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Attracting Talented Employees

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It takes a lot of effort to attract talented individuals to join your team. To help ease the process it’s important to start by evaluating what you offer compared to your competitors. Presenting an attractive opportunity is as much about the value package you provide as it is about the work and culture. To help… Read More

It takes a lot of effort to attract talented individuals to join your team. To help ease the process it’s important to start by evaluating what you offer compared to your competitors. Presenting an attractive opportunity is as much about the value package you provide as it is about the work and culture.

To help you think through some of these factors we’ve broken this post into two parts. Bend Law Group will discuss equity compensation, and TriNet will bring it home with a brief discussion about Medical Benefits and the importance of implementing the right “strategy” for your company.

Incentivizing Employees with Equity Compensation

When you’re a startup, it’s important not to overlook the equity compensation aspect when filing the certificate of incorporation. Most businesses don’t grant stock options or seek venture capital as their options continue to grow and expand. However, because a startup will seek to scale and grow, we strongly encourage our clients to authorize 10,000,000 shares when they file the certificate of incorporation.

Now you may be saying, “but couldn’t we obtain the same results just sticking with 1,000?”  Yes, you could! But unfortunately people (employees/consultants/directors) like to have a large number of stock even if the percentage of the company would be the same. 50,000 stock options sounds better than 5 even if they mean the same ownership percentage of the company, and we cannot discount ego and vanity when people are comparing an offer within their networks. Thus, a key aspect of the long-term planning involves compensating future service provisions through equity compensation.

When planning for the future you must also keep in mind that you cannot sell or give away stock unless the securities are either (i) registered with the SEC, or (ii) are issued pursuant to an exemption. Rule 701 is the federal securities law exemption for compensatory equity issuances.

When creating an equity compensation strategy, here are a few key components to consider:

1. Disclosure Requirements

Rule 701 requires issuers to provide the service provider with a copy of the equity incentive plan.

2. Understand How the Number of Shares Impacts Future Investment

Keep in mind when deciding how many shares to contribute to the plan that investors will calculate the share price on a fully diluted basis. For example, if the founders owned 6 million shares, and the equity incentive plan had 2 million, the investors would say the fully diluted the share structure was 8m, and not 6m, even if no one had received shares out of the equity incentive plan at the date of investment. Therefore, it’s very important to put only the amount of shares you forecast you’ll need to attract the talent necessary to fulfill key roles.

3. What type of Grant Makes Sense for the Company

An equity incentive plan that authorizes multiple types of awards will permit greater downstream flexibility, even if the company only intends one type of grant at the time of creation.

Here’s a quick breakdown of the two primary awards:

i. Stock Options

A stock option gives the holder the right to purchase shares at a fixed exercise price over a specified period of time. The award may either be an incentive stock option (often referred to as an “ISO”), which can only be granted to employees, or a nonqualified stock option, which is commonly used with consultants and advisors.

ii. Restricted Stock

 Restricted stock is a grant of equity that remains subject to forfeiture until an applicable vesting schedule lapses.

The key difference is that a grant of restricted stock is immediately taxable (unless the service provider pays for the shares) and the service provider may vote and receive distributions on the shares even though they may be subject to vesting.

Furthermore, stock options may or may not be deferred compensation subject to Section 409A of the Internal Revenue Code. The analysis depends heavily on if the option was granted at or above fair market value, and the consequences for failing to comply with 409A are severe. Of Internal Revenue Code Section 409A’s three approved valuations, the two that are most pertinent are (1) independent appraisal, which is done by a professional firm experienced in valuation methods, or (2) a company that has been in existence less than 10 years and does not reasonably anticipate an IPO (or acquisition) in the next 180 days can rely on a valuation performed using Section 409A’s enumerated valuation factors by a person (can be a company employee) with significant knowledge and experience or training performing similar valuations.

What this brief discussion highlights is the importance of following both the SEC and IRS rules for equity compensation. Crafting a proper plan so that you are capable of granting proper equity compensation that competes or exceeds your competitors can be one of the key factors for why a candidate chooses you.

Medical Benefits

As Bend Law Group stated, it absolutely takes a lot of effort to attract talented individuals here in the Bay Area and even more to retain them. So how do Medical Benefits play a role in this?

I would submit to any company the answer is all in your company’s “strategy” behind your Medical Benefits offering.

I meet with start-ups on a weekly basis in an effort to help them navigate through all the complexities of having “a” employee, let alone 5 to 100 employees here in the wonderful Bay Area. A question I always start my meetings with when it comes to benefits is this:

“Do you offer medical benefits?”… Sounds like a crazy question to most because what qualified and talented candidate is going to accept an offer from a company that doesn’t offer benefits, right?

So why do I ask this question?

I ask this question because 95% of the time the answer is “yes, of course we offer medical benefits.” That then leads me into my follow-up question, which will always be…. “Why do you offer medical benefits?”

A company’s response to this very basic question and the subsequent discussion it leads to will give me more insight on how I can help them than almost any other discussion we will have.

Allow me to explain.

The 5%:

If I am meeting with the owner(s) of one of these companies and they tell me “We don’t offer medical benefits because we don’t care” (and trust me this happens) I typically will end the meeting because at the end of the day if you don’t care about your employees, then I don’t want to do business with you and I can’t “help” a company at that point. Furthermore, I feel bad for your employees. I digress…

The 95%:

Over the years I have heard a multitude of responses as to why a company offers Medical Benefits. From “because we legally have to offer them” to “my employees are my most valuable part of my business so I take care of them” and everything in between.

But what is right reason for offering Medical Benefits?

In my opinion it is important to understand the “right” reason for offering medical benefits will be unique to each company. However, the “strategy” behind the Medical Benefit Offering is where the focus needs to be.

As a start-up it is imperative that you understand that the power lies in the implementation of your “strategy.” When my team and I work with companies we have to always look at the dynamics of the company. We evaluate the demographics (is it primarily millennials, baby boomers, a blend, etc.), we look at the culture and how it plays into the business as a whole, and from there we begin building and then implementing the “strategy.”

For anyone who has ever had to look or “shop” all the different medical carriers here in California and all the different types of plans and offerings each carrier has, it is overwhelming to say the least. There are literally thousands of plans and a plethora of providers.

That being said, when putting together your “strategy” you will have to understand the following in great detail:

1. The Company Contribution:

First figure out your company’s contribution strategy. How much of the premium are you going to pay? 100% of the premium for the employee and their family? 100% for the employee and 50% for their family? 50% for the employee and nothing for their family? Something I believe is crucial for any company venturing to do this without outside help is KNOW WHAT YOUR COMPETITION IS OFFERING. That piece of information will be your building block for your “strategy.”

Why is that?

Because it is important to understand that just because your competition offers 85% or 100% medical benefits contribution that doesn’t mean the plans they offer make any sense to the talent they are seeking. Your competition could be throwing money out the window because they have a flawed strategy!

For instance, the millennial candidate you may be seeking does not need nor want to pay anything for what a 30-year-old to 50-year-old with a family will require. So paying for that premium for your millennial hire with a 100% contribution from you is bleeding your capital for no reason.

A high deductible plan that costs very little to the company and nothing to the employee per month means a lot to a young professional who may or may not even go to an annual check-up. Don’t underestimate the power of your contribution “strategy.”

2) The Plan Design(s):

When discussing plan designs, given all the carriers and plans available, know that as a small group (new start-up/under 100 employees) your options are expensive and limited with or without a broker (unless you partner with a Professional Employer Organization). So be smart and educated when you choose the plans.

Choose plans that make sense for your company’s culture.

If you are going to hire millennials you probably don’t need to bother with any “Gold” type plans. The high deductible plan mentioned above will absolutely suffice and you can contribute 100% because it will cost you much less and the talent you seek will feel that you are taking great care of them by offering them “free” Medical Benefits.

Please keep in mind this is a very high-level overview of the Medical Benefits “Strategy” but I am hoping that my point will hit home: Know why you are offering Medical Benefits and use your “strategy” to your advantage. Make your “strategy” work for you and make it a tool for attracting the talent you seek. Don’t just let your Medical Benefits offering be your second largest expense—get an ROI on your Medical Benefits by implementing the right “strategy”!

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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Tips & Tricks For Naming Your California Corporation

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When forming a corporation in California, it is important to keep in mind the rules that the California Secretary Of State’s Office uses when reviewing formation filings. You should also look ahead two or three moves ahead, like a chess match, and consider what the U.S. Patent & Trademark Office will consider when reviewing a… Read More

When forming a corporation in California, it is important to keep in mind the rules that the California Secretary Of State’s Office uses when reviewing formation filings.

You should also look ahead two or three moves ahead, like a chess match, and consider what the U.S. Patent & Trademark Office will consider when reviewing a trademark application to protect the name of your business.

Naming Rules When Forming A California Corporation

The California Secretary Of State’s Office has a few quirky rules for naming your California corporation.  Some of the most frequent reasons a filing gets rejected include:

1. Geographic Designation

For purposes of running a conflict check when approving the articles of incorporation, the Secretary Of State’s Office drops geographic designations (place names). 

For example, when reviewing a filing to create “California Sushi Bar Inc.,” the word California would be dropped when evaluating the name and the filing would be rejected if there was already a Sushi Bar Inc. registered. Similarly, a filing for America Sushi Bar Inc. would be rejected because America is also the name of a place.

In contrast, Californian, unlike California, would not be dropped. So “Californian Sushi Bar Inc.” could be approved because Californian is not the name of a place. In addition, American, unlike America, would not be dropped and so American Sushi Bar Inc. could be approved.

To further complicate the geographic designation rule, it only applies to California corporations – not to LLCs.

2. Numbers

In doing its name conflict analysis, the California Secretary Of State’s Office also drops numbers.

For example, “10 Hot Wings Inc.” would be rejected if Hot Wings Inc. was already registered with the California Secretary Of State’s Office.

3. Accents

Neither the IRS nor the California Secretary of State accepts accents above letters (example: Mūsic LLC).

4. “Scream Words”

The Secretary Of State’s Office also has a list of what it describes as “scream words” that will cause a filing to be rejected.

For example, if you file articles of incorporation to form “Californian Sushi Bar LLC Inc.” the filing will be rejected as it has the scream word of LLC in a filing to create a corporation.

5. Names Of Other Entities

Finally, the California Secretary Of State’s Office has separate databases for corporations, LLCs, and LLPs so it could approve a filing to form a corporation with the same core name of an existing LLC.

For example, a filing to create Californian Sushi Bar Inc. might be approved even though Californian Sushi Bar LLC already exists.

That being said, you should also take trademarks into consideration to make sure your company name does not get you in legal hot water.

Trademark Law

You can read more here, but basically you need to take into consideration trademark law when naming your company.

A trademark is a recognizable word, phrase, design, or expression which identifies the source of a good or service. Registering your trademark on the U.S. Patent and Trademark Office’s (USPTO) federal registry provides you with a legal presumption that you are the rightful owner of that mark nation-wide. This means that if you file a claim for trademark infringement based on a federally registered mark, the burden is on the other party to prove they were not infringing.

The two most frequent reasons a trademark application gets rejected are:

1. Likelihood of Confusion

The question of whether another mark presents a conflict to your trademark’s registration is one that is difficult to assess. The test for trademark infringement is “likelihood of confusion.” This is not a quantitative test, and there is no set rubric for which to score or grade your risk. Instead the USPTO looks at several factors and weighs the totality of the situation, with the most important factors being (a) the relation between the goods or services; (b) whether the goods or services compete; and (c) the similarity of the marks in terms of their appearance, meaning and sound.

2. Merely Descriptive

Another common objection that the USPTO cites against a trademark application is that the mark is “merely descriptive” of the goods and/or services with which it is associated. The USPTO is hesitant to provide trademark protection to descriptive aspects of a trademark, in part because of the belief that one party should not have a monopoly over a widely used word or phrase.

You can learn more about how Bend Law Group helps businesses with their trademarks and brands at the Bend Law Group Trademarks website, www.blgtrademarks.com.  Please don’t hesitate to contact us at info@bendlawoffice.com or (415) 633-6841.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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Starting a US Company as a Non-Resident

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If you are a non-US citizen or company considering opening a business in the US, there are three primary considerations: (1) U.S. Immigration visa requirements, (2) the legal structure of your business, and (3) how it will impact your personal taxes. To help analyze these three factors we’ve brought in an immigration attorney and a… Read More

If you are a non-US citizen or company considering opening a business in the US, there are three primary considerations: (1) U.S. Immigration visa requirements, (2) the legal structure of your business, and (3) how it will impact your personal taxes. To help analyze these three factors we’ve brought in an immigration attorney and a CPA.

1. U.S. Immigration Considerations

by Dan Roten, a partner at Kaiser and Roten

There are three primary immigration options for starting and running a business in the U.S.

  • E-1 Trade Visa/E-2 Investor Visa

The E visa category allows foreign nationals who are citizens of treaty countries to start businesses in the U.S. There are two types of E visas. The E-1 Visa is for foreign nationals who engage in substantial international trade of goods, services, or technology between their home country and the U.S. The E-2 Visa allows foreign investors to direct and develop a U.S. business in which the investor has either already invested or is in the process of investing substantial funds. E visas are valid for 5 years and E visa holders are admitted to the U.S. for two year periods. The foreign national can renew the E visa indefinitely as long as they continue to maintain an E business in the U.S.

  • L-1 Multi-national Transfer Visas

The L-1 Visa enables foreign companies to transfer managerial, executive, and specialized knowledge employees to a U.S. subsidiary, affiliate, or branch who have been employed at the foreign company for at least one year. If the foreign company wishes to open a new U.S. branch, affiliate, or subsidiary, immigration laws allow for the transfer of one managerial or executive employee to open and manage the new U.S. entity through the initial start-up phase.

  • EB5 Job Creation – Permanent Residency Visa

The EB5 program allows for permanent residency in the U.S. (Green Card) for foreign nationals who invest $1 Million in a new U.S. commercial enterprise (new is considered any business formed after 11/29/1990). The $1 Million investment must directly or indirectly create 10 full-time jobs for U.S. citizens or lawful permanent residents. The foreign investor is given a conditional two-year green card based on the investor’s business plan and then must place all funds at risk and create the required jobs within the two-year conditional period. Once Immigration is satisfied the funds have been invested and the jobs created, the conditions on permanent residency will be removed.

2. The Legal Structure

by Alex King of Bend Law Group, PC

Depending on the state you incorporate in and the type of business you plan to operate, there can be a myriad of options for incorporating your business. The two most popular options are the Limited Liability Company (LLC) and the Corporation. Why do some entrepreneurs choose to form an LLC instead of a corporation, and vice versa? Below are some considerations to help you decide what type of entity might be the best fit for your business.

  • Ownership

The owners of a corporation are shareholders, while the owners of an LLC are members. An LLC is much more a product of contract law, while a corporation is a child of statute. Therefore, it is much easier to create separate classes of ownership within an LLC operating agreement because you can draft the agreement to fit the desired ownership structure. However, unlike a corporation, it can be much harder to set up an equity incentive plan that includes stock options within an LLC. For many startups, especially tech startups that rely on equity compensation to attract talent, this can be a major hindrance.

  • Corporate Formalities

Unlike a corporation, an LLC does not have to hold regular meetings and keep corporate minutes, which reduces the paperwork of maintaining your entity. A corporation must hold annual shareholder and board meetings to elect the board of directors and appoint corporate officers. In California, an LLC must file a statement of information with the Secretary of State every other year, while a corporation must file a statement of information every year.

  • Management

An LLC’s members or managers can manage the company. In contrast, a board of directors handles the management responsibilities, while the corporate officers handle the day-to-day operations.

  • Distributions

A corporation must allocate its distributions in proportion to each shareholder’s ownership share. An LLC, on the other hand, does not necessarily have to allocate its profits or losses in proportion to each owner’s membership interest. Instead, the LLC’s operating agreement (which is subject to certain IRS restrictions against negative capital accounts) can determine the distributive share of gains, losses, deductions, or credits (often referred to as “special allocations”), provided these distributions have “substantial economic effect.”

  • Investment

Entrepreneurs hoping to achieve venture seed funding typically choose the Delaware Corporation. Venture capital firms won’t automatically screen out businesses that are not incorporated in Delaware, but they prefer it due to its friendly corporate governance benefits, ease of dealing with the DE secretary of state, and well known and predictable corporate laws. Furthermore, investors prefer the corporate structure because they often are prohibited from investing in an LLC, which is taxed as a partnership. They prefer a structure that allows the company to freely grant equity compensation to talented new hires without the added hassle that comes with an LLC structure. (For additional Delaware considerations you can check out these two blog posts, here and here.)

3. Taxes

by Chun Wong, principal at Safe Harbor LLP

There are many tax considerations for a non-US citizen holding ownership in a US entity. Here are a few of the big ones.

  • Type of Entity

U.S. business entities are generally classified for U.S. tax purposes as corporations, partnerships, or disregarded entities. Corporations are subject to income taxes themselves (the dreaded “double taxation”). The income of partnerships and disregarded entities (“pass-thru entities”) is generally taxed directly to the owners of those entities.

  • Income Taxes (Federal & State)

U.S. businesses are generally subject to U.S. federal and state income taxes. Federal corporate income taxes are imposed at graduated rates up to a maximum rate of 35%. State corporate income taxes range from 0% to 12%. State income taxes are generally only due to states in which the entity is doing business. Individual federal income taxes are imposed at graduated rates up to 39.6%, and state rates for individuals range from 0% to 13.3%. Individual income taxes are generally imposed on individuals who own interests in pass-thru entities (such as a Limited Liability Company).

  • Withholding / Branch Profits Taxes

The U.S. imposes a 30% withholding tax on certain types of payments to non-U.S. persons (such as dividends, interest, rents, and royalties) and on the U.S. branch profits of foreign corporations. These 30% taxes are generally a second level of U.S. tax (in addition to income taxes).

  • Estate & Gift Taxes

The U.S. imposes estate and gift taxes on nonresident aliens that own property situated in the U.S. For U.S. estate tax purposes, shares in a U.S. corporation are treated as situated in the U.S. Importantly, the estate tax exemption for nonresident aliens is only $60,000 and there is no gift tax exemption for nonresident aliens. There are far fewer estate and gift tax treaties. However, to the extent they exist, they can reduce U.S. gift and estate taxes.

  • State Sales Taxes

Many U.S. states impose sales taxes on goods sold in their state. The threshold of activity that requires a seller to withhold on sales into a state can be quite low. Each individual state must be analyzed to determine whether sales taxes must be withheld.

  • Treaties

Income tax treaties with the U.S. can reduce or eliminate U.S. withholding taxes. Treaties may also prevent U.S. income taxation altogether if a foreign business does not have a permanent establishment in the U.S. Income tax treaties do not apply to the individual states.

  • International Tax Compliance and Organizational Structures

Along with the complex domestic tax issues, there are often even more complex U.S. international tax issues for both outbound and inbound transactions. In choosing the optimal entity choice, international investors or business owners must always align legal, tax, and accounting structures to avoid adverse consequences of foreign-owned U.S. entities, and U.S. companies must also be cognizant of foreign-owned corporations (CFCs). Proper structuring or organization can also create benefits such as deferral of tax and optimal utilization of foreign tax credits or even avoiding triple taxation in some cases. Some of the more common terms of description for U.S. international tax include: controlled foreign corporations, foreign partnerships, FBAR, FATCA, Passive Foreign Investment Company’s (PFICs), Interest Striping, FIRPTA, and anti-inversion. The common descriptors contain many traps and pitfalls for the unwary. Obtaining the advice of attorneys and well-versed tax advisors in advance will often, if not always, result in more beneficial outcomes and eliminate or minimize adverse consequences.

As you can see, one size does not fit all. Crafting a strategic entity can mean a world of difference as your business begins to take off. With so many considerations, it can be immensely helpful to schedule a consultation with each expert as you plan your US company.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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A Closer Look at Title III Equity Crowdfunding

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With Title III equity crowdfunding finally taking effect this month it’s worthwhile to take a peek into what a startup may face in costs to execute a successful raise. One important thing to keep in mind is that this analysis is based on my exposure to only a limited number of portals. The numbers and… Read More

With Title III equity crowdfunding finally taking effect this month it’s worthwhile to take a peek into what a startup may face in costs to execute a successful raise. One important thing to keep in mind is that this analysis is based on my exposure to only a limited number of portals. The numbers and opinions expressed below should be digested through an upfront admission that my analysis may change as time goes on.

As many analysts surmised, the funding portal will handle the bulk of the legal compliance. A Title III funding portal must be registered with the SEC, and the portal must become a member of the national securities association. Thus, the SEC has effectively made the portal the gate-keeper to the public. This means a lot of the compliance work will be handled by the portal, instead of your company’s attorney and CPA.

Areas where an outside attorney can still be helpful include: corporate cleanup in preparation for the raise, organizing the necessary documents and information to complete the Form C disclosure schedule, educating the client on the communication standards that can be used offline when discussing the deal with a potential investor, and the initial application process to use your chosen portal. Therefore, there is still plenty of opportunity to take advantage of an outside counsel’s knowledge and experience, but many of the compliance matters that would be handled by your attorney will instead be handled by the funding portal.

Speaking of a funding portal, it’s helpful to consider the budget you’ll need to engage with one. Generally, the upfront cost should be around $15,000 to $20,000 and it is broken down with $4-7k for the portals legal compliance team, $4-7k for preparing reviewed financials with the portal’s CPA, and $4-7k to setup escrow and the transfer agent to close the deal. However, it’s important to note that those are just the upfront out of pocket costs. In addition to those fees the funding portal will take anywhere from 3-7% of the cash raised, and 3-7% in equity that mirrors what you’re selling through the Title III raise.

We’re still months, and maybe years, away from understanding how this will all shake out, but as you consider different strategies for raising money, please don’t hesitate to reach out to discuss costs, and other implications by contacting us at info@bendlawoffice.com or (415) 633-6841.

If you’re thinking about raising funds in 2016, I encourage you to check out these posts on our website

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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Private Placement Roadmap

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Private placements are the nation’s most frequently used method for startups and small businesses to raise capital. For smaller businesses, public offerings are not a viable option due to the high expenses and disclosure requirements associated with registration. While the Securities Act of 1933 (Securities Act) generally requires that companies register with the SEC whenever a… Read More

Private placements are the nation’s most frequently used method for startups and small businesses to raise capital. For smaller businesses, public offerings are not a viable option due to the high expenses and disclosure requirements associated with registration. While the Securities Act of 1933 (Securities Act) generally requires that companies register with the SEC whenever a security is sold, some businesses can sell securities under certain exemptions without registering. Securities sold under one or more exemptions are referred to as “private offerings.”

In general, in order to qualify for an exemption, companies must adhere to several restrictions, such as the manner in which the offering is made, who can participate in the offering, verification of investors, and the maximum amount of capital that can be raised. Traditionally, only public offerings allowed the use of general advertising and solicitation to attract investors. However the recent adoption of Rule 506(c) has extended this ability to private offerings as well, so long as specific requirements are met.

This post will broadly explore a roadmap for conducting a private offering with the following steps:

  1. Choosing an exemption,
  2. Finding investors,
  3. Qualifying investors,
  4. Negotiating the terms of the offering,
  5. Preparing private placement and offering documents, and
  6. Closing the deal.

1. Choosing an Exemption

Section 5 of the Securities Act mandates that every time a security is sold (and for avoidance of doubt, a convertible note is considered a security), it must either be registered with the SEC or exempt from registration. In a private offering, a company can obtain its capital needs while avoiding complex registrations and associated costs.

The following descriptions of exemptions are only meant to highlight some key characteristics and not meant to serve as an in-depth overview. Please work with an attorney to consider what exemption is right for you.

i. Regulation D

Regulation D is a “safe harbor” private offering exemption that allows for a limited offer and sale of a company’s securities without registration with the SEC. There are several different types of exemptions under Regulation D that are briefly discussed below.

ii. Rule 504

Rule 504 allows for an unlimited number of investors and a maximum aggregate offering price of $1 million in a 12-month period. Companies are not required to provide disclosure materials about the offering to investors, but it is frequently done as best practice over considerations of fraud and misrepresentation. General advertising and general solicitation may be permitted only if state registration requirements are met. Overall, Rule 504 is used less frequently because of its $1 million cap on the amount of possible capital raised.

ii. Rule 505

Rule 505 provides a $5 million ceiling on the amount of capital that can be raised, but it limits the number of possible accredited investors and only allows up to 35 non-accredited investors. Companies must provide these investors with substantive disclosure documents that include financial statements. Whether an investor is considered an accredited investor will be discussed below.

iii. Rule 506(b)

Rule 506(b) has no limit on the amount of capital that can be raised, but issuers cannot engage in general advertising or general solicitation. The rule allows for an unlimited number of accredited investors, but only up to 35 non-accredited investors, and investors must receive detailed disclosure documents including financial statements. Additionally, companies relying on 506(b) are required to take “reasonable steps” to verify the accredited investor status of investors.

iv. Rule 506(c)

Rule 506(c) for the most part is the same as 506(b) in that it allows for an unlimited amount of capital to be raised and requires certain investors to receive disclosure documents. The key difference is that under Rule 506(c), companies can use general advertising and general solicitation if specific conditions are met, including the issuer taking “reasonable steps” to verify that each person is an accredited investor.

v. Section 4(5)

Section 4(5) differs from Regulation D in that securities can only be offered to accredited investors. Section 4(5) has a maximum aggregate offering price of $5 million. Under this section, companies cannot rely on general advertising or general solicitation to market their securities. This exemption is not used often because it is similar to Rule 505, but lacks Rule 505’s flexibility of being able to offer securities to non-accredited investors.

vi. Rule 147: The Intra-State Offering Exemption


Rule 147 grants an exemption from registration to issuers through an intra-state offering provided the following conditions are met:

  • The company must be organized and doing business within the state
  • Advertising and solicitation methods are allowed only within the state
  • Resales are permitted beginning nine-months after the last sale of securities to in-state residents only.

There is no limit to the amount of securities sold, provided you meet the criteria above.

2. Finding Investors

After choosing a type of offering, companies must obtain investors. Depending on the type of offering, general advertising and general solicitation may be permitted. In order for the marketing of a security to not be considered “general” advertising, there must be a substantive and pre-existing relationship between the company and potential investors. In addition, an unsolicited investor can express interest in buying the security.

If general advertising and general solicitation is not permitted, issuers can establish a pre-existing relationship with investors through intermediaries. One type of intermediary is associated persons, including the companies’ officers, directors, and employees. Further, unregistered finders and registered broker-dealers are third parties that help issuers find investors. Issuers shall require finders and brokers to sign compliance certificates, mandating that they comply with the offering’s conditions and regulations. They should also make sure that finders and brokers have the proper experience and a successful track record.

III. Qualifying Investors

For the exemptions discussed above, some or all of the investors need to be “accredited investors.” An accredited investor is a person who meets one of eight different enumerated definitions. Under these definitions, an accredited investor may be a certain type of business, including a business with assets over a certain amount, or it can be a natural person. Generally, a natural person is an accredited investor if he or she has a net or joint net worth of at least $1 million, or if he or she has income exceeding $200,000 ($300,000 including spousal income) in the past two years, and expects to have the same income in the current year.

For a closer look at whether your prospective investors are accredited, please consult an attorney as there are numerous and nuanced characteristics that meet the definition of accredited investor (including trusts and other small businesses). To help document the company’s attempt to vet investors, it’s advisable to request that prospective investors complete a purchaser suitability questionnaire, which will allow the placement agent and counsel determine whether the investor meets the suitability requirements of a specific exemption.

IV. Negotiating the Terms of the Offer

Negotiating the terms of the offering should include a discussion of various important terms. An experienced attorney can help walk you through the important details.

Generally, terms to discuss include type of security, price of security, voting rights, registration rights, right to designate board members, protective provisions which include a vote on key business decisions, information rights, conversion rights, anti-dilution protections, and liquidation preference.

Furthermore, you should consider tax implications when it comes to debt to equity ratios, how the current round will impact your common stock price, your anticipated burn rate, and when you forecast additional capital needs.

V. Preparing Private Placement and Offering Documents

Issuers offering securities to non-accredited investors must provide them with full, fair, and complete disclosure of material facts about the issuer, its board of directors and officers, and its finances, including audited financials. Even when not required, to meet investors expectations and to protect against anti-fraud provisions of the SEC, it’s advisable to provide some form of a disclosure document. Completing a Private Placement Memorandum (PPM) is aimed at fulfilling these requirements. You’ll likely work with your CPA and attorney to complete the PPM to ensure the proper narrative format and that information is presented to comply with Rule 502(b)(2).

Only after the prospective investors have been qualified, as discussed above, should the issuer provide the PPM and deal terms to the prospective investor. A subscription or investment agreement can be provided to the investor with detailed representations and supporting documents showing that reasonable steps have been taken to verify the accredited investor status.

VI. Closing the Offering

If the issuer accepts the investor’s subscription/investment documents, an agreement is formed and the offer is closed. If relying on a private offering under Regulation D, once the offering is closed a Form D must be filed with the SEC and at the state level within 15 days. When subscription funds are accepted into escrow, the 15 days filing requirement is triggered even though the security hasn’t technically been sold. Additional state and federal registration may be required depending on the type of exemption you are relying on, and preparing a strategy with an experienced attorney is crucial to maintaining the validity of your private placement.

As this roadmap reveals, the process of providing a private offering is still extensive and detailed, but with the help of an experienced attorney, small businesses can take advantage of its less stringent requirements than those required by public offerings. To set up a consultation to discuss your fundraising efforts in greater detail, please contact us at info@bendlawoffice.com, or at (415) 633-6841.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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Incorporating Socially-Conscious Purposes Into a New Business

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Increasingly, new business owners and entrepreneurs are envisioning companies that value social and environmental issues and want to make these values part of the company culture, brand, and purpose. Yet while a corporation can make efforts to create products, market itself, and accept funding in ways that are aligned with certain values, the directors in… Read More

Increasingly, new business owners and entrepreneurs are envisioning companies that value social and environmental issues and want to make these values part of the company culture, brand, and purpose. Yet while a corporation can make efforts to create products, market itself, and accept funding in ways that are aligned with certain values, the directors in any corporation have a fiduciary duty to act in the best interests of the corporation. Traditionally “the best interests of the corporation” have been to generate profits for the shareholders, and decisions made for any other reason could subject the directors to a shareholder lawsuit.

Luckily, different types of entities exist in California that give directors the ability to consider other interests. More than just sounding good, choosing a company type with a socially-conscious purpose gives directors more flexibility in how they structure, run, and even sell the company, as traditionally without such a purpose the board must approve a sale to the highest bidder without consideration of other factors.

The entities listed below provide a survey of the various types of California corporations. The General Stock Corporation is the most well-known entity and provided for comparison, and the other entities are for founders who would like to incorporate a social, charitable, environmental, or other non-monetary purpose into their company activities.

General Stock Corporation:

A for-profit entity with this as its only purpose.

  • Articles of Incorporation: purpose of the corporation is “any lawful activity”;
  • Interests that the directors must consider when making decisions: the interests of shareholders (paying dividends) take top and sole priority;
  • Reporting requirements: annual Board and shareholder meetings are required but do not need to be reported anywhere;
  • Best used: when a company wants to take on investors and not be required to consider any objectives besides profit generation.

Benefit Corporation:

A for-profit entity that allows founders to pursue social and environmental goals alongside the traditional objective of maximizing profits (see a more detailed description of benefit corporations here).

  • Articles of Incorporation: one of the purposes of the corporation must be creating a general public benefit, plus it may also have a specific public benefit stated;
  • Interests that the directors must consider: the interests of shareholders are considered along with the interests of other stakeholders, such as employees, customers, the community, the environment, and the ability to accomplish the corporation’s public benefit purposes, and all must be considered;
  • Reporting requirements: required to produce and distribute an annual “Benefit Report” that outlines the corporation’s performance and includes an assessment of the company’s overall environmental and social performance using an independent third-party standard;
  • Best used: when a company wants social and environmental goals to play a role in its business strategy, while also taking on investment money.

Bonus: Become a certified B-Corp

“B Corp is to business what Fair Trade certification is to coffee or USDA Organic certification is to milk.” – B Labs

Corporations that include the necessary provisions in their Articles, recruit directors who are motivated to fulfill their fiduciary duties, and follow the reporting requirements can be successful benefit corporations. If you are interested in taking the commitment one step further and becoming part of a global network of like-minded businesses, a benefit corporation can become a certified B Corp by meeting performance requirements monitored by B Lab, “a nonprofit organization dedicated to using the power of business to solve social and environmental problems.” Hundreds of companies are B Corp certified, including household names such as Patagonia, Ben & Jerrys, Etsy, Dansko, and Fetzer Vineyards (and Bend Law Group!).

Social Purpose Corporation (formerly known as a “flexible purpose corporation”):

A for-profit entity in which directors are required to consider specific socially responsible purposes, in addition to shareholder interests

  • Articles of Incorporation: must set out a special purpose(s) that can be a charitable or public purpose activity, or promoting positive effects, or minimizing adverse effects, of the corporation’s activities upon the corporation’s employees, suppliers, customers, and creditors, the community and society, and/or the environment, provided that the corporation considers these purposes in addition to the financial interests of the shareholders;
  • Interests that the directors must consider: the interests of the shareholders and the special purposes of the corporation;
  • Reporting requirements: an annual report sent to shareholders containing a management discussion and analysis related to the corporation’s special purpose and corporate financial statements, plus a “current report” must be sent to shareholders when certain financial decisions are made related to the special purpose;
  • Best used: when a company wants to take on investment and work for shareholder profits in addition to a specific purpose, but in a more limited way than the many interests considered in a benefit corporation.

Non-Profit Corporation: 

A not-for-profit corporation organized for a charitable or public purpose that is designed to benefit the public and typically will apply for tax-exempt status (see a more detailed post, including the differences between non-profit corporation and tax-exempt status, here)

  • Articles of Incorporation: must include the specific purpose(s) of the corporation using language that complies with the IRS’s definition of tax-exempt purposes, plus language related to how funds will be distributed if the corporation dissolves;
  • Interests that the directors must consider: the specific purposes of the corporation and ensuring that the corporation is not engaging in any non-exempt activities or benefiting any private individuals;
  • Reporting requirements: IRS Form 990 or its equivalent and an Annual Report at least sent to the corporation’s directors, plus detailed records of all meetings, compensation, and decisions must be kept in case of an audit, which are more common for tax-exempt organizations;
  • Best used: when the company is relying on donors and grants that require tax-exempt status.

Bonus: Fiscal Sponsorship

Fiscal sponsorships are not an entity type, but rather a legal arrangement that allows groups or companies that do not have IRS tax-exempt status to indirectly receive donations from foundations or others who will only donate to 501(c)(3) organization. There are two types of fiscal sponsorships: 1) Comprehensive, wherein the outside group’s project becomes an internal program of the sponsor, such that the sponsor takes on all liability and legal requirements while the outside group may volunteer or become employees of the sponsor; and 2) Pre-Approved Grants, through which the outside group remains a separate entity running the project, and then receives all funds from the project as grants from the sponsor.

Fiscal sponsors can be an organization that does similar work and therefore can easily integrate an outside group’s project into its operations, or there are organizations that operate largely to provide fiscal sponsorship services, such as Netroots Foundation. Regardless of the type of fiscal sponsor, it is critical that a well-drafted fiscal sponsorship contract is in place before the project begins for the benefit of the sponsor and the outside group.

If you are interested in running a company that has socially conscious goals, it is important to consider the many options available to ensure that your goals and capacity are in line with the abilities and requirements of your entity. Bend Law Group can assist with deciding which entity type is best for your new business, forming your desired entity, applying for federal tax-exempt status, drafting and reviewing fiscal sponsorship contracts, and advising you on annual reporting requirements. If you would like to talk more about any of these issues, please give us a call at (415) 633-6841 or send us an e-mail at info@bendlawoffice.com.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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Updating the Government When You Buy or Sell a Business in CA

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When buying or selling a business in California, you need to update all relevant governments agencies. You should consult with your attorney as each business has different requirements, but here is a list of agencies that most often need to be updated. 1. The California Employment Development Office If the business runs payroll in California, you… Read More

When buying or selling a business in California, you need to update all relevant governments agencies. You should consult with your attorney as each business has different requirements, but here is a list of agencies that most often need to be updated.

1. The California Employment Development Office

If the business runs payroll in California, you will need to update the Employment Development Office (EDD).

You can do so by submitting the Notification of Change of Employer Account Information (Form DE 24).

2.  Seller’s Permit

If the business collects sales tax, you will need to close out the current seller’s permit account and open up a new account.

To close out the current permit, you will need to file Form CDTFA-65.

To open up a new account, you will go to the Board Of Equalization’s website, which you can access here.

If you have any trouble, you can call the Board Of Equalization at 1-800-400-7115 and they will walk you through the process step-by-step.

3. IRS

If you are selling the equity in a legal entity, to update the IRS of the responsible party you will need to write a letter. The letter must include: (i) the name and social security number of the person that will be the new responsible party, (ii) the business name, (iii) the company’s federal employer identification number (EIN), and (iv) the company’s the mailing address.

If the entity’s principal business is located in California, you can mail the letter to:

Internal Revenue Service
M/S 6273
Ogden, UT 84201

Or you can fax it to (801) 620-7116.

4.  California Secretary Of State’s Office

You will need to file an updated Statement Of Information with the California Secretary Of State’s Office. You can do so here.

5. City Business Registration Certificate

You will have to update the business registration with the city.

Buying or selling a company has many steps and we highly recommend that you speak with an attorney before starting the process.  If you would like to talk more about selling or buying a business, please give us a call at (415) 633-6841 or send us an e-mail at info@bendlawoffice.com.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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