January 2011 Archives

Finding a Buyer for Your Business: Dating Silicon Valley Style

January 31, 2011,

Finding a buyer for the sale of a business is a lot like dating. Your prospects and your ultimate happiness increases with the number of people you meet. Whether you cruise the bars in San Jose, or schmooze partners at a trade show in San Francisco, building interest in your company is a critical step in finding buyers.

One of the key tools used in building business acquisition interest is a set of documentation often referred to as a "book". The book will describe the business, the industry, and the potential for growth. It may also include financial statements, projections, and risk factors.

The content of the book must be considered carefully. Financial projections should be accompanied by appropriate disclaimers, and competitive and other risks to the business post-sale should be outlined. If the sales transaction is in the high tens of millions of dollars, language stating that an acquisition could reduce competition or permit other forms of market dominance should be avoided.

The manner in which the book is distributed requires some care. First, because of the competitive sensitivity of the information, the book should only be provided under a non-disclosure agreement (or "NDA") after the business approves its delivery to a particular recipient. Second, a recipient should be pre-cleared to make sure information can't or won't be used for competitive purposes. Third, a recipient should have some sort of preexisting relationship with the business or the person distributing the book or should be otherwise highly sophisticated in financial matters. Distributing the book in any type of public context, such as in a seminar or through online advertisements or print media, should be avoided without first consulting with an attorney familiar with public solicitations.

As part of, or in lieu of, a book, the business may need to make presentations describing the opportunity it presents. The guidelines for the content of a presentation are very similar to those for a book.

Throughout this process, the need for secrecy is critical. Competitors who are able to disclose the possible business sale will use it to deprive the selling business of product or service sales. For this reason, potential acquirers should be screened carefully and NDAs should be tailored to prevent the inappropriate use of sensitive information.

Employees that become aware of the sale may lose motivation, or start looking for alternate employment. To help prevent or mitigate this, knowledge of the transaction within the selling business should be kept to a very small number of upper level management personnel. Any presentations or discussions with potential acquirers should occur at a location removed from the seller's operations.

Like any relationship, finding a buyer for a business requires sufficient time and attention to make sure the result is a successful closing, rather than a costly breakup.

Separate Your Business Enterprises for Maximum Liability Protection: Sunnyvale Real Estate, Mountain View Manufacturing and Real Estate

January 27, 2011,

Two recent conversations have reminded me of the importance of separating business enterprises for liability protection. I was helping a Sunnyvale real estate investor negotiate a commercial loan extension with a bank, and was thrilled that we had planned well in the past to separate all of his major properties into separate LLCs. It gave the bank a lot less power in negotiating against us - my client's other properties were safe from this potential liability, but could be used as additional collateral if he chose to do so. At the same time, I was talking to a Mountain View manufacturing client about the risk of a potential employee lawsuit and realized that, due to some bad advice in the past that my client got from another advisor, he was holding real estate in the corporation thereby making the real estate subject to any liabilities of the company.

The example I often use is that each of your business enterprises or major assets is like a domino. Putting all of your dominoes in one entity means that a single domino falling can knock the others down too. Separating your dominoes into multiple entities means that if one entity is subjected to a lawsuit, the assets in the other entities should be insulated. Therefore, if my Mountain View client is faced with a large judgment on his employee problem, thanks to the appreciation in the real estate, the company looks like a really deep pocket.

Deciding how many entities to form, and how to separate your assets, is a complex cost/benefit analysis that depends highly on your level of comfort with risk. A good rule of thumb is to separate unrelated businesses (such as manufacturing and real estate, operating companies and investments). For real estate, consider grouping properties by the level of liability and the equity in each property, as well as the location of the properties. Also check with your professional advisors, such as your attorney and CPA, for liability, tax and insurance issues that could affect your decision.

LP verses LLP verses LLC - What is the Difference?

January 24, 2011,

In my San Jose law practice, I often meet with clients who tell me they want to form a certain type of entity, and then proceed to tell me some facts that actually disqualify them from that form of entity. Even worse is when the client tells me that some other advisor told them they should be that form of entity. Recently, I met with a Cupertino real estate investor who said his financial advisor told him he should form an LLP for his property (he was not eligible to be an LLP). In Silicon Valley, we have a lot of do-it-yourselfers who form their own company online and then regret their ill-informed choice of entity and have to pay an attorney a lot more to fix the problem than they would have paid to do it right in the first place.

Here are some basic facts about LPs, LLPs and LLCs in California to help you make a more knowledgeable initial decision.

LP: This stands for "Limited Partnership." In a limited partnership, at least one partner must be a general partner, which means that partner will be personally responsible for any liabilities of the partnership, as well as partnership decisions. The limited partners are not responsible for partnership liabilities, but also do not have any say in the management of the partnership.

LLP: This stands for "Limited Liability Partnership." In California, only attorneys, accountants, architects, and now engineers and land surveyors are eligible to be LLP partners. The partners operate much like general partners, but have insulation from each others' liability.

LLC: This stands for "Limited Liability Company." [Note: there is no such thing as a "Limited Liability Corporation" in California.] Only certain types of businesses are eligible to be LLCs in California. You are not eligible if you are in the trust or banking business or if your business requires a license or certification under the California Business and Professions Code ("B&P Code") unless that section of the B&P Code specifically allow for LLCs. For example, as of January 1st of this year, the B&P Code provides that licensed contractors are eligible to be LLCs in California. LLCs can be managed either by designated managers, or by the members. The members and managers are not personally responsible for LLC liabilities.

Once you understand LPs, LLPs and LLCs, don't forget to still consider the corporation to see if it is the best fit for your business. Above all, make sure to run your decision by a legal professional to make sure you haven't missed any other considerations when you are ready to form an entity.

Finally! LLCs for Licensed Contractors in California

January 20, 2011,

As usual, January is a time when people think about getting their business in order and consider the 'choice of entity' question. Already this month I have received calls from two contractors, one from San Jose and one from Sunnyvale, who want to form an entity for their construction business. I was able to give them the news that, as of January 1, 2011, the California Corporations Code finally allows a California limited liability company ("LLC") to operate as a licensed contractor. However, the Contractors' State License Board is only required to start processing applications no later than January 1, 2012.

For years, contractors were limited by a provision in the LLC Act that said an LLC may not "render professional services, as defined in Section 13401 and in Section 13401.3, in this state." Sections 13401 defines professional services as "any type of professional services that may be lawfully rendered only pursuant to a license, certification, or registration authorized by the Business and Professions Code, the Chiropractic Act, or the Osteopathic Act." In addition, a section of the Contractors' State License Law provided for the issuance of contractors' licenses only to individuals, partnerships and corporations.

As of this year, the LLC law was changed to add: "...a limited liability company may render services that may be lawfully rendered only pursuant to a license, certificate, or registration authorized by the Business and Professions Code if the applicable provisions of the Business and Professions Code authorize a limited liability company to hold that license, certificate or registration." The Contractors' State License Law was changed to allow for individuals, firms, partnerships, corporations, limited liability companies, associations, organizations, or any combination thereof.

This is great news for contractors who will no longer be limited to corporations in their choice of entities for liability protection. Hopefully more sections of the Business and Professions Code will soon be revised to provide the same opportunity to other licensed professionals.

Bankers, Brokers and Finders, Oh My - Part 2

January 17, 2011,

In Part 1 of this entry, I discussed the importance of a business owner choosing the right professional advisors to assist in the sale of the company, whether in San Jose or Palo Alto, and some of the different types of experts.

Although there is overlap, advisors that assist with businesses having a substantial sales price are investment bankers that specialize in mergers and acquisitions. These professionals often help in cleaning up a company's operations, provide pre-acquisition strategic guidance, act as chief negotiators in the sales transaction, and provide advice and formal opinions concerning deal valuation.

Compensation is a key issue in any agreement with an advisor. Compensation can involve payment of an initial fee, such as where acquisition solicitation materials are prepared, to a commission, such as where the broker takes an active role in negotiations that are successfully closed. Brokers and investment bankers will typically request a non-refundable engagement fee and a success fee. The latter can take many forms. One form provides for a set amount, plus a percentage commission based on the transaction value. Another form provides for a commission percentage which changes with the transaction value, often providing higher percentage commissions for higher values to encourage the advisor to be more aggressive in its pricing negotiations. Exceptions or adjustments to the fee structure are often made for introductions or transactions then in process which were not sourced with the assistance of the professional. Most advisor contracts contain a "tail", which allows the advisor to collect a success fee for transactions occurring within a certain period, typically 12 - 18 months after the advisory relationship ends. Sometimes the tail can be limited to transactions for which the introduction was made by the advisor.

Advisors can go a long way toward guiding a company and its stakeholders through a successful transaction. Management, however, can't expect that the advisor will take care of everything involved, and must be prepared to contribute extensively toward the transaction's success.

Continue reading "Bankers, Brokers and Finders, Oh My - Part 2" »

Bankers, Brokers and Finders, Oh My - Part 1

January 13, 2011,

Every business owner at one time or another wants to sell their Silicon Valley business and move from Los Altos, Mountain View or San Jose to Tahoe or Tahiti. Being bogged down in daily operations doesn't leave a lot of time for an owner to make the necessary contacts to build interest in their company. Owners wish they could just have someone else sell their business.

There are a number of professional advisors that can assist in the sale of a company. Like fundraising, however, management cannot simply pass to someone else a function this important. One of the key reasons for management involvement is that a business buyer is typically found through the company's own contacts.

As with any advisor, choosing the right professional to advise on potential acquirers and transaction terms is a combination of validation by your network, expertise, and your own personal comfort with the individual with whom you will be working.

One requirement that is often overlooked is the need for the professional to be licensed. States have differing licensing requirements. Putting aside securities laws, business brokers in California typically must have some form of license. Often, a real estate broker license, or law license may be required. If the business sale is structured to involve a merger, stock transfer, or similar transaction, the broker may need to be licensed as a broker-dealer for securities laws purposes. Working with licensed professionals provides some comfort of expertise and sensitivity to legal compliance.

Advisors in transactions are typically compensated on a commission basis. Because of this, there may be a temptation for less scrupulous advisors to color their advice to allow a sale to proceed. It is always important to explore with the advisor, before he or she is hired, instances in which they have recommended clients not to proceed with deals.

Advisors that assist with businesses having a sale price in the low millions or less are generally considered either finders or brokers. A finder will simply make an introduction to a potential buyer in exchange for a fee or commission, while a broker will provide more extensive services, such as valuation determination and preparing the business for sale.

See Part 2 for more on professional advisors.

New Rules for California Limited Liability Partnerships ("LLP")

January 10, 2011,

Since 1995 only attorneys, architects and accountants were eligible to practice as a limited liability partnership in California. However, as of September 30, 2010 new rules now allow engineers and land surveyors to take advantage of the LLP form of entity as well.

Although the law currently only extends until January 1, 2016, this is still great news for engineers and land surveyors that may have wanted a liability protection entity for their businesses, but did not want to deal with the hassle of annual meetings and minutes required of a corporation. These businesses are not eligible to be limited liability companies (LLCs) because of the restriction in the LLC Act preventing any business that requires a license or certification under the Business and Professions Act to be an LLC in California.

Section 16306(c) of the California Corporations Code provides in part that: "... a partner in a registered limited liability partnership is not liable or accountable, directly or indirectly, including by way of indemnification, contribution, assessment, or otherwise, for debts, obligations, or liabilities of or chargeable to the partnership or another partner in the partnership, whether arising in tort, contract, or otherwise, that are incurred, created, or assumed by the partnership while the partnership is a registered limited liability partnership, by reason of being a partner or acting in the conduct of the business or activities of the partnership."

This liability protection is a very important reason to operate your business through an LLP.

Continue reading "New Rules for California Limited Liability Partnerships ("LLP")" »

Selling Your Business - It Takes a Team

January 6, 2011,

Any large business transaction, particularly a merger or acquisition, requires a well-coordinated team for success. Assembling your team early on makes a large difference between success and failure, whether you are in San Jose, California or Sydney, Australia.

The most critical advisors are your attorney and your accountant. If you are a business owner and you don't have an attorney or an accountant advising your company, you need to get one now. Although either professional can "parachute in" to assist your company in the event of a sale, their advice to you will be much more efficient and effective if they have direct and long term experience with your company. Failing to have ongoing advice in legal, tax, and financial matters will likely result in the need for remedial work and higher expense in closing a business sale.

Finding a suitable attorney will likely be your first task in assembling your business team. As with any advisor, you should use your referral network to find a professional that is appropriate to your business. You should only choose someone who you believe can act as a trusted, strategic advisor in planning, growing, and selling your business, rather than someone who can merely produce documents. An attorney who you allow to attend your board and/or shareholder meetings and generally become familiar with your business will be able to advise you on building the proper foundation for an ultimate sale of your business. He or she will also be able to tailor their advice to the realities of your business and your own risk preferences.

Businesses will often have an attorney that they use for operational matters who is unfamiliar with the specifics of a merger or acquisition transaction. In these cases special acquisition counsel is retained, often at the recommendation of company counsel, to assist in the transaction. Special counsel should be brought in as soon as possible. If you have been presented with any type of proposal to sell your business, such as a letter of intent or term sheet, you should not sign any documents until you have had an attorney who is knowledgeable in mergers and acquisitions review them.

Your accountant should be familiar with generally accepted accounting principles, or GAAP, for your industry. As mentioned in an earlier blog posting, your company should not rely on tax-oriented financials in an acquisition, but should maintain financials based on GAAP to allow for accurate business valuation and comparison. Any accountant should be experienced with the tax issues facing your business's operations and eventual sale. As your company grows, your accountant can recommend a controller and other potential employees who can perform daily accounting functions in-house. Like your attorney, it is critical that you view your accountant as a key advisor to your business, rather than as someone who merely prepares your company's financial statements and tax returns.

Independent Contractor or Employee? The Wrong Answer Could Cost You

January 3, 2011,

Whether your business is located in Silicon Valley or somewhere else, whenever you hire someone, that worker is either an independent contractor or an employee. Using the correct classification is crucial because federal and state governments are targeting businesses with incorrectly classified employees to collect substantial employment taxes and penalties. In addition, workers may sue for employee benefits they claim they should have been eligible for.

How do you determine the proper classification?
The IRS and the state governments have different tests. The IRS tells you to consider behavioral control (do you have the right to control what will be done and how?), financial control (is the worker offering their services to others and incurring their own costs?), and relationship of the parties (more than just the title of any employment contract). California boils it down to one question: Does the employer have the right to direct and control the manner and means in which the worker carries out the job? If the answer to that is not clear, there are ten secondary factors to consider.

What can a business do to protect itself?
The most important thing a business can do to protect itself from a claim of improper classification is to have a written, signed contract with every independent contractor. The process of reviewing appropriate contract terms is as important as the writing itself. Consult a corporate or employment attorney for assistance in creating a contract for your company, and before making any changes to that contract. Then, follow its terms. Give independent contractors control over how they perform their duties, maintain good records such as invoices for their services, and send them a Form 1099 if you pay them more than $600 in a calendar year. Finally, treat them consistently and treat your employees differently, and be very careful when changing a workers classification - especially when you are changing it from employee to independent contractor. If you are not sure of the proper classification, you can get help from the IRS (fill out Form SS-8) or the EDD (use Form DE-38 or file form DE-1870). Be careful - a worker can also complete Form SS-8 to determine their proper classification, and if they think they have been misclassified, they can choose to only pay employee side taxes and file Form 8919, telling the IRS to go after their employer for the other half.