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Shareholder Rights to Access to Books & Records

Under Texas law, shareholders of corporations and members of limited liability companies ("LLCs") have the right to inspect the company’s books and records, provided they have a proper purpose. This right, outlined in the Texas Business Organizations Code, ensures that investors can assess the financial health of the company and monitor for potential misuse of assets or self-dealing. Who Can Request Company Records? The eligibility criteria for requesting access to records differ for corporations and LLCs: Corporation Shareholders - Must have held their shares for at least six months, or - Own at least 5% of the corporation’s outstanding shares. LLC Members - Any member of the LLC is eligible to request access to the company’s books and records. Steps to Request Financial Records in Texas To access financial records, shareholders or members must submit a written request to the corporate secretary or managing member of the company. This request must cite a "proper purpose" for the inspection. - What is a “Proper Purpose”? Texas courts define a proper purpose as any request reasonably related to protecting the shareholder’s interest in the company. For example, verifying the company’s financial health or investigating potential misuse of assets are valid reasons. However, the company may deny your request if: - You have previously misused information obtained during a prior inspection. - The request is not made in good faith. What Records Can You Request? The scope of records you can request depends on the type of entity: - For Corporations: Shareholders may examine and copy the following records: - Books - Records of account - Minutes of meetings - Share transfer records (Texas Business Orgs. Code § 21.218(b)) - For LLCs: Members are entitled to inspect records related to: - The business, affairs, and financial condition of the company - Books and accounting records - Meeting minutes - Membership records (Texas Business Orgs. Code § 101.502(a)) Inspections can be conducted personally or through an agent, such as an accountant or attorney. What If Your Request Is Denied? If your proper request for records is denied, you can seek legal recourse by filing a lawsuit. A court can compel the company to provide access to the requested records. Under Texas law, if the court orders the production of records, the company must cover your attorney’s fees and legal costs. Responsibilities of Corporate Officers and LLC Managers If you are a corporate officer or LLC manager, it’s critical to handle shareholder requests for records with care. Ignoring or denying a valid request can result in litigation, financial penalties, and court-mandated reimbursement of legal fees. To ensure compliance: - Refer to Texas Business Organizations Code Section 21.218 for corporations. - Review Section 101.502 for LLCs. Properly responding to these requests can help avoid costly disputes and maintain good faith with shareholders or members. Legal Assistance for Shareholders and Corporate Officers Whether you’re a shareholder seeking access to records or an officer responding to a request, our legal team can help. We’ll guide you through the process, ensuring your rights are protected and obligations are met. Contact us today for tailored advice on navigating shareholder rights and corporate responsibilities. Joseph J Raetzer Raetzer PLLC Read the full article

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Preemptive Rights: Anti-Dilution of Shares

In corporations and closely held companies, ownership is determined by the number of shares held. For example, a shareholder owning 1,000 shares in a company with 10,000 total shares has a 10% ownership stake. However, this ownership percentage can be threatened by dilution, a common concern for minority shareholders. For example, if the company issued an additional 10,000 shares, that 10% stake would then drop to 5% of the company. The Impact of Shareholder Dilution Shareholder dilution occurs when a corporation issues additional shares, reducing the ownership percentage of existing shareholders. Dilution can erode voting power and investment value, making it a frequent tactic in minority shareholder oppression or squeeze-outs. To combat such risks, preemptive rights can provide protection for shareholders. What Are Preemptive Rights? Preemptive rights, sometimes called anti-dilution provisions, grant shareholders the opportunity to purchase a proportional share of any new stock issuance before it is made available to others. These rights safeguard a shareholder’s ownership percentage by allowing them to maintain their stake in the company. Preemptive rights can be included in: - Shareholder agreements. - Governing documents such as bylaws or articles of incorporation. - Securities, merger, or option agreements. Preemptive rights protect shareholders against damages from dilution, particularly when new shares are sold below their fair value. These rights may: - Preserve ownership percentage and voting power. - Protect early investors from value loss due to lower-priced new shares. - Serve as an incentive for early or high-risk investors. Preemptive Rights in Texas In Texas, preemptive rights are not automatically granted to all shareholders. Their availability depends on when a corporation was formed and its governing documents: - Corporations formed before September 1, 2003: Shareholders have preemptive rights unless explicitly excluded in the articles of incorporation or bylaws. - Corporations formed on or after September 1, 2003: Shareholders do not have preemptive rights unless explicitly provided for in the governing documents. Preemptive rights are more commonly granted to majority shareholders, early investors or as an incentive in funding rounds. However, these provisions can complicate efforts to raise capital quickly, particularly in times of financial difficulty in the capital markets. Exceptions to Preemptive Rights Under Texas law (Texas Business Organizations Code § 21.204), certain stock issuances are exempt from preemptive rights unless stated otherwise in the share certificates. Exemptions include: - Shares issued as compensation to directors, officers, or employees. - Shares issued to satisfy conversion or option rights tied to compensation. - Shares authorized in the Certificate of Formation and issued within 180 days of incorporation. - Shares issued for non-monetary consideration. These exceptions highlight the limitations of preemptive rights. Even with such rights, shareholders without the financial means to purchase additional shares may still face dilution. Legal Remedies for Shareholder Dilution Because preemptive rights are not a comprehensive safeguard, minority shareholders experiencing dilution or oppression may need to explore alternative legal remedies. Potential claims include: - Breach of Fiduciary Duty: For issuing shares below fair market value or causing loss of value to the corporation. - Derivative Lawsuits: Pursuing damages on behalf of the corporation. - Individual Claims: Addressing breaches of fiduciary duty, trust, or conversion of stock. - Breach of Contract: Based on shareholder agreements. - Fraud: Claims of fraudulent inducement or securities fraud. - Ultra Vires Actions: Challenging unauthorized corporate acts. Legal action can be subject to specific statutes of limitations. For example, claims based on preemptive rights in Texas must be filed within 1 year of written notice of the violation or four years from the stock issuance. Preventing Disputes and Oppression To mitigate risks of shareholder disputes, dilution, and litigation, corporations should: - Establish Clear Bylaws: Define how and when new shares can be issued. - Grant Preemptive Rights Strategically: Ensure these rights are balanced with the corporation’s need for financial flexibility. - Enforce Fiduciary Duties: Directors must act in the corporation's best interest when issuing shares. In short, the decision to include preemptive rights in corporate governance requires careful consideration. While these provisions can protect against dilution and foster investor confidence, they can also limit a corporation’s agility in raising capital. For minority shareholders, understanding the protections available and exploring legal remedies for unfair dilution is crucial. Corporations and shareholders alike should consult experienced attorneys to navigate preemptive rights, shareholder agreements and strategies to balance ownership protection with financial flexibility. Joseph J Raetzer Raetzer PLLC Read the full article

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Breached Business Purchase Agreements

From major mergers and acquisitions ("M&A") to the purchase of real estate or even a simple inventory order, all business transactions are essentially contracts. While we may not think of smaller purchases in legal terms, they fulfill the same basic principle of a legally enforceable agreement: two parties agree to exchange something of value. For instance, when you pay for inventory, and the seller promises to deliver them, you’ve entered into an agreement. However, not all agreements go smoothly. While failing to deliver inventory may be a minor inconvenience, breaches involving more significant transactions, such as business purchases, can lead to serious consequences. In business purchase agreements, the goal is to safeguard rights, minimize damages and pursue appropriate remedies when contractual obligations are not met resulting in a breach of the business purchase agreement. What Is a Business Purchase Agreement? A business purchase agreement is a written document that formalizes the terms of an agreement between a buyer and a seller. While small transactions may not require such documentation, purchase agreements are essential for more complex or high-value transactions. They clearly outline the terms and conditions for: - Tangible Assets: Purchases of real estate, equipment, or machinery. - Intangible Assets: Transfers of stocks, shares, or intellectual property. - Legal Instruments: Facilitating asset transfers via assignment agreements or bills of sale. - Liabilities: Addressing tax obligations, assumed contracts, or employment issues tied to the assets. These agreements are designed to provide flexibility, allowing parties to selectively acquire assets and avoid certain liabilities. However, their complexity also creates potential risks. A well-structured agreement, tailored to specific goals, requires the expertise of seasoned business attorneys. When Does a Breach of a Purchase Agreement Occur? A breach of a purchase agreement happens when one party fails to fulfill their contractual obligations. For a breach to be actionable, it must meet these criteria: - Existence of a Valid Contract: The agreement must be legally enforceable. - Material Breach: The failure must significantly undermine the purpose of the agreement. - Damages: The breach must cause measurable harm to the wronged party. For example, if a seller misses a delivery deadline but ultimately fulfills the order with no significant harm to the buyer, it may not constitute a material breach. However, if the delay causes the buyer to lose business opportunities or revenue, the breach could result in legal action. Protecting Your Interests and Addressing Breaches Purchase agreements are critical safeguards, particularly in high-stakes transactions like M&A. To protect your interests: - Proactive Protection: Work with experienced attorneys to draft, review and negotiate agreements that address potential risks and align with your goals. - Responsive Action: If a breach occurs, legal remedies are available to help the wronged party recover losses and enforce their rights. Potential Remedies for Breach of Contract: - Monetary Damages: - Compensatory Damages: Reimbursement for incurred costs or lost profits. - Liquidated Damages: Predetermined compensation outlined in the contract. - Quantum Meruit: Compensation for services already performed that benefited the breaching party. - Equitable Remedies: - Specific Performance: Requiring the breaching party to fulfill their obligations. - Rescission: Canceling the contract and restoring both parties to their original positions. - Reformation: Modifying the contract to reflect the true intent of the parties. - Injunction: Preventing specific actions that would further harm the wronged party. In short, business purchase agreements are more than just formalities—they’re vital tools to mitigate risks and protect against significant losses. When crafting or enforcing these agreements, the guidance of knowledgeable attorneys can make all the difference. Joseph J Raetzer Raetzer PLLC Read the full article

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Buy a Business vs. Start Your Own: Which is Better?

Many aspiring entrepreneurs dream of running their own business, but aren’t sure where to begin. A common assumption is that starting from scratch with a groundbreaking idea and building a company from the ground up is the only option. While launching a business from the ground up is a popular route, it’s not the only way. Buying an established business is another viable option, and with proper research and guidance, it can be a rewarding path to success. Deciding between these two approaches requires weighing the pros and cons of each to determine which aligns best with your goals. Starting a Business From Scratch Starting a business from scratch offers the chance to create something uniquely yours. You get full control over every aspect (for better or worse!), from designing the business model to building the team, ensuring that the company aligns with your vision. This path is ideal for those with innovative ideas and the drive to shape their business from the ground up. Advantages: - Creative Control: You call the shots from day one, shaping the business exactly how you want. - Personal Vision: The company reflects your ideas, values, and innovations. - Team Building: You can carefully select the individuals who join your team. Challenges: - Funding: Securing financing for a new business with no track record can be difficult. - High Initial Investment: Both time and money must be heavily invested to get started. - Building a Client Base: Establishing a reputation and attracting customers can take time and effort. While the road to success may be long and challenging, the rewards of building a business from scratch can be immense for those who are prepared for the effort it requires. Buying an Existing Business Purchasing an established business can bypass many of the challenges associated with starting from scratch. The groundwork has already been laid—funding, development, and customer acquisition are done, and the business is generating revenue. Advantages: - Established Operations: The business already has a proven model, customer base, and cash flow. - Reduced Startup Effort: Initial challenges like branding and marketing are largely addressed. - Immediate Profitability: Many established businesses are already profitable, saving you time. Challenges: - Due Diligence: Thoroughly investigate the company’s history, finances, and legal standing to ensure no hidden liabilities exist. - Fit with Your Goals: Make sure the business aligns with your objectives and that you have the expertise to manage it. - Change Management: Adapting an existing team and operations to your leadership style may take time. Buying a business removes some of the uncertainty of starting from scratch but comes with its own complexities. Careful evaluation is crucial to ensure the opportunity aligns with your skills and vision. Seeking Professional Guidance Regardless of whether you decide to start your own business or purchase an existing one, there are no guarantees of success. Proper preparation and informed decision-making are essential. An experienced business advisor or attorney can be a vital asset, helping you: - Define your business goals and assess your expertise. - Evaluate how much time, money, and risk you’re willing to commit. - Conduct due diligence to identify opportunities and potential pitfalls. By addressing these critical factors, you’ll be equipped to make the choice that best suits your objectives and maximize your chances of success. In sum, both starting a business from scratch and buying an existing one have unique advantages and challenges. The right choice depends on your goals, skills, and resources. By understanding the nuances of each path and seeking expert advice, you can confidently embark on your entrepreneurial journey. Joseph J Raetzer Raetzer PLLC Read the full article

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Voting Formalities Around Merger Agreements: More Than Just a Draft

In Ap-Fonden v. Activision Blizzard, Inc., C.A. No. 2022-1001-KSJM, 2024 WL 863290 (Del. Ch. Feb. 29, 2024), the Delaware Court of Chancery declined to dismiss claims asserting that Activision Blizzard, Inc.’s ("Activision") Board of Directors violated Section 251(b) of the Delaware General Corporation Law ("DGCL") by approving a merger agreement with Microsoft Corp. that was allegedly incomplete. This decision, authored by Chancellor McCormick, underscores the need for boards to ensure that merger agreements meet statutory requirements before approval. Background In January 2022, Activision’s Board of Directors approved a draft merger agreement with Microsoft. However, this draft lacked several critical components, including: - A disclosure letter, referenced dozens of times but not finalized. - Disclosure schedules, still under negotiation. - The surviving corporation’s certificate of incorporation. - Key details such as the consideration amount, the target company’s name and terms for handling post-signing dividends. Section 251(b) of the DGCL mandates that a board of directors adopt a resolution approving a merger agreement. The plaintiff, a stockholder, argued that this approval requires the agreement to be “execution ready,” while Activision contended that approving near-final drafts is standard market practice. The Court’s Analysis The Court emphasized that Delaware’s merger statutes are mandatory, requiring strict compliance. It rejected the argument that a merger agreement must be “execution ready” but held that it must be “essentially complete.” The Court found it “reasonably conceivable” that Activision’s draft agreement fell short of this standard due to the numerous omissions, particularly: - The missing consideration (a fundamental term of any merger). - The absence of the disclosure letter, which contained critical information. - The missing certificate of incorporation, explicitly required by Section 251(b)(4). - The unresolved Dividend Provision, a material issue. While the necessity of disclosure schedules was left open for interpretation, the Court underscored the importance of completeness in the approval process. The plaintiff also challenged Activision’s compliance with Section 251(c), which requires that a copy or summary of the merger agreement accompany the stockholder meeting notice. Activision’s notice referenced an annex in the proxy statement attaching the merger agreement. The Court deemed this insufficient, holding that the agreement was deficient because it lacked the surviving corporation’s certificate of incorporation. Furthermore, it ruled that a summary in the proxy statement does not satisfy Section 251(c) unless explicitly integrated into the notice, which differs from practices permitted under other DGCL sections. Implications This decision challenges longstanding market practices, highlighting potential conflicts between federal securities regulations and Delaware corporate law. Notably, Regulation S-K, Item 601(a)(5) allows omission of disclosure schedules from SEC filings if they do not contain material information not otherwise disclosed. However, the Court clarified that Delaware’s statutory requirements take precedence in corporate governance matters. Proposed Amendments to the DGCL In response to this and similar rulings, the Delaware State Bar Association swiftly proposed amendments to the DGCL. These amendments, aimed at mitigating the impact of these rulings, include: - Allowing merger agreements approved by boards to be in “final or substantially final form” rather than “essentially complete.” - Clarifying that a surviving corporation’s charter is not required in the merger agreement when target stockholders are not receiving surviving company stock. - Establishing that disclosure letters and schedules are not inherently part of the merger agreement. - Treating any document enclosed or appended to a notice as part of the notice. Key Takeaways Practitioners should ensure: - Completeness of merger agreements: Agreements must include essential terms, exhibits, and statutorily required elements before board approval. - Compliance with stockholder notice requirements: Agreements or summaries must be properly integrated into the notice to align with Section 251(c). - Awareness of statutory developments: Proposed DGCL amendments may significantly alter compliance expectations and reduce litigation risk. This case highlights the Court’s commitment to strict statutory interpretation, serving as a cautionary reminder to balance market practices with Delaware’s legal standards. Given the wide variety of companies that form in Delaware, and the following of Delaware laws by many other jurisdictions, knowing these developments is important when dealing with any potential transaction. Joseph J Raetzer Raetzer PLLC Read the full article

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Federal Trade Commission’s Sweeping Final Rule to Ban Non-Competes: What You Need to Know

UPDATE: On August 20, 2024, a federal judge in Texas, Justice Ada Brown, set aside that rule nationwide, finding that the FTC “promulgated the non-compete rule in excess of its statutory authority.” This means that the FTC’s ban on non-compete agreements will not be enforced or take effect on its effective date of September 4, 2024, or thereafter. You can access the ruling HERE In April 2024, the Federal Trade Commission ("FTC") finalized a rule that broadly bans non-compete agreements for employees across all levels, with only narrow exceptions. This decision comes after a lengthy review process, which included almost 30k public comments on the initial proposal from January 2023. Although the rule passed narrowly (3-2 along party lines), it has not yet taken effect, and legal challenges are already underway. Key Provisions of the Final Rule The rule bans all non-compete clauses, defined as any term or policy that restricts a worker from seeking or accepting new employment or starting a business post-employment. This definition extends beyond traditional written agreements to include any oral or implied policies that may function as a non-compete. The FTC's initial “de facto” test to determine whether a clause functions as a non-compete has been simplified. Now, any term that effectively prevents an employee from pursuing future work or business after leaving the company could be prohibited. However, standard non-solicitation agreements and many non-disclosure agreements are generally not impacted by the new rule, unless they are overly restrictive. Who is Covered? The final rule applies to all employees—current and former—regardless of their role, position, or contractual arrangement. The rule prevents new non-competes for senior executives but allows existing non-competes to remain enforceable for those in executive roles prior to the effective date. Executives under this rule are defined as employees in policy-making positions with an annual income of at least $151,164. Exceptions to the Rule The rule includes 2 limited exceptions: - Sale of a Business: The rule does not apply to non-competes linked to the sale of a business or the seller’s interest in the business. Unlike the proposed rule, this final version does not require the seller to own a specific minimum percentage of the business being sold. - Pre-existing Legal Claims: The rule does not apply to any non-compete claims filed before the effective date. Additionally, enforcement of a non-compete is not considered an unfair competitive practice if the enforcing party has a reasonable belief that the rule does not apply. Notification Requirements Employers must notify workers bound by a non-compete clause that the clause is unenforceable. This notice must clearly state the specific person or company that entered into the non-compete with the worker and be delivered by hand, mail, email, or text message. The final rule provides model language for employers to use. What’s Next? The rule is scheduled to take effect 120 days after it is published in the Federal Register. If deemed “significant” in terms of economic or policy impact, it will undergo an additional review by the president before publication. Congress and the Government Accountability Office will also review the rule, and if Congress disapproves, the rule could be nullified. Legal challenges are already in progress. On the day of the announcement, Ryan, LLC filed a lawsuit challenging the FTC’s authority to enact the rule, arguing it is unconstitutional. Shortly after, the U.S. Chamber of Commerce filed a federal lawsuit seeking to halt enforcement of the rule, potentially delaying its effective date. What Should Employers Do Now? While the rule is not yet effective, it may still become enforceable in the future. To prepare, employers should review and potentially narrow restrictive covenants to ensure they are reasonable and focused on legitimate business interests, such as protecting trade secrets, confidential information, or customer goodwill. Limitations should be narrowly tailored in terms of duration, geographic scope, and prohibited activities. Drafting contracts in a way that allows unlawful provisions to be removed while keeping other restrictions intact is advisable. Moreover, employers should avoid using restrictive covenants with lower-level employees unless there is a valid reason. Should the final rule become effective, all traditional non-competes will be barred, including any terms that effectively prevent or penalize workers for competing after employment ends. Joseph J Raetzer Raetzer PLLC Read the full article

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How To Raise Capital for Your Business Through A Private Placement Memorandum (PPM)

A Private Placement Memorandum ("PPM") is a detailed legal document used to offer ownership stakes in a company to investors who are Accredited Investors as defined by Regulation D of the Securities and Exchange Commission ("SEC"). It serves as a tool for raising capital, especially when traditional financing options are unavailable or unsuitable. What is a PPM? A PPM enables businesses to raise funds without the need to undergo the extensive SEC or state registration process required for public offerings. Instead, companies can directly solicit investments from accredited investors, bypassing significant regulatory burdens which can result in substantial savings in time and money. PPMs provide comprehensive information about the company, including its structure, operations, financials and the specific terms of the investment including the risk factors associated therewith. They are commonly used by startups and small businesses seeking capital. Why Use a PPM? - Alternative to Traditional Financing Businesses that struggle to secure bank loans or access capital markets often turn to PPMs. Investors may be willing to provide funding in exchange for an equity stake, offering businesses an opportunity to grow without incurring significant debt. - Tailored to Accredited Investors Accredited investors are typically wealthy individuals or institutions capable of assuming the risks associated with private placements. According to SEC guidelines, an accredited investor must either: - Have an annual income exceeding $200,000 ($300,000 with a spouse) for the past two years, with a reasonable expectation of the same in the current year, or - Possess a net worth of over $1 million (excluding their primary residence). PPMs cater to these investors, who are more equipped to handle the high-risk nature of private placements. 3. Flexibility in Structuring Investments PPMs allow businesses to customize investment terms to meet their capital needs. For instance, a company could issue ten $300,000 shares or a hundred $10,000 shares, depending on its strategy and investor base. Multiple funding rounds can also be structured to align with business milestones, such as securing licenses or achieving growth targets. - Avoiding Pitfalls: The Risks of Using Templates While templates can provide a starting point for drafting a PPM, relying on generic, uncustomized forms found online is extremely risky. Legal errors or omissions in a PPM can lead to serious consequences, including: - Investor disputes - Regulatory issues - Potential collapse of fundraising efforts Working with experienced attorneys and financial advisors ensures the document is tailored to the unique aspects of your business and its offering, minimizing risks and maximizing investor confidence. Cost of a PPM The cost of drafting a PPM varies depending on the complexity of the offering and the level of professional services required. Fees can range from a few thousand dollars to tens of thousands, especially if the process involves extensive due diligence or multiple investment rounds. While these upfront costs may seem significant, they are a necessary investment in ensuring compliance, protecting the company and securing investor trust. Key Considerations for PPMs - Non-General Solicitation Private placements are not public offerings. Unless using Rule 506(c), which allows for general solicitation under specific conditions, PPMs are meant for a select group of investors. Initial meetings with potential investors should focus on relationship-building to determine suitability. - Transparency and Risk Disclosure Private placements inherently involve risk. A well-drafted PPM must transparently outline these risks, ensuring investors understand the potential for loss and are making informed decisions. - Regulatory Compliance Adhering to SEC and state regulations is critical. Failure to meet requirements, such as ensuring investors meet accreditation criteria, can lead to legal and financial repercussions. A Private Placement Memorandum is a powerful tool for businesses seeking to raise capital without traditional financing. It provides flexibility, bypasses regulatory hurdles, and allows direct access to accredited investors. Whether you're an entrepreneur with a new startup or a small business looking to expand, a well-prepared PPM can be instrumental in achieving your goals. Working with experienced legal and financial professionals ensures your PPM is properly customized, protecting both your business and your investors. Joseph J Raetzer Raetzer PLLC Read the full article

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The Critical Role of Disclosure Schedules in M&A Transactions

Mergers and acquisitions ("M&A") involve complex processes, with due diligence playing a pivotal role. Among the essential components of an M&A transaction are disclosure schedules—documents that complement and support a seller's representations and warranties. Properly prepared disclosure schedules can mitigate liability risks for sellers and ensure smoother transactions. Why Disclosure Schedules Matter Disclosure schedules are integral to addressing liabilities that could otherwise jeopardize the seller's financial security: buyers often hold a portion of the sale price in escrow for a negotiated period. If undisclosed liabilities, such as lawsuits, employee claims or tax issues arise post-closing, buyers can withdraw all or a portion of such funds from escrow without contest. Failure to disclose liabilities in disclosure schedules can also lead to lawsuits or arbitration. Comprehensive and accurate schedules not only protect sellers but also facilitate a more efficient and successful transaction process. Understanding Disclosure Schedules What Are Disclosure Schedules? Disclosure schedules supplement the representations (i.e., statements of fact) and warranties (i.e., promises about future conditions) in an M&A agreement. They serve as a platform for sellers to disclose exceptions to these assertions. For example, if an agreement states there is no ongoing litigation, the disclosure schedule may outline exceptions such as an active lawsuit. This would be documented in the agreement as "There is no ongoing litigation against the seller except as set forth in Exhibit A." Any active lawsuits would need to be in a schedule on Exhibit A so the buyer can take such litigation into account for their valuation and risk assessment. Who Prepares Disclosure Schedules? Drafting disclosure schedules is a collaborative process involving: - The Seller: Gathers critical business data. - The Seller’s Attorney: Aligns the schedules with representations and warranties. - The Seller’s Accountant: Ensures financial data accuracy. Errors in preparation can derail the transaction, making experienced legal and financial guidance essential. What Do They Include? While the content varies by transaction, common sections include: - Contracts: Material agreements like leases, NDAs, and supplier contracts. - Employees and Benefits: Workforce details, including disputes and benefit plans. - Financial Statements: Historical data, accounting policies, and liabilities. - Customers and Suppliers: Key relationships and terms. - Intellectual Property (IP): Patents, trademarks, and trade secrets. - Litigation and Regulatory Issues: Pending legal or government actions. - Tax Information: Filing history and liabilities. - Insurance Policies: Coverage details and exclusions. When Are They Due? Disclosure schedules are generally required before the closing date, either: - At the time of signing in simultaneous sign-and-close deals. - Shortly after signing, in deals where closing occurs later. Common Mistakes and How to Avoid Them Disclosure schedules are detailed and time-intensive, leaving room for errors such as: - Incomplete or outdated information (e.g., contracts, employee rosters). - Missing disclosures about litigation or financial matters. - Failing to list material details like insurance policies or IT assets. Tips for Success: - Start Early: Delays increase the risk of errors and omissions. - Understand the Purpose: Recognize that disclosure schedules are separate from due diligence. - Engage Key Personnel: Collaborate with employees knowledgeable about the relevant data. - Stay Organized: Track revisions in the agreement to ensure schedules remain accurate. - Hire Experienced Counsel: An M&A-savvy attorney can help clarify requests and anticipate challenges. Disclosure schedules are vital to successful M&A transactions. By thoroughly preparing these documents, sellers protect themselves from post-closing liabilities and ensure a smoother sale process. Engaging knowledgeable legal and financial professionals, starting early, and maintaining organization are key to minimizing risks and achieving a favorable outcome. Raetzer PLLC Read the full article

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What Does an M&A Lawyer do?

An M&A (Mergers and Acquisitions) lawyer is at the core of the deal-making process, acting as the central figure in a network of deal parties and advisors. The M&A lawyer is typically the main point of contact for all involved parties, overseeing every aspect of the transaction to ensure it reaches a successful close. Often, an M&A lawyer is an external specialist from a law firm, though some companies rely on in-house counsel. This role requires a wide array of skills, including: - Strategic thinking - Negotiation - Multitasking - Delegation - Organization - Complex drafting - Precision and attention to detail - Speed and efficiency While grounded in corporate, contract, and fiduciary duty law, the M&A lawyer's work also intersects with areas such as securities, tax, environmental law, labor, executive compensation, real estate, antitrust, intellectual property and more. Key Responsibilities in an M&A Transaction An M&A lawyer plays a role in nearly every stage of a transaction, from initial strategy to finalization. Some of the primary tasks include: - Preparing the Target for Sale: Ensuring that corporate formalities are in order, vendor and supplier relationships are formalized, and any areas of potential risk are addressed. - Drafting Preliminary Agreements: Drafting and negotiating key preliminary documents like the engagement letter, letter of intent, and confidentiality agreements. - Structuring the Deal: Collaborating with tax and financial advisors to shape the transaction’s structure in a way that benefits all parties. - Conducting Legal Due Diligence: Leading the due diligence process to review the target’s contracts, permits, organizational documents, and other relevant materials. Due diligence findings are typically summarized in a memorandum for the buyer. - Developing an Implementation Checklist: Creating a detailed list of actions and required documents, helping keep the transaction on track. - Drafting and Negotiating the Main Transaction Agreement: Drafting and negotiating the principal agreement, including representations, warranties, covenants, and closing conditions, all tailored to the findings of the due diligence process. - Advising on Fiduciary Duties and Shareholder Rights: Advising directors and management on fiduciary responsibilities, minority shareholder rights, and identifying any conflicts of interest that may warrant heightened scrutiny. - Reviewing Financial Adviser Materials: Reviewing the fairness opinion and other materials presented to the board to ensure compliance with fiduciary obligations. - Disclosure and Compliance with Securities Laws: Managing disclosure requirements under federal securities laws and exchange standards, and preparing necessary documentation, such as Form 13Ds, press releases, proxy statements, Form 8-Ks, tender offers, and registration statements. - Negotiation Support: Providing strategic guidance to the client during negotiations. - Coordinating with Specialist Attorneys: Integrating feedback from various specialists (e.g., tax, environmental, and labor attorneys) into the transaction agreements. - Drafting Ancillary Documents: Preparing ancillary transaction documents, including exclusivity agreements, legal opinions, bills of sale, assignments, escrow agreements, and transition services agreements. - HSR Filings and Antitrust Compliance: Working with antitrust counsel to prepare and submit Hart-Scott-Rodino (HSR) filings. - Managing Hostile Takeovers and Activist Interference: Advising on strategies to deter hostile takeovers or activist shareholder disruptions, which may involve drafting shareholder rights plans (poison pills) or advising on proxy contests. - Securing Third-Party Consents: Identifying any necessary third-party approvals and coordinating with client representatives to obtain them. The M&A lawyer’s broad expertise and strategic leadership are essential for guiding a transaction from inception through to its conclusion, aligning the deal team’s efforts with the client’s goals and mitigating risks to ensure a smooth closing. Raetzer PLLC Read the full article

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How do Drag Along Rights Work?

Drag-along rights are contractual clauses, typically found in shareholder agreements, that empower majority shareholders to compel minority shareholders to participate in a company sale. These provisions play a significant role in aligning shareholder interests, especially when majority owners wish to proceed with a transaction. How Drag-Along Rights Work - For Majority Shareholders: Drag-along rights allow majority owners to sell the company according to their timeline and terms, compelling minority shareholders to join the sale even if they would prefer to retain their stake. - For Minority Shareholders: Although drag-along rights may require minority shareholders to sell their shares, these rights generally ensure they receive the same price and terms as the majority. Minority shareholders may also negotiate “tag-along” rights to guarantee their inclusion in future sales on equal terms. Drag-along provisions can be included in shareholder agreements, company bylaws or formation documents. Both majority and minority shareholders should carefully consider the terms of these clauses, as they could significantly impact any future sale. The Value of Drag-Along Rights Drag-along rights can make a company more appealing to potential buyers by ensuring that the buyer can acquire full ownership of the business, rather than only the majority interest. This prevents situations where a minority shareholder might block a sale or create complications that could derail the transaction entirely. Who Benefits from Drag-Along Rights? - Majority Shareholders: Drag-along rights simplify the sales process and reduce the risk of minority shareholder resistance, helping majority owners attract buyers and negotiate deals with greater control. - Minority Shareholders: When properly structured, drag-along rights protect minority shareholders by ensuring they receive equal terms and compensation as the majority shareholder in any sale. Additionally, “tag-along” rights can provide minority shareholders with the option to join in on a sale if the majority owner is not using drag-along provisions. What Triggers Drag-Along Rights? Certain events or conditions, defined within the drag-along provision, will trigger the rights. Key considerations include: - Types of Transactions: Determine which events will activate the drag-along provision, such as mergers, asset sales, or sales of ownership interests. - Ownership Threshold: Specify the ownership percentage that must be sold to trigger the drag-along. For example, does a sale of 30% of shares trigger it, or does it require a larger portion? - Advance Notice: Define whether majority owners must give advance notice of the sale to minority shareholders, including the timing and contents of such notices. - Restrictions: Set any limitations, such as minimum sale prices or waiting periods, to ensure a fair process for all shareholders. Sale Proceeds and Procedures in Drag-Along Sales It’s essential to clarify how sale proceeds will be distributed. Majority shareholders may negotiate for illiquid securities if it benefits the deal, whereas minority shareholders might prefer cash proceeds. Other procedural questions may include: - Transaction Costs: Decide which party will bear the costs of transaction expenses, including legal fees, valuation services and other expenses. These costs could be allocated based on ownership interest or charged solely to the shareholder invoking drag-along rights. - Dispute Resolution: Outline a process for resolving disputes that may arise during a drag-along transaction. A qualified attorney experienced in shareholder agreements can help anticipate potential scenarios, protect shareholder interests, and draft a balanced agreement. Enforceability of Drag-Along Rights Drag-along rights are enforceable when drafted in a clear, valid contract and adhered to precisely as outlined. For instance, if the provision mandates advance notice of a sale and minority shareholders don’t receive it until after the transaction, the provision might be deemed unenforceable in court. Tag-Along Rights Explained Tag-along rights offer protection to minority shareholders by giving them the right to join a sale if the majority shareholder decides to exit the company. This ensures they are not left behind with a new, potentially incompatible majority owner and can sell their shares on the same terms. Drag-Along vs. Tag-Along Rights While drag-along rights allow majority shareholders to compel a sale, tag-along rights enable minority shareholders to participate voluntarily in any sale negotiated by the majority. Essentially, drag-along rights enforce participation, while tag-along rights grant optional involvement. Understanding and negotiating drag-along and tag-along rights is essential for shareholders seeking to safeguard their interests in any future sales. Raetzer PLLC Read the full article

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Representations and Warranties in Mergers & Acquisitions

In mergers and acquisitions ("M&A"), the primary transaction agreement typically includes representations and warranties (or "reps and warranties" or just "reps") from each party to the other. These statements address various aspects of a party’s status, business, assets, liabilities, properties, condition, operating results and future prospects. Representations and warranties often span 15 to 30 pages within the transaction agreement and may extend further when referencing definitions. Drafting and negotiating these terms is a significant part of any M&A deal. Why Are Representations and Warranties Important? Representations and warranties fulfill four main roles: - Disclosure Reps and warranties enable one party with an informational advantage to disclose essential information about itself—or in a sale, about the target company or assets—to the other party. Most of the information flows from the seller to the buyer, particularly when the transaction involves a cash purchase price rather than buyer stock. Acting as an extension of the due diligence process, reps and warranties reduce information imbalances. While drafting them, parties often uncover information that could impact the deal’s value, leading to potentially significant adjustments to the transaction. - Walk Rights Reps and warranties also protect each party’s right to terminate the agreement if conditions are unmet. In deals with a delay between signing and closing, the transaction agreement will include conditions that must be satisfied or waived before either party is obligated to proceed. These conditions often require that the reps and warranties remain accurate up to closing. This enables both parties, especially buyers, to continue due diligence during this "gap period" and to walk away if a rep becomes untrue due to unforeseen changes. - Risk-Shifting Representations and warranties shift risk from one party to the other, often entitling the harmed party to compensation for losses resulting from inaccurate statements. This risk-shifting is especially relevant in private M&A transactions (as opposed to public deals where post-closing indemnities are rare). The buyer generally expects that the seller will assume the risk of losses from false reps, helping the buyer accurately price the transaction and make informed plans for the business post-closing. This risk-shifting function frequently arises in negotiations, where parties may challenge specific representations. Skilled M&A lawyers often counter objections by emphasizing that the goal is not simply truth but allocating risks in a manner that protects their client from specific potential losses. - Discipline Finally, reps and warranties encourage accountability. The risk of a broken deal or potential claims for breached reps incentivizes the disclosing party to ensure that its statements are accurate and that the target company is compliant with requirements such as good standing, due authorization, and the absence of conflicting contracts. What Do Representations and Warranties Cover? Reps and warranties can address a wide range of topics, such as the target’s legal existence, financial statements, and the buyer’s financing capabilities. A common example of a rep provided by the seller is an “absence of conflicts” statement, which confirms that the transaction will not conflict with the company’s other obligations or create legal violations. Common topics addressed in the seller’s reps and warranties include: - Organization and good standing - Authority and enforceability - Capitalization and ownership - Financial statements - Assets and liabilities - Intellectual property - Material contracts - Tax matters - Employee benefits - Environmental, health, and safety compliance - Legal proceedings - Insurance - Full disclosure The transaction agreement typically includes reciprocal representations from the buyer to the seller. When the buyer issues stock as part of the purchase, its representations will mirror those of the seller to a greater extent. In cash-only deals, however, the buyer’s reps are generally narrower, often focusing on: - Organization and good standing - Authority and enforceability - Absence of conflicts - Governmental consents - Financing In short, representations and warranties play a vital role in M&A agreements, facilitating disclosures, enabling termination rights, shifting risk, and encouraging disciplined, accurate statements. These provisions ensure that both parties are informed and protected, fostering smoother transitions and more successful transactions. This is yet another example of how "off the shelf" agreements that are not carefully drafted can harm a buyer or seller. Raetzer PLLC Read the full article

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How to Form an Anonymous LLC in Texas

If you want to establish a business while safeguarding your privacy, forming an anonymous LLC could be a good option. Although Texas does not permit the formation of anonymous LLCs, you can register your LLC in a state that does, and then bring it to Texas. What Is an Anonymous LLC? An anonymous LLC is a limited liability company where the owners’ identities are not publicly disclosed by the state. While not a specific legal term, an "anonymous LLC" refers to a standard LLC registered in a way that keeps ownership details private. It’s sometimes called a "confidential" or "private" LLC. Though anonymous LLCs protect the owner’s identity from public records, they still require tax payments, bank accounts, and are subject to lawsuits. Benefits and Drawbacks of an Anonymous LLC Registering as an anonymous LLC offers several privacy benefits, including keeping your identity and address out of public view. This structure is popular among public figures, victims of abuse and those running controversial businesses (e.g., cannabis operations), as it provides a layer of protection against unwanted attention and harassment. Anonymous LLCs can also help those looking to separate their business and personal life, or those wanting to shield financial details from employers, creditors or family members. However, complete anonymity is not guaranteed. For example, you’ll still need to disclose your identity to banks and the IRS, and lawsuits can sometimes compel you to reveal your information. Securing a commercial lease may also require sharing your name, so working with a contract attorney can help ensure that confidentiality clauses are added to safeguard your privacy in contracts. How to Set Up an Anonymous LLC for Use in Texas Anonymous LLCs are only available in certain states, including Delaware, Nevada, New Mexico and Wyoming. For Texas residents, a workaround allows you to achieve similar privacy by forming an anonymous LLC in one of these states, then registering it as the owner of a new LLC in Texas. By following the right process, you can protect your name, address, phone number, and email from appearing on Texas public records in association with your business. Best States for Registering an Anonymous LLC Delaware and New Mexico are among the most popular states for forming anonymous LLCs: - Delaware has a well-developed business court system and offers enhanced personal liability protections. Additionally, Delaware does not require corporate income tax. - New Mexico is attractive for its privacy options, as it does not require any individual names in LLC filings and has no annual reporting fees or taxes In both states, a registered agent (such as an attorney or service provider) can act as a third-party representative, helping to maintain your privacy - not to worry, we can have the connections in each state to make it happen! Once established, this out-of-state LLC can serve as the owner of your Texas LLC. Why You Need an Anonymous LLC Attorney Working with an attorney can simplify the process of forming an anonymous LLC and ensuring your privacy in Texas. In addition to setting up your LLC in a privacy-focused state and registering it in Texas, an attorney can act as your registered agent, ensuring your Texas LLC receives legal and tax documents confidentially. An attorney can also draft confidentiality clauses for leases and contracts to prevent your identity from being disclosed. Raetzer PLLC Read the full article

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Material Adverse Effect Clauses

Business transactions don’t always go as planned—earnings may fall short, partnerships can dissolve, regulatory hurdles arise, lawsuits surface and even disasters occur (remember COVID?). This uncertainty is especially significant during the interim period between signing and closing a merger or acquisition ("M&A") deal. Sellers typically believe that these events should not affect the agreed purchase price or terms, while buyers argue that they shouldn’t bear the risk of negative developments that might impact the target company, especially since sellers continue to manage day-to-day operations during this period. To balance these perspectives, M&A agreements often include terms that allocate some risk to the seller, such as indemnification and termination provisions. A critical part of these agreements is the Material Adverse Effect ("MAE") clause, sometimes called a Material Adverse Change ("MAC") clause. Purpose of Material Adverse Effect Clauses MAE clauses serve two main functions in an M&A agreement. - Limiting Seller Representations, Warranties, and Covenants: MAE clauses set a high threshold for events that must be disclosed or conditions that must be met, focusing only on significant changes in the target’s business. For instance, a seller’s representation may state that all liabilities have been disclosed "except for those that wouldn’t result in a Material Adverse Effect." Here, the MAE clause benefits the seller by reducing their disclosure obligations and the risk of breach. - Setting Conditions for Deal Closure: If an MAE occurs during the interim period, the buyer may have the right to terminate the agreement, also known as a "MAC out." Over 90% of M&A agreements include such a provision. This use of the MAE clause favors buyers, giving them a chance to withdraw if the deal’s anticipated value decreases substantially. In both scenarios, sellers aim to narrow the scope of MAE clauses to reduce the likelihood of termination, while buyers seek broader terms to allow flexibility if adverse changes occur. Material Adverse Effect Definitions: Pro-Buyer vs. Pro-Seller MAE definitions differ in scope and language, depending on whether the terms favor the buyer or the seller. - Pro-Buyer Example: A broad MAE definition might state: "Material Adverse Effect" means any event, change, circumstance, or other matter that has or could reasonably be expected to have, a material adverse effect on (a) the business, assets, liabilities, properties, or financial condition of the Acquired Companies as a whole, or (b) the ability of the Seller to fulfill obligations or complete the transaction as agreed. This definition is broad and includes "forward-looking" language, allowing the buyer to act on potential future risks, rather than only current ones. - Pro-Seller Example: A narrower MAE definition might say: "Material Adverse Effect" means any event or change that has a material adverse effect on (a) the business or financial condition of the Acquired Companies as a whole, or (b) the Seller’s ability to complete the transaction, but excludes matters arising from (i) war or terrorism, (ii) regulatory changes, (iii) industry-wide changes, (iv) economic fluctuations, (v) failure to meet projections (unless due to reasons not excluded), and (vi) actions requested or consented to by the Purchaser. This pro-seller version has limited reach and excludes certain risks beyond the seller’s control, thus reducing the likelihood of the clause being triggered. Key Differences in MAE Definitions - Forward-Looking Language: Pro-buyer definitions often include phrases like "could reasonably be expected to have", allowing potential future risks to be considered. - Targeted Impact Areas: Buyers might include narrower categories like "assets" and "liabilities" in MAE definitions to create specific triggers for potential withdrawal, while sellers favor a focus only on broad operational or financial performance. - Exceptions: Pro-seller definitions often list events or circumstances that won’t be considered MAE triggers, like economic downturns or regulatory shifts. This list is common in most agreements, although the specific inclusions vary. - Disproportionate Impact Clause: To moderate seller-favorable exceptions, a "disproportionately impacts" clause is frequently added, stating that if the target company is affected more severely than its industry peers by an event, the buyer may still terminate. This balances the exceptions by protecting the buyer if the target is uniquely affected by a listed circumstance. MAE clauses are pivotal in M&A agreements, helping balance the risks between buyers and sellers during the period leading to deal closure. Buyers look for clauses that allow flexibility in the face of potential downturns, while sellers aim to limit their scope, ensuring that only significant adverse changes impact the deal terms. Through negotiation, both parties can define MAE clauses that address their unique concerns and reflect the expected risks of the transaction. These are carefully drafted provisions and just one more example of why "off the shelf" contracts are shunned. Raetzer PLLC Read the full article

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Retaining Key Employees in M&A Transactions

In business mergers or acquisitions, especially for small- to medium-sized businesses, retaining key employees is a critical component of success. In these businesses, essential roles, deep knowledge, and important client relationships may be concentrated among a few individuals, making their retention vital to achieving a smooth transition. Why Retaining Key Employees is Essential As a buyer, your due diligence should include evaluating employees whose roles, relationships, or expertise add substantial value to the target business. These may include top performers, specialists, or individuals leading critical projects. Here’s why retaining key employees is so important: - Preserving Institutional Knowledge: Key employees possess insights into operations, clients, and processes, which can help sustain business continuity post-acquisition. - Maintaining Culture: Employees in key roles often shape company culture, which can help ease transition periods. - Protecting Intellectual Property: Even with legal protections, retaining employees who know proprietary information can reduce the risk of trade secrets becoming public. - Upholding Client Relationships: Key employees often have strong client relationships that, if disrupted, could lead to business losses. - Boosting Morale and Productivity: Retaining influential employees helps keep morale high, avoiding productivity declines that can follow a wave of resignations. Identifying Key Employees Defining “key employees” should be tailored to your business’s specific needs. Consider employees who are top producers, have unique skills, manage key relationships or are culture-shapers within the organization. Here are some questions to help identify them: - Who are the top performers or those with essential skills? - Who manages critical relationships with clients, vendors, or suppliers? - Who leads important projects or has specialized expertise? - Are there internal influencers whose presence positively impacts company culture? Similarly, consider if there are employees you may not want to bring into the new organization and plan for their exit. Strategies to Retain Key Employees Before the Acquisition - Transparent Communication: Inform key employees early about the acquisition and its rationale to build trust and reduce anxiety. - Highlight New Opportunities: Emphasize growth prospects, career development, and new resources available after the acquisition. - Retention Packages: Offer targeted retention packages, such as signing bonuses, stock options, or guaranteed terms for a specific period. During the Acquisition - Maintain Regular Communication: Address any concerns or rumors with regular updates. - Minimize Workplace Disruption: Aim for consistency in employee routines and benefits to ease the transition. - Involve Key Employees: Engage key employees in decision-making or due diligence, both to gain their insights and to encourage loyalty. After the Acquisition - Build Trust: Ensure any transition promises are fulfilled to foster trust in the new leadership. - Explain New Terms: If the acquisition brings new employment terms like non-compete or confidentiality agreements, explain these clearly and offer supportive benefits to ease adoption. - Succession Planning: Expect some turnover post-acquisition, and establish a plan to fill key roles should they become vacant. Reviewing Employee Agreements Employees may see a change in ownership as an opportunity to pursue other ventures, so it’s essential to review and, if needed, update employment agreements as part of the acquisition process. Key agreements may include non-compete, non-solicitation and confidentiality clauses. Enforceable Non-Competes In Texas, non-compete agreements must be reasonable in duration, geographic scope and activity restrictions. Courts are generally supportive of non-compete agreements that protect legitimate business interests, like trade secrets or client relationships, but may reform or void agreements that are overly restrictive. To ensure enforceability, tailor restrictions to employees with access to confidential information and limit geographic scope to areas where the business operates. In summary, a well-executed strategy to identify and retain key employees is essential for a successful business acquisition. As trusted advisors in business transactions, Raetzer offers insights and solutions to help buyers navigate this critical aspect of business acquisitions. Raetzer PLLC Read the full article

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Common Mistakes in Small Business Purchase Agreements

When buying or selling a small business, it can be tempting to skip hiring a lawyer and rely on templates or simple agreements. However, we strongly advise against this. Even in small transactions under $100 million, the stakes are high: sellers want a fair return without lingering legal issues, and buyers need to protect their investment. A properly drafted purchase agreement is essential, as small business sales involve many moving parts. Here are some common pitfalls with overly simplified purchase agreements: 1. No Clear Distinction Between Asset Sale and Stock Sale In many simple agreements, there’s no clear indication of whether the sale includes the business’s assets or the stock in the entity that owns the business. This distinction is critical: buying a company’s stock means taking on all its rights and obligations, which can be risky if you’re not fully aware of those obligations. To avoid this, many buyers prefer to purchase just the assets of the business (e.g., furniture, accounts, trademarks, client lists), enabling them to continue operations without assuming all liabilities. 2. Poor Identification of Assets to Be Sold Vague references to “all the assets” without further details can lead to disputes later on. The agreement should clearly define the “Purchased Assets” and specify any “Excluded Assets,” like cash or bank accounts, which typically remain with the seller. A common mistake is referring to “assets listed in Exhibit A” without including Exhibit A in the final agreement. 3. Overlooking the Need for Landlord’s Consent If the business includes a leased location, you must review the lease and ensure the landlord consents to the lease transfer. Without this consent as a condition of sale, you could end up with the assets but no business location. Additionally, clarify who receives credit for the security deposit held by the landlord; it’s often refunded to the seller at closing unless agreed otherwise. 4. Insufficient Representations and Warranties The agreement should include warranties regarding the assets. Avoid terms like “as is.” At a minimum, the seller should confirm that tangible assets are free of liens, in good condition, and that all associated contracts are valid and enforceable. 5. Undefined Closing Deliveries The closing is the formal transfer day when the agreement is finalized. The agreement should detail what each party must deliver at closing. Buyers might require the full purchase payment, a promissory note for installments, and assignment agreements for any transferred contracts. Sellers might need to provide a bill of sale, landlord consent for lease transfer, and executed copies of other relevant agreements. Bottom Line Selling or buying a business without legal guidance can lead to costly mistakes. A well-crafted purchase agreement, tailored to your specific transaction, is vital. A template simply won’t do. Raetzer PLLC Read the full article

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When Are the Benefits of an LLC Stronger Than an S Corp?

When choosing a business structure, many people find it challenging to determine where to begin. You may have heard about forming an LLC or an S Corporation, but understanding what these terms mean and how they differ can be confusing. Both Limited Liability Companies ("LLCs") and S Corporations offer personal liability protection, meaning your personal assets are generally protected from business liabilities and debts. Additionally, both structures provide tax advantages compared to other types of business entities. What is an S Corp? An S Corporation is a tax classification, not a standalone type of business entity. To become an S Corporation, you must first establish a C Corporation or an LLC. Both S Corporations and LLCs are "pass-through entities," meaning their profits pass directly to the owners' or shareholders' personal tax returns, which helps avoid corporate tax and double taxation. For LLC owners with above-average income in their industry, opting for S Corporation taxation can reduce self-employment taxes. This setup allows you to take a reasonable salary (aligned with industry standards), while any remaining profits can be distributed as dividends, which are not subject to self-employment tax. What is an LLC? An LLC is a legal business structure that offers liability protection to its owners, shielding their personal assets from business debts or legal claims. There are two types of LLCs: - Single-member LLC: Owned by 1 person and taxed like a sole proprietorship. - Multi-member LLC: Owned by multiple people and generally taxed like a partnership, unless it elects to be taxed as an S Corporation. LLCs are popular because they’re relatively simple to start and manage while providing liability protection and potential tax benefits. However, if your annual income exceeds a certain threshold, you may face a high tax bill. To reduce taxes, LLC owners can elect S Corporation taxation, which changes how certain portions of income are taxed. To form an LLC, you’ll need to file Articles of Organization with your state’s Secretary of State office. Then, file IRS Form 2553 to choose your tax classification. Once approved, your LLC can elect S Corporation taxation if it meets specific IRS requirements. So what's the difference? So, what are the main differences? The key distinctions between an LLC and an S Corporation relate to ownership, management, and required business formalities. These factors can influence which structure is the best fit for your business. 1. Ownership LLCs offer flexibility in ownership. They can have an unlimited number of owners (referred to as members), who don’t need to be U.S. citizens or residents, and can even include other business entities. In contrast, S Corporations face more restrictions: they can have no more than 100 shareholders, all of whom must be U.S. citizens or residents, and they cannot be owned by other business entities like C Corporations, LLCs, partnerships, or other S Corporations. 2. Classes of Stock and Voting Rights The IRS limits S Corporations to a single class of stock, which means all shareholders have the same voting rights. This restricts S Corporations from offering voting and non-voting shares, a flexibility typically available to traditional corporations. If an S Corporation tries to implement different voting rights, it may face tax penalties. LLCs, however, don’t issue stock. Instead, ownership and voting rights are defined in their membership agreements, allowing for customizable ownership and voting rights among members. 3. Management Structure An LLC can choose to be managed by its members (owners) or by appointed managers. A member-managed LLC operates more like a partnership, while a manager-managed LLC resembles a corporation, with selected managers making business decisions. S Corporations, on the other hand, are required to have directors and officers. The directors oversee the company’s affairs, while the officers handle daily operations. Business Formalities Both LLCs and S Corporations must adhere to some formalities, but the requirements for S Corporations are generally more extensive. S Corporations are required to adopt bylaws, authorize and issue stock, hold annual shareholder and director meetings, and keep detailed meeting minutes. LLCs may choose to follow these practices but are generally not legally required to do so. Tax Considerations One of the key reasons some people choose an S Corporation is the tax treatment it offers, allowing owners to take a salary and receive distributions from profits while potentially reducing self-employment taxes. However, an LLC can also elect to be taxed as an S Corporation by filing the necessary IRS paperwork, providing the flexibility of both structures. Making the Right Choice There’s no one-size-fits-all answer for small businesses when deciding between an LLC and an S Corporation. Your choice should depend on the specific needs and goals of your business. Raetzer PLLC Read the full article

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Can I Get Out of That Contract?

Sometimes small business owners find themselves bound to contracts that seem unfair, were not fully understood or the market has made a drastic shift. If you’re wondering whether you can get out of a contract, here are some factors to consider. 1. Review the Contract Carefully Before assuming you must comply with a demand, review the contract thoroughly. Ensure that it explicitly requires you to perform the actions the other party is asking. A clear understanding of the contract’s terms regarding your specific situation is essential. 2. Check for Termination Clauses Look for any clauses that provide an option to terminate the contract. If such a clause exists, follow the required steps precisely to end your obligations under the agreement. 3. No Termination Clause? If the contract doesn’t have a termination clause or seems open-ended, you may still have the right to end it with reasonable notice. Open-ended contracts can typically be terminated, but obligations that arise before termination must still be fulfilled (e.g., paying for services already provided). 4. Is the Other Party in Breach? If the other party hasn’t fulfilled their contractual obligations, you may have grounds to terminate the contract due to a material breach. A material breach is a substantial failure that defeats the contract’s primary purpose. However, minor issues (like a late invoice) don’t usually qualify. 5. Is the Contract or Clause Enforceable? Not all contracts or provisions are enforceable. In some cases, a court may find a contract or certain clauses unenforceable, providing a defense if the other party sues for breach. Common scenarios include: - Consideration: For a contract to be enforceable, both parties must receive something of value. If this is missing or the terms are too vague, the contract may be unenforceable. - Fraud: If you were misled or tricked into signing, such as by fraudulent statements or unauthorized contract changes, you might not be legally bound. This can be challenging to prove, so always double-check contracts before signing. - Illegal Provisions: Courts won’t enforce contracts involving illegal activities or terms that violate public policy, like unreasonable non-compete clauses or penalty provisions not tied to actual losses. 6. Is the Contract’s Purpose Frustrated? “Frustration of Purpose” is a doctrine that may apply if unforeseen events fundamentally alter the contract’s purpose. This is different from “force majeure” clauses, which are specific contractual terms covering certain disruptions. However, frustration of purpose is rarely accepted by courts and typically applies only when the contract’s central purpose has been nullified. And if none of the above apply, consider simply talking to the other party. They may be open to termination or substantial revision (e.g., you can terminate the contract if you find a suitable replacement) if it allows them to service / sell goods to a more desirable customer or if it's a lease they may be able to rent the space for more than your paying. There are a lot of creative solutions and we'd love to speak with you about any issues your facing. Raetzer PLLC Read the full article