April 1st, 2010
There has been a bit of an uproar recently concerning Senator Dodd’s financial regulatory reform bill and its adverse effects on startup companies and angel investors. Traditionally, seed capital can be raised from those deemed by the federal government to be “accredited investors” without much fuss from the SEC or State security regulators.
Under the new reformatory bill, however, a filing must be made with the SEC even if all of the investors are “accredited”. The SEC will have 120 days to review the filing, and if that time lapses without review, the security will then be subject to review by the applicable State securities commissions.
Moreover, the bill increases the qualification of an “accredited investor” from one with a net worth of $1 million to one with a net worth of $2.3 million, and from $200,000 of annual income to $449,000 ($674,000 for joint annual income with a spouse).
Business Week reported that this change would lower the number of individual accredited investors by 77%. Yikes!
If this bill passes, not only will the pool of angel investors be dramatically reduced, but the cost and time associated with angel financing will increase substantially. This will likely hurt entrepreneurs, decrease the number of new business ventures, and adversely affect job creation.
For a more in-depth discussion of the bill and the goals lawmakers are hoping to achieve, check out this article at TechFlash. If interested in voicing your opposition, take a minute to sign this petition.
Tags: Angel Investors, Corporation, Securities, Startup, Venture Finance
Posted in Corporation, Startup, Stock, Venture Finance | No Comments »
March 20th, 2010
One of the most attractive features of a corporation is the ability of a shareholder to invest in the business without facing personal risk for the actions and debts of corporation. But this limited liability is not absolute. The doctrine of ignoring the corporate form and holding shareholders accountable is commonly known as “piercing the corporate veil”.
One method courts use to determine if corporate protections should be set aside is the alter ego test. Here, shareholders can be held personally liable when there is such a unity of interest between the corporation and the shareholders that they are essentially one in the same, and that some injustice would occur if the shareholders were permitted to escape personal liability.
When applying this test, courts will consider a number of factors, such as: whether corporate funds were used for personal use; whether personal and corporate property were held separately; whether stock was properly issued; whether the shareholders kept corporate records and adhered to legal formalities; and whether the corporation was adequately capitalized.
Courts have also used inadequate capitalization or undercapitalization as the sole means to pin liability on shareholders. Measuring the adequacy of capital is no easy task. Courts will look to whether capitalization is unreasonably small or illusory given the size, nature, and liabilities of the business. Although no bright-line rule has been set, officers and directors would do well to consult their financial advisors, prepare budgets and financial forecasts, and examine the need for liability insurance.
In short, to protect yourself from personal liability you must see to it that the corporation is ran on the up-and-up. Make sure that you and your fellow shareholders treat the corporation like a separate entity. See to it that the business has a reasonably strong capital structure. Observe all of your corporate formalities. Fulfill your tax obligations. Keep good records. And do not, under any circumstances, treat corporate property like personal property, or vice versa.
* LLC members should also take note. In California, much of the above also holds true for LLCs.
Tags: Corporation, Liability, LLC, Piercing the Corporate Veil
Posted in Corporate Compliance, Corporate Governance, Corporation, Formation, LLC, S Corporation | 1 Comment »
March 16th, 2010
A mysterious new kind of stock has emerged within the startup circuit that is generating a bit of buzz. “Class F” stock was created to give founders an edge up in their negotiations with company investors. This special class of stock, designed by The Founder Institute, gives entrepreneurs certain voting, election, and protective rights that typical “Class A” stock does not.
Is issuance of Class F Stock a good idea for founders? Well, the jury is still out. For an interesting summary of Class F Stock, including possible pros and cons, check out
this featurein VentureBeat’s weekly attorney/startup Q&A section, Ask the Attorney .
Tags: Corporation, Formation, Startup, Stock
Posted in Corporation, Formation, Startup, Stock | No Comments »
March 14th, 2010
In a general partnership, yes.
The general partnership is the consensual association of two or more persons formed to carry on as co-owners of a business for profit. There are no formal formation requirements for the GP. In fact, the general partnership can be formed whether or not the partners actually intend to create one.
Except under narrow circumstances, all partners of a GP may act on behalf of the business, binding the partnership to any agreements. Likewise, all general partners are jointly and severally liable for the debts of the partnerships and the actions of the other general partners. This means that a partner’s personal assets can be reached by a creditor if the business fails to make good on its contractual obligations.
For the above reasons, the general partnership is often disfavored as a form of business ownership. Business associations often find the limited liability company (LLC) or the subchapter S corporation more attractive. These entities give partners much of the legal protection given to corporate shareholders while allowing the individual-based tax treatment usually favored by small business.
Tags: Formation, general partnership, Liability, LLC, partnership, S Corporation, Startup
Posted in Formation, LLC, Partnerships, S Corporation, Startup | No Comments »
March 12th, 2010
The California Limited Liability Company (LLC) is a business entity favored by many businesses because its corporate-like limited liability protections and its relatively informal structural and governance requirements. It also allows “members” (the LLC term for owner) to take advantage of the favorable tax treatment afforded to partnerships.
The California Corporations Code allows for two LLC management situations that should be considered prior to formation.
1. Management by all members: The Code’s default provisions provide that the LLC will be managed by all of its members unless its articles of organization state otherwise.
Before choosing an all-member management structure, the members should give careful consideration to how the day-to-day operations of the business will be carried out. Here, all members will generally have the authority to act on behalf of the LLC, binding it to any agreements he or she executes. Choosing this option does help avoid imposition of state and federal securities laws for each member, but it may complicate the businesses operations if some members choose to be less involved with the business.
2. Management by one or more managers: If your business opts for this type of management, no member, acting solely as a member, has the power to bind the LLC. This authority is reserved for the designated manger(s).
Managers can be elected or removed by the vote of a majority in interest of the members. These managers can be members, or they can be individuals without any ownership interest in the LLC who are selected (hopefully) for their experience and expertise. In either case, managers, if there is indeed more than one, have equal authority to manage the business. Unless the operating agreement provides otherwise, decisions will be made either by a majority vote of managers or by unanimous written consent.
LLC members may opt to go this route if one or more of them intends to be more of a passive investor in the venture. If so, it is important that those non-managing members consider the impact of securities laws which may require them to either register their LLC interest as a security, or seek an exemption to registration.
Tags: Governance, LLC, Management, Startup
Posted in Corporate Governance, LLC, Startup | No Comments »
March 10th, 2010
If a foreign corporation – that is, a corporation organized under the laws of any state other than California – is considered by the state to be a quasi-California corporation, it will be subject to a number of enumerated provisions of the California Corporations Code.
What corporations are considered quasi-California corporations? Section 2115 of the California Corporations Code provides that a foreign corporation is a quasi-California corporation if (1) the average of the corporation’s property, payroll, and sales factors in the state exceeds 50 percent, and (2) more than half of its outstanding voting securities are held by persons having California addresses (as disclosed on the books of the corporation on the record date).
To determine whether the company meets the first prong, simply add (1) the percentage of the company’s property (measured in value) located in California; (2) the percentage of payroll that was paid in California; and (3) the percentage of total sales made in California. Then divide the result by 3. If this figure is greater than 50, and if the percent of outstanding voting securities are held by people with California addresses is greater than 50, then the company is indeed a quasi-California corporation.
Publically traded companies can also fall under Section 2115’s test unless their outstanding securities are listed on the New York Stock Exchange or the American Stock Exchange, or they are quoted on the NASDAQ.
When a foreign corporation qualifies as a quasi-California corporation, California law supersedes the law of the jurisdiction of incorporation with respect to:
• the election and removal of directors
• a director’s liability for breach of duty and unlawful distributions
• cumulative shareholder voting
• voting in corporate reorganizations
• changing the number of directors
• rights of inspection
• shareholder meetings
Tags: California Corporate Compliance, Corporation, Quasi-California Corporation
Posted in Corporate Compliance, Corporation | No Comments »
