Corporate Formation

This article is about how to approach the question of forming a new entity.  Many wonder what the steps are to forming a new entity and what questions should be considered. This list should not be seen as the complete list of questions but rather an approach. I would be happy to discuss your particular situation.

  1. Picking an Entity Type
    • Do you already have an entity?  Are there problems? Read about common issues.
    • Have you maintained the “corporate formalities” to be able to argue that the entity protects the individual owners from certain liability?
    • Are you in a regulated industry such as the financial industry, health care or do you store customer data in the EU?
    • Where do you do business? Where are your customers? Your officers and directors?
  2. Common Entity Types: The tax goals, liability issues or issues regarding jurisdiction (i.e, how much risk of being sued in a specific state are you willing to take?) often dictate the entity forms.
    • Delaware entity that is qualified to do business in another state
    • Delaware entity only qualified to do business in Delaware – often as a holding company
    • A California entity only qualified to do business in California
  3. Filing Process and Timing
    • Each state has its own one-time filing and annual fees
    • If you are forming an entity in Delaware, filing can happen almost in one day
    • California takes as long as 7 to 10 business days and a statement of information must be filed within a reasonable period of time (e.g. 90 days) after formation
    • New York requires publication in a News Paper
    • Appointment of a Registered Agent: We recommend that a Registered Agent be appointed – such as Corporation Services Corporation.  They charge an annual fee.
    • If you use a different name than your entity name to conduct business, you will ALSO have to file a fictitious business name in the county (or counties) where you (or the entity) operate(s) your business.  Each filing has a filing fee and most require publication so check with your local county rules, or ask me.
  4. Shareholder and Operating Agreements: 
    • One of the most important parts of forming your entity is the agreement between the owners.
    • Depending on whether you form a C corporation or an LLC, you will have a shareholder (for C corps) or operating agreement (for LLCs)
    • The most common error I see is 50/50 ownership with no mechanism for resolving deadlocks.
  5. Fees: I often do formation work for a flat fee and have various packages depending on the particular issues presented by your entity and arrangement.

For more discussion on corporate formation services, please write or give me a call at 310-570-2399

Now What: You’ve Messed Up Corporate Formation

I get quite a few calls from clients that MESSED UP their corporate formation.

  • Owners are afraid of being SUED because their entity is not “formally” set up
  • The State Franchise Tax Board has SUSPENDED the entity
  • NO ONE has been ISSUED any equity (stock if a C corp; units if an LLC)
  • NONE of the owners have a  shareholder agreement (e.g. c corp) or
  •  operating agreement (e.g. LLC)
  • Directors are ONE THE HOOK for anything that GOES WRONG
  • Someone has left the entity and there is NO RIGHT TO REPURCHASE

Some of these problems are EASY FIXES.

  1. Let’s Diagnose YOUR Problem

First – let’s compare notes.  Do you have all of the below?

screenshot-2016-11-14-14-30-18

2) Let’s drill down one more level.

a) DO YOU USE UNANIMOUS WRITTEN CONSENTS in lieu of Annual Meetings of Shareholders or Directors?  √ CHECK

–> (Note: LLC’s use Resolutions.)

b) Do your Unanimous Written Consents (or Resolutions) specify ALL material events to your shareholders or directors? √ CHECK

By material – I mean, that any event or decision or information that a reasonable person would need to make an informed decision.  Are we on the same page?

[the SEC defines materiality as: “to which there is a substantial likelihood that a reasonable investor would attach importance in determining whether to buy or sell the securities registered.”

Practice Tip: Consider being as specific about what you put into these Consents and Resolutions.  They can be used to disclose an entity’s important (ie. material) facts and events and can serve as a chronological record of the decisions made by the entity.

3) What is the status of these documents:

screenshot-2016-11-14-14-31-24

Have ALL shareholder’s executed a stock purchase, shareholder or if an LLC – an operating agreement?

Are there differences in the agreements between these individuals?

If so, is that because some have more or less rights than others?

Fiduciary duties:  In the LLC context, did you limit the duties that one member has to the others or between the manager and any member?

Deadlocks: How do you resolve deadlocks? If there are only two owners and they each own 50% of the equity, how will you resolve a deadlock?

Rights to Repurchase or Buyouts: What triggers the rights? what is the method of valuation? Does one equity holder have the right to force another equity holder to buy them out (ie. they have a put) versus the Company or a member have the right to buy away the equity of another member (ie. an call like option?).

4) Tax Matters: Many suspension and reporting problems come about because the tax preparer, advisor and the Client are not communicating about the following items:

screenshot-2016-11-14-15-37-03

 

IF YOU WOULD LIKE TO GO THRU MY APPROACH TO FORMATION, PLEASE GIVE ME A CALL 310-570-2399.  I offer fixed or flat fee programs for various scenarios. 

 

 

Got Marijauana Cash? Working with Banks

I get multiple calls each week – how can you help me – a licensed dispensary – obtain a workable banking relationship? 

The answer I give is really a question. A series of questions about the business that is calling me and few ever can answer the simplest question.

The simple questions are:

  • Regardless of what you sell, explain how your business works to me.
  • Are you licensed?
  • Who formed your dispensary?
  • Do you have a lease?
  • How about a simple one paragraph business plan?
  • Have you ever been in any type of business?

If you can’t answer these questions to me, lord knows, a bank won’t want to take your money as a depositor.  That would be almost true regardless of the fact you propose to be in the medical marijuana business but the marijuana part takes it up a notch. You must be even more organized. This is not the 60s and you must begin to talk and act like a real business person. 

Federal Law makes banking as a “marijuana-preneur” really hard.

Here is why: It is plain and simple, Marijuana is still a Class 1 drug and possession and distribution violate Federal law. State law, like in California, differs from Federal law and that only makes things more complex and confusing.  For example, how on earth can you maintain a bank account? Nothing here is intended as advice to circumvent state of federal law.  Caveat Emptor.  But if you prepare a Business Profile based on the concerns of the Federal enforcement agencies, your likelihood of developing a workable relationship with a bank, improves drastically.

  1. Prepare yourself: Create a Business Profile
    1. Business Plan: Using the Cole Memo and SAR Due Diligence Items as your Table of Contents
    2. What assets do you have? Build a simple balance sheet
    3. Business licenses
    4. Organizational Documents
    5. Background on Members of LLC
    6. Credit Reports and Credit background
  2. Know the Cole Memo (Prosecution Guidelines):
    1. Know the Federal Government’s Priorities for Prosecuting Marijuana Activity (things to avoid)
    2. The “Cole Memo priorities” include:
      1. Preventing the distribution of marijuana to minors;
      2. Preventing revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels;
      3. Preventing the diversion of marijuana from states where it is legal under state law in some form to other states;
      4. Preventing state-authorized marijuana activity from being used as a cover or pretext for the trafficking of other illegal drugs or other illegal activity;
      5. Preventing violence and the use of firearms in the cultivation and distribution of marijuana;
      6. Preventing drugged driving and the exacerbation of other adverse public health consequences associated with marijuana use;
      7. Preventing the growing of marijuana on public lands and the attendant public safety and environmental dangers posed by marijuana production on public lands; and
      8. Preventing marijuana possession or use on federal property

[More on the Cole Memo: “The Cole Memo reiterates Congress’s determination that marijuana is a dangerous drug and that the illegal distribution and sale of marijuana is a serious crime that provides a significant source of revenue to large-scale criminal enterprises, gangs, and cartels. The Cole Memo notes that DOJ is committed to enforcement of the CSA consistent with those determinations.” See Fin Cen Directive)]

3. Suspicious Activity Reports: Even if you find a bank that you can work with, they will most likely have to file a SAR. But you should go in prepared to answer these question in advance.

  1. Note: “This FinCEN guidance clarifies how financial institutions can provide services to marijuana related businesses consistent with their BSA obligations. In general, the decision to open, close, or refuse any particular account or relationship should be made by each financial institution based on a number of factors specific to that institution.”
  2.  Due Diligence Items You Must Address:
    1. verifying with the appropriate state authorities whether the business is duly licensed and registered;
    2.  reviewing the license application (and related documentation) submitted by the business for obtaining a state license to operate its marijuana-related business;
    3. requesting from state licensing and enforcement authorities available information about the business and related parties;
    4. developing an understanding of the normal and expected activity for the business, including the types of products to be sold and the type of customers to be served (e.g., medical versus recreational customers);
    5. ongoing monitoring of publicly available sources for adverse information about the business and related parties;
    6. ongoing monitoring for suspicious activity, including for any of the red flags described in this guidance; and
    7. refreshing information obtained as part of customer due diligence on a periodic basis and commensurate with the risk.
  3. “Marijuana Limited” SAR Filings: This is the reality
    1. To quote the above FinCen Notice: “A financial institution providing financial services to a marijuana-related business that it reasonably believes, based on its customer due diligence, does not implicate one of the Cole Memo priorities or violate state law should file a “Marijuana Limited” SAR.”
    2. Red Flags: If your business exhibits any of these, change your business:
      1. A customer appears to be using a state-licensed marijuana-related business as a front or pretext to launder money derived from other criminal activity (i.e., not related to marijuana) or derived from marijuana-related activity not permitted under state law.
      2. Relevant indicia could include:
        1. The business receives substantially more revenue than may reasonably be expected given the relevant limitations imposed by the state in which it operates.
        2. The business receives substantially more revenue than its local competitors or than might be expected given the population demographics.
        3. The business is depositing more cash than is commensurate with the amount of marijuana-related revenue it is reporting for federal and state tax purposes.
        4. The business is unable to demonstrate that its revenue is derived exclusively from the sale of marijuana in compliance with state law, as opposed to revenue derived from (i) the sale of other illicit drugs, (ii) the sale of marijuana not in compliance with state law, or (iii) other illegal activity.
        5. The business makes cash deposits or withdrawals over a short period of time that are excessive relative to local competitors or the expected activity of the business.
      3. Deposits apparently structured to avoid Currency Transaction Report (“CTR”) requirements.
      4. Rapid movement of funds, such as cash deposits followed by immediate cash withdrawals.
      5. Deposits by third parties with no apparent connection to the account holder.
      6. Excessive commingling of funds with the personal account of the business’s owner(s) or manager(s), or with accounts of seemingly unrelated businesses.
      7. Individuals conducting transactions for the business appear to be acting on behalf of other, undisclosed parties of interest.
      8. Financial statements provided by the business to the financial institution are inconsistent with actual account activity.
      9. A surge in activity by third parties offering goods or services to marijuana-related businesses, such as equipment suppliers or shipping servicers.
      10. The business is unable to produce satisfactory documentation or evidence to demonstrate that it is duly licensed and operating consistently with state law.
      11. The business is unable to demonstrate the legitimate source of significant outside investments.
      12.  A customer seeks to conceal or disguise involvement in marijuana-related business activity. For example, the customer may be using a business with a non-descript name (e.g., a “consulting,” “holding,” or “management” company) that purports to engage in commercial activity unrelated to marijuana, but is depositing cash that smells like marijuana.
      13.  Review of publicly available sources and databases about the business, its owner(s), manager(s), or other related parties, reveal negative information, such as a criminal record, involvement in the illegal purchase or sale of drugs, violence, or other potential connections to illicit activity.
      14. The business, its owner(s), manager(s), or other related parties are, or have been, subject to an enforcement action by the state or local authorities responsible for administering or enforcing marijuana-related laws or regulations.
      15. A marijuana-related business engages in international or interstate activity, including by receiving cash deposits from locations outside the state in which the business operates, making or receiving frequent or large interstate transfers, or otherwise transacting with persons or entities located in different states or countries.
      16.  The owner(s) or manager(s) of a marijuana-related business reside outside the state in which the business is located.
      17. A marijuana-related business is located on federal property or the marijuana sold by the business was grown on federal property.
      18. A marijuana-related business’s proximity to a school is not compliant with state law.
      19. A marijuana-related business purporting to be a “non-profit” is engaged in commercial activity inconsistent with that classification, or is making excessive payments to its manager(s) or employee(s).

 

To speak further about having us help you develop your Business Plan to help you determine compliance with the Cole Memo, the FinCen and the SAR and Red Flags, please give me a call 310-570-2399

What is Happening in US Corporate Governance Law

Last week in Beijing, I gave the following talk CorpGov2 to the Temple LLM Beijing program. What an impressive, fluent in English, group of professionals. We started with this Hypothetical as a structure for our discussion. So many smart questions – including, why did the board kick Steve Jobs out of Apple. I really look forward to hearing about this group and to hopefully meeting them again soon.

Cleaning Up Your Business

For years, prospective (and current) clients call me often with the following problem: they are entering into a transaction that requires them to confirm that their corporate documents are up to date.  I thought I would jot down a few notes for everyone so that they have  a checklist to start this work on their own. And if you need me to help along the way, don’t hesitate to ask. Or go to the Secretary of State Website (California’s see http://www.sos.ca.gov/business/be/faqs.htm).

Disclaimer: The reason you keep entity formalities is to ensure that the entity is separate from other entities – including your individual person. If you do business as an LLC or S-corp or C-corp however, there is no guarantee that you will not be sued as an individual. In fact, I often see individuals sued with their entity.  However, if the claim against you is essentially a claim against the entity – you are alleged to have done something, as a corporate officer, in the name of the entity, AND you have maintained corporate formalities, then even if you lose the lawsuit, the partying suing you is less likely to be able to go after non entity assets for recover. Notice I said less likely?! The devil is in the details.  I will be happy to – at no charge – high light for you whether or not your existing entity has maintained corporate formalities and point out potential gaps in your veil of protection.

1) Step One: Find what you’ve already done. 

a)  Filing with the secretary of state.  If you’re a California entity – C corp, LLC or partnership, and registered with the state of California (or any state) someone filed various registrations with the state when you were established.  If you are an S-corp, remember you need to make an election so talk to your CPA. (see: irs.gov S Corporation Fact Sheet for details.)

Find those first forms. They will most likely include: Certificate of Formation, Articles of Incorporation, the entities’ first Statement of Information (which lists officers and directors); Bylaws.

b) Every year: Did you file statements of information each year? Find the ones you filed.

c) Did you or the founder actually purchase the initial stock, membership or partnership interest? Did they pay cash for the rights? How much?

d) Did you hold or have actions in lieu of a shareholder’s meeting?

e) Is there a business license for the entity in each city or state that requires a license to operate?  How about a doing business as (aka Fictitious Business Name) filing? One is required unless the entity is doing business name in its own name. For example, let’s say the entity is ABC LLC but does business as The A Solution.  A fictitious business name filing is required for the “The A Solution” so that someone interacting with it in the marketplace is on notice that it is actually the ABC LLC and not some other entity.

f) Insurance policies? Are they in the name of the entity?

g) Other rights owners? Did the founder orally or in writing offer or grant rights to anyone else? Get those existing papers together.

h) Did you get an EIN?  Go to IRS website. There is no filing fee.

i) Payroll taxes enrolled and paid? In California, go to EDD. I recommend you engage a payroll service like surepayroll or adp to handle payroll and pay and file payroll returns.

This list does not address contracts and proprietary rights that the entity might have. 

2) Clean Up: 

a) Often, when the entity was formed, no one (i) made sure the founder purchased her/his initial rights; (ii) gave the entity it’s initial powers via organizational minutes; (iii) appointed the proper number of directors (you need at least one in California and no fewer than two if there are more then one shareholder); (iv) held a shareholder mtg annually or took a corp act in lieu of a shareholder meeting).  Which ones of these did you not do?

b) To catch up: Write in a chronological fashion, all of the major events of the business since formation: For example, January 2011, one shareholder Jim, decided to lease space at 123 Main and on January 2012 decided to offer employment to initial employee Sally. In January 2012, Jim decided to enter into long term lease for 123 Main and we paid Sally X.

Bylaws: Your by laws – if you are a c-corp, your operating agmt if you are an LLC and your partnership agmt if you are a partnership – will dictate when you are to hold shareholder and/or meetings of board of directors.  If you want to ensure that you maintain the corporate form, you should take notice of these things.

Shareholder minutes: These are technically notes from a shareholder meeting: I encourage you to use services like Rocketlawyer.com but they are not free and they are not lawyers. If you do, you might get corporate minutes to include all of the bells and whistles but are not required.  For example, My Corporate Minutes is a Rocketlawyer.com produced minutes. I do not confirm that this is compliant with any state law but it is an example.

Shareholder consents: If you did not have actual meetings, you will need annual consents in lieu of a shareholder meeting or meeting of board of directors. Often, when the shareholder is one and the director of the entity is the same as the sole shareholder, you will have Annual Consents of Sole Shareholder and Director In Lieu of Meeting. Here is a ANNCONN annual consent in lieu of meeting. Again, use these forms at your own risk.

d) Have your current statement of information filed timely.

e) Pay all back payroll taxes and income taxes. Engage a CPA if you are behind to deal with penalties and late filings.

f) Once you have your minutes done, you will want to use the chronology to clean up your annual shareholder meetings. It is in these meetings that you.

g) Valuations: There has been a lot of discussion about valuations lately. If an entity offers stock to any stake holder, it will be important to know the value of the entity when the shares are granted.  Subsequent discussions will address IRC 409A Valuations Final and fairness duties to minority shareholders.

For further information and help, do not hesitate to call me.