Articles Tagged with Shareholder

Entrepreneurs are faced with numerous decisions when forming a business. First, they need to contemplate the nature of the corporate entity they wish to operate (i.e., corporation, limited liability company, partnership, etc.). This decision hinges on many factors including the type of business, the desired ownership structure, tax considerations and potential financing opportunities. If the entrepreneur determines that forming a corporation is most advantageous for his or her particular situation, then he or she must next decide whether the corporation will be taxed as an S-corporation or a C-corporation.

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The “S” and “C” designations refer to different subchapters of the federal tax code. They each have their own governing requirements and qualifications, some of which are laid out below.

S-Corporations

Foreclosure of a Charging Order

Limited liability companies (LLCs) provide their owners (members) a number of protections that do not exist for partnerships or sole proprietorship’s. One critical protection is limited liability protection.  Because an LLC is considered a separate legal entity and its assets and debts are separate and distinct from any assets or liabilities that its owners may have, a creditor of an LLC member typically cannot reach or interfere with the LLC and vice versa. However, California law does provide a tool for creditors to try to reach a judgment debtor’s LLC interest. The tool is called a charging order.

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A charging order is roughly akin to a wage garnishment, but instead of directing an individual’s employer to pay over a portion of the individual’s salary to the creditor, it directs an LLC in which the individual judgment debtor has a membership interest to pay over any distributions that would otherwise be made to the member to the creditor. Notably, a charging order ordinarily cannot compel an LLC to make a distribution to a member and does not confer any management rights, instead extending only to distributions made to a member. For this reason, charging orders do not always result in payment to the creditor. Nonetheless, a charging order can still be effective because they can cut-off an LLC member’s rights to receive any distributions from the LLC and may impact the member’s dealings with the LLC and its other members.

A startup or entrepreneur looking to raise capital is willing to do almost anything to accept capital from an investor.  As a corporate and business law attorney, experience with more successful clients has led to some observations about what an entrepreneur might also want to look for or consider in an investor besides capital only.

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Consider the following observations when looking to attract investments.

Build Friends Not Just Investors

When the shareholder of a corporation files bankruptcy, the shareholder’s stock becomes part of the debtor’s bankruptcy estate and will generally be subject to liquidation by the bankruptcy trustee for the benefit of the debtor’s creditors.

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However, when a limited partner in a limited partnership (LP) or a member of a limited liability company (LLC) files bankruptcy, the debtor’s ownership interest may well be treated differently because interests in LPs and LLCs are typically considered and treated as more contractual in nature.

Membership Interests in LLCs

When a shareholder of a corporation believes that he or she has been wronged, the shareholder generally has two options to file a lawsuit.  The shareholder may either bring a direct action or a derivative action, depending on the facts of the case.  In many instances, it is only appropriate for the shareholder to bring one of these two types of actions against the company.   Below is a general explanation of how a corporation is set up, and a discussion of the differences between the two types of shareholder actions.

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Let’s say that you decide to open a lemonade stand by yourself as a simple business.  In a simple business, you would own the lemonade stand.  If the lemonade stand did well, you would make more money, and if it did badly, you would not.  In addition to being the owner, you would also run the lemonade stand.  You would make day-to-day decisions about the lemonade stand, like how where to order to the lemons from, what equipment to use, and how much customers should pay for the lemonade.  To sum up, you alone would both own and run everything.

The possibility of a hostile takeover is a very real concern for many publicly traded companies. A hostile takeover can occur in a number of ways, but one of the most common is purchasing enough stock on the open market to obtain a controlling majority. The main characteristic that defines a corporate takeover as “hostile” is the fact that the transaction is opposed by the target companies’ management.

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In many cases, a shareholder rights plan, often referred to as a “poison pill,” is an extremely effective tool to prevent hostile takeovers of publicly traded corporations. Basically, these plans trigger rights for existing shareholders that, when exercised, make the potential transaction much less attractive for a potential buyer. As a result, potentially hostile acquiring parties are then economically incentivized to negotiate with the target company’s board of directors, strengthening the target’s bargaining position.

While there are many potential types of shareholders rights plans, two of the most common are “flip in” and “flip-over” plans, which are detailed below.