Recently in Start-Ups & Financing Category

Funding a Startup: Regulation D

August 29, 2014,

There are a number of ways to fund a startup. We've all heard about loans, grants and crowdfunding but new rules from the SEC will make it easier for entrepreneurs to raise capital. In this post we're going to look at changes to "Regulation D" and what that means for startups.

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Understanding Regulation D

Regulation D is part of the Securities Act of 1933. Section 506 specifically deals with the solicitation of private offerings. In the past, the SEC essentially banned all forms of advertisement for private investment. The revised Regulation D does away with most of the restrictions. It's now possible for a company to publicly solicit funds for a private venture.

The New Regulation D

The game has changed but that doesn't mean there aren't rules. Only accredited investors can utilize the changes to Regulation D. These are people with $1 million in net worth or who make $200 thousand dollars a year in individual income. There is also a strict process for weeding out "bad actors." Generally, these are people who have committed some kind of financial crime or who have been disciplined by the SEC.

What it Means

The change to Regulation D is great news for startups. Increased access means greater opportunity to spread the word about a business and its product. A startup can now use every tool at its disposal to try and raise money. Another interesting aspect of Regulation D offerings is that there isn't a limit to the amount of capital that can be raised. Crowdfunding is a popular way to support startups. The key difference is that the total dollar amount in this model is capped at $1 million.

There is plenty more to learn about Regulation D and its cousin Regulation A. To find out more, contact 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.

Steps to Creating Bylaws

July 18, 2014,

rules.jpgOne of the first things any newly formed corporation should do is draft bylaws. Bylaws are a corporation's operational blueprint. They identify what the business does, how it is run and who is in charge. Here then are five steps to drafting a set of bylaws.

5 Steps to Creating Corporate Bylaws

1. Detail relevant information concerning shareholders. This includes who holds stake in your corporation, what rights they hold and when and where meetings are to be held.

2. Identify the Board of Directors. Include information on meetings, procedures for resignation and removal or addition of directors.

3. Outline the procedure by which officers are elected. Officers are people like the CEO or CFO. Detail their roles and responsibilities as well as how they will be compensated.

4. Indemnification of Officers, Directors, and Agents. In order to protect those who labor on behalf of the corporation, the bylaws should spell out who is indemnified for acts taken on behalf of the corporation, as well as the procedure for handling claims.

5. Finally, bylaws are made to be amended. What's the process look like? Deciding on this issue now will prevent headaches down the road. You'll want to figure out who has the authority to add, alter or completely remove a bylaw.

These five steps are really just a working model. There are fine points that should really only be handled by a professional. An attorney can help you craft a set of bylaws that are clear, sensible and legal. In reality, this process consists of at least six steps with the first being contacting a local lawyer to help get you 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.

3 Steps to Creating a Strategic Alliance

July 11, 2014,

hands.jpgA strategic alliance is a fairly simple concept. Two companies with similar interests join forces to produce favorable outcomes for all involved. An everyday example is the Starbucks inside of Barnes and Noble bookstores. This move helped Starbucks expand, but it also kept people in the bookstore, perhaps reading the first few pages of a book they were thinking of buying. A strategic alliance is good for business, but you'll need to take the proper steps to make it work.

1,2,3 - The Steps to Creating a Strategic Alliance for Your Company

Step 1: Choosing a Partner

Companies create a strategic alliance to help increase their profits. A solid partnership is one that generates revenue that couldn't be achieved by going it alone. Therefore, it's important to pick a partner you trust and that has a solid reputation. Also, a strategic alliance is a long-term commitment. Results are monitored over years, not months, so be sure the company you pick is one you can work with for the foreseeable future.

Step 2: Crafting a Deal

Perhaps the most important part of this step is determining a strategy. How will you go about achieving your goals over the next 3-5 years? This is also the time to set boundaries and determine roles. It's critical that you and your potential partner agree on such things like operation details and rules for intellectual property.

Step 3: Making it Work

Remember, these are two companies with two different ways of doing things. To make your alliance work you'll need to cultivate relationships. You'll need to know who's in charge and what happens when something unexpected happens. The way you handle a particular situation may be different than your strategic alliance partner.

The best way to avoid confrontation is by creating a clear contract. A good contract will outline roles and responsibilities as well as provide an "out" should the alliance fall apart. The team at Structure Law Group can craft an agreement that satisfies such objectives. By putting everything in writing you protect your company legally from any problems that may arise.

Have questions about creating a strategic alliance for your company? Contact Structure Law Group today!

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: 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.

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

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.

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.

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.

Crowdfunding Made Easy? Not So Much

October 1, 2013,

I have always known that Silicon Valley is home to many innovative companies and has a lot of entrepreneurial talent, but I was still amazed to read that start-ups in Palo Alto, Mountain View, Redwood City, Sunnyvale and San Jose received a combined $980+ million in funding in Q2'13. [Source: Silicon Valley Business Journal, July 16, 2013]. As a business lawyer in San Jose, I have seen a number of attempts to make fundraising for start-up companies easier. Recently, a new technique has come into favor.

The new buzz word for start-ups looking for funding is crowdfunding (sometimes known as crowdsourcing). In this type of deal, a group or entrepreneur will receive contributions from a large number of people for a project. The process started with artists raising money for their projects. Their success led for-profit companies to look at crowdfunding to raise money. Websites like kickstarter.com and indiegogo.com are just a few that provide crowdfunding opportunities.

To encourage crowdfunding, Congress passed the JOBS Act a year ago last September. In response, the Securities and Exchange Commission (SEC) released new regulations intended to encourage crowdfunding. One of the new regulations relaxes the public solicitation limitations that had been imposed for certain types of private financing deals.

A little background may be helpful at this point. Because start-up fundraising involves selling stock, start-ups have to comply with federal securities laws. To avoid the formal and expensive registration process, companies comply by using an exemption, known as Regulation D. To be eligible to use Regulation D, you could not publicly solicit your stock. Here is where the SEC relaxed its requirements. For issuances involving only financially sophisticated persons who are accredited (meaning, rich) investors, you can publicly solicit your stock. Life is good!

Well, not so fast. The SEC said if you publicly solicit, you need to be sure the investor is actually accredited. So, what do you have to do?

In the past, most stock purchase documents merely have the purchaser state they are accredited. Under this new rule, that will not be enough. Instead, the issuer has to take "reasonable steps to verify that such purchasers are accredited investors." The SEC did not want to dictate what has to be reviewed to verify accredited status, but did make some suggestions. For example, if you are using income as a basis for accredited status, you can look at tax returns. If you are looking at net worth as a basis, you can look at bank statement, brokerage statements, and a consumer report as to liabilities from a nationwide consumer reporting agency. You can also accept a written statement from a registered broker-dealer, registered investment advisor, or attorney.

Another set of regulations that is required under the JOBS Act governs the operation of funding portals, essentially companies that will enable investors to invest in start-up companies. The only problem with these regulations is that they do not yet exist. We are all waiting for these new regulations, and the latest rumors are that we should see something in the last quarter of this year.

What this all means is that if you want to use crowdfunding to sell stock, you will need to be a lot more invasive in investigating the financial status of your investors. Investors may not be comfortable releasing this information. As a result, this newest revision from the SEC may not open the floodgates of capital to start-ups. In addition, if you want to use a funding portal, you need to wait a little longer for the SEC to get its regulations together. Still, it all adds up to a new way of raising funds, and may prove to be useful in the right situation.

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.

New Corporate and LLC Startups May Find Relief with the Passage of a New Bill in California

July 15, 2013,

In Silicon Valley, home to many large technology corporations and thousands of innovative startups, businesses need to move quickly to stay ahead of the competition. As a small business attorney in San Jose, I have formed countless of limited liability companies (LLCs), partnerships and corporations with the Delaware and California Secretaries of State over the years. And one of the first questions my eager small business clients ask me in our initial meetings is almost always, "How long will it take to form my company?"

For many years my answer was that we could have the filed Articles of Incorporation (for a Corporation), Articles of Organization (for an LLC), or Certificate of Partnership within about a week. When the California Secretary of State slowed down a few years ago, I had to tell clients that it could take as much as several weeks. However, in the last year or so the delays crept up to three months or more for the California Secretary of State to process and return a business filing.

Of course, California does provide a 24-hour expedited filing option, for an additional $350 over the usual filing fees. In my more cynical moments I have had to wonder whether it was the California budget crisis that was causing filing times to slow down because of lack of resources, or if the Secretary of State was purposefully taking longer to return routine filings in order to force virtually everyone to pay the "rush" fees.

Now it seems my cynicism may have been misplaced. Governor Brown just signed a bill (AB 113) which will provide $1.6 million in funding to the California Secretary of State to be used to eliminate the backlog of over 100,000 filings and speed up the business filing process. The stated goal is to reduce waiting times for a business filing to be processed and returned from three months to between 5 and 10 days by November, 2013. [Source: Spidell's California Taxletter, Vol 35.6, June 1, 2013, p.71]

Although I applaud the Governor for trying to do something, I think we need to go a lot further than this. As the home of Silicon Valley, California should be setting the standard for the use of technology in business. Never mind that we can form corporations and LLCs usually the same day by email in Delaware (with no extra fees). I want to be able to form entities immediately on-line, without extra State charges, and without the need to pay extra fees to filing agents in Sacramento to walk my client's filings into the Secretary of State's office to be at the front of the line (processing times for filings by mail are much slower).

If our business owners and inventors can start their business in California faster and less expensively (with no rush fees), this will benefit everyone. The State will collect more franchise taxes and will likely start collecting more payroll taxes and sales taxes from new businesses sooner. With this in mind, I hope the Secretary of State is seriously considering significant investments in technology both as part of the $1.6 million and in addition to the AB 113 funds.

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.

U.S. Market Entry - Legal Structures for Foreign Startups

June 13, 2012,

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.

Is a B Corporation the Right Choice of Entity for Your New Company?

April 3, 2012,

I recently taught a program to California lawyers for the Santa Clara County Bar Association concerning B corporations, a subject I covered in a previous blog. As a Silicon Valley business attorney, with an increasing number of clients forming new companies, I want to discuss some attributes of these corporations that should be considered by anyone starting a new business.

The first consideration is whether becoming a B corporation will assist in a company's funding and operations. B corporations arise from a national movement to allow companies to consider factors other than just profits and shareholder value in making their decisions. Certain types of investors and employees are drawn to companies that share similar values. Because of the attractiveness of value-driven organizations to these constituencies, start-up companies should strongly consider whether becoming a B corporation can provide them with a unique story when soliciting investment, and an edge when recruiting employees.

The second consideration is whether the goods or services "fit" with the concept of a B corporation. Fortunately, a B corporation does not necessarily need to exist solely to pursue its social goal. Almost any business can be a B corporation if it adopts the kind of public purpose that is required under one of California's two B corporation statutes. For a "benefit corporation", the purpose needs to one which creates a material positive impact on society and the environment, taken as a whole. For the "flexible purpose corporation", the purpose needs to be one which could be pursued by a California nonprofit benefit corporation, or one which promotes or mitigates the effect of the corporation's activities on the corporation's stakeholder, the community or society, or the environment. The open ended nature of these purposes allows a wide variety of businesses to organize as a B corporation.

Because California created two different types of B corporations, you will need to consider which type of B corporation your new company should form. One way to approach this decision is to ask yourself how much the corporation should be forced to consider its public purpose. In the "benefit corporation", the board of directors MUST consider the impacts of any action on the company in the short term and long term, and its shareholders, employees, customer, community, and environment, and its ability to accomplish its public purpose. This will force the board to deliberate very carefully, and will require your counsel to prepare corporate documentation carefully to record the board's deliberations. By contrast, the "flexible purpose corporation" merely allows the board to consider its public purpose when making decisions, but does not require that furthering the purpose be a component of its decision.

In making your decision to conduct your business using a B corporation, you can avoid some common misconceptions. One common myth is that a B corporation needs to be certified. There is nothing in any of California's B corporation laws that require any type of third party certification. There is, in the "benefit corporation", a need to compare the efforts toward meeting public purpose to a third party standard, but this falls short of requiring actual certification. Another common question that often arises is whether B corporations are taxed differently. At this time, they are not. Of course, a B corporation does not need to be a nonprofit corporation for tax purposes.

In a future blog, I will cover one of the most critical considerations you face when adopting a B corporation - the disclosure of your company's activities.

Continue reading "Is a B Corporation the Right Choice of Entity for Your New Company?" »

Proposed Filing Deadlines Could Impact Fundraising in California

March 6, 2012,

As a Silicon Valley business attorney, I often help small businesses and start-up companies in San Jose and Santa Clara with their financing transactions. Whether my client is a newly formed software corporation getting capitalization from its founders or an existing company trying to raise money by making a preferred stock offering, as my client's business lawyer, I need to counsel them in their fundraising efforts to ensure that the company complies with securities laws.

However, a bill recently introduced in the California State Senate will make it harder for small businesses and start-up companies to raise money in California. The bill, SB 978, could eliminate a securities exemption commonly used in fundraising transactions and expose a company to fines, and its controlling persons to individual liability, if a certain filing is not completed in time.

A little background is helpful to understand why this bill is such a disaster. Fundraising to start or grow a company requires compliance with both state and federal securities laws. If an offering violates the securities law, anyone who purchased the securities in that offering can rescind their purchase and get their money back. The aggrieved investor can look to the company for return of funds, or can look to any of its controlling persons individually. If you are considered to be a controlling person of a company that misses a securities filing deadline for an offering, your house may be on the line.

California's securities laws require an offering to a California resident to be "qualified" by the California Commissioner of Corporations, a somewhat time consuming and expensive process. For certain securities and securities transactions, exemptions from the qualification requirements are available. These exemptions allow a company to comply with the securities laws on an expedited and less expensive basis.

Exemptions typically outline the conditions required to use the exemption. For many exemptions, if you meet the conditions, you are good. For others, within a short period of time following the first sale in the offering, a notice has to be sent to a government agency informing the agency of the company's reliance on the exemption. The notice is typically required so that regulatory agencies can collect information about securities offerings in their jurisdiction. The notices do not really offer any particular protection for an investor participating in the offering described in the notice.

California law contains a widely used exemption for private placements. This exemption, used for fundraising transactions ranging from the initial formation of a company to a venture financing, requires an online filing 15 days after the first sale in the offering. Currently, failure to file the form does not result in the loss of the exemption, although additional fees may be required once the company realizes it has missed the deadline.

SB 978 changes existing law by saying that if a company fails to make the filing by the 15 day deadline, then the exemption is unavailable. If a different exemption is unavailable, and the company cannot get a post sale qualification (not a particularly common practice without a rescission offer), then the offering is out of compliance. This is not pretty. If a company has just violated the securities laws, then, as mentioned above, its officers' personal assets may be at risk. Even if none of the offending company's current investors sues it, the company will need to disclose this problem to its future investors.

This new law does nothing to protect investors. There is simply no logical argument that filing an online form within a particular period of time protects investors in an offering. The law will, however, severely and adversely impact fundraising in California, both for California companies and California residents investing in companies in California or other states. Here's why:

Fundraising is not a smooth process. It is not uncommon for my corporate clients to accept funds without contacting me first, or to forget to contact me once they have cashed their first fundraising check. By the time some clients get to my office, more than 15 days have gone by. Under the current state of the law, the discussion is narrowed to some theoretical risks and the need to pay additional filing fees. Under a post-SB 978 world, the discussion is more difficult because it will focus on highly expensive and potentially unsuccessful fixes and the client's exposure to personal liability. This discussion will not stimulate fond feelings for doing business in California.

The issue is even worse for out-of-state companies. Many high tech, software and medical start-ups in Silicon Valley often seek money from California investors when fund raising. Out of state counsel and companies may not be familiar with the loss of a private placement exemption, particularly in those states where there is no need to file a form in the first place. SB 978 could impair investment opportunities for California residents, especially after a company is advised by its counsel that investment funds have to be returned because no exemption is available.

Securities laws must focus on investor protection. California's private placement scheme has worked for years, and there is no showing that investors will be better protected by the draconian consequence of failing to timely file an online notice.

In a state with a large structural budget deficit, policy makers should be focused on encouraging increased business activity, rather than furthering the impression of California as an unfriendly business state. Please contact your state representatives to put a stop to this unwise misuse of the securities law.

Contact Anna Eshoo for the 14th Congressional District, who covers portions of San Mateo, Santa Clara and Santa Cruz Counties, including parts of Sunnyvale, Menlo Park, Mountain View, Saratoga, Cupertino and Santa Cruz. Contact Michael Honda for the 15th Congressional District, who covers much of the central, northeastern and southeastern area of Santa Clara County, including parts of Milpitas, Santa Clara, Cupertino, Los Gatos, Campbell, and Gilroy. Contact Zoe Lofgren for the 16th Congressional District, who covers portions of Santa Clara County, including parts of San Jose and Morgan Hill. For other Districts, go to: http://www.govtrack.us/congress/replookup.xpd?state=CA.

Employment Basics for Employers - Employee Performance Reviews

October 4, 2011,

Silicon Valley is experiencing a "war for talent," even as the nation struggles with unemployment. The Bay Area has not been unaffected by unemployment, but with the number of high technology startups based in cities such as Palo Alto, Mountain View, San Jose, and Santa Clara, companies are finding themselves competing for talent. The value of human capital is greater than ever, which is why it is essential for companies to perform assessments on their employees. Employees can be a company's most valuable asset or its greatest liability.

Conducting employee performance reviews is one of the most important and often most dreaded tasks of management. Employee reviews take a lot of time and cause a lot of stress for managers even if the reviews are generally positive. Many employers try to avoid employee performance reviews. However, regardless of the size of your company, not conducting performance reviews can really hurt you both in productivity and in an increased risk of employment-related litigation.

I recently worked with a San Jose consulting business that was sued by a former employee of the corporation. The company had a salesperson in their Mountain View office that was drastically underperforming, but had never documented those failures in any way. The corporation eventually fired her and the salesperson then sued the company for wrongful termination. An employee file documented with poor performance reviews could have made that case go away much faster, and kept the settlement offers much lower. Below are some suggestions to make the most out of review time.

First of all, employee reviews should be conducted at least once a year, sometimes twice a year or more depending on the company and the employee. Good performance review practices help communicate issues before they get to the point of firing. In addition, if an employee is having performance issues, don't wait until review time to bring them up. Deal with the issue immediately.

Second, when conducting employee performance evaluations, be honest. Many managers give their employees high marks, even if they're not justified, just to avoid a confrontation. If an employee is performing poorly, discuss the poor performance in their review. Don't give an employee all high marks, especially if you are not happy with their performance. This could cause a problem if you decide to fire an employee for poor performance later. The employee may claim he or she had no idea that there was a performance issue and that former employee may try to sue on the basis that the real reason for termination was something else like discrimination. Courts like to see documentation of poor performance issues and the employee review is a great place to document any problems.

Third, consider keeping notes throughout the year when your employees do something positive. You can then bring these up during the evaluation instead of just focusing on the most recent items. This helps you provide specific examples of strengths and weaknesses. Give employees goals so they have something to strive for throughout the year.

Fourth, consider having employees complete self evaluations. Self evaluations help managers know where employees may not be receiving appropriate feedback throughout the year, especially if there is a large discrepancy between a manager's evaluation and an employee's self-evaluation.

Fifth, try to use a form of evaluation that actually fits the employee's job description, rather than a pre-printed form, or a form someone else is using. The right form will enable you to objectively measure an employee's performance on specific essential taxes required for their job. When conducting several evaluations at once, be careful to avoid certain pitfalls including the tendency to evaluate all employees as outstanding, average or poor, especially if that is not a true reflection of their performance.

Finally, use the evaluation process as an opportunity to talk to your employees and allow them to provide feedback to your organization. This is an excellent opportunity to gather ideas for your business, improve your organization, reduce grievances and prevent lawsuits. It is also an excellent opportunity to train your management staff in the evaluation process.