or approvals are required, are the one's held by the seller assignable and if so what must be done to obtain the transfer of the permit.</li>
<li>Does the business operate in a number of states or foreign countries, and if so what is necessary to operate the business in each jurisdiction.</li>
<li>Are there particular regulatory concerns.</li>
<li>Is any aspect of the business governed by privacy rules which mabe implicated by the purchase. </li>
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(c) <em>Ownership and Transfer of Assets/Intellectual Property</em>.<br />
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<li>The seller will need to prove good title to the assets of the business.</li>
<li>Are any of the assets encumbered or pledged.</li>
<li>Does the company own or license intellectual property. </li>
<li>If there is intellectual property, have the rights been registered, such a s trademark or are there pending or issued patents.</li>
<li>Does the seller own the domain name(s) as often companies will overlook this issue and the domain will be registered in the name of the original web developer, an employee or a shareholder.</li>
<li>All licenses that are key to operating the business must be assignable by the terms of the license agreement as the licensor could otherwise refuse or require additional payment for consent to the assignment.</li>
<li>Have Invention Assignment Agreements been executed giving the seller rights to intellectual property developed by third parties or by partners, employees or consultants.</li>
<li>Customer and Customer Information are important assets and therefore before purchasing the business the buyer must be sure customers and customer account information can be transferred to the purchaser without violating privacy or other laws, especially in the event of an asset sale. </li>
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(d) <em>Material Contracts</em>. The material contracts must be reviewed to ensure they are assignable/assumable and that they don't terminate in the event of a sale of the business or change of control of the business.<br />
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(e) <em>Employment/HR Matters.</em> </div>
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<li>Make sure all the company's records are in order detailing information as to employees, including salary, sick/vacation time, and benefits. </li>
<li>Is there an employee manual. </li>
<li>Are there open employment or labor issues.</li>
<li>Is there a stock option or similar employee incentive plan, and if so what are the obligations of the company under the plan.</li>
<li>If there are employees in other countries, what are the foreign laws particular to those employees and what rights to employees have in those countries that are different from the US (for example, Hong Kong requires payment of an additional "13th Month" as an employee bonus).</li>
<li>What is the status of the personnel -- employees vs. consultants, and are these employees being properly classified for purposes of FICA, etc. since improperly classifying an employee as a consultant will result in sever financial penalties.</li>
<li>Are there any restrictions on the termination of employees.</li>
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(f) <em>Litigation.</em> <br />
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<li>If there are pending litigation matters, how you will these claims be addressed in the Purchase Agreement.</li>
<li>Who will assume responsibility for these claims and related litigation costs.</li>
<li>Has the company been threatened with any lawsuits or other claims, and if so how will these be addressed in the Purchase Agreement.</li>
<li>Are there claims asserted by the company, and if so who has a right to receive the damages or insurance recovered on such claims.</li>
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(g) <em>Nature of the Business</em>. <br />
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<li>Does the particular nature of the business give rise to areas of due diligence in addition to standard due diligence questions.</li>
<li>An example of where additional due diligence will be required is environmental issues: for example, a gas station, dry cleaner, manufacturing business will require specific environmental assessments.</li>
<li>The business may implicate specific employee safety requirements under OSHA.</li>
<li>The main point is that due diligence must be modified and/or expanded to address the particular nature of the business and therefore buyer should clearly understand what additional due diligence is required to properly vet all relevant issues. </li>
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2. <u>Financial Due Diligence</u>. The buyer will need to conduct financial due diligence of the business, and therefore should engage an accountant or other financial professional who can examine the financial records. <em>A word of advice: engage an accountant and/or other financial consultant that understands the business being purchased and has experienced with business buyouts</em>. It is not enough to understand a profit and loss statement (P&L) and ledgers, as an experienced financial consultant will be able to determine if revenues and expenses are properly booked, the method of accruing revenues and expenses (which will affect how the P&L looks), what tax obligations exist or may arise from the transaction, how the tax basis in the assets will be affected by the transaction, and a myriad of other issues. Understanding these issues is important as it will reveal (a) if the profits/losses are being properly stated and (b) if any issues need to be addressed in the Purchase Agreement. </div>
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3. <u>Technology Diligence</u>. Nowadays, most companies rely on technology for some aspect of the business. In some cases, it is the essence of the business and for others it is simply an operational necessity. Therefore, technology due diligence is a must. If the essence of the business is a technology company, the level of due diligence is obvious. However, even where technology is more a matter of part of the operations, there are a number of due diligence concerns.</div>
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<li>Are there back-ups of key records, data and information.</li>
<li>Are there back up copies of computer code and software. </li>
<li>Are the necessary redundancies in place.</li>
<li>Does the business have in place a disaster recovery plan.</li>
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4. <u>Operational Due Diligence</u>. The buyer should conduct due diligence of the business operations, examining issues such as:<br />
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<li>Does the seller have a road map (manual) of important business processes as a buyer will appreciate anything that makes for a smooth transition.</li>
<li>Will transitioning of the business require continued assistance from the seller or seller's key personnel post-closing.</li>
<li>Will there be any issues with respect to the transfer of customers/clients.</li>
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5. <u>The Due Diligence is Completed, Now What</u>?<br />
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Once the due diligence is completed, the buyer needs to consider how it wishes to proceed in light of any issues that may have been discovered.</div>
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(a) Terminate the Transaction. If the due diligence has disclosed material legal, financial or other issues, the buyer can choose simply to walk away. The decision will be a function of how material the issues are and whether they can be resolved.<br />
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(b) Reduce the Purchase Price. In many cases, the due diligence issues can be resolved by adjustments to the purchase price (assuming the Seller is amenable).<br />
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(c) Detail terms for transition of the business to the buyer, including any requirement that the seller or key personnel assist with the transition post-closing. <br />
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(d) Address the Issues in the Purchase Agreement. The parties can agree to address any due diligence concerns in the Purchase Agreement by (i) requiring the Seller correct the issue(s) by a defined date, (ii) escrowing a portion of the purchase price, and (iii) defining the rights and remedies of the buyer in the event the issue(s) cannot be resolved.<br />
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Due diligence is an essential aspect of any purchase transaction, regardless of the size of the deal or whether the purchaser is buying assets rather than the company itself. The above is by no means an exhaustive list of due diligence topics, but it should demonstrate the importance of:<br />
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<li><h3>
Tailoring the due diligence to the nature of the business (or business assets) being purchased.</h3>
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<li><h3>
Engaging experienced professionals who can assist with the investigation of legal, financial, operational and technology matters relating to the business.</h3>
</li>
<li><h3>
Conducting thorough due diligence to ensure that any issues can, where possible, be addressed in the purchase agreement. </h3>
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Disclaimer: <span style="font-family: Times; font-size: xx-small;">The discussions in this blog do not constitute legal advice nor create any attorney-client relationship. You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters</span><br />
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</div>Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-18226301571332116332012-05-17T09:21:00.002-04:002012-05-17T09:21:55.337-04:00Legal Issues When Buying a Business: Indemnification BasketAs discussed in prior installments of this series on buying a business, there are a number important legal issues you need to consider before signing the purchase agreement. The first installment discussed the role of the Exclusivity Agreement, and the second installment examined the differences between structuring the transaction as stock purchase as opposed to a purchase of assets. This Part III stays on the theme of key provisions of the purchase agreement by exploring the importance of escrowing a portion of the purchase price to cover any issues that may arise post closing whether the deal is structured as a stock or asset purchase transaction.<br />
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When buying a business, the purchase agreement will include a number of covenants requiring a party to specifically perform certain actions post closing, representations, and indemnifications which may survive the closing of the transaction. Covenants can include such significant post-closing obligations as assisting the buyer with transition of customers, completing and delivery tax documents, the resolution of outstanding litigation, filing of intellectual properly assignments, and the Seller's completion of items that could not be resolved prior to closing. Similarly, the purchase agreement will also include representations that survive closing and indemnification rights protecting the Buyer against third party claims arising from pre-closing events (think: environmental representations). What happens, however, if the Seller fails to perform the post-closing obligations, breaches a representation that survived the closing or a thrid party asserts a claim against the purchased assets giving rise to indemnification rights? Of course, the Buyer can file a lawsuit to enforce its rights, but resolution of litigation can be very costly and drag out for years. And, even if the Buyer eventually prevails on the claim, very often the Seller no longer has the financial ability to satisfy the claim.<br />
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The solution to addressing post-closing liabilities is to create a basket of segregated funds to be available for post-closing claims. In other words, the parties should agree to escrow a reasonable portion of the purchase price for a defined period of time after the closing. The time period will vary: of course the Buyer will demand a longer period and the Seller a shorter post-closing escrow, and this will often be an important negotiated aspect of the purchase Agreement. An alternative to setting up an escrow is simply allowing the Buyer to hold back a portion of the purchase price to cover post-closing claims. The Buyer would likely prefer a hold back because it will continue to control a portion of the purchase price, but the Seller should require an escrow arrangement rather than leaving part of the purchase price in the hands of the Buyer. Under the escrow arrangement, a third party ("escrow agent") holds the portion of funds set aside from the purchase price and can only release the escrowed funds in accordance with the provisions of the purchase agreement.<br />
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If the parties agree to include an escrow of funds to cover post-closing claims, they must carefully draft the terms of the escrow and be sure to address: <br />
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<li>The amount of the escrow, which can be further broken down based on the type of claim asserted (for example, the inability to settle an outstanding litigation may allow Buyer to use a defined amount of the escrowed funds to settle the claim). </li>
<li>The time period for holding the funds in escrow, and even the time period by which certain types of claims must be asserted before they are deemed waived.</li>
<li>The actual procedure for the Buyer to assert a claim, the notice required to the Seller, and the right of the Seller to dispute the claim. </li>
<li>How disputes are to be resolved, which can include referral to a mediator or arbitration.</li>
<li>When the escrow agent is permitted to release all or a portion of the funds to seller or buyer, as applicable. </li>
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Both the Buyer and Seller need to pay particular attention as to how post-closing claims are to be handled under the terms of the purchase agreement. The parties need to set forth clearly what claims can give rise to an obligation on the part of the Seller post-closing and the mechanism for the enforcement of those claims. The escrow of a portion of the purchase price is a common tool for addressing these issues, but the parties must make sure the purchase agreement clearly spells out when the Buyer can assert a claim against the escrowed funds and the procedures for making post-closing claims.</div>
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Disclaimer: <span style="font-family: Times; font-size: xx-small;">The discussions in this blog do not constitute legal advice nor create any attorney-client relationship. You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters</span><br />
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Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-38796695111713412082012-05-03T07:30:00.000-04:002012-05-03T09:14:30.805-04:00Legal Issues When Buying a Business: Asset Purchase vs. Stock PurchaseAs discussed in Part I of this series on buying a business, regardless of the scope of the operations and purchase price, there are a number important legal issues you need to consider before signing the purchase agreement. The first installment discussed the role of the Exclusivity Agreement when considering the potential transaction and the terms that should be included if the parties agree to exclusivity while the due diligence is conducted and the purchase agreement is being negotiated. In this Part II, the structure of the transaction is discussed, contrasting the stock purchase transaction from the purchase of assets of the business. The take away is that it is usually preferable for the acquiror to purchase the assets of the business rather than the stock of the company because of the (a) tax advantages and (b) potential risks and liabilities in connection with purchasing shares of a business.<br />
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1. <u>Tax Advantage of Purchasing Assets of a Business</u>.<br />
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The acquiror will obtain a tax benefit from purchasing the assets of the seller rather than the equity of the business entity. When the acquiror purchases the assets, it gets the right to step-up the tax basis in the acquired assets. This means the basis is not what the seller paid to acquire the assets (often many years prior to the transaction) but what the buyer pays for the assets. Also, note, that it is very important to work with your accountant when allocating the purchase price to the purchased assets -- for example, assets depreciate at different rates (and some cannot be depreciated at all), which will affect your profits and losses. <br />
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2. <u>Purchasing Assets Reduces the Chance that Buyer has Assumed the Seller's Liabilities</u>. <br />
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When the purchaser acquires the stock of the business entity by way of a stock purchase transaction or merger, the buyer is deemed to have assumed the liabilities of the seller. In contrast, the parties to an asset purchase transaction can assign liabilities in such a manner as expressly stated in the asset purchase agreement. In most circumstances, the purchaser will expressly deny the assumption of any of the liabilities of the selling entity. There may be liabilities the buyer elects to assume (for example, a promissory note or perhaps the risks from a pending litigation), and because the liabilities can be assigned as the parties agree in the purchase agreement, the asset purchase transaction gives the parties greater flexibility to negotiate existing or potential liabilities. <br />
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3. <u>There are Some Liabilities the Purchaser Cannot Avoid</u>.<br />
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Even if the parties adopt the structure of the asset purchase transaction, some liabilities will by operation of law become the obligation of the purchaser -- this is referred to as the doctrine of successor-liability. The doctrine of successor liability precludes a buyer from avoiding certain types of liabilities Among the liabilities which the buyer will be deemed to assume regardless of the structure of the purchase transaction, include (a) environmental liability, (b) certain taxes, such as sales taxes, employment related taxes, and other taxes as provided under state law, (c) certain employee benefits and labor matters, and (d) liability under “bulk sales” law, which can arise, depending on applicable state law, in connection with unpaid sales taxes or an attempt to avoid creditor obligations -- as a word of warning, do not overlook the bulk sales law of your state as this often missed and can result otherwise avoidable liability for the purchaser.<br />
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4. <u>Indemnification Basket for Liabilities</u>.<br />
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As a purchaser, you can address the risk of unforeseen liabilities by creating a basket (or escrow) for the indemnification of the buyer with respect to such liabilities. The buyer and seller should agree to escrow a portion of the purchase price to address post-closing liabilities that the purchaser did not agree to assume. Whether the escrow is the sole recourse for a buyer to be indemnified is often a sticking point the parties will need to negotiate -- obviously the buyer would prefer not to be limited to the recourse of the escrowed funds. Whatever the parties negotiate as to amount of the escrow (or alternatively a hold back) and if it is the sole avenue for indemnification, the escrow (or hold-back) rights need to be properly drafted, detailing the terms and procedures for asserting a claim for indemnification.<br />
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Disclaimer: <span style="font-family: Times; font-size: xx-small;">The discussions in this blog do not constitute legal advice nor create any attorney-client relationship. You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters</span><br />
<br />Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-64695449495705215422012-04-18T10:08:00.000-04:002012-04-18T10:08:35.355-04:00Legal Issues When Buying a Business: Exclusivity (Part #1)If you are buying a business, regardless of the scope of the operations and purchase price, there are a number important legal issues you need to consider before signing the purchase agreement. The next several installments of the blog will address the issues that a buyer should address when purchasing a business. The first installment in the series discusses the role of the Exclusivity Agreement when considering the potential transaction and the terms that should be included if the parties agree to exclusivity while the due diligence is conducted and the purchase agreement is being negotiated.<br />
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1. <u>What is an Exclusivity Agreement/No Shop?</u><br />
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An Exclusivity Agreement or No Shop is a separate agreement or a provision in an Letter of Intent between the seller of a business and the potential buyer prohibiting the seller from seeking to transfer the business or assets to anyone else during a defined period. In simple terms, the seller cannot shop around the business or assets during the prescribed period. <br />
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2. <u>If You are the Buyer, You Should Demand Exclusivity.</u><br />
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If you are considering the purchase of a business or its assets, you should demand exclusivity for a reasonable period necessary to complete due diligence, negotiate and finalize the purchase agreement. As a purchaser, you want to preclude the seller from using your proposed deal as an opportunity to shop around the business. Without the exclusivity restrictions, the seller can freely seek a better offer from a third party or even create a bidding war between you and another interested buyer. The minute you begin engaging in due diligence and enter the process of negotiating the purchase agreement, you not only will be incurring substantial costs in terms of actual out-of-pocket expenses (business advisers, lawyers, accountants, etc.), but also the intangible loss of time and the inevitable distraction to your current business operations. The seller's initial reaction to a demand for exclusivity may be to refuse to enter into a No Shop, in which case you need to decide whether to demand exclusivity as a non-negotiable condition. If the seller is refusing to agree to exclusivity, another approach is to let the seller know you are exploring other similar businesses -- assuming this is a viable argument -- and you will simply switch your efforts to other potential opportunities.<br />
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3. <u>What is the Proper Place for the Exclusivity Terms.</u> <br />
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The exclusivity terms can be incorporated as a provision of a Letter of Intent (i.e., the No Shop Clause) or as a stand-alone agreement. Generally, however, the LOI is not a binding agreement but rather a road map for the potential transaction. Therefore, the LOI should clearly state that notwithstanding its non-binding nature, the provisions of the No Shop Clause (exclusivity, term and remedies, as discussed below) are binding on the parties. <br />
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4. <u>What are the Essential Terms of the Exclusivity Provision/No Shop Clause?</u><br />
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The exclusivity agreement should be carefully drafted, but that does not mean it needs to be complicated; instead just make sure there is a clear and concise agreement/clause that defines (a) the Term (period) of the exclusivity, (b) the remedies in the event of a breach by the Seller, and (c) governing law/forum for disputes and enforcement.<br />
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(a) Term: The exclusivity agreement should set a clear time period that commences on signing the agreement and terminates in a specific number of days. Often, parties will agree to ninety days for the exclusivity period, but whatever the period be sure if you are the purchaser that there is sufficient time to conduct due diligence, draft and negotiate the purchase agreement. <br />
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(b) Remedies for Breach: The No Shop should expressly set forth the remedies available to the potential buyer in the event of a breach. The remedies can include a right to equitable relief (such as an an injunction), a right to damages or (as I often prefer) a stated amount for liquidated damages which reimburses the potential buyer for reasonable costs of due diligence, attorney's fees and other reasonable costs. The remedies provisions should require the seller reimburse the buyer for attorney's relating to enforcement of its rights and a waiver of any bond (i.e., deposit of a bond with the court) that may otherwise be required to seek equitable relief.<br />
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(c) Forum: Include a governing law clause and forum selection provisions so that you can require the breaching seller to defend any claim in a convenient forum. Also, since the buyer is looking for ease of enforcement of its rights in event of a breach of the no shop, incorporate a provisions allowing for service of process by regular mail (to the extent permitted by the law of the jurisdiction where the seller is located in the case of a foreign party).<br />
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5. <u>Exclusivity is Not the Same as a Requirement to Sell.</u><br />
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In the same way it is important to understand what a No Shop is, it is equally important to understand what it is not. The exclusivity required by a No Shop is not the same as an obligation for the seller to complete the transaction and sell the business or assets. The exclusivity requirement only precludes the seller from marketing the sale of the business or entertaining other offers during the exclusivity period. While you should include language requiring the seller provide the potential buyer a reasonable opportunity for the to conduct the due diligence, in reality if the seller decides not to proceed it can let the exclusivity period expire without executing a binding purchase agreement. This does not mean the exclusivity agreement has no value, as in fact it is an important aspect of negotiating the purchase of a business (or the assets of the business) because it prevents the seller from shopping your potential deal while giving the parties the opportunity to finalize the transaction. <br />
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The next installment in this series discussing issues relating to buying a business willexamine transactions involving the purchase of stock of the seller compared with a purchase of the business assets.<br />
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<span style="font-size: x-small;">Disclaimer: <span style="font-family: Times; font-size: xx-small;">The discussions in this blog do not constitute legal advice nor create any attorney-client relationship. You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters.</span></span> Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com0tag:blogger.com,1999:blog-261480462574984425.post-39670115241328917652012-04-10T08:00:00.000-04:002012-04-10T09:12:09.136-04:00The Buy-Sell Agreement is Essential for All Closely Held Businesses with Multiple Owners<div class="MsoNormal" style="margin: 0in 0in 0pt;">
If you own a piece of a business and have one or more partners, it is essential that the partners enter into a Buy-Sell Agreement. The Buy-Sell Agreement is intended to address what happens in the unfortunate event of the demise or disability of you or one of your partners as well as other events resulting in the departure of an owner. If you view the Buy-Sell as unimportant because you have an excellent relationship with your other partners, consider the nightmare scenario that one of the owners dies, and the only surviving heir is her dead-beat brother or her fifteen year old son. Without a Buy-Sell Agreement in place, the result of taking on an unwanted partner could be devastating to the business operations; or the cost of buying out the new partner could increase dramatically, or obtaining the funds to pay for a buy out could put a substantial drain on the finances of the business. A properly drafted Buy-Sell Agreement can eliminate these issues, ensuring the business continuity that is desired upon the disability, death of an owner or other triggering event. Below is an overview of the essential components of a Buy-Sell Agreement. </div>
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1. <u>What Events Should Trigger the Application of a Buy-Sell Agreement?</u> </div>
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The Buy-Sell Agreement addresses "what happens if ......" or, in other words, becomes essential upon the occurrence of a triggering event. The key triggering events that should be included within the Buy-Sell include: </div>
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(a) Disability or death of a partner: It is very common to include death or disability of partner as an event requiring invocation of the Buy-Sell. The Agreement should specify when a "disability" is deemed to have occurred. In the event of disability or death, specify who is obligated to purchase the interests of the disabled/deceased partner -- is it the company itself or the surviving partners, and under what formula. A major issue for all triggering events is how will the buy out payment be financed because the entity itself or the surviving members may not have the resources to pay the buy out price. Therefore, the entity or the shareholders can anticipate the issue by purchasing life insurance. Other issues, which apply to all triggering events, include how the purchase price is to be determined and timing for payment of the purchase price.</div>
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(b) Retirement of a Partner: It is important to include retirement as an event triggering the Buy-Sell. The Agreement should detail what constitutes legitimate retirement, in other words, when does an owner have a right to retire. While price, payment terms, and timing must be detailed, owners need to be aware that the funding will need to come from the entity or other owners, as applicable, rather than relying on a life insurance policy.</div>
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(c) Divorce or bankruptcy of a partner: Be sure to include divorce and bankruptcy as a triggering event because either of these can lead to an unwanted, or even unknown, person becoming an owner in the business.</div>
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(d) Voluntary Decision of a Partner to Sell to a Third Party: Provide a detailed procedure in the event an owner decides to offer her ownership to a third party. The agreement should detail the mechanism, including the right to receive and match any third party offer; timing; the methodology for valuation of the interests; payment and closing terms; and rights of the parties in the event of the failure to close the transaction by the third party or the company/owners. </div>
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(e) Gift of Stock: The Buy-Sell could allow a gift of stock upon consent of the corporation/shareholders or even a right without consent to certain defined persons (such as family members or a living trust), but in such instances the donee should be required to execute the Buy-Sell.</div>
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(f) Pledge of Interests: The Buy-Sell should address the right of an owner to pledge its shares, and if permissible, the obligation of a pledgee to comply with the Buy-Sell in the event of a default.</div>
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(g) Material Breach of a Key Agreement: One event that is often overlooked in a Buy-Sell is an involuntary termination of a partner. Termination events include, for example, breach of a material term of an LLC operating agreement, breach of confidentiality, or a "for cause" event. </div>
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2. <u>Valuation Methodology.</u> The biggest fight in any buy out of another owner is how to value the departing member's ownership interest since in a closely held company there is no public market to determine the value. Valuation should be viewed in terms of three concepts: (a) who is making the determination, (b) the procedure, and (c) what actual methodology should be employed? As to whom is making the determination, consider whether an accountant or a person with expertise in valuation of your particular type of business makes sense. When considering the procedure, issues include timing, will each party appoint the valuation expert, what if the valuations differ among the appointed experts, and how will the expenses of conducting the valuation be handled. As to the methodology, consider whether it would make sense to choose a particular expert based on the nature of the business. </div>
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The actual formula for the valuation varies as well, and the parties should consider identifying the applicable formula rather than leaving it up to the valuation experts: book value, adjusted book value, a multiple of revenues or net income, or discounted cash flow. The owners could actually fix a price in the Buy-Sell and update it as needed, but this requires a diligent effort to perform the annual or periodic update (so have a fall back formula in the event an update has not been performed in an unreasonably long time). Be sure to consider all of these issues and then detail the valuation methodology in the Buy-Sell Agreement.</div>
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3. <u>Funding the Buy Out/Types of Agreements.</u> Where a buy out is triggered by death of a partner, regardless of whether the buy-out right is held by the entity or the other partners, funding of the purchase price can be arranged through a life insurance policy.</div>
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(a) <em>Entity as Purchaser/Entity Redemption</em>. The entity can purchase a life insurance policy which is distributed tax free to the entity upon the death of a partner, and the proceeds of which are then used to pay the estate of the deceased for the stock. Understand, however, that there are several disadvantages to funding the buy out with a life insurance policy, including: </div>
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(i) The proceeds and policy are not immune from the entity's creditors;</div>
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(ii) The basis in the stock of the surviving owners will differ depending on whether the entity is a corporation (no step up) or a pass-through, like an LLC (basis will increase in part); </div>
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(iii) There is a potential for the redemption to be viewed as a taxable dividend;</div>
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(iv) A majority owner could change the insurance<span style="background-color: white;"> </span>policy beneficiaries; and</div>
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(v) The AMT (alternative minimum tax) may apply to the company's receipt of the insurance proceeds.</div>
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(b) <em>Cross Purchase Arrangement</em>. Under a Cross Purchase Arrangement, each owner purchases a policy on the life of the other owners, providing a tax free source of funding to pay for the decedent's stock upon his death. Significantly, a cross purchase arrangement eliminates the above-mentioned disadvantages of the entity redemption arrangement. However, disadvantages include:</div>
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(i) The need for multiple policies if there are multiple owners, and premiums will vary depending on age and insurability of each partner;</div>
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(ii) Transfer for Value Rule: The transfer-for-value rule provides that, if a policy is sold by its owner after the policy is issued, the income tax exclusion for life insurance proceeds will be lost and the beneficiaries will pay income tax on the amount of the death benefit less the purchase price and premiums paid. Thus, owners swapping policies to implement a cross purchase agreement results in a transfer for value. For example, A might want to transfer his policy to B (and vice versa) to fund the cross-purchase obligation. Upon A's death, B would collect the proceeds on A's life insurance and distribute them to A's estate in exchange for A's shares. Since there has been a transfer of the policies for value, B would be required to pay income tax on the insurance proceeds, less the amount subsequently paid in premiums. Under an equity redemption arrangement, this problem would not exist. Unlike with a corporation, notably partners in a LLC (taxed as a partnership) escape the effects the transfer for value rule. Another possible work around is the appointment of a trustee to own the policies on each shareholder, otherwise known as a trusteed buy-sell, but there is a possibility that this could also be viewed as violative of the transfer for value rule.</div>
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<strong><em> </em></strong>(c) <em>Hybrid Agreement. </em>Also referred to as the "wait and see" agreement, this situation gives the entity and its owners flexibility at the time of the triggering event to decide whether to exercise the buy-out right. The entity may also purchase life insurance on the owners (or it may decide not to). If the entity does not purchase the shares, the surviving owners can do so under a cross-purchase agreement (and also may purchase insurance for this purpose). <br />
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The Buy-Sell Agreement is a necessary document for any business with multiple owners, but it is also an essential tool for estate planning. Without an agreement, you may find your new partner is that crazy brother of your old partner, and without a properly drafted Buy-Sell Agreement you may be exposed to unwanted tax liabilities.<br />
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<span style="font-size: x-small;">Disclaimer: <span style="font-family: Times; font-size: xx-small;">The discussions in this blog do not constitute legal advice nor create any attorney-client relationship. You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters.</span></span> Jeffrey W. Berkmanhttp://www.blogger.com/profile/00751920181042524765noreply@blogger.com2