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Practicing business law in Silicon Valley over the past year, I have seen start-up activity pick up. We are in that part of the cycle where the survivors of the not so great recession have decided that they are better off on their own and have decided to make their dreams come true by forming their own companies.

Because many of these companies hope to become a welcome opportunity for outside investors, their choice of entity is the corporation. From the legal end, the process of incorporation is fairly straightforward and can be accomplished relatively quickly. Founders have a number of decisions to make, such as how much they want to each contribute to the new venture, and who will have which role.

Where a group of founders is involved, one of the most difficult issues, relatively speaking, is the issuance of stock. The first issue involves what percentage of the corporation each of the founders should receive. There are few, if any, rules of thumb as to whom should get what, and the decision is typically made by the founders assessing each of their respective strengths and weaknesses, and their contribution to the new venture, and deciding on a split. If the new corporation never expects to issue any new stock, and each founder will be actively involved in the business with profits being split at the end of each year, there may be little more to do with the stock other than to create a suitable buy-sell relationship.

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As a business and real estate attorney in California, I often assist clients in real estate transactions using Internal Revenue Code Section 1031 to defer the tax on the sale of their real estate by transferring the tax attributes of that property into a new, like-kind, property. IRC Section 1031 is a federal statute, but we can also take advantage of the tax deferral on the exchange of like-kind property for California income taxes.

However, historically, when the exchange was made into property in another state, it was difficult for California to track these exchanges and make sure the state eventually got its share of deferred taxes. For example, if a real estate investor were to sell a shopping center in Sunnyvale, California and buy a shopping center in Incline Village, Nevada, and the real estate investor satisfied all of the IRC 1031 requirements, both federal and California taxes could be deferred until the later taxable sale of the Nevada property (or any other property into which it had been exchanged). The problem was that part of those deferred taxes were California income taxes, and California had no system in place to make sure the FTB was aware of the eventual tax recognition event. A new rule now provides the Franchise Tax Board with the information it needs to keep track of these transactions and the deferred taxes so that it can collect them when the time is right.

Starting January 1, 2014, if you exchange California property for out-of-state property you will be required to file an information return with the FTB for the year of the exchange and every subsequent year that the gain is deferred. Regardless of your state of residency at the time of the exchange, if you are a California resident when the out-of-state property is later sold, all of the gain is taxable in California. But don’t think that moving to Nevada can get you out of theses deferred taxes. If you were a California resident at the time of the exchange but you are a nonresident when it is sold, the previously untaxed California gain is still taxable to California. Also, if you exchange out-of-state property for California property you must reduce the California basis on the property by the amount deferred, even if you were a nonresident at the time of the exchange. [Source: Spidell’s California Taxletter, Vol. 35.7, July 1, 2013]. The new filing requirements will help the FTB track these exchanges.

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It is that time of year again. Every year in the fourth quarter, businesses in San Jose and all over the United States are looking at the quickly approaching year-end and trying to figure out what they can do now before it is too late to save on taxes for 2013. This is especially true for small businesses, where every dollar of deduction is important because it hits the owner(s) directly in the pocketbook. My law firm is an LLP, so all items of profit and loss flow through to the partners. Therefore, this is the time of year that I look very carefully at how much money is available and what my law firm is going to need or want to buy in the next few months. Do we need a new copier? Do we want to upgrade our software? If so, let’s do it in December rather than January and get the deduction this year. With this in mind, here are a few things for business owners to consider before 2013 is over.

Purchase Equipment for Your Business

Make your equipment purchases before year-end. In 2013, up to $500,000 of both new and used assets purchased and actually put in use by December 31st can be expensed. This means you get a dollar for dollar deduction this year, without having to depreciate the asset over its useful life. This is really helpful for partners that want a deduction for every dollar spent so that they do not have taxable profits without available cash for distribution. But this benefit is limited. If you purchase and put in place more than $2,000,000 of assets during 2013, the $500,000 expense is phased out on a dollar for dollar basis. These limits will likely be even lower next year, so take advantage of them now.

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I have always known that Silicon Valley is home to many innovative companies and has a lot of entrepreneurial talent, but I was still amazed to read that start-ups in Palo Alto, Mountain View, Redwood City, Sunnyvale and San Jose received a combined $980+ million in funding in Q2’13. [Source: Silicon Valley Business Journal, July 16, 2013]. As a business lawyer in San Jose, I have seen a number of attempts to make fundraising for start-up companies easier. Recently, a new technique has come into favor.

The new buzz word for start-ups looking for funding is crowdfunding (sometimes known as crowdsourcing). In this type of deal, a group or entrepreneur will receive contributions from a large number of people for a project. The process started with artists raising money for their projects. Their success led for-profit companies to look at crowdfunding to raise money. Websites like kickstarter.com and indiegogo.com are just a few that provide crowdfunding opportunities.

To encourage crowdfunding, Congress passed the JOBS Act a year ago last September. In response, the Securities and Exchange Commission (SEC) released new regulations intended to encourage crowdfunding. One of the new regulations relaxes the public solicitation limitations that had been imposed for certain types of private financing deals.

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The personal guarantee has long been used to bolster the quality of a commercial loan, real estate loan or business loan. Often the personal guarantee is a full guarantee, extending to all obligations of the borrower and giving a lender potential recourse to all property of the guarantor in an enforcement action. Sometimes, however, the lender and guarantor agree that the guaranty will be more limited. A recent case out of the Bay Area, Series AGI West Linn of Appian Group Investors DE LLC v. Eves, 217 Cal. App.4th 156 (2013), dealt with such a limited guarantee , which carved-out the guarantor’s home and exempted it from the lender’s reach under the guarantee. The personal guarantee was very broad, but for the specific exclusion for the house. After the guarantee was signed, but before the loan soured and the lender demanded payment, the guarantor sold the exempted house for cash and put the proceeds of the sale in segregated accounts. Once defaults occurred under the loan, the question at issue was whether the carve-out under the guarantee exempted only the asset named, a house in Como, Italy (but for our purposes it could have been a home in San Jose or Palo Alto as well!) or extended to the proceeds from the cash sale of the house.

In the AGI West Linn case, the lender sued the guarantor and also asked the court to enter a right to attach order and writ of attachment to lock up the cash from the sale of the house. The guarantor opposed this, arguing that the money was simply proceeds of the excluded residence and, as the house itself was excluded from lender’s recourse, the direct proceeds of the sale of the house should be excluded as well. The lender countered that the guarantee did not say anything about “proceeds” being excluded, only the house.

The court held for the lender, taking a strict reading of the guarantee.

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One of my clients is a medium sized manufacturing plant here in San Jose. Although not a high-tech business, they have extensive capital assets and specialized skills. The business is being run by the second generation of family members, and the third generation is now being trained to take the reins someday. The family has recognized that many of their competitors are still being run by the first generation of owners, and it does not look like those businesses are likely to transition to other family members. As the owners of the competitive businesses age and want to retire, they will be looking to sell their manufacturing plants. My client wants to buy them. We recently sat down and discussed acquisition strategies. I explained that there are two common ways to buy a business – either you buy the stock, or you buy the assets. What most people do not realize, is that even when you are only buying the assets, you could be liable for up to three times the purchase price in state taxes that should have been paid by the seller.

Most people know that when you buy the stock of a corporation (or membership interests in an LLC), you get all of the assets as well as all of the liabilities in that company. As a result, many of my clients want to buy only the assets of a company as a strategy to avoid the liabilities (known and unknown) that come with a business with history behind it. To accomplish this, we draft an asset purchase agreement that includes lists of which assets we are buying, which liabilities we are buying, and which liabilities we are not taking on. For example, when you buy the stock of a company, you get all of its employees including their accrued and unpaid vacation time. When you buy the assets of a company, we ask the selling business to terminate all of its employees so that we can start over by hiring them in the acquiring company as new employees, without any potential claims for what came before. However, many people do not realize that certain tax liabilities may follow the business of the company rather than the company itself. So, if you buy enough of the assets to be considered as having purchased the company, you could be buying tax liabilities… even if they are on your list of items excluded from the sale.

Each of the Franchise Tax Board (state franchise and income taxes), the Board of Equalization (sales taxes) and the Employer Development Department (employment taxes) has the right to come after the buyer of a business for unpaid taxes in an amount up to the entire purchase price. So, if you pay $100,000 for the assets of a company, you could be liable for unpaid taxes of up to $100,000 to each of those three government entities. Your $100,000 purchase price just became $400,000!

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Small businesses dominate the U.S. economy. According to the U.S. Small Business Administration (SBA), 99% of all independent companies in the U.S. have less than 500 employees. As a small business attorney in San Jose, most of the time I am working with clients to form new businesses. However, as we all know, not all businesses succeed. Recently I was counseling a client with regard to the sale of her retail store. She had worked hard building the store into a business that could support her needs, but it was time to retire. Rather than going through the hassle of selling the business as a whole, she decided to simply sell the inventory to a competitor and shut the doors. However, shutting down a company can still be a hassle, and if you forget to do one thing it could result in a big liability later.

So, what does it take to shut down a small company? Here is just a short to-do list of the basic items common to most small businesses. This list does not take into account the added complexities of a business with multiple owners.

1. Talk to your accountant, attorney, financial advisor and any other professionals that may be able to assist you in a smooth closure of your business.

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In this digital age, the courts increasingly have zero tolerance for errors on a UCC-1 financing statement intended to perfect a lender’s security interest in collateral as part of a loan transaction. Most recently, a federal court in Rushton v. Standard Industries, Inc., et al. (In re C.W. Mining Company), 488 B.R. 715 (D. Utah, 2013) ruled that a UCC financing statement that omitted two periods from the debtor’s name was materially misleading, and the “secured party” was therefore not perfected. A lender who thought it was properly secured on a $3 million obligation suddenly found itself entirely unsecured because of this seemingly trivial mistake!

The debtor in this matter was C.W. Mining Company, whose fortunes had slipped, leading to a bankruptcy. Well before the bankruptcy petition was filed a creditor with a security interest in coal owned by the debtor (C.W. Mining Company was a coal producer) filed a UCC-1 financing statement naming the debtor as “CW Mining Company.” The bankruptcy trustee (usually the bad guy in these situations, from the secured creditor’s point of view) brought an action to, among other things, avoid the lien because of this mistake, arguing that the creditor was not properly perfected.

The Bankruptcy Court and the Federal District Court, on appeal, agreed with the trustee. They held that the manner in which the creditor set forth the debtor’s name on the UCC-1 financing statement was seriously misleading, as it omitted the two periods. Of major importance was the fact that the search algorithm used by the state – Utah in this instance – did not pick up the filing in its data base when the debtor’s proper name was entered.

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In Silicon Valley, home to many large technology corporations and thousands of innovative startups, businesses need to move quickly to stay ahead of the competition. As a small business attorney in San Jose, I have formed countless of limited liability companies (LLCs), partnerships and corporations with the Delaware and California Secretaries of State over the years. And one of the first questions my eager small business clients ask me in our initial meetings is almost always, “How long will it take to form my company?”

For many years my answer was that we could have the filed Articles of Incorporation (for a Corporation), Articles of Organization (for an LLC), or Certificate of Partnership within about a week. When the California Secretary of State slowed down a few years ago, I had to tell clients that it could take as much as several weeks. However, in the last year or so the delays crept up to three months or more for the California Secretary of State to process and return a business filing.

Of course, California does provide a 24-hour expedited filing option, for an additional $350 over the usual filing fees. In my more cynical moments I have had to wonder whether it was the California budget crisis that was causing filing times to slow down because of lack of resources, or if the Secretary of State was purposefully taking longer to return routine filings in order to force virtually everyone to pay the “rush” fees.

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Head’s up!! UCC financing statements are changing as of July 1, 2013. Lenders and borrowers need to take extra care to ensure that they have correctly prepared UCC financing statements and, of course, consult with an attorney as necessary. UCC filings are of critical importance in any secured loan transaction, whether it involves asset based loans, technology lending, construction financing, equipment financing, and even real estate lending where fixture filings may be an integral part of the transaction or personal property may be included in the collateral pool. Accordingly, changes in UCC forms affect every lender, secured party and borrower. In a problem loan, loan workout or bankruptcy situation, the validity of the lender’s security interest becomes of paramount importance.

For lenders, the basic rule for perfecting a lien or security interest in most types of assets is to file a UCC-1 Financing Statement with the Secretary of State where the debtor or borrower is registered. If the borrowing company happens to be in San Jose or Palo Alto, California, for example, and is registered as a California corporation, the UCC-1 is filed with the Secretary of State in California. As of July 1, a revised form of UCC-1 is to be used in most states, including California and Delaware.

The changes to the form are driven by privacy concerns and primarily involve eliminating entries for a company’s registration number and an individual’s social security number. Such identifying information has not been required – in fact, social security numbers have automatically been redacted or made unreadable – for a while now in California. One thing the change highlights, however, is the ever-increasing importance of getting the debtor’s name correct on the UCC form, character by character, as other references to a borrower or debtor no longer appear.

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