Articles Posted in Corporations

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Whether you are a startup company in Sunnyvale or a family owned business in San Jose, as an employer, you will have some basic employment concerns. In my previous two blogs, I discussed risks in looking for employees and evaluating potential applicants. This blog focuses on reference checks, both for potential employees and when another business owner calls you with regards to an ex-employee of yours.

When you are interested in an applicant, a reference check is always a good idea. In particular, checking references may be crucial to avoiding a claim of negligent hiring. This is very important when your employee will be working with young children, like a daycare teacher, or entering homes or businesses, such as an installer or a janitorial worker. However, reference checks can be a concern both when you are the potential employer and when you are the previous employer. Any information you ask and any information you give to a potential employer must not be discriminatory or retaliatory.

Often, a good strategy as the previous employer is to have a strict policy of only providing very basic information such as confirming that the employee did work for you, dates of employment, and position.

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In my previous blog, I discussed the risks faced by companies that are looking to hire new employees. This blog focuses on issues employers need to be concerned with once they have found some candidates and need to choose between them.

Once you are ready to interview candidates, you still need to be wary of a discrimination claim for the questions you ask and the information you gather, even if the information is crucial to determining whether the person would be a good fit for your company. So, you have to be very careful about how you obtain information and decide between candidates. Looking up candidates on the web through social networks is the subject of many articles itself. This blog just deals with the old fashioned methods of considering job applicants.

If you require potential applicants to complete a job application, don’t just download a form from the web and think you are safe. The questions you ask must be relevant to the position you are trying to fill. This means that even within your company one application may not be appropriate for all positions. Avoid asking questions about age (including requesting date of birth!), race, religion, nationality, disabilities, gender, marital status and whether or not the applicant has kids, is a single parent, etc. When it comes time for an interview, be prepared with a list of potential questions to ask as well as ones to avoid, and have each interviewer review these questions before an interview. I strongly recommend for employees who have never been the interviewer to go through a practice interview so that he or she can rehearse the role and responses to various questions. Questions should be geared towards a candidate’s past job performance and qualifications, and careful emphasis should be placed on returning the conversation to an appropriate line of questions if the applicant volunteers information that may be considered discriminatory if asked.

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Silicon Valley’s job market heats up even as national employment stalls, thanks to an increase in venture capital and personal investing. Large corporations are competing with small businesses and start-ups for talent. Although some of my business clients are start-up companies where the founders are the only employees, more and more of my clients are operating businesses with day to day concerns, the most common of which is employee issues. A growing business that is hiring may need employment contracts and possibly a stock option plan in place. All businesses need employment policies and possibly an employee handbook. And almost all businesses at some time or other will need to deal with employee complaints, discipline and even terminating employees. This is the start of a series of blogs on some of the basics you should know as an employer, whether here in Santa Clara County or elsewhere. Keep in mind that every situation and every employee is different and the laws of other states may be different than California. This is not a substitute for calling your company’s lawyer, but more of a guide to help you spot issues and know when you need to ask for help.

Looking for New Hires:

The first rule of hiring is to be wary of discrimination. You can hire anyone you want, as long as you don’t discriminate based on age, race, nationality, gender, disability or any other protected class. Discrimination can show up or be inferred from many situations where it may not have been intended. For example, I represent a janitorial company in Santa Clara that employed many people from one religion and those employees often referred their friends and family when positions opened up. When looking for new hires, the company has to be very careful to ask all their employees for referrals and not just that group of employees, or the company could be found to be discriminating against people who are not part of that religion.

Anyone that represents your company in recruiting new employees should be well trained in employment laws. Be careful about how you write your employment ads so they don’t exclude any class of potential employees, and make sure to include a statement that your company is an Equal Opportunity Employer in each ad. Be careful about where you advertise. For example, I represent a bilingual English/Chinese preschool in Sunnyvale. Although it may be okay for the school to advertise in an all-Chinese newspaper when they are looking to hire Chinese teachers, it may be considered discriminatory against non-Chinese speakers when they are looking to fill any position that does not require Chinese language capabilities.

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The standard mileage rate is very important to my business clients because it is not only the rate at which they can deduct miles driven for business use, but it is also often the rate at which the businesses have agreed to reimburse their employees for miles driven on the job. The IRS has once again changed the standard mileage rate for the use of business vehicles. For the final six months of 2011, the standard mileage rate will be 55.5 cents per mile, up from 51 cents. The IRS made this decision due to the spike in gas prices earlier this year, but the rate is good for the rest of the year even though prices seem to be falling now. The mileage rate for medical and moving expenses also goes up by 4.5 cents to 23.5 cents per mile, but the mileage rate used when driving for charity is unchanged at 14 cents per mile.

The IRS will announce the mileage rate for 2012 in the fall.

Source: Kiplinger Tax Letter, Vol. 86, No. 13 (June 24, 2011)

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I recently did a blog about California clients wanting to form LLCs outside of California in order to avoid California franchise taxes, and how the Franchise Tax Board has been steadily trying to eliminate those possibilities. In response to that blog, I was asked about other non-tax considerations for choosing a state for the formation of a business. So, here is a brief analysis of some of the things I consider when helping my clients choose the right jurisdiction for their new corporation.

When a client comes into my office in San Jose and asks about forming a business entity outside of California, the most common jurisdictions they are considering are either Delaware or Nevada. Delaware has traditionally been the favorite jurisdiction, and Nevada is gaining in popularity.

Why incorporate in Delaware?

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In negotiating a recent acquisition for a client selling a business in Santa Cruz, we were presented with a letter of intent outlining the terms of the transaction. The letter was well-constructed, and contained the material aspects of the deal, all of which were nonbinding. There were, however, a number of terms that were expressly made binding.

There are four binding terms most commonly used in nonbinding letters of intent for acquisitions of privately held companies. The first is that the parties will agree to standard nondisclosure obligations. The second is that the acquirer will be allowed to conduct a diligence investigation of the target. The third is that each party will pay its own fees incurred in connection with the transaction. If the transaction is a stock transaction, there may be some negotiation over whether the target can pay fees, under the theory that a stock deal is a deal among stockholders, rather than the corporation.

The fourth is the most hotly negotiated term – the “no shop” or “exclusivity” provision. The no shop is just as it sounds: the target company agrees not to “shop” itself while the transaction is in process. Acquirers usually demand this term so that their offer is not used by the target to get a better deal, and so that the time and expense they spend in the due diligence and negotiation process is not thwarted by another suitor. An acquirer will also ask that the target company stop any discussions with any other potential acquirer, and notify the acquirer if the target company receives any other acquisition inquiries.

Target companies attempt to insert a number of qualifications and limitations to the no shop clause. First, the target will request a “fiduciary out”. In this exception, the no shop is ineffective where an unsolicited alternate offer must be accepted in order for the target’s board of directors to satisfy its fiduciary duties. Second, the target will attempt to impose strict time deadlines which, if not met, will cause the no shop to expire. The primary deadline will be on the parties entering into a definitive agreement. Other deadlines include the acquirer’s completion of its due diligence investigation, and the closing of the acquisition.

Other binding terms include break-up fees where one party, typically the acquirer, will pay the other party, typically the target, if the acquirer decides not to proceed with the transaction.

As with most deals, the extent of number and type of binding terms in a letter of intent depends on the relative bargaining strength of the parties.

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I was recently working with some doctors who co-owned their Sunnyvale medical office building. They were concerned about the liability of having the property in their own names, so we worked with their lender and transferred the property into an LLC. Then, I suggested forming a professional corporation to operate their medical practice. Although doctors cannot avoid personal liability for their own malpractice, the corporation will limit their vicarious liability for the acts of their professional partners.

The California Professional Corporations Act allows licensed professionals in the fields of law, medicine, dentistry and accountancy to conduct business in a corporation, through the licensed individual shareholders. The Articles of Incorporation must include special language about the professional corporation. In addition to registering with the California Secretary of State, the corporation must also follow the naming and registration rules of the professional agency. The shareholders must be licensed, and transfers may only be to other shareholders or back to the corporation.

If a shareholder dies, the shares must be transferred within six months. If a shareholder is no longer qualified to practice medicine, the shares must be transferred within 90 days. For these reasons, I always recommend a shareholder buy-sell agreement to give the corporation or the remaining shareholders time to pay for the shares so it does not create financial difficulties for the company. Ideally, the corporation will also obtain life insurance on the professionals to fund a cash buy-out of a deceased shareholder’s shares.

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

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

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

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I was recently asked by a Cupertino real estate investor whether he should form his limited liability company in Nevada or some other state in order to avoid California taxes. I had to tell him that if anything, this would just increase his overall costs and taxes.

California franchise taxes can be much higher than taxes in other states, and include a minimum tax of $800 per year. As a result, companies often do not want to be classified as doing business in California. One way to avoid this classification used to be to form your entity in another state, and not register it in California. Some of my clients have numerous Delaware LLCs or Nevada LLCs. Often, those LLCs own other LLCs, which own property in California. In order to avoid the California minimum franchise tax for multiple entities, they just register the entity that actually owns the property in California.

However, a new ruling says that if the entity is doing business in California, owns property in California, or is managed by people in California, this exemption is no longer available at the parent LLC level.

The California Franchise Tax Board just issued FTB Legal Ruling 2011-01, stating that activities of a disregarded entity will be attributed to the entity’s sole owner. A disregarded entity is a single member LLC or a Qualified Subchapter S subsidiary (“QSub”) which is disregarded for income tax purposes so that its income passes through to its parent for tax reporting purposes. Therefore, if the disregarded entity is doing business in California, the 100% owner will be considered to be doing business in California and, if it is an entity, will have to register with the Secretary of State in California. This is true even if that owner entity has no other activities in the state, other than owning the disregarded entity.

This ruling is in addition to a previous California Franchise Tax Board ruling that an entity will be considered to be doing business in California if its managing person(s) are in California, even if all of its other activities are out of state.

For real estate investors, lenders often require a special purpose entity (“SPE”) to hold the property, which is structured as a single member Delaware LLC. Under these new Franchise Tax Board rulings, the single member LLC holding the property must be registered in California, and its 100% owner parent company must be registered in California as well. The bad news is that both entities are required to pay the $800 minimum franchise tax to California. However, the LLC gross receipts tax is not incurred twice on income that flows through from one LLC to another.

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

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

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

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