Gross Lease vs. Net Lease

July 6, 2014,

lease.jpgWhether you're starting a business or looking to expand, chances are you'll encounter some kind of lease. The most common are the gross lease and the net lease. In this blog post we'll take a look at the differences between the two and the benefits of each.

Gross Lease

In this scenario, the tenant pays a fixed amount each month. The landlord is responsible for the costs associated with property taxes, insurance and maintenance. A gross lease offers some flexibility because these properties are generally deemed as either Class B or Class C. They're less desirable so the landlord may be willing to negotiate over things like who pays the utility bill.

Net Lease

You'll likely see a net lease in properties deemed Class A. These are typically high value structures in a popular part of town. As such, tenants can expect to pay a fixed amount along with maintenance charges, insurance and taxes. The benefit to you as a business owner is exposure and the possibility of working in a new, less problem prone building.

Letter of Intent

Before you sign a gross lease or net lease, it's a good idea to craft a letter of intent. This document typically addresses issues like length of the rental, when the space is available and whether or not expansion is possible. You'll want to have a lawyer look over any lease documents. The professionals at Structure Law Group can help you craft a suitable letter of intent that protects your interests.

There is plenty more to consider when crafting a lease. At least now you understand the key differences between the two main types of commercial leases. This information will help you when you're coming up with a budget for your business. Knowing these costs up front eases some stress and makes it easier to get started.

About Structure Law Group

Structure Law Group is a San Jose based firm that specializes in business issues including business formations, commercial contracts and litigation.

Business 101: Litigation

June 20, 2014,

scale.jpgWith any luck, you or your business will never end up the subject of a lawsuit. Since this isn't a perfect world, it's best to start thinking about what to do if the unforeseen happens. Like most things, business litigation is an involved issue. We can't go through the entire process in one post, so we'll start with three basic steps to take if you find yourself in legal trouble.

Step 1: Purchase Liability Insurance

This step should happen long before trouble starts. In reality, this is one of the first things you should do as a business owner. Liability insurance protects the purchaser from the risks of liabilities imposed by lawsuits and similar claims. Say a customer slips on a wet spot in your store; your insurance would step in and handle the costs. You may want to add extra protection such as errors and omissions coverage. For businesses that have a Board of Directors it's a good idea to have directors and officers coverage. This type of coverage protects the corporation as well as the personal liabilities for the directors and officers of the corporation.

Step 2: Separate Yourself from Your Business

Sole proprietorships are a popular business structure. Unfortunately, these entities can leave you personally exposed. In this arrangement your personal property, including your home or car, are fair game in a lawsuit. To avoid this you want to create separation by forming a trust, or consider an alternative business structure. A trust is a legal entity that pays its own taxes and can own assets. Making the trust the legal owner of the business safeguards your money and property. Also, consider forming a corporation. Trusts and corporations are miles apart in terms of regulation but offer protection to the individual.

Step 3: Hire a Good Attorney

Of course it is always advisable to have an attorney on your side before any litigation to avoid potential lawsuits. If all else fails and you are served with the lawsuit, you should immediately consult your attorney. Time is of the essence. A quality attorney can help you through the initial steps.

Finally, it's a good idea to hire lawyers who specialize in specific fields. If you're served with a lawsuit or anticipating one then it's smart to hire an attorney familiar with litigation like the professionals at Structure Law Group.

About Structure Law Group

Structure Law Group is a San Jose based firm that specializes in business issues including business formations, commercial contracts and litigation.

LLC's and Corporations: Making the Switch

June 13, 2014,

plan.jpg
Converting a limited liability company to a corporation is a relatively easy process. Before I take you through the steps, let's take a quick look at the differences between the two types of business structures.

3 Differences Between Limited Liability Companies and Corporations

1. LLCs are formed by one or more people (members). These members file Articles of Organization and craft an Operating Agreement. Corporations file similar paperwork. However, unlike LLCs, corporations have shareholders and governing bodies like a Board of Directors.

2. Corporations have the ability to offer preferred stock which can be desirable to investors, including angel investors and venture capital investors. LLCs do not have a recognized class of preferred ownership.

3. LLCs are subject to a gross receipt fee based on the gross revenues of the company. This fee is charged based on the gross receipts, irrespective of whether the company had net income or a net loss. Corporations by comparison are taxed on net income.

Converting an LLC to a Corporation

Now that I've gone over some of the key differences, it's time to talk about converting your limited liability company into a corporation. There are details specific to your company, but in general the process is pretty straightforward.

1. Adopt a plan of conversion. Here you'll need to address some key questions like the name of your new corporation and how you plan to convert membership interests into shares.
2. Craft a statement of conversion. The statement needs to include the following: the name of your LLC, the Secretary of State's file number for your LLC, documentation that your plan of conversion was approved by the LLC's members and is compliant with California law.

Once these tasks have been completed and approved, your LLC is now a corporation - but don't think you're done. You'll need to draft bylaws, elect officers and directors, hold an initial board meeting and issue stock certificates. The team at Structure Law Group can help you with the transition. You can find more information about our services by clicking on this link.

About Structure Law Group

Structure Law Group is a San Jose based firm that specializes in business issues including business formations, commercial contracts and litigation.

LLC: Choosing a Management Structure

June 6, 2014,

llc.jpgLimited liability companies combine parts of both corporations and partnerships. Because they're a hybrid, LLC's can be more difficult to setup. One part of this process involves choosing a management structure to fit your specific LLC.

Single Member or Multiple Member LLC

The difference here is implied in the name. Single member LLC's have only one owner, while multiple member LLC's have at least two. Choosing one over the other typically comes down to financing. Starting a single member LLC comes with a higher level of risk as the profits and losses are reported on the individual's tax return. However, as the sole owner, you don't have the stress of running a company with another person.

Member Managed LLC or Manager Managed LLC

This type of structure only applies to Multiple Member LLC's. If both owners (members) plan to be actively involved in the business, then a member managed LLC is the best choice. In this scenario each owner can act on behalf of the company. A manager managed LLC is a good option if you have investors who don't plan on being involved. These silent partners typically elect the owners to run the day-to-day operations of the company.

Operating Agreement

Whatever you do, make sure to put it in writing. An operating agreement outlines the particulars of your business and helps to ensure your status as a limited liability company. A good operating agreement should include: powers and duties of members, distribution of profits and losses, buyout and buy-sell rules, ownership percentages and voting rights.

It should be noted that California recently revised the Uniform Limited Liability Company Act or RULLCA. The revised act specifically addressed operating agreements. New details were added concerning which RULLCA sections can be, and which cannot be, overridden by the operating agreement. Also, more detail was added regarding withdrawal and the consequences of withdrawal of a member from an LLC

Determining which type of company organization to choose can be difficult. Consider hiring an attorney, like the ones at Structure Law Group, to guide you through the process. If you've done most of the leg work but need help crafting an operating agreement, the professionals at Structure can help with that too.

About Structure Law Group

Structure Law Group is a San Jose based firm that specializes in business issues including business formations, commercial contracts and litigation.

Employee vs. Independent Contractor

May 30, 2014,

You're ready to hire. Should you go with an employee or independent contractor? Your decision will have implications for your business. In this blog post we'll address the differences between employees and independent contractors, the benefits of both and how to tell the difference between the two.

What is an Employee?

A simple definition of an employee is someone you hire and directly manage. Employees are generally provided training by the business and work for only one employer. A benefit of hiring an employee is that you get to set a schedule and train the person in the way you want things done. Employers generally have more control over the end result in this situation.

What is an Independent Contractor?

A contractor can have his or her own business. They do not fit within the company framework. Contractors can work for more than one business at a time and they set their own schedule. A major advantage to hiring a contractor is that you don't have to pay into Social Security, Medicare and unemployment. You also can set the terms for employment. If you don't like their work you can let them go at the end of the contract.

How do you know?

The IRS offers some general guidelines to help you determine whether or not you have an employee or independent contractor. The agency looks at degrees of control and independence. The three categories they use are behavioral, financial and relationship.

• Behavioral refers to whether or not your business has the right to control how the worker does his or her job.
• Financial is a measure of how the worker is paid and if he or she is reimbursed.
• Relationship examines any contracts or benefits.

There are several questions to ask yourself to determine if you're hiring an employee or independent contractor.

1. Do you want full control of how the person does the work? If so, the person will be an employee.
2. Do you plan to have the worker paid regularly via your normal payroll system as opposed to having them send you invoices for their services? If so, the person will likely be an employee.
3. Will the worker will be paid by the project rather than hourly? If so, they're likely an independent contractor.
4. Will the person be eligible for company benefits? If so, the person will be an employee.

These are just some of the important things to consider when determining if you're hiring an employee or an independent contractor. If you need help you can fill out a Form SS-8 and send it to the IRS. For quicker results consider calling or email the professionals at Structure Law Group. We're happy to help.

About Structure Law Group

Structure Law Group is a San Jose based firm that specializes in business issues including business formations, commercial contracts and litigation.

Mergers and Acquisitions: Understanding the Difference

May 23, 2014,

A quick scan of the headlines shows come confusion about the deal between AT&T and DirecTV. Some media outlets are calling it an acquisition while others say the 48 billion dollar purchase is a merger. Mergers and acquisitions are similar with a few important distinctions. In this post we'll address the key differences between these two kinds of transactions.

What is a Merger?

One component of mergers and acquisitions is relational. Mergers are seen as the more friendly way of doing business. When two firms merge, both shed their old companies to form a new one. A good example is the merger between Daimler-Benz and Chrysler. In this scenario, both companies ceased to exist. They issued new stock as Daimler-Chrysler. Mergers are a common occurrence between two companies of equal size and standing.

What is an Acquisition?

An acquisition is when one company purchases another. The target company is absorbed by the purchaser and no longer exists. A recent example is the acquisition of Bell South by AT&T. AT&T bought Bell and reformed it as AT&T South.

Mergers and Acquisitions: The Benefits

There are several perceived benefits to merging or acquiring another company. A business can save money on labor and expand its reach into new markets. Also, bigger companies have more purchasing power. Finally, a target company might have a unique product or skill set that creates new revenue for the parent.

So is the deal between AT&T and DirecTV a merger or acquisition? The telecommunications giant is buying the satellite provider. However, DirectTV will still keep its name but will be operating under AT&T. Confused? You're not alone. The media can't seem to decide. Given the basic definitions we discussed earlier this would be an acquisition.

There are many types of mergers and acquisitions. If you're considering either one make sure to get some assistance. Legal professionals, like the ones at Structure Law Group, are needed to sort through the mess.

About Structure Law Group

Structure Law Group is a San Jose based firm that specializes in business issues including business formations, commercial contracts and litigation.

Business Tips: 4 Steps for a Successful Contract Negotiation

May 19, 2014,

Business is an ongoing back-and-forth between interested parties. Contract negotiations, whether they be with employees or a competing business, can be contentious. There's a lot at stake and big feelings are involved. A successful contract negotiation is one where all parties feel they got something out of the deal. This isn't wishful thinking. By following these four simple tips you can create an environment where everyone is heard and respected.

1. Multiple Meetings

The first tip is pretty straightforward. Break down the negotiation into multiple sessions. The longer you sit at a table arguing over the same points the less likely you'll come to an agreement. Give the person time to digest the information. Clear eyes and a fresh head make for better judgment.

2. Focus on Interests not Positions

The second tip involves removing emotion from the table. If a person is angry or frustrated, chances are it's not because of you. Identify the interests behind the issue. Business is a world of clashing personalities and ideas. Depersonalize the process by removing statements like, "I think" or "I believe." Instead, focus on the facts. If an employee is asking for a salary increase you can't afford, then be honest. Say something inclusive like, "We don't have the funds right now." This way you're not making a judgment about the person's abilities, which can lead you into trouble.

3. Know your Priorities

The third tip is all about you. What do you want to see happen? Know what you want before you go into the negotiations. This doesn't mean you should box your ears and ignore what the other person has to say. Good faith negotiation requires keeping an open mind. Still, knowing what you want and expressing those views provides a starting point that is clear to the other party.

4. Ask Questions

Finally, don't be afraid to delve deeper. If the other party is coming back to the same issue it's okay to ask why. This is clearly an important topic to them, so find out why it's so critical; just be mindful of your approach. You want to sound interested and not accusatory.

A successful contract negotiation will help your business. These four tips are a good start. If you need further guidance consider consulting an attorney like those at Structure Law Group. This is a good idea if you need clarifications about contract law or have an especially difficult other party.

About Structure Law Group
Structure Law Group is a San Jose based firm that specializes in business issues including business formations, commercial contracts and litigation.

Photo Credit: Jonny Goldstein via Flickr

Business Plan 101: The Legal Steps to Starting A Company

May 8, 2014,

Starting a business can feel overwhelming. Whether you're opening a brick and mortar store or an online business, there are a lot of steps involved in turning your idea into reality. Creating a business plan and securing funding are a solid beginning; at this point you'll also need to do a few things to make sure your business is legal.

Steps to Legally Starting a Business: It Takes More Than a Business Plan! 

Picking a name is a fun element of starting a business. A name not only tells potential customers what you sell but it also reveals something of your personality. Before you jump into the next activity on your business plan and start advertising your store front or online business, make sure someone else isn't already using the name. Fortunately, most states offer a searchable database through the Secretary of State's Office. Also, be sure to do a national trademark search to find out if another company owns the rights to the name.

It's also extremely important to choose an appropriate structure when starting a business. Will you be operating as a sole proprietorship, a Limited Liability Company or something else? The form your brick and mortar or online business takes will determine which regulations you are governed by as well as the taxes you'll need to pay. A second part of this process is obtaining a federal tax ID number. The IRS uses this number to locate your company and assess the appropriate tax level. You'll also need an employee identification number, better known as a tax ID, before you can start hiring.  

Whether you're a brick and mortar store or an online business, you'll need to secure the proper licenses and permits. Some companies, like ones that sell alcohol, need federal approval. Different states have different rules. The Small Business Administration has a helpful tool to get you started. It's quick and easy; all you need to do is enter your zip code and business type.

Once you’ve completed the above steps, you're just about ready to open to the public. One of the last things to do is familiarize yourself with the laws concerning employees. There's quite a bit to learn. Some of the finer points center around verification and insurance. Even if you're an online business, the federal government requires companies to verify all employees are eligible to work in the United States by filling out an I-9 form. Finally, if you plan on having employees then workers' compensation insurance is a must.

Of course there's plenty more to know when it comes to starting a business, but these few important steps should help get you started on the right path to creating a successful company. Does your business plan allow for these vital start-up activities?

Structure Law Group is a San Jose based firm that specializes in business issues including business formations, commercial contracts and taxation.

Photo Credit: Jake and Lindsay Sherbert via Flickr

Business Entities: Beware of New Reporting Requirement for Change of Mailing Address, Business Location or Responsible Party

February 20, 2014,

If you are an employer in San Jose, you are most likely aware that on January 1, 2014, the minimum wage increased to $10.15 per hour for your business; California's minimum wage increase was to $9 per hour. In addition to new employment laws, there, there have been other new laws that affect businesses in 2014, such as the all new California limited liability company act. But one law actually applies to all business entities with an Employer Identification Number ("EIN"), including entities such as corporations, partnerships, limited liability companies, and even nonprofit organizations. As of January 1, 2014, any entity with an EIN must notify the IRS of a change of (1) a mailing address, (2) a business location or (3) the identity of a "responsible party." A change in a company's mailing address or business location is pretty clear, but the identity of a responsible party may not be so clear.

If you are not sure who the "responsible party" was initially, check the Form SS-4 application that was filed initially by the organization to obtain its EIN, and it will be the person or entity listed as responsible on that form. Then, look at the instructions to Form 8822-B to determine if your responsible party has changed. The instructions define a responsible party as "the person who has a level of control over, or entitlement to, the funds or assets in the entity that, as a practical matter, enables the individual, directly or indirectly, to control, manage, or direct the entity and the disposition of its funds and assets." If the entity's original responsible party at the time of filing the Form SS-4 is no longer affiliated with the organization or no longer fits that definition, then the entity must use Form 8822-B to let the IRS know.

Form 8822-B must be filed within 60 days of the change. If such a change occurred before January 1, 2014, and the entity has not previously notified the IRS in some other manner, Form 8822-B must be filed before March 1, 2014. If you no longer have a copy of the SS-4 Application or remember who was named as the "responsible party," you may wish to file a Form 8822-B before March 1, 2014.

So, if you are a corporation or LLC making changes on your Statement of Information filing with the California Secretary of State, or if you are amending your LLC operating agreement or your corporate documents, keep in mind that you may also need to notify the IRS of the change. If you are not sure whether your company needs to notify the IRS or other agencies of changes, or if you have questions regarding the "responsible party" for your business, you may wish to consult with a business lawyer or accountant.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

Founders' Equity: Repurchase of Unvested Stock by a Company

February 10, 2014,

I spend a lot of time talking to founders of Silicon Valley start-ups about the stock they will receive in exchange for their contributions to their new company, and then preparing restricted stock purchase agreements for the founders. In the last couple of blogs, I have discussed the issues surrounding how founders' stock could vest.

The concept of vesting is usually intertwined with the concept of repurchase rights. Simply put, for founders' stock, vesting is where the repurchase rights held by the company disappear or change. In a typical scenario, when a triggering event occurs, a company can repurchase unvested stock for its original purchase price. A company may not, however, repurchase any vested stock or may only repurchase vested stock at the stock's then fair market value.

What kind of triggering events might allow a company to purchase unvested stock? One common trigger is anything that results in the shareholder not working for the company. Most often, this means a termination of employment.

Termination occurs for a number of reasons. As a result, the number of shares the company can repurchase often changes depending on the reason for the termination. Put another way, vesting can accelerate as a result of certain events occurring. There is no law that dictates how vesting can change, if at all, on the occurrence of a particular triggering event. Founding groups design a variety of triggering events and repurchase rights to meet their goals.

Sometimes it is the company's decision, rather than the shareholder's decision, to end employment. Termination can occur for no particular reason, i.e., at-will, or where the company changes the employment relationship to such an extent that the shareholder terminates its employment, i.e., a termination for good reason. Where a termination occurs other than as a result of the shareholder's decision, it is not unusual for some of the vesting to accelerate. In these cases, the shareholder may receive an extra year of vesting. In cases where a shareholder decides to leave on his or her own, or the shareholder is fired for cause, no vesting acceleration will occur.

Stock purchase agreements will often describe what it means for an employee to be fired for cause, or for an employee to be allowed to leave for good reason. The more objective the description of cause or good reason, the less opportunity there will be for a dispute if a triggering event does occur.

Another common triggering event is an acquisition of the company. In this case, vesting may accelerate to such an extent that all of the shareholder's shares will be vested. Having shares of a founder, who may be critical to the success of a company, completely vest may scare off potential buyers who may want the founder to remain after the acquisition closes. For this reason, a double trigger is often used. In a double trigger, a shareholder's shares will vest if the company is acquired AND the acquirer later terminates the shareholder's employment for no reason. Before a newly formed company issues stock to its founders, it may wish to consult with a corporate or business attorney to be sure to take all of these considerations into account and make sure the founders discuss whether their shares should be issued subject to restrictions and, if so, how those restrictions should be structured.

Before I leave our discussion of vesting, there is one last critical point to mention. Purchasing stock that is subject to vesting can raise important tax consequences. If you receive any stock that must vest, it is critical that you consult your tax advisor BEFORE you sign any agreement purchasing unvested stock.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

Common Pitfalls in Real Estate Loan Documents: A Top Ten List - Part 2

January 28, 2014,

At a recent conference with San Jose and Silicon Valley real estate owners and lenders, Attorneys Jack Easterbrook and Tamara Pow presented their "Top 10 List" of issues that commonly arise in commercial real estate loan transactions. Having been involved in countless real estate and commercial loan transactions, Tamara and Jack developed the list to share with the participants key points to be attentive to when entering into a real estate transaction. The Top 10 List assumed that the basic business terms of the transaction had been decided, so the focus was on items that can arise in the documentation phase and create issues or obstacles in getting a deal to closing.

A previous blog presented three items from this Top 10 List, including: (1) inconsistency between a borrower's state of registration and a lender's requirement; (2) the special purpose entity and the independent direct/manager requirements of the lender; and (3) the personal guaranty. Here are three more items to keep in mind when negotiating a commercial real estate loan:

No. 4: Treatment of Other Creditors, Including Any Mezzanine Lender.

Comment: Are other creditors or lienholders involved, and will intercreditor or subordination agreements be necessary? If the answer is "yes," these agreements will need careful scrutiny. The recent trend in the case law continues on the path of strictly construing the terms of such agreements. This includes Bank of America v. PSW NYC LLC, in which it was held that an agreement between a senior secured lender and a mezzanine lender prevented a foreclosure by the mezz lender until it cured payment defaults in the senior secured lender's loan. The bottom line: other creditors of the owner/purchaser, whether new or existing when the deal is done, can significantly affect getting a transaction to closing. It is very worthwhile to have a strategy concerning them worked out early.

No. 5: Prohibition on Transfers, Including Transfers of Fractional Interests in a Borrowing Entity.

Comment: Standard loan documents often contain language that says that the borrower is in default if the property securing the loan, or any interest in the property, is transferred. However, an owner or borrower should not think it is safe from this provision if the title to the property is held in an entity, such as an LLC, just because the title is not changing. Many loan documents also provide that if an interest - perhaps even a small interest - in the ownership entity changes, a default is triggered. An owner or borrower is wise to not ignore these provisions. Borrowers should carefully consider whether they will need to (or want to) transfer partial ownership interests in the future and lenders should consider the magnitude of such changes that may be acceptable. A transfer of an ownership interest could occur as a result of estate planning needs, in connection with a management transfer, or perhaps the unforeseen death of someone in an ownership group, such as an LLC member. If the parties don't address these provisions before loan documents are finalized, subsequent events may trigger an unexpected and immediate default with unknown future implications.

No. 6: Prohibition on Changes in Management of the Borrower.

Comment: Are the borrower's short-and medium-term management plans prohibited by the loan agreement? Make sure the loan documents accommodate planned future changes in managers of the owner. For example, a family owned LLC may be intending to pass management to the next generation or a key employee long before the maturity date of the loan. Like prohibited transfers of ownership interests, loan documents may prohibit transfers of management power. Pay attention to these provisions and make sure intended changes are not prohibited by the loan documents. It may also be prudent to have potential future managers pre-approved by the lender.

Watch for our next blog for the remaining items addressed in the presentation.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

Founders' Equity - Stock Vesting Schedules

January 9, 2014,

Working with start-ups in San Jose, I have often had to counsel founders on the intricacies of business law as it relates to issuing stock. A large part of initial discussions with the founding group involves the funding needs of the new corporation, how shares will be divided, and the best way to provide equity incentives to founders, advisors, and new employees.

As I discussed in my last blog, one of the key issues involved in issuing stock to founders is how to incentivize them to stay with the new corporation. One mechanism discussed is reverse vesting, where the corporation can repurchase a founder's shares of company stock at their original purchase price when certain events specified in a contract occur.

A typical reverse vesting structure is to allow the corporation to purchase a declining number of a founder's shares at their original purchase price as time goes on. Typically the number of shares the corporation can repurchase will reduce on a straight-line basis over the course of three or four years.

Time may not be the only factor, however, to contribute to the growth of a company. The success of a new venture may be measured by its ability to develop something new and different, or to access markets others have failed to access. Accomplishing this often requires a number of milestones to be met, with many intermediate steps along the way. Because of this, some companies have adopted vesting schedules that allow shares to vest only when the corporation satisfies a particular goal.

As with anything, there are advantages and disadvantages to this approach. One disadvantage is that the milestones that the corporation believes are important at the outset become less critical, especially if the corporation has had to pivot its product or service offerings. Amending stock purchase agreements may not be easy down the line due to founder resistance, among other things. Recognizing this, valuable talent may not be disposed toward accepting stock with this kind of structure and may seek greener pastures. Another disadvantage is that the growth path for the venture may be so uncertain that it is very difficult to define the critical tasks that allow the stock to vest. This is especially true here in Silicon Valley where technology advances and competition often require shifts in start-up strategies. This may result in stock becoming vested on an event that does nothing for the corporation.

There are some important advantages to vesting by milestone. The first is that it could prevent a founder, who contributed little to the corporation's growth, from having a large interest just because he or she stuck around. In those cases where a founder has since left the corporation but still maintains a sizeable interest, management may not have the flexibility to increase the corporation's stock option pool because investors may believe that they have already suffered too much dilution. The solution may be for the remaining founders to reduce their interest, at least on a relative scale, to be able to have a meaningful stock option plan. A well thought out milestone vesting structure can help prevent this from happening.

A second advantage to vesting by milestone is that it forces the founders to really think through their business plan, and to set up a milestone schedule that is objective and attainable. Investors can be comforted by this approach because it shows that the founders have a plan over which success can be measured. This may prevent investors from increasing the time for shares to vest as a condition of their investment.

A third advantage to using milestones rather than time for stock to vest is that it assists in keeping founders focused on the particular goal because of the strong reward provided in reaching that goal.

So what is the bottom line here? Basically, if you have a start-up where technology and market development can be objectively defined, and there is a little risk of a pivot, then milestone-based vesting may be the way to go. Otherwise, you are probably best to use a time-based vesting and staying on top of each founder's efforts to make sure an adequate contribution is made to the venture.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

Common Pitfalls in Real Estate Loan Documents: A Top Ten List

December 19, 2013,

Attorneys Tamara Pow and Jack Easterbrook recently participated in a panel discussion of San Jose and Silicon Valley commercial real estate owners, lenders, borrowers and other professionals about issues arising in recent commercial real estate transactions. Jack and Tamara, at the conference, presented a "Top 10 List" of things to be alert to in real estate loan documents. It was assumed that the basic business terms of the purchase and sale agreement and loan transaction had been negotiated and agreed upon. The question posed was, "So what pitfalls can occur after that, and what issues do you want to be alert to as the deal gets documented - particularly in connection with the debt financing?" The point being emphasized was that a transaction can move to a closing with a minimum of angst if the parties identify early on those issues that will be important deal points, but may not be covered in detail in the financing terms outlined in a term sheet or commitment letter.

This blog addresses three of the "Top 10" points raised in the presentation. Subsequent blogs will address remaining items discussed at the conference. No one point is necessarily more important than the others, as the relative importance of a particular item will vary transaction to transaction. However, the attorneys at Structure Law Group see these factors repeatedly arising in real estate loan transactions.

No. 1: Inconsistency Between Borrower's State of Registration and Lender's Requirement.

Comment: An institutional lender sometimes has very specific requirements. If the owners are establishing a new entity to serve as the borrowing entity, they may want to wait to register the company until after a lender is chosen and any jurisdictional issues are clarified. In some unfortunate situations, we have seen borrowers go ahead with the formation of their entity in California, only to later be asked to provide the lender with a nonconsolidation opinion that may only be viable under the law of another state such as Delaware. So, in addition to asking the lender for any requirements it may have with regards to the type of entity being formed, the jurisdiction, or the bankruptcy remote requirements, make sure to ask what opinions, if any, they will be requesting from counsel. Often these opinions can be negotiated in advance so that you are sure you are forming in a state that is consistent with those requirements.

No. 2: The Special Purpose Entity and Independent Director/Manager Requirements of the Lender.

Comment: In addition to possible Lender requirements regarding which state to form your legal entity in, your lender may have specific requirements that the entity you form to take title to the property is a special purpose entity, meaning that it is formed for the purpose of holding this property only, and will not hold other properties or do other lines of business. This way the lender can feel secure that its collateral will not be negatively affected by any other properties or going concerns in the entity. In addition, the Lender may require that the entity appoint independent directors or managers who will act on its behalf when a vote is required for the entity to declare bankruptcy, or other dangers to its collateral. Sophisticated lenders will have clear language requirements that must be added to the entity's formation documents. In some instances, we have seen lenders require certain language be added to the Articles of Organization of an LLC, but usually it is required to be in the operating agreement of the LLC. However, again, make sure you and your advisors check with your potential lenders in advance of forming your entity, otherwise you may have the additional expense of amending and restating your organizational documents.

No. 3: The Personal Guaranty: Details of Its Scope.

Comment: Several different kinds of guarantees are in use beyond the full guaranty often preferred by lenders. Examples of these are the partial guaranty exempting assets or obligations, the "Bad Boy" guaranty, and the springing guaranty. A recent court case, known as Series AGI West Lynn, held that carve outs or limitations in guaranties will be very strictly construed. A carve out prohibiting the lender from taking any action against the guarantor's house, the court found, did not include proceeds from the sale of the house even though the funds were placed in segregated accounts. In a victory for the lender, the court noted that although the house was excluded under the guaranty, it did not expressly provide that proceeds from a sale of the house were excluded. The court noted that it was not its job to protect the parties from the ugly implications of the plain language in their negotiated agreements.

The remaining items addressed at the conference will be the subject of a later blog, coming in early 2014!

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

The Vesting of Stock - Founders' Equity

December 9, 2013,

Practicing business law in Silicon Valley over the past year, I have seen start-up activity pick up. We are in that part of the cycle where the survivors of the not so great recession have decided that they are better off on their own and have decided to make their dreams come true by forming their own companies.

Because many of these companies hope to become a welcome opportunity for outside investors, their choice of entity is the corporation. From the legal end, the process of incorporation is fairly straightforward and can be accomplished relatively quickly. Founders have a number of decisions to make, such as how much they want to each contribute to the new venture, and who will have which role.

Where a group of founders is involved, one of the most difficult issues, relatively speaking, is the issuance of stock. The first issue involves what percentage of the corporation each of the founders should receive. There are few, if any, rules of thumb as to whom should get what, and the decision is typically made by the founders assessing each of their respective strengths and weaknesses, and their contribution to the new venture, and deciding on a split. If the new corporation never expects to issue any new stock, and each founder will be actively involved in the business with profits being split at the end of each year, there may be little more to do with the stock other than to create a suitable buy-sell relationship.

For those corporations on the start-up path, where technology will need to be developed at the expense of salaries, and where outside funding may be required, additional mechanisms are often designed. The mechanisms, known as vesting, repurchase rights, and transfer restrictions, each have a number of complications and purposes, and this next series of blogs will explore the basic issues that founders should consider when determining whether to apply these mechanisms to their stock.

Let's start with vesting. Simply put, when something vests, you have the right to it. For example, when an option vests, you have the right to exercise it and receive stock.

How do you apply this concept to already issued shares, particularly those shares that are issued to founders when the corporation is formed? In this case, you adjust the vesting concept so that the shares can be repurchased by the corporation under certain events. This mechanism often referred to as "reverse vesting". The number of shares that can be purchased, however, is reduced over time or on the occurrence of certain events. Shares that can't be repurchased are deemed to be vested.

So, why do this? Start with the proposition that vesting only works with shareholders who are actively involved in the business. Vesting encourages the shareholder to stick around and continue to work with the corporation for a period of time so that all of the shareholders get the full benefit of their shares. This helps bind the founders together, because they are doing more than promising that they will work to make the new corporation a success. They now have an economic reason to do so.

Another reason is to make sure that if a founder does not work out, or cannot contribute for reasons of death or disability, their interest will be reduced appropriately. The shares that are repurchased can then be used as incentives for the founder's replacement.

How does this mechanism work? Here are some examples of time-based vesting. In Silicon Valley, a common vesting structure (although not necessarily for founders) is a four-year vest with a first year cliff. This means that all of the shares will vest in four years so long as the founder is employed by the corporation for those four years. This is the four-year part. For any of the shares to vest, however, the founder needs to be employed for at least one year, at which time 25% of the shares will vest. Thereafter, shares will typically vest evenly on a monthly basis.

Another example, sometimes used with founders, is to allow vesting over a three-year period, with no cliff. This means that so long as the founder stays with the corporation, his or her shares continue to vest on a monthly basis. If the founder is with the corporation for three years, all of his or her shares are vested.

Vesting schedules based on time are by far the most common form of vesting used. Vesting schedules based on time may also be the least effective. My next blog will tell you why.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

California Has a New Rule for Tracking Deferred Taxes from Section 1031 Exchanges

December 4, 2013,

As a business and real estate attorney in California, I often assist clients in real estate transactions using Internal Revenue Code Section 1031 to defer the tax on the sale of their real estate by transferring the tax attributes of that property into a new, like-kind, property. IRC Section 1031 is a federal statute, but we can also take advantage of the tax deferral on the exchange of like-kind property for California income taxes.

However, historically, when the exchange was made into property in another state, it was difficult for California to track these exchanges and make sure the state eventually got its share of deferred taxes. For example, if a real estate investor were to sell a shopping center in Sunnyvale, California and buy a shopping center in Incline Village, Nevada, and the real estate investor satisfied all of the IRC 1031 requirements, both federal and California taxes could be deferred until the later taxable sale of the Nevada property (or any other property into which it had been exchanged). The problem was that part of those deferred taxes were California income taxes, and California had no system in place to make sure the FTB was aware of the eventual tax recognition event. A new rule now provides the Franchise Tax Board with the information it needs to keep track of these transactions and the deferred taxes so that it can collect them when the time is right.

Starting January 1, 2014, if you exchange California property for out-of-state property you will be required to file an information return with the FTB for the year of the exchange and every subsequent year that the gain is deferred. Regardless of your state of residency at the time of the exchange, if you are a California resident when the out-of-state property is later sold, all of the gain is taxable in California. But don't think that moving to Nevada can get you out of theses deferred taxes. If you were a California resident at the time of the exchange but you are a nonresident when it is sold, the previously untaxed California gain is still taxable to California. Also, if you exchange out-of-state property for California property you must reduce the California basis on the property by the amount deferred, even if you were a nonresident at the time of the exchange. [Source: Spidell's California Taxletter, Vol. 35.7, July 1, 2013]. The new filing requirements will help the FTB track these exchanges.

For more information on California Taxation of Nonresidents and Individuals Who Change Residency, see FTB Publication 1100.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.