San Jose Business Lawyers Blog

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?" »

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.

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.

Most letters of intent describing acquisitions in Silicon Valley, as elsewhere, will describe the material points of a transaction. Although a properly drafted letter of intent will provide that the business points of the deal are nonbinding, it is difficult in the course of any negotiation to change a business point already agreed upon. As a result, take care to describe those points that are most important to a transaction and to leave others to be negotiated as part of the definitive agreement.

The most important point is obviously the purchase price. This can be expressed, among other ways, as an absolute amount. If the transaction is a merger, the absolute amount is converted into a conversion or exchange rate based on the market value of the acquirer's stock over a period of time preceding the closing.

It is very unusual for the price to be paid all at once. Typically, the amount ultimately paid will be subject to post-closing adjustments based on issues unrelated to financial performance (often referred to as a holdback) as well as issues related to financial performance or other milestones (often referred to as an earnout). These provisions must be considered very carefully, as they are often a source of litigation. This blog will only discuss the holdback.

The liability holdback is the most significant holdback and is used to cover any liabilities which may arise after the closing. The holdback is used to help protect the buyer when the state of the Company, often described as representations and warranties, is found to be inaccurate. These liabilities can arise when the Company is sued after the closing, e.g., when an infringement claim is made, or can arise if a representation is inaccurate, e.g., when a cost of a particular liability is found to be greater than originally disclosed. Liability holdbacks will also cover any liability arising out of the seller's failure to perform an obligation.

The percentage of the liability holdback varies considerably, although they typically are between 10% and 20% of the purchase price. For known claims that cannot be quantified yet, a separate holdback can be created, and the amount held back can vary with the amount of the claim.

The audit holdback, another common holdback, is that amount of money to be used to cover any adjustment which may be required to adjust, following a post-closing audit, an inaccurate working capital cushion. The employee retention holdback is another holdback that is used where employees are crucial to a target company, where an amount is held back for a period of time and reduced if employees depart the target company after the closing.

The amount of time that funds will be held back varies. Liability holdbacks typically run between one and two years. Audit holdbacks will typically run for 90 to 120 days after the closing to encourage the audit to be completed. Employee retention holdbacks can run to one year, and potentially longer.

My next blog will discuss the earnout, and the portions of this important mechanism that are usually found in a letter of intent.

I was talking to a client in Cupertino this week about helping his friend with a start-up business in San Jose. Originally, my client wanted to form a corporation online by himself, but he was not sure if the company should be an S corporation ("S-corp") or a C corporation ("C-corp"). He was only thinking about the pass-through implications of an S corporation and the "double taxation" of a C corporation, but was unaware of the small business stock tax exclusion in C corporations and the potential benefit to investors.

I explained that as an incentive to investors to make long term investments in small businesses, for investments made after September 27, 2010 but before January 1, 2012, 100% of the capital gain from qualified small business stock held for more than five years will not be taxed. The amount of gain excluded is the greater of $10 million or ten times the taxpayer's basis in the stock (usually the amount paid for the shares).

To qualify for this incentive, there is a list of rules. The taxpayer must acquire the stock upon its original issuance for cash, property or services. The corporation must be a C corporation with a maximum of $50 million in assets, including the investment. It must not be a regulated investment company, real estate investment trust, real estate mortgage investment trust or other type of entity with special taxation, must not own investments or real estate with a value exceeding 10% of its total assets, must not own portfolio stock or securities with a value exceeding 10% of net assets, and must use at least 80% of the value of its total assets in the active conduct of a trade or business. The corporation's trade or business cannot include professional services, banking, insurance, financing, leasing or the hotel or restaurant business.

Because this start-up company qualified for the small business stock exclusion, and the client was hoping to grow the company with investment from third parties, he decided a C corporation was the right choice. Also, because he realized how much he did not know about forming a new corporation, he asked me to do the formation for him. Once it is formed we will talk about the best way for him to get his promised share of the company.

Any Silicon Valley mergers and acquisitions lawyer helping clients buy and sell high technology companies is invariably provided with a simple letter of intent, happily signed by a couple of companies without input from their tax and legal advisors, and asked to prepare binding documents. In one case, my San Jose business client was not too worried about the lack of detail in the letter because, after all, it was just a "letter of intent". She was less than happy when I told her that she had actually signed a binding agreement, particularly since very little due diligence had been performed on the target company and a number of 'minor' issues that were important to her still required resolution.

A letter of intent (also called "LOI", or memorandum of understanding, or "MOU") is usually a short letter that outlines the basic business terms of a deal. Without language expressly stating that the letter is nonbinding, and that no obligations arise except under a definitive agreement, however, that letter you signed may be a legally binding contract. Even with this kind of language, a letter of intent can morph into a binding contract IF the parties conduct themselves as if the target company has been acquired. Announcing a deal (when not otherwise legally required), combining operations before a closing, and similar actions, can create a contract from conduct. With no definitive agreement signed, the letter of intent may be used as evidence to set the terms of the deal.

Why do you want an LOI to be nonbinding? Letters of intent are usually prepared and signed after the initial business proposition and marketing analysis have been performed. They are typically signed before the acquirer has a chance to really investigate the target. This is because neither party will want to conduct an expensive diligence investigation until each is sure they have a deal. If the letter of intent is binding, then the acquiring company may find itself purchasing a lot of problems of which it wasn't aware when it signed the letter of intent.

Even in a nonbinding letter of intent, there are a number of provisions which should bind the parties. In my next blog, I'll discuss the importance of having binding terms in a nonbinding letter of intent.

Bridge financing for Silicon Valley start-up companies is a fairly standard, relatively inexpensive method to raising money pending a larger investment round. This type of financing is typically provided in the form of debt that converts into shares issued in the next funding round, often at a discount from the per share purchase price.

Recently, the simple convertible bridge loan has changed to provide substantial tax incentives to investors. For any qualified small business stock, or QSBS, purchased before December 31, 2011, the recently enacted 2010 Tax Relief Act allows 100% of the gain recognized from the stock to be excluded from taxable income.

Although a convertible loan will not qualify as QSBS, the stock that a start-up company issues normally will. Bridge loan investors have a great incentive to purchase stock in exchange for their bridge funds instead of a convertible note. Designing stock that has many of the same attributes as convertible debt has provided some additional complexities to what was formerly a plain vanilla transaction.

Because debt is not being issued, the investor will have no right to return of its funds, barring securities violations. Most bridge loan investors, however, provide funds on the expectation of ultimately holding stock. As a result, the lack of a repayment feature is not a concern. If it is, a redemption feature could be designed, but it is unlikely the Company would be able to legally redeem the stock if it couldn't otherwise raise money.

The key advantage to a convertible note, that value need not be negotiated, is eliminated because stock is issued. This creates the need to negotiate a valuation, which adds time to the transaction. This can be solved, in a sense, by requiring the stock to convert into stock issued in the next round if the next round is expected to close soon. If this approach is used, a separate and forced conversion rate must be established to make sure the bridge stock converts into the next round.

As a result of the above items, and the need to issue stock, a new series of stock will need to be created. This requires charter documents to be amended and corresponding board and stockholder approval to be secured.

Price-based antidilution adjustments may be triggered. If so, capitalization estimates have to take account of corresponding changes in the conversion rate of the applicable series of preferred stock.

Tax benefits will come at some cost in the deal due to more complex documentation and expense. The structure, however, may provide just the right push to close that extra funding.

Technology start-up companies in Silicon Valley exist in a highly dynamic environment, where survival can be crushed by competition from a kid in a garage or a fund partner refusing further investment. As a last gasp, some companies may try to be acquired. Companies which have had to take refuge from their creditors may be able to sell their business through bankruptcy proceedings.

When compared to a standard sale of a business, sales of financially troubled companies require the professional advisors to manage a number of different stakeholders to successfully close a transaction. More so than in standard transactions, professional advisors play an important role in helping a transaction proceed smoothly. Under certain circumstances, their fees may be paid by the buyer or the bankrupt estate.

Most acquisitions of financially troubled companies are structured as an asset purchase. This prevents the acquirer from having to automatically assume liabilities that it doesn't want. The existing creditors are then left with satisfying their claims out of the proceeds from the sale. Most companies, however, need the products or services of its creditor vendors to survive. In the case of technology companies, these vendors often include technology and hardware suppliers who are core to the company's business. Irritated suppliers may not want to deal with the company even after its acquisition. Creditors and stockholders of the company may have claims against the company's board of directors if a company is sold for less than the reasonably equivalent value of its assets. At the same time, key employees of the company, aware of the company's financial stress, may be looking for alternate opportunities. The importance of these stakeholders, and how they are managed as part of the acquisition, is at the heart of any purchase of a financially troubled company.

The first task of any potential buyer is to perform extensive due diligence to determine what employees and suppliers are necessary to the company post-closing, and whether the company's operations can be streamlined sufficiently to enable it to become viable. For the seller, the key task is to maintain those relationships of most value to the company. This may require creating cash retention bonuses for key employees.

The second task is to document a letter of intent and definitive agreement rapidly so that the company remains viable. Preliminary negotiations can be challenging, because, among other things, the buyer will need access to the seller's vendors to determine if payment accommodations can be made. In exchange for the time the buyer requires for vendor discussions, the seller may insist that the buyer funds the company's operations, particularly its payroll, until closing.

The third task is to close the transaction quickly so that valuable employees and vendor relationships are not lost. This can be difficult given that contracts for many of the seller's key relationships will need to be assigned, and the consent of the other contracting party may be required.

In my next blog, I'll discuss how the bankruptcy process is used in acquiring a financially troubled company.

In Parts I and II of this Article I talked about how important a complete and properly formed business entity is for estate planning and liability protection. There are also many other potential impacts of not having your corporation or LLC documentation in order. Here are just a few:

IRS Problems: Just over five years ago I got a call from a licensed contractor in Campbell who was being audited by the IRS and needed to present his corporate minute book to the auditor in five days time. His company had not done minutes of the shareholders or the board of directors for the previous six years. It took us much more time to go back and recreate the corporate minutes and ended up costing my client at least twice what it would have if we had prepared the minutes each year when the information was fresh. However, it was necessary to document certain shareholder loans which would not have been upheld by the IRS if they weren't properly authorized by the corporation.

Securities: Many new business owners do not understand that an ownership interest in a corporation or a manager-managed limited liability company is considered a security and may require federal and/or state securities filings. Failure to make these required filings may result in shareholders having rescission rights whereby they can demand their investment back from the company, and any person controlling the entity could have personal liability to return those funds.

Debt v. Equity, Ownership and Control: I have worked with a Santa Clara consulting company for many years. Over the years the corporation went from being wholly owned by family to being owned by third parties as well. Unfortunately, it has been very hard for the family shareholders to adjust from the casual way they used to run the corporation. For years they added capital to the corporation without taking additional shares and without making it clear whether the additional capital was debt or equity. Now that third parties are involved, it is necessary to document every dollar that is put into the corporation and to determine whether that capital contribution results in additional shares which could impact control.

Shareholder Disputes: Every so often I get a call from small business owners asking me what their rights are to continue the business without their partner's consent. Usually I tell them that the answer lies in their ownership interests, their control of the board of directors, and their rights under their partner or shareholder buy-sell agreement. Failing to complete the entity formation means they are subject to the default rules of the California Corporations Code, which could be a lot different than what they intended, and may result in the termination of the business. I hate to see goodwill wasted like this. See Part IV of this Article for how a buy-sell agreement can help avoid this situation.

Filing your Articles of Incorporation or Articles of Organization with the Secretary of State is only the first step in creating your corporation or LLC. Unfortunately, most online business formation services take your money and don't do much more than that for you. And many do-it-yourselfers don't perform the required tasks unless they are somehow notified that additional filings or documents are needed to complete the formation of their entity. Even some business owners that have an attorney form their company correctly initially often fail to keep up the required formalities. The problem with stopping at filing your Articles, or even your initial formation documents, is that if you do not treat the corporation or LLC properly, then the courts can do what is called "piercing the corporate veil" and look through the company to the business owners for liabilities of the business.

Some of the basic formalities required in order for the courts to maintain the liability shield of a corporation include:

• Holding annual meetings of the shareholders and the board of directors.
• Maintaining the corporate minute book, including organizational minutes, corporate resolutions authorizing or ratifying major decisions, and minutes of annual shareholders and board meetings.
• Issuing and canceling stock certificates as appropriate and maintaining an accurate stock ledger.

For both corporations and limited liability companies, requirements include:

• Having bylaws for a corporation or an operating agreement for an LLC.
• Not commingling funds with personal funds or funds of another entity, including maintaining separate bank accounts, paying company expenses out of the company only, and not running individual expenses through the company.
• Making required Secretary of State filings.
• Filing federal and state business tax returns.
• Making required federal and state securities filings

Continue reading "An Incomplete or Improperly Formed Corporation or Limited Liability Company Can Hurt Your Silicon Valley Business in Several Ways, Part II: Liability Protection" »

I recently met with a new client from San Jose whose father was dying. My client's father owned a small business and was a director and officer of that company. There were two immediate issues for us to deal with. First, the corporate minute book was a mess and we needed to clean up the stock certificates and minutes of the board and shareholder meetings quickly to make sure they actually said what my client's dad intended. Second, we needed to re-title several assets that were supposed to be in the corporation but were not currently titled that way, including some real property in Campbell.

Why is the minute book important? In this case, the share certificates were inconsistent and did not agree with the Articles of Incorporation or the stock ledger. This could result in a shareholder dispute as to ownership of the company and voting control. Also, there were no minutes for the last five years. Without minutes of the shareholders and the board of directors, the corporation was risking its liability shield. [See Part II of this Article for more about Liability Protection.]

Why is the title of the assets important? Assets owned by the corporation should be in the name of the corporation and not held personally by a shareholder. In this case, assets were in dad's name but he had always treated them as owned by the corporation. So, if dad died and left the corporation to his son, he was intending those assets go with it. But, those key assets of the company would not be included in an inheritance that leaves the corporation to the son and the other assets to other beneficiaries. In addition, property that is not titled in the name of the corporation might not carry the liability protection of the corporation in case of a lawsuit. [See Part II for more about Liability Protection.]

Although dealing with an impending death of a loved one is difficult, this family was lucky in many ways because they had some warning and a chance to fix things before dad died. Working with them reminded me that having your property not go the way you want it to on your death is just one more potential consequence of not properly completing the formation and funding of your business entity or keeping up with corporate maintenance. Other problems with incomplete or improperly formed corporations and limited liability companies are addressed in Parts II through IV of this Article.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

See Part 2 for more on professional advisors.

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

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

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