San Jose Business Lawyers Blog

As a veteran M & A lawyer in San Jose, where deal making has never gone out of style, I have been though my share of mergers and acquisitions. For business counsel, the closing of a deal is one of the times I get to spike the ball in the end zone as I watch the cash flow to a happy (and relieved) seller. Needing only to put together a closing package, my work is done and I am off to popping the corks at the closing dinner. Or is it?

From sole proprietors and small businesses to large corporations, many business owners enter the sale process believing the closing of a deal is accompanied by a one-way ticket to paradise. They often find out, however, that the fun is just beginning. The first year after closing presents a number of challenges, all of which must be carefully managed to make sure the seller gets the full value of the business.

As I have discussed in prior blogs there are a number of adjustments, associated with audits and working capital, which occur within the first three to six months after closing, including the following:

Post-Closing Audit
The first concerns the post-closing audit. Typically, a selling company's books will close on the actual closing date, and funds will be held back to deal with any adjustments exposed by the audit. Hopefully, the buyer and seller will have agreed in advance to the accounting procedures which must be used, i.e., how generally accepted accounting principles will be interpreted. Otherwise, the first fight will be over whose interpretation should control. This is particularly difficult, because each side may be constrained to using accounting procedures that differ from each other. Key issues in accounting procedures that can lead to disputes revolve around revenue recognition (a favorite for software companies), collectability of receivables, and valuation of hard assets.

Adjustment of Working Capital
The second concerns the working capital adjustment. This follows closely behind the audit, because it is the audit that establishes whether the working capital adjustment established in the acquisition agreement has been satisfied. I have talked before about the working capital adjustment, and like any post-closing adjustment, it is critical to ensure that the parties establish agreed upon accounting procedures to make sure they are not comparing apples to oranges.

Earnouts
The mother of all battles, however, usually occurs around earnouts. I have spoken about earnouts before. Earnout disputes are so pervasive in merger and acquisition deals that litigation attorneys have another word for them: inventory. This is also where the seller must be the most involved. Earnouts depend on business performance, and as much as the seller wants to start their new life, their presence and operation of the company post-closing can make a large difference in the amount ultimately received for their business. Changing business operations, sales approaches, and collection procedures are all matters the former owner needs to watch carefully. One of the biggest issues comes in the form of administrative overhead allocations, with the earnout payment being reduced due to a reduction in net earnings as a result of over allocation of administrative overhead.

Breach of Fiduciary Duty
Another fruitful area for litigation is where a representation or warranty may be breached. We discussed these in past blogs, and noted that, in most deals, funds are held back to satisfy buyer damages arising out of a breach of a representation or warranty. A seller that remains on the shop floor, so to speak, often has the institutional knowledge and relationships to prevent or minimize the acts or omissions that lead to a breach, and thereby reduce the ultimate hit against the holdback that might otherwise occur.

Resolving post-closing disputes is not easy. Most acquisition agreements will require disputes to be resolved through arbitration, which is usually faster than waiting for a court (especially here in California with our impacted court system). Arbitration, however, is not simple, fast or inexpensive. Where post-closing adjustments are involved, many of the issues revolve around accounting concepts, requiring accounting experts to be retained. These experts are not cheap. Where a seller's representation has been breached, complex indemnification provisions are often triggered, which can muddy ultimate resolution. It is not unusual for post-closing disputes to add a year or more to ultimate payout to a seller.

For this reason, sellers should expect that their full payout from the sale of their business may require continued involvement for a year or two after the closing. Sellers may find, however, that the additional involvement is a small price to pay.

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.

Some tax law changes recently went into effect that that will have an impact on both individuals and businesses in San Jose and throughout the State:

Yet Another Gas Tax Increase
On February 28th the Board of Equalization approved a 3.5 cent gas tax increase, effective July 1, 2013. This brings the gas tax rate to 39.5 cents for 2013-2014. This adjustment should produce revenue at the same rate as if Proposition 30 applied to gas sales. (Proposition 30 resulted in a 0.25% state sales tax increase which does not apply to gas sales.)
Source: Spidell's California Taxletter, Vol. 35.4, April 1, 2013.

Payroll Tax Reporting Changes
The Employment Development Department has announced two changes:

First, employers must use "business days," not "banking days" to determine payroll tax deposit due dates.

Second, an employee is considered a rehire if she returns to work for an employer after a separation of at least 60 consecutive days. Employers must report all new and rehired employees to the New Employee Registry within 20 days of starting work.
Source: Spidell's California Taxletter, Vol. 35.4, April 1, 2013.

For Real Estate Professionals
A real estate professional that spends over half of his or her working hours and at least 750 hours per year materially involved in real estate is exempt from the passive loss rules. These tests are difficult to meet if you also have a job, and the IRS knows it. Since 2007 the IRS has been specifically pulling returns for audit of individuals that claim they are real estate professionals but also have significant W-2 wage income. Be reasonable -- records of time spent on real estate must be contemporaneous and believable.
Source: Kiplinger Tax Letter Vol. 88 No. 8, April 12, 2013.

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.

Having represented both buyers and sellers in mergers and acquisition transactions in Silicon Valley for more years than I care to admit, I have been through a number of closings. Some M&A closings that I have been involved in were smooth affairs, accomplished through an exchange of a single phone call with a confirming email, while others have stretched into all night marathons. Although it is often difficult to know whether your deal will allow you to finish at a reasonable time, there are a number of actions you can take to make sure your closing is as smooth and stress free as possible.

Obtain Third Party Consents:
The most important task for both the seller and acquirer is to plan ahead. Everything you will need, to accomplish the closing, will take longer than you think. One item which often delays a closing is getting the necessary consents to the transaction required from third parties. Certain third parties, often parties to major relationships that the acquired company, post-closing, requires for its operations, have rights under their contracts to consent to any change in control. Many of these contracts create significant value for the acquired company and their continued existence are often a key incentive for the buyer proceeding with the deal. It is best to identify these material agreements early on and plan a strategy for securing the necessary consents. Other areas where third party consents might be required are when a party, often a strategic investor, has a right of first refusal that is triggered by the transaction.

Obtain Stockholder Approval:
Stockholder approval, especially where large numbers of stockholders exist, can often be a gating item. As with third party consents, it is critical that the parties design a strategy early on for soliciting approvals from the stockholders, and, if necessary, investigate and resolve any securities compliance issues that might exist. This may require significant advance planning and document creation, particularly for securities compliance purposes.

Complete Agreements and Disclosure Schedules Before Closing:
Part of planning ahead is to front load all of the work that needs to be accomplished for the closing. For those transactions in which a closing follows sometime after the contract signing, agreements and schedules required for the closing, such as key employment agreements and disclosure schedules, should be completed and attached to the contract as part of signing. The temptation to put these types of schedules and agreements off until the closing can prove costly, as these types of documents, particularly a disclosure schedule, can raise issues which may require significant time to resolve.

Remove Contingencies:
As a closing approaches, it is critical to make sure all contingencies pertaining to the closing are removed or waived. One way to ensure this is to make sure, during contract negotiation, that contingencies are based on standards that are objective and easy to determine. One area that can be problematic is a contingency based on the occurrence of a material adverse effect. Because these tend to be very broadly and qualitatively designed, it is best to objectify them as much as possible. This can be accomplished by tying the effect to financial or other measures, or limiting it to known risk issues.

Have a Pre-Closing Review:
Expectations during this period need to be rational. If there is any deal term or contingency that is open, the transaction simply is not ready to close. For this reason, it is always a good idea for the deal team to conduct a pre-closing a few days before the planned closing date, to make sure all remaining issues and contingencies are resolved and that the documentation is sufficiently in order to close.

Be Closely Involved:
The most important task for the business executive is to understand that his or her job at this point in time is not necessarily to run the business, but to get the deal done. The executive needs to be closely involved with the transaction, and should not merely rely on his or her advisors. There is no substitute for carefully reviewing all of the documents involved in the transaction. In addition, the executive needs to ensure that the entire deal team be available for the inevitable last minute decisions.

Like many things in life, closings benefit from advanced planning and hard work early on. Save the surprises for birthdays and holidays. When it comes to closings, boring is best.

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.

A few years ago, I met with a new client here in San Jose about forming a corporation for his real estate management business. He wanted to use his name as the name of the corporation, e.g. John Smith, Inc., and he had no problems with using his name as the Agent for Service of Process, and having his home address as the business address on public record. Imagine my surprise when I went to the Secretary of State's database to confirm that the name was available and found that the exact name was taken by the same client at the same address. The corporation had been formed back in 1989 and had been suspended for decades.

I discussed it with the client and discovered that he had spoken with another lawyer about forming a corporation many years ago, and although he thought it was just an informational meeting, the attorney actually formed the corporation and the client didn't even know about it. If my client wanted to use the name of the suspended corporation, he would first have to revive it, in which case, he would have had to pay tens of thousands of dollars in back franchise taxes and interest. I counseled the client to walk away from the suspended corporation and simply start a new one under a different name. In this case, that was okay because he took no assets from the corporation and therefore could not be held personally liable for the corporation's taxes. However, shareholders should not walk away from a corporation without carefully considering whether the same conclusion would apply to their situation, and whether they are willing to endure the annoying tax notices to the corporation in the meanwhile.

The landmark case in this area is the Appeal of Howard Zubkoff and Michael Potash, Assumers and/or Transferees of Ralite Lamp Corporation (April 30, 1990, 90-SBE-004). In that case, the Board of Equalization stated that the only way shareholders are liable for the corporation's franchise taxes would be if the Franchise Tax Board proves that all of the following conditions were met:

- The corporation transferred property to the shareholder(s) for less than full and adequate consideration;
- At the time of transfer and when shareholder liability was asserted, the corporation was liable for the taxes;
- The transfer was made after liability for the tax was accrued;
- The corporation was insolvent at the time of the transfer or as a result thereof; and
- The FTB had exhausted all reasonable remedies against the corporation.

Source: Spidell's California Taxletter Vol. 34.11, Nov. 1, 2012

Even if a shareholder thinks he, she, or it qualifies under the Ralite conditions, and would not be held personally liable for the taxes, the shareholder must understand what the last condition means - the FTB may exhaust all remedies against the corporation in trying to get it to pay the taxes. The FTB will send the corporation a Demand to File notice, then a Notice of Proposed Assessment, and then try to collect against the corporation. Since the FTB is pursuing the corporation and not the shareholder (yet), there is no defense that the shareholder can offer. A Ralite defense is inapplicable at this stage because that is a defense by the shareholder, not the corporation. A shareholder needs to be willing to receive these documents on behalf of the corporation and not respond until the FTB eventually comes after him or her personally for payment. That is when Ralite can be invoked. And that is when the taxpayer will have to prove the above conditions are met by providing supportive documentation to the FTB. This could be a long process requiring ample time and attention from the shareholder.

If the corporation was formed back in 1989, and the shareholder clearly meets the above conditions because he wasn't even aware of the formation, walking away makes sense. However, if the corporation just failed to file a final tax return or dissolve with the Secretary of State in the last few years, the shareholder may be better off paying the back taxes and interest to avoid this hassle in the future.

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.

Although 2013 is well under way, taxpayers in San Jose may not be aware of changes to California laws that may affect them. Some of these changes include:

Proposition 30

With all the talk about federal income taxes going up this year, do not forget about the Proposition 30 retroactive increase in California taxes, effective as of January 1, 2012. For taxpayers with taxable income over $250,000, the California maximum rate is now 12.3%. On top of this, there is a 1% mental health surcharge for taxpayers with taxable income over $1,000,000. Together, these taxes give California the highest maximum state tax rate. If you fall under these tax brackets, you may not have paid enough taxes throughout the year, through either withholding or estimated tax payments, to avoid being under-withheld. However, there will be no penalty for the under-withholding so long as you pay the tax due in full by April 15, 2013. The ability to get out of penalties expires on April 15th. An extension to file doesn't extend the payment deadline or the penalty exclusion. A late payment penalty of 5% plus 0.5% per month will be due if the full 2012 liability is not paid in full by April 15th.

Source: Spidell's California Taxletter Volume 34.12, December 1, 2012.

Sales Taxes

As of January 1, 2013, the California state sales and use tax rate increased by 0.25% to 7.5% for four years. Of course, city and county district taxes are added on top of the 7.5%.

Source: Spidell's California Taxletter Volume 34.12, December 1, 2012.

Retirement Contributions

Taxes may be going up in 2013, but dollar limitations on retirement plans will also be higher this year. The maximum 401k contribution has gone up $500 to $17,500, with people born before 1964 able to put in as much as $23,000. The pay-in limitation for defined contribution plans goes up to $51,000, and the pay-in limits for IRAs and Roth IRAs goes up to $5,500, with an extra $1,000 of pay-ins available to those born before 1964.

Source: The Kiplinger Tax Letter, Vol. 87, No. 22 (Oct. 26, 2012).

IRS Mileage Rate

It is important for businesses to be aware of the current standard mileage rate since many use that rate to figure out both their reimbursement amounts and their tax deduction for miles driven in the course of business operations. The IRS has announced the mileage rates for 2013:

• 56.5 cents for business miles (up from 55.5 cents in 2012)
• 24 cents for medical and moving miles (up from 23 cents in 2012)
• 14 cents for charitable miles

California conforms to these amounts.

Source: Spidell's California Taxletter Volume 34.12, December 1, 2012, p. 143.

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.

Having practiced corporate law in Silicon Valley for 15 years, I must say that there is nothing more frustrating for my clients, who are mostly closely held businesses in the San Jose area, than spending months or years training an employee only to have her leave and go on to compete with the company that trained her. In particular, I represent several staffing and consulting companies and have had to listen to their complaints of how unfair this is from the employer's perspective. Often, I have to tell these hard working, small business owners that there is almost nothing they can do (except pursue a claim against the employee for misappropriation of trade secrets). In 2008, the California Supreme Court decided Edwards v. Arthur Andersen LLP, making it clear that employee post-employment non-compete agreements are unenforceable in California except in certain very limited circumstances, including in connection with the sale of a good business involving goodwill.

Now, a new California Court of Appeals case, Fillpoint, LLC v. Maas (August 24, 2012) further enforces California's attitude towards fostering open competition and disfavoring restrictions on employees. In the Fillpoint case, a major shareholder and key employee signed both a three year non-compete agreement related to the sale of his stock, and a one year post-employment non-compete in his new employment agreement. The Court paid particular attention to whether the stock purchase agreement and the employment agreement should be read together as one document. The employment agreement alone would violate California's view of post-employment non-compete agreements as against public policy. However, in connection with the sale of the business, it could be enforceable. In this case, the shareholder/employee worked for the acquired company until the three year non-compete ran out, but then terminated his employment and went to work for the competition. The company claimed that the one year non-compete covenant in the employee's employment agreement should restrict him from such competing employment. The employment agreement non-compete provision specifically prohibited him from making sales contacts or actual sales to any customer or potential customer of the company, working for or owning any business that competes with the company, and employing or soliciting for employment any of the company's employees or consultants.

The court found that the two agreements should be considered integrated because the covenants were executed in connection with the sale or disposition of stock in the acquired company. In particular, they noted the integration clause in the documents, which stated that if there were any conflicts between the two documents, the stock purchase agreement would control. The court went on to consider whether the non-compete and non-solicitation covenants should be void and unenforceable, and found that they were because they were overly broad. In particular, the court noted the over-broad restriction against selling to potential customers of the company.

So what does this new case teach us? Non-competes are still extremely limited in California. And for me, as a business attorney in the Silicon Valley where mergers and acquisitions are either a way of life or an exit strategy for most businesses, this case reminds me how careful business lawyers have to be when drafting these provisions to make sure they are enforceable. Non-compete provisions should be clear that they are connected with the purchase and sale of a business, including any specific payment allocated to such non-compete covenant. And when drafting a non-compete, do not try to make it any broader than necessary to protect the goodwill being acquired.

There is another question that comes up often in my practice. After I am done explaining how most non-compete covenants are illegal and unenforceable in California, my small business clients almost always ask about whether they can include an employee non-solicitation agreement instead, to at least prevent the person leaving from taking key people with them. I really wish I could clearly and conclusively tell them that they can, but I am not so sure anymore. In the past, we could point to the Loral Corp. v. Moyes (1985) case which held that employee non-solicits are enforceable in California. However, the Arthur Andersen case and now the Fillpoint case make this position a lot less certain, even though they don't specifically overturn Loral corp.

Where does this leave us? It seems like we say this every year, but it is time to revisit your employment agreements and independent contractor agreements. If you insist on keeping an employee non-solicitation covenant, make sure it is as narrow as possible and that your agreement has a severability clause to (hopefully) save the rest of the document in the event a court finds the restrictive covenant to be void and unenforceable.

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.

As a Silicon Valley corporate attorney, I work with a lot of Internet law and cyberspace law issues and am often asked by businesses to make sure their websites keep them free from trouble. Whether you are a large, multi-national corporation, a mid-size company, or a small business owner, chances are you run and operate a commercial website. One way to minimize the risk that comes from operating a commercial website is to create the conditions, sometimes called Terms of Use, that govern a visitor's use of the site. A court decision in September, however, found that website terms could be invalid and therefore fail to provide any protection to website operators. Because the court is located in the federal district that includes California, it is a critical decision that affects California website operators.

The case, In re Zappos.com Inc., Customer Data Security Breach Litigation, 2012 WL 4466660 (D. Nev. Sept. 27, 2012) arises out of Zappos' customer data security breach in January of this year. As is typical in a data breach situation, Zappos notified all persons whose personally identified information may have been compromised. When the inevitable lawsuit was filed, Zappos attempted to enforce an arbitration clause in the Terms of Use found on its website. A federal court in Nevada said "not so fast".

Some background is helpful. Terms of Use are often created with little thought, and can often be changed at any time by the website operator. They typically are submitted as a "browse-wrap" agreement, which, unlike a "click-wrap" agreement, does not require the user to click on a box to confirm the user's consent to the agreement. Browse-wrap agreements are usually referenced with an inconspicuous link at the bottom of a home page.

Courts have previously upheld website Terms of Use where users consent to them, such as in a click-wrap agreement, or where users knew about them, such as in a browse-wrap agreement. Like many things in the law, knowledge does not just mean that the user actually knew about the terms of use, but that the user was properly (or, in legalese, "reasonably") notified that the Terms of Use existed. As we will see, this is where Zappos ran into problems.

The court said the Zappos' Terms of Use failed for two reasons.

First, the court said that the Zappos Terms of Use were not set up to create a binding contract. The problem is that the link to the Terms of Use was not conspicuous, so a user would not have notice of its terms. The court said that a link that "is the same size, font, and color as most other non-significant links" will not work to form a contract. The court also noted that the website did not direct a user to the Terms of Use when creating an account, logging in, or making a purchase. Absent any direct proof that the user had read the Terms of Use, no contract existed.

Second, even if a contract was formed, the Zappos Terms of Use could be changed by Zappos, but not the user, at any time and without notice. Specifically, the court said that Zappos' ability to change the arbitration requirement allowed Zappos to change its mind about whether to arbitrate or litigate, notwithstanding the same option was not provided to users. In legalese, this meant that the arbitration clause lacked a "mutuality of obligation". The court looked to other federal courts that had examined the same issue, and said that this one-sided ability to follow a provision rendered the provision invalid, or, in legalese, "illusory". In other words, when it came to arbitration, there was not a deal. Therefore, Zappos could not enforce its arbitration clause.

In light of this case, any website operator should review its Terms of Use, preferably with the assistance of counsel, to make sure the website's Terms of Use can adequately protect the operator and business from liability.

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.

Whether an acquisition is in San Jose, Cupertino, San Francisco, or anywhere else in California or the United States, any corporate lawyer will tell you that a buyer will not close a deal unless certain conditions are satisfied. Fortunately, closing conditions contained in mergers and acquisitions documentation have become standardized. Exceptions, however, always arise based on the unique attributes of the transaction, and standard does not always mean simple.

Some merger or acquisition closing conditions are standard and rarely require negotiation. For example, one of the standard closing conditions is that there is no injunction, law, or court order that prevents the transaction from proceeding. Outside of an actual known threat to a transaction, these clauses are rarely negotiated in a private company acquisition transaction.

Another standard closing condition is that the requisite corporate approvals will be secured. Because the respective Board of Directors of the each company will have approved the acquisition agreement, this is usually a noncontroversial item.

Similarly, stockholder approval is a standard condition but it can derail a deal if the company does not approach it carefully. Stockholder approval adds an additional wrinkle: dissenters' rights. These rights allow a stockholder to receive in cash the fair market value of its stockholdings, based on the value of the selling company, absent any change in value arising as a result of the acquisition. To receive this cash payment, the stockholder must vote against the acquisition. It is not sufficient for the stockholder to simply abstain from voting. To enable the stockholder to take advantage of its dissenters' rights, the selling corporation must provide notice of the right to exercise dissenters' rights, and the notice must contain specific provisions.

Why would the corporation want to allow one of its stockholders to have this right? To protect the transaction, that's why. Any stockholder who had the right to exercise its dissenters' rights, but failed to do so, can never attack the validity of the transaction. The only exception to this is if there was a problem with stockholder approval. In essence, dissenters' rights give the stockholder the choice between selling-out or going along with the deal. From the corporation's standpoint, it can feel comfortable that a transaction will proceed since all it has to do is buy-out its disgruntled stockholders.

Or can it? The problem with dissenters is that they have to be paid. If the deal is a cash deal, then the purchase price proceeds can be used to pay off the dissenters. If, however, the acquisition is a merger, where shares are going to be exchanged, the issue is tricky. Recall my discussion some time ago about an acquirer wanting to have working capital in the purchased company so that it can conduct business after the closing. Any payment to a dissenting stockholder will reduce the amount of the seller's working capital (assuming that the buyer will not use its own working capital to pay the dissenter).

The reduction in working capital arising out of a payment to dissenters will lead to a closing condition limiting the number of stockholders which can dissent to the deal. Typically, this number is less than 5% of the stock entitled to vote. Sellers who find themselves faced with such a condition find that a stockholder or stockholders holding a relatively small number of shares have, essentially, a veto right on a transaction. For this reason, executives of selling companies need to review their stockholder lists carefully to determine if there is any likelihood that a stockholder will exercise its dissenters' rights.

In my next blog, I'll discuss some of the other conditions that might crop up in a common acquisition deal.

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.

In the past couple of years, corporations and limited liability companies that were formed or registered in California have had to deal with long delays from the Secretary of State in getting their documents processed. Whether the document that is being filed is a Statement of Information, Certificate of Dissolution or Cancellation, or Articles of Incorporation or Organization, the Secretary of State is taking weeks or even months to process a filing. As a business lawyer in San Jose, I have seen a multitude of problems resulting from such delays.

Statements of Information are experiencing the greatest delays, as the Secretary of State is taking several months to process a filing. This has actually created problems for some businesses that pay the filing fee with a check that contains an expiration or "void-by" date. If the check expires before the Secretary of State is able to process the Statement of Information, the Secretary of State will either reject the Statement or treat the payment as a dishonored payment.

Since many of my San Jose clients are newly formed LLCs, I frequently see these delays cause another type of problem. Very often, my client's bank will require a copy of the LLC's filed Statement of Information before opening a bank account or approving a loan. Because of the significant amount of time that it is taking for the State to process Statements, I often have to work with my client to take advantage of a relationship with the bank and ask the bank to accept a copy of the Statement that the LLC has submitted for filing.

I can avoid this situation in several ways if I am aware of the need to provide a filed copy of a Statement of Information by a certain date.

For a corporation, we can file the Statement of Information online with the Secretary of State and then request a copy of the record (this option is currently not available to LLCs). This avoids the usual queue. In addition, most regional state offices offer the opportunity for a corporation or LLC to pay an expedited service fee for filing a Statement of Information in person at the Secretary of State's Sacramento office. We can email the document to our agent in Sacramento who actually walks it into the Secretary of State and files it on an expedited basis over the counter. The benefit to using the expedited service is that we can receive a filing confirmation or response within a guaranteed time frame (usually 24 hours).

Continue reading "Processing Delays at the California Secretary of State Continue for Business Documents Filings" »

Every corporation, limited liability company and limited partnership, that either forms in California or registers to do business in California must pay an annual minimum franchise tax of $800. However, I just read an article in Spidell's California Taxletter that really annoyed me (Volume 34.7, July 1, 2012, pages 75-76). The article, entitled "Midyear switch from S to C corporation means an extra $800" says that when a corporation files two short year returns for one calendar year, each return is subject to the $800 minimum tax even though the corporation is the same entity for civil law purposes. Because it is changing its tax status, it is two different entities for tax purposes and therefore must pay the minimum tax twice in one year. As a corporate and business attorney, I am sensitive to this issue since many of my clients are small businesses or partnerships in San Jose, Santa Clara and other parts of Silicon Valley, and every dollar counts when you are running a small business.

This could be an issue in many midyear circumstances, including:
• When an S corporation loses its S election
• When an LLC switches from single member to multiple member
• When an LLC switches from multiple member to single member
• When a limited partnership changes into a limited liability company
• When 50% of the ownership of a limited partnership or limited liability company changes hands
• When an LLC elects to be taxed as a corporation, or revokes such an election
• If an entity changes accounting periods resulting in two short-period returns

Although this may look reasonable on the surface of one tax return independently, when you look at both returns together this looks like double-dipping to me. If one entity has to file two tax returns for one calendar year, I think the entity should get credit in the second tax return for any minimum tax already paid for that entity for that year. However, with California's ongoing budget crisis, I know this argument will fall on deaf ears. Therefore, I applaud Spidell's California Taxletter for informing tax practitioners of this tax trap. I'm hoping California business owners, as well as out of state owners with businesses registered in California, will read this blog and avoid inadvertently paying double minimum taxes. As a California business lawyer, I will do what I can to structure deals for my clients to avoid this double tax.

Continue reading "When the Minimum Franchise Tax is Not the Minimum Franchise Tax" »

San Jose and Santa Clara are such vibrant places to do business that many foreign companies want to relocate to Silicon Valley. As a corporate lawyer working with start-up companies, I have helped a number of ventures enter the U.S. market, and have worked with companies from Australia, Canada, China, Denmark Finland, India, and Israel, among others.

In past blogs, I have discussed some of the threshold considerations faced by companies leaving their home countries and relocating in the U.S. I have also discussed some of the entity forms that companies can adopt when deciding to access the U.S. market merely to sell their products or services.

Companies that decide that they want to access the private equity markets and managerial and technical talent resident in Silicon Valley often relocate their headquarters here in the U.S. For these companies, a "flip-up" will allow them to grow their company in the U.S. by being in a position to access local capital and hire a sophisticated workforce.

A flip-up is essentially a corporate reorganization. At its simplest, owners of the foreign company will exchange their interests for shares in a U.S. company. When the transaction closes, the foreign company is a wholly-owned subsidiary of the U.S. company, and the U.S. company is owned by the former owners of the foreign company.

A successful flip-up will require coordination among a company's U.S. and foreign tax advisors, legal advisors, and advisors for the foreign company's stockholders.

Flip-ups occurring during the early stage of a company are typically easier to accomplish than late-stage flip-ups. This is because the number of affected stockholders is usually smaller, as is the number of outside relationships that require special attention. If a company is considering a flip-up and a financing transaction, it should flip-up first and then close the financing. Often, U.S. investors will require that a company flip into the U.S. as a condition to a funding transaction.

A related reason for engaging in a flip-up early is that older companies usually have a capital structure and stockholder agreements that can be challenging to manage through a transaction. Companies that have closed numerous financing rounds often are subject to constraints that add complexity to closing. These constraints include stockholder rights enabling particular groups to have veto rights over reorganization transactions, outstanding options, warrants, and other convertible securities, and large numbers of stockholders. In addition, securities laws compliance can become relatively more expensive because the laws of the jurisdiction where the issuer (i.e., the U.S. company) resides, and the laws of the jurisdiction where each of the stockholders reside, must be followed.

On the other hand, new companies may face unique constraints. For example, young foreign companies may have received government grants to help them develop technology and grow their operations. Because these grants often require that the company be owned by citizens of the funding government, the terms of each grant must be reviewed carefully to determine whether the terms of the grant will permit a flip-up.

Whether accomplished when the company is young or more mature, a flip-up's structure needs to be carefully reviewed by experienced tax advisors to minimize or eliminate any tax impacts, particularly on the stockholders. This is particularly important because flip-ups rarely generate cash for any stockholders, and any tax liability would have to be paid out of a stockholder's other resources. Tax advisors should also be consulted in connection with determining where the company's intellectual property should reside for tax purposes after the flip-up is closed.

Flip-ups almost always require the approval of a company's stockholders. This will require the company to review its stockholder approval procedures, especially any voting agreements that might exist, and any relevant law. Likely, there will be minimum notification procedures that must be followed. In addition, disclosure documentation may be required. The cost and time of each of these must be built into the transaction so that the parties have a realistic expectation of the closing schedule.

Flip-ups are one of the best methods for a company that wants to take advantage of U.S. private funding opportunities and enter the U.S. market. The earlier the company can make the decision to reorganize as a U.S. company, the easier the transaction will be for all concerned.

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.

As a business lawyer representing many closely held corporations, I often see shareholders elect board members without much thought, either because they are family members or employees of the business. The board of directors serves a very important management role for a corporation and the decision of who you put on the board should not be taken lightly. If an elected board member is no longer a good fit for your company, do not wait too long to replace him/her or you could be missing an opportunity to find a board member who will add value to your company.

Electing a Director

In most corporations, the bylaws provide that directors will be elected at each annual shareholders' meeting and will hold office until the next annual shareholder meeting and until their successors are elected and qualified, unless they are removed from the board before that time. Each year when it is time to renew your board, make sure you stop to consider whether the same directors should continue serving the company, or if it is time for some new blood. It is much easier to not re-elect a director, than it is to remove one during his/her term.

Removing a Director

Directors can be removed for cause, which means the director being removed did something wrong. The board can declare a director's seat to be vacant if that director is convicted of a felony or declared incompetent. A director can also be removed for cause by a court order, but the court will require at least 10% of the outstanding shares to petition for removal, and a showing of fraudulent or dishonest acts or gross abuse of authority by the director to be removed.

Shareholders may remove directors without cause if the removal is approved by a majority of the outstanding shares entitled to vote for the election of directors. However, no individual director can be removed over an objection by one or more shareholders who, collectively, have enough votes to elect that director under cumulative voting.

Filling a Vacancy on the Board

Generally, the shareholders are supposed to elect the board of directors. However, depending on how the seat was vacated, either the board itself, or the shareholders, can fill a vacant board seat. If a director dies, is incapacitated, or resigns, the remaining directors can usually appoint a replacement director (unless the corporate documents say otherwise). If a director is removed, the vacancy must be filled by the shareholders unless the corporate documents authorize the board to fill such a vacancy. In the event that a majority of the directors have been appointed by the board, there is a safeguard to make sure the shareholders have the ultimate authority. Holders of 5% or more of the outstanding shares may call a special meeting of the shareholders and elect an entirely new board.

Whether or not your entire board is in place, in order to maintain your corporate liability shield, the corporation must follow the statutory rules regarding regular and special board meetings for the board to make decisions on behalf of the company. The rules for board meetings will be covered in another blog.

Continue reading "California's Corporate Requirements - Electing and Removing a Director" »

In my last blog concerning market entry into Silicon Valley by foreign companies, I discussed some of the basic issues and tasks surrounding the effort. As an attorney practicing corporate law and representing technology startup companies, I am often asked to assist in designing and implementing the legal structures that enable a foreign-owned company to access the US market.

There are a number of factors that guide a company's decision to enter the US market. First, what is it trying to sell? Second, does the company hope to generate its return on investment through a cash-flow from sales, or by building value and ultimately selling the company or taking it public? Third, does it need funding from US private investors? Let's look at how each of these factors guide entity form.

The first factor focuses on the best method for product distribution. If the company is trying to sell simple, commodity type products using an established distribution network, it may be able to get by with no entity at all. In other words, it can sell its products directly into the US through a distributor or independent sales representative. Even if the product is complex, but does not require a sophisticated domestic marketing, sales, or support organization, an independent sales representative could be used.

Where the product requires more than a sales representative to adequately exploit the US market, the company will need to consider forming some kind of entity. This is where the second factor comes in.

If the foreign company only wants its US company to generate sales and build up revenues for possible distribution to the parent company, and does not expect to use profits to drive expansion, it should explore forming the US company as a pass through entity, such as a limited liability company or partnership. Subject to certain exceptions, this will allow the US entity to avoid income taxes at the entity level. The extent of the overall tax burden, however, to the company as a group will need to be explored with an international tax professional.

If, on the other hand, the US company is expected, among other things, to grow on its own, secure outside funding, or be sold to another company, then a corporation is the preferred entity. A corporation, particularly if incorporated in Delaware, is a well-recognized method of doing business and can be created and organized easily. The US company will also be able to use operational profits to grow without the phantom income issues associated with pass through entities, and can avail its stockholder of beneficial tax treatment if it is later acquired.

Foreign startup companies often outgrow their home market, and look to the US, particularly Silicon Valley, as a beachhead into the US. This is where the third factor comes in. Many of these companies have built their technology, and have generated sales that validate the market for their products. They are stymied in their home countries, however, by the lack of expansion capital and become attracted to the established and sophisticated private investor market in the US. Knowing that investors prefer to invest locally, foreign startup companies soon realize they must relocate their headquarters to the US. The process by which they accomplish this is often referred to as a "flip-up", and will be the subject of a subsequent blog.

Analyzing basic distribution, return on investment, and funding requirements is necessary to determine the best approach to entering the US market.

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.

Silicon Valley is a magnet for foreign technology companies seeking to expand their offerings into the US market. As a San Jose-based attorney specializing in corporate law, I have seen an uptick in US-based management talent being solicited by foreign companies to help the companies start up their US operations. When faced with the question of what to do, many of the same issues arise in structuring the US market entry of foreign-owned companies.

The first issue is why the company is coming to the United States in the first place. If the company merely wants to sell widgets, it may be able to make do with a simple contractual relationship with a sales professional or distributor. If, on the other hand, the company wants to access US management talent and venture investors, it might look at reorganizing, or flipping-up, its legal headquarters into the US.

The second issue involves taxes. If the company is a mature company and expects to generate significant revenue from its US operations, there are a number of tax planning opportunities that may enable the company to minimize its international tax burden. Understanding the company's existing structure and its goals, and designing an appropriate corporate and technology ownership and use structure is a necessary task. It can, however, be an expensive undertaking depending on the nature of the company and its products and services.

The third issue involves the need to allocate resources to basic housekeeping. For example, it is surprisingly time consuming for a foreign company to open a simple bank account. This is because an account will require, among other things, a Federal Employer Identification Number, and the IRS will require that an individual provide some form of US-recognized personal tax number. Although this is easy for a US citizen with a social security number, it is more difficult for a company with no US contacts. A foreign company will usually need to coordinate the filing with the IRS to determine precise requirements, and its own foreign agencies to secure the necessary documentation to satisfy IRS requirements.

Another important housekeeping task is assembling the necessary team of advisors. If the foreign company hopes to enter the market through a sales representative or distributor, its group of professional advisors can be limited to an attorney and an accountant. If the entry strategy is more involved, the advisor group will likely extend to international tax professionals and bankers, among others.

The fourth common issue is making sure the foreign company understands the dynamic US business culture, especially here in Silicon Valley, and the rapid swings prompted by the business cycle. Many foreign companies are enamored with the potential market size of the United States, but may not have the stomach for the roller coaster life of a US technology company. Any entrepreneur working with a foreign company must probe beyond the usual discussions to determine the amount of funding and other resources that the foreign company is willing to devote to the effort, and whether that funding will be provided all at once, or dripped over time.

The Silicon Valley area will continue to attract foreign technology companies hoping to establish a beachhead in the US marketplace. In an upcoming blog, I'll discuss the legal structures that are often used in US market entry.

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.

As a corporate lawyer representing small businesses here in San Jose and throughout Silicon Valley, I often need to walk my clients through the process of forming a corporation, whether in California, Delaware, or another state, but also the ongoing requirements of maintaining their corporation. It is important to remember that California law provides limited liability to shareholders, so long as the corporation is treated appropriately. When corporate formalities are not followed, creditors and claimants can "pierce the corporate veil" to allow for a judgment against shareholders for a liability that should only have been an obligation of the corporation. One of the most important corporate formalities is the shareholder meeting.

Every California corporation is required to have an annual meeting of the shareholders, and can have additional 'special' meetings at any other time when properly called. In order to hold a proper meeting, the meeting must be properly called, noticed, and held. This is a general roadmap on how to do that, but any corporation is subject to the specifics of its corporate documents and should only rely on legal counsel familiar with its documents for requirements specific to its company.

When should the annual shareholder meeting be held?
The annual meeting should be held on a date and time that is stated in the bylaws. Recently I began representing a client that controlled multiple different corporations formed by his previous corporate attorney. Each of the corporations had a different annual meeting date, making it much more difficult for the client to remember to hold his meetings on time. We held a special meeting of the shareholders to amend the bylaws of each corporation to have the meetings on the same date, and then held the meetings back to back in his office. In this case, the shareholders and the board of directors were essentially the same people, so we actually noticed and held a joint annual meeting.

What action is required at the annual shareholder meeting?
The only action required to be taken by the shareholders at an annual meeting is the election of the board of directors. Any other proper business may also be acted upon, so long as it was included in the meeting notice.

Required Notice - What should the notice say?
All shareholders who are entitled to vote are entitled to written notice of the annual meeting (and any special meeting). The bylaws cannot override this requirement. However, most of the time, my small business clients with closely held corporations hold their meetings without formal notice, and we just have the shareholders sign a written waiver of the notice requirement at the meeting. Of course, you should not depend on this if there is any hint of a potential disagreement between the shareholders. Otherwise, a disagreeable shareholder could refuse to waive the notice requirement, and delay or block the shareholders from taking any action at the meeting.

The notice to shareholders must include the date, time and place of the meeting, and whether shareholders can attend by telephone or electronic meeting. For annual meetings, or any other meetings where directors will be elected, the notice must also state the names of the persons nominated for the election. Any other matters the board intends to present to the shareholders for any action at an annual meeting must also be stated in the notice. Although at an annual meeting the shareholders may still be able to act on a matter that was not included in the notice, certain matters may require the unanimous vote of the shareholders, including those not attending the meeting, if the shareholders were not given notice of them in advance.

At a special meeting, the shareholders are not allowed to act on business not included in the notice unless all shareholders provide written waiver of notice for that matter. For this reason, if the corporation has any adverse interests among its shareholder, I recommend that a very specific agenda be provided with the notice of any special meeting. The safest method is to provide the actual language of proposals the board will be presenting to the shareholders at the meeting.

In addition to providing notice before the meeting, in California the corporation must provide an annual financial report to the shareholders at least 15 days before the annual meeting, and no later than 120 days after the end of the corporation's fiscal year. However, if the corporation has less than 100 shareholders, this requirement can be waived in the bylaws.

Required Notice - How do you give notice?
You should always check to see what the corporation's bylaws say about notice, but for most corporations, notice can be given by first class mail, in person, or by electronic delivery such as facsimile or e-mail. Notice should go to the address or contact information provided by the shareholder to the corporation. If you do not have an address, or if the electronic notice gets rejected twice, you can mail the notice to the shareholder care of the corporation at its principal executive office, or you can publish it in a local newspaper. In other words, if you cannot find a shareholder you do not have a legal requirement to spend your time looking for them.

The corporation is considered to have provided notice as of the date it mails the notice, or delivers it personally, by fax or electronically. I recommend that the secretary of the corporation sign an affidavit of mailing or electronic transmission for the corporate minute book. I may be able to provide notice and sign the affidavit as the transfer agent for corporations that are my clients.

Required Notice - When should it go out?
Written notice of a shareholder meeting must be given no less than 10 days and no more than 60 days before the scheduled meeting. Corporations will often provide at least 15 days notice so that the annual financial report can be sent to the shareholders at the same time.

Improper Notice
As I mentioned earlier, shareholders can waive the required meeting notice if they did not get notice, or they can waive any problem with the notice they received. If a shareholder does not attend a meeting, they can waive notice in writing either before or after the meeting. If a shareholder shows up at a meeting and does not actually object to the improper notice at the beginning of the meeting, the shareholder is deemed to have waived the notice requirement. However, a shareholder can still object at any time during the meeting if a matter is raised that was not included in the meeting notice. Be very careful about the content of the waiver. Although usually the waiver does not have to include information about what was supposed to be considered at the meeting, certain matters do require a more specific waiver, otherwise unanimous vote of the shareholders may be required on those matters.

Once a company has set a date for its shareholder meeting and either provided proper notice or had the notice requirement waived, the company must now determine who has the right to vote at that meeting, and what votes are required.

Continue reading "California's Corporate Requirements - Shareholder Meetings" »