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What are valuation caps?

What are valuation caps?

What is valuation cap

 

Valuation Caps

A valuation cap is a term of a convertible note or a SAFE. It is also a great way to attract investors to any startup, providing them with an incentive to invest.

Starting a successful financing round for your business will expose you to a slew of new terms. It is essential that you grasp these terms and what they represent to secure finance on favorable terms for your company.

If you’re thinking about obtaining financing for your startup or firm, you’ve probably heard the term “convertible notes,” “SAFEs,” or “value cap” before. Here’s an explanation of what these phrases imply and how they relate to the financing process.

Relevant definitions

Convertible Note

A convertible note is a loan made to your startup or firm by an investor. It is essentially an investment vehicle that is frequently utilized by seed investors who want to delay setting a value for a business until a later round of funding or a milestone.

They are structured as loans with the goal of being converted to equity. At a certain milestone -generally the value of a later financing round- the existing loan balance is automatically converted to stock.

SAFE

A SAFE -simple agreement for future equity- is a financial contract that a business can utilize to acquire capital during its initial fundraising rounds. Some see the instrument as a more founder-friendly alternative to convertible notes.

A SAFE is designed as an investment contract between a startup and an investor that grants the investor the right to obtain ownership in the firm in the case of specified triggering events, such as further equity funding or the company’s sale.

What is a Valuation Cap?

The definitions mentioned above are useful because valuation caps depend on SAFE or convertible note holders to exist. A valuation cap provides SAFE or convertible note holders an opportunity to convert their investment into equity at the lower end of the valuation cap, or the price in subsequent funding rounds.

Simply put, a valuation cap assures that an investor’s investment to a startup or firm in the form of a SAFE or convertible note gets converted into stock at a predetermined maximum price. It is crucial to note that this maximum price is restricted — even if the value of a firm in succeeding rounds exceeds the amount stated in the valuation cap.

Let’s assume a firm engages into a SAFE or offers convertible notes to an investor with a $1 million valuation cap. If the company’s valuation reaches $2 million in the next fundraising round, the investor’s SAFE or convertible note will convert into equity at the valuation cap price of $1 million.

If there’s a $1 million valuation cap, and the next round the company it is decided that the company is worth $2 million dollars, and pay $1/share, your note will convert into equity as if the price had been $1 million.

So, in this case, if you divide $1 million by $2 million, you will get an effective price of $0.50/share. That means that you would get twice as many shares as the investors after the company’s valuation for the same price.

Benefits of Valuation Caps

Valuation caps incentivize people to invest early in potential businesses. As mentioned above, if the valuation cap, for example, is half the valuation of a startup or firm at the time of the next fundraising round, the investor will receive twice the amount of stock in return for their contribution.

A lower valuation cap, on the other hand, will offer an investor with a potentially larger equity share in the next fundraising round. A valuation cap also safeguards investors from excessively low equity conversion percentages in succeeding valuation rounds.

How to add a member to an LLC

Generally speaking, to add a new member to any LLC, you must first follow the operating agreement or the state law regarding LLCs. Though there are some additional things to take into consideration.

Most operating agreements lay out how to add a new partner on their operating agreement. However, if your LLC doesn’t have an operating agreement, you would need to follow your state’s laws concerning LLCs.

The process for how to add an LLC member involves amending the LLC’s operating agreement that brings in the new member. Current LLC members must then vote on the amendment for it to pass—and most states, as well as many LLC operating agreements, require unanimous approval. In this sense, aside from the partner’s name, you should also include their financial contribution, if any, and the new member’s share of interest in the company.

Review Your Operating Agreement

The operating agreement that governs your LLC should lay out the process of adding a new partner, including how the members vote on the issue. If it does include this information, following the process is important, as it shows the independence of your organization and its willingness to abide by its own rules. If your operating agreement does not include this process, it may be a good idea to have an attorney draft one for you. If you would rather do this yourself, many states have forms that can be tailored to the needs of your LLC.

The rule in most states is that when a new member is considered for addition, and no operating agreement exists on how to accomplish this, the agreement of all existing LLC members is needed. Any new member will automatically become a partner equal to the current members. However, adopting an operating agreement can change such rules, allowing new members to be let in by a majority vote, with their share being less than that of the more senior members.

Remember, an LLC is a distinct business entity that protects its owners from personal liability. Following formal procedures and keeping good records helps to maintain that protection and to avoid future disputes among the owners.

Decide the Specifics

After the process for bringing on a new partner is laid out, the exact details of the arrangement should be determined. In ownership structure, LLCs have almost limitless flexibility. For instance, one could own a percentage of a business that differed from his profit percentage. Ownership percentages should be discussed with current members of the LLC and the potential member to make sure that all are in agreement. Unless state default rules apply because there is no operating agreement, each member’s percentage of ownership need not correspond with the percentage of capital they invest in the company.

Once this is agreed upon, the new member’s capital contribution should be collected, then the interest the new partner will own in the company and how much this will cost should be decided. In an LLC, all members need to have a capital account representing their equity contribution to the company in the form of service, property, or money.

Vote on an Amendment to Add an Owner to the LLC

Once a decision has been reached regarding the percentage of the new member’s share, an amendment to bring the oncoming member into the LLC should be prepared for addition to the operating agreement. On this amendment, there should be listed the new partner’s name, percentage of stake in the company, capital contribution, and percentage of losses and profits she will be allocated. Once this is done, a vote should be held concerning the amendment in accordance with the process in the operating agreement.

In voting on a new partner, one should remember that other partners cannot be forced unilaterally to dilute their own shares by bringing on a new member — the agreement must be mutual, and the vote must follow the rules of your operating agreement. If there is no agreement, then the vote has to comply with your state’s LLC Act, which usually demands a unanimous consensus.

However, this vote is conducted, it should be documented in the LLC’s minutes or recorded in a resolution, and all members of the LLC (along with the newest one) should sign the amendment. This document should also state:

  • The voting rights,
  • managerial responsibilities,
  • and ownership percentage

of each member, and it should be kept in your place of business along with your other business documents.

Amend the Articles of Organization, If Necessary

When your LLC was formed, you were required to submit articles of organization to the state. When you add a new member, certain states will require you to submit a form amending your articles, while others do not. Such state requirements can be checked through the agency that handles business filings, which is usually the secretary of state.

One should also be aware of any deadlines if an amendment is necessary. Additionally, if your business management structure is being changed from a manager-managed LLC to a member-managed LLC or vice versa, you will need to amend the articles of organization, as well.

File Required Tax Forms

Although having a single-member LLC allows you to use your Social Security number for your federal tax identification number, you will be required to get a federal Employer Identification Number (EIN) when you change to a multimember LLC. You can get this by completing a free form on the IRS website, and it will act as your LLC’s tax number for both state and federal filing.

Generally, if your LLC’s structure or ownership changes, you will need to get a new EIN; however, if you are adding a new partner and already are a multimember LLC, you most likely will not need to change your EIN. If in the past, your LLC was classified for tax purposes as a partnership or sole proprietorship, additional forms will need to be filed with the IRS in order to elect corporate status. A tax accountant or lawyer can inform you of the best way to have your LLC taxed.

Check Your State’s LLC Act

If you lack an operating agreement, the state in which you set up your LLC has rules outlining the required steps for bringing in another member, as well as the documents that need to be submitted or amended by law.

Amend Your Operating Agreement

When bringing a new member into your LLC, numerous parts of the operating agreement will need updating. At the least, the sections covering the percentage of shares of each of the company’s members, the dispensation of losses and profits, the member’s capital contributions, and the voting capacity of all the members must be updated. Because an oncoming member will receive a stake of the corporation, the shares of current members’ distributions, losses, and profits will be changed, and any rules in the operating agreement related to the current members’ fiscal interests must be adjusted. 

Submit the Amendments to the Secretary of State

If amending the articles of your organization is deemed necessary, this amendment must be filed with the secretary of state or other state agency that deals with business filings. Because operating agreements do not need to be submitted to the state, the agreement can be amended without any filing being done, although there are some states that do allow you the ability to file your operating agreement. If you do choose this option, your amendment should be filed with it, too.

You should also check in with your secretary of state’s office to see if it is possible for the amendments to be filed online or if paper forms are required. Don’t forget to ask how much you must pay for the filing, although it is usually about $100.

Either the business filings agency in your state or your secretary of state will be able to tell you what the fees are and what they include. Should a certified copy of the filing not be included in the fee, then you also must pay for that in order to obtain a copy for your business records.

File the Entity Classification Election Form With the IRS, If Needed

Bringing a new partner to your LLC can result in the LLC’s classification being changed. If it does, an Entity Classification Election Form must be filed with the IRS. Unless a different election form is made using Form 8832, your LLC will be classified by the IRS in accordance with the default rule.

By default, multimember LLCs are regarded as partnerships for tax purposes, so if you want your LLC to be classified as a corporation, you must file Form 8832. Usually, as long as your LLC has two members prior to a new member being added, the income tax status of the LLC will not change by bringing on a new partner, and there will be no need to contact the IRS. 

Register the Name Change With Federal and State Authorities, If Needed

Sometimes when a new member is added, the company’s name is changed. For instance, let’s say you and a friend ran “Jim and John’s Jukebox, LLC.” Then, a mutual friend named Jake joined the business, and thus you wanted to change the name to “Triple J Jukebox, LLC.” To accomplish this, documents would need to be filed with both the IRS and the secretary of state.

The secretary of state will require the appropriate business name change form to be filled out along with a fee that could be up to $200. The IRS would require notice of the street address where your return was to be filed, with said notice being signed by all business partners involved.

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Stock Warrant Purchase Agreements

Stock Warrant Purchase Agreements

Stock Warrant Purchase Agreements What is a stock warrant? According to Investopedia, warrants are derivatives that give the right -but not the obligation- to buy or sell a security at a certain price before expiration. The price at which the underlying security is...

Virginia Cannabis Lawyer

Virginia Cannabis Lawyer

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Thomas Howard

Thomas Howard

Real Estate Lawyer

Whether this is your first land use issue or most recent, our office has helped people and businesses alike.

Thomas Howard was on the ball and got things done. Easy to work with, communicates very well, and I would recommend him anytime.
R. Martindale

How to add a new member to an LLC

How to add a new member to an LLC

Generally speaking, to add a new member to any LLC, you must first follow the operating agreement or the state law regarding LLCs. Though there are some additional things to take into consideration. Most operating agreements lay out how to add a new partner on their...

Subscription Agreements

Subscription Agreements

A subscription agreement is an investor's request to become a member of a limited partnership (LP). It also serves as a two-way warranty between a corporation and a new shareholder (subscriber). The company intends to sell a specific number of shares at a fixed price...

Stock Warrant Purchase Agreements

Stock Warrant Purchase Agreements

Stock Warrant Purchase Agreements What is a stock warrant? According to Investopedia, warrants are derivatives that give the right -but not the obligation- to buy or sell a security at a certain price before expiration. The price at which the underlying security is...

Virginia Cannabis Lawyer

Virginia Cannabis Lawyer

Virginia Cannabis Lawyer Earlier this year, Virginia voted to legalize adult-use marijuana becoming the first southern state to do so. Under the newest legislation on the matter, home cultivation and personal possession will become legal as of July 2021, but retail...

Ohio Cannabis Lawyer

Ohio Cannabis Lawyer

Ohio Cannabis Lawyer Are you from the buckeye state and want to establish a cannabis business? Having a good cannabis lawyer in Ohio makes the difference between getting a license or not. Even though Ohio’s medical marijuana market had a bumpy start, the market has a...

Michigan Cannabis Lawyer

Michigan Cannabis Lawyer

Michigan Cannabis Lawyer Are you from the great lake state and want to start a cannabis company or need assistance with an existing one? You probably need a Michigan cannabis lawyer. As the cannabis industry gets more recognition and the market expands, recreational...

Need A Business Lawyer?

Call our law offices with your legal questions for help on:

  1. real estate contracts
  2. business contract disputes
  3. Shareholder litigation
  4. cannabis business
  5. fraud actions
  6. mechanic's liens

 

Subscription Agreements

Subscription Agreements

Subscription Agreements

Subscription Agreements

A subscription agreement is an investor’s request to become a member of a limited partnership (LP). It also serves as a two-way warranty between a corporation and a new shareholder (subscriber). The company intends to sell a specific number of shares at a fixed price in exchange for the subscriber’s promise to buy the shares at the same price.

How Subscription Agreements Are Regulated

Subscription agreements are generally covered by SEC Rules 506(b) and 506(c) of Regulation D. These stipulations define the method of conducting an offering and the amount of material information that companies are required to disclose to investors.

When new limited partners are added to an offering, general partners seek the approval of existing partners before making changes to the subscription agreement. Raising capital through a Reg D investment entails far fewer stringent requirements than a public offering. This allows companies to save time and sell securities that they would not be able to issue otherwise in some cases.

Subscription Agreements With Private Placements

When a company wishes to raise capital, it will often issue shares of stock for purchase by either the general public or through a private placement. The primary disclosure form for potential general public investors is a prospectus. The prospectus is a disclosure document listing information about the business and its underlying security.

A private placement is a sale of stock to a limited number of accredited investors who meet specific criteria. The criteria for accredited status include having a particular level of investment experience, assets, and net worth. Investors will receive a private placement memorandum as an alternative to the prospectus. The memorandum provides a less comprehensive description of the investment.

In many cases, a subscription agreement accompanies the memorandum. Some agreements outline a specific rate of return that will be paid to the investor, such as a particular percentage of company net income or lump sum payments.

Also, the agreement will define the payment dates for these returns. This structure gives priority to the investor, as they earn a rate of return on the investment before company founders or other minority owners.

KEY TAKEAWAYS

  • A subscription agreement is an agreement that defines the terms for a party’s investment into a private placement offering or a limited partnership (LP).
  • Rules for subscription agreements are generally defined in SEC Rule 506(b) and 506(c) of Regulation D.
  • Regulation D lets companies doing specific types of private placements raise capital without needing to register the securities with the SEC.

Free Strategy Session?

For a quick assessment of your needs – let’s talk to discuss how Trusts can help your business.

Stock Warrant Purchase Agreements

Stock Warrant Purchase Agreements

Stock Warrant Purchase Agreements What is a stock warrant? According to Investopedia, warrants are derivatives that give the right -but not the obligation- to buy or sell a security at a certain price before expiration. The price at which the underlying security is...

Virginia Cannabis Lawyer

Virginia Cannabis Lawyer

Virginia Cannabis Lawyer Earlier this year, Virginia voted to legalize adult-use marijuana becoming the first southern state to do so. Under the newest legislation on the matter, home cultivation and personal possession will become legal as of July 2021, but retail...

Thomas Howard

Thomas Howard

Real Estate Lawyer

Whether this is your first land use issue or most recent, our office has helped people and businesses alike.

Thomas Howard was on the ball and got things done. Easy to work with, communicates very well, and I would recommend him anytime.
R. Martindale

How to add a new member to an LLC

How to add a new member to an LLC

Generally speaking, to add a new member to any LLC, you must first follow the operating agreement or the state law regarding LLCs. Though there are some additional things to take into consideration. Most operating agreements lay out how to add a new partner on their...

Subscription Agreements

Subscription Agreements

A subscription agreement is an investor's request to become a member of a limited partnership (LP). It also serves as a two-way warranty between a corporation and a new shareholder (subscriber). The company intends to sell a specific number of shares at a fixed price...

Stock Warrant Purchase Agreements

Stock Warrant Purchase Agreements

Stock Warrant Purchase Agreements What is a stock warrant? According to Investopedia, warrants are derivatives that give the right -but not the obligation- to buy or sell a security at a certain price before expiration. The price at which the underlying security is...

Virginia Cannabis Lawyer

Virginia Cannabis Lawyer

Virginia Cannabis Lawyer Earlier this year, Virginia voted to legalize adult-use marijuana becoming the first southern state to do so. Under the newest legislation on the matter, home cultivation and personal possession will become legal as of July 2021, but retail...

Ohio Cannabis Lawyer

Ohio Cannabis Lawyer

Ohio Cannabis Lawyer Are you from the buckeye state and want to establish a cannabis business? Having a good cannabis lawyer in Ohio makes the difference between getting a license or not. Even though Ohio’s medical marijuana market had a bumpy start, the market has a...

Michigan Cannabis Lawyer

Michigan Cannabis Lawyer

Michigan Cannabis Lawyer Are you from the great lake state and want to start a cannabis company or need assistance with an existing one? You probably need a Michigan cannabis lawyer. As the cannabis industry gets more recognition and the market expands, recreational...

Need A Business Lawyer?

Call our law offices with your legal questions for help on:

  1. real estate contracts
  2. business contract disputes
  3. Shareholder litigation
  4. cannabis business
  5. fraud actions
  6. mechanic's liens

 

Board Member Agreements & How to Control Corporate Owners

Board Member Agreements & How to Control Corporate Owners

Board Member Agreements & How to Control Corporate Owners

Board Member Agreement

Board Member Agreements & How to control Corporate Owners

In the Cannabis Industry, having the right partners is essential. In practice, a lot of times you will be looking at a “49/51 deal” in which one of the partners has a 51 percent and there’s a second partner –or a number of partners- that share 49 percent ownership of the company.

A partnership is a risky business endeavor because partners can fail to meet their obligations to the organization, which can cause relationships to sour. A partner who owns 51 percent of a company is considered a majority owner. Any other partner in the business is considered a minority owner because he owns less than half of the business.

In this sense, the most important things you’d have to consider about getting into these partnerships can be boiled down to two specific sections: economics and control.

The economics section can be understood, in a fairly simple way, as how much money both parts of the partnership make. Usually –as expected- the person with a higher percentage of ownership will earn more, although this can be leveled through bonuses, salaries, etc. This part is fairly straightforward and will highly depend on the negotiation skills of the partners.

The control section is, on the other hand, fairly complicated. But any business partnership needs to tackle this aspect headon in order to find any success. Long story short: you are never going to have a successful business if you don’t get the nuances of controlling the company right, in a way that works for you.

How can a Board Member Agreement help you gain control over a business

A Board Member Agreement is a written contract setting forth the organization’s expectations for Board members. These contracts help setting clear expectations for the board members.

Common Board Member Agreement expectations include the following:

  • Attend at least X% of board meetings
  • Participate in all Board meetings and Board committee meetings using fair, independent judgment, and due care in conducting the business of organization
  • Recuse yourself from any discussions or votes on matters that amount to a conflict of interest with organization
  • Be loyal to the organization, always exercising Board powers in the primary interest of organization, and not primarily for the interest of yourself or others
  • Keep all organization matters confidential
  • Avoid all political campaigns in the name of organization
  • Be available for phone consultation
  • Serve on at least one organization committee
  • Attend at least one signature organization event
  • If appointed to an officer position, fulfill officer duties as stated in the bylaws.
  • Read financial reports and other corporate documents
  • Read reports on corporate programs, finances, and management
  • Direct all media inquiries to the Executive Director or party designated by the Board on a particular matter
  • Promote the organization to your contacts and on social media
  • Communicate to Chair when if you are no longer able to fulfill these duties. 

Board contracts should be customized to reflect the organization’s core values, address any areas that may cause friction, and memorialize any fundraising expectations.

Naturally the partner with a higher percentage of ownership will be able to -pretty much- run the business anyway they want. They can make decisions including, but not limited to:

  • The direction the business will take.
  • Prices for the company’s products or services.
  • Compensation and benefits payable to employees and owners.Entering into a contract unfavorable to the company but to the advantage of one or more of the owners.
  • Selling the company altogether and at what price.
  • Demoting, firing, or decreasing other owners’ pay.

In this sense, a 51/49 deal comes down to trust. With a 51/49, you really have to trust – particularly if you’re the 49 percent person – that the 51 percent is going to hear you. That’s a massive degree of control for what is ostensibly two peers being in business together. You really have to trust that that person’s going to treat you right and handle things correctly.

It is said that good fences make good neighbors. So do good contracts. The time to work out these details is before problems arise, when everyone still has stars in their eyes and is operating with a high degree of trust and good faith.

Free Strategy Session?

For a quick assessment of your needs – let’s talk to discuss how Trusts can help your business.

What should you include in your Board Member Agreement

Usually, any good Board Member Agreement would include:

  • Services and consideration. In which it would be included the services the 51 percent member (manager) would agree on.
  • Units of the company. How many units have been issued to the manager, what’s the cost of each unit and conditions regarding the possible causes of repurchasing of them.
  • Confidentiality. What constitutes confidential information, limits the manager has using this information and the obligation to return the confidential information the manager possesses to the company in case of termination of the agreement.
  • Ownership of Intangible Property. Determining how the company is going to treat all inventions or creations conceived in whole or in part by the manager that relate in any matter to the business.
  • Return of Company’s Property. The manager’s obligation to return company’s property once its role as board chairman comes to an end.
  • Conflicting Obligations. The obligation of the manager to not engage in any other obligation or agreement that conflicts with the interests of the company.
  • Terms and Termination. Causes for which the board member agreement would terminate.
  • Impossibility of Assignment. Impossibility for the manager of assigning the board member agreement or any other agreement without the consent of the company.

If made right, a good Board Member Agreement would be able to stop any kind of future confrontation thus establishing clear boundaries to corporate owners. If your company doesn’t have a Board Member Agreement yet, you should contact us, so we can work with you and help you figure out what your best options are.  

Free Strategy Session?

For a quick assessment of your needs – let’s talk to discuss how Trusts can help your business. 

Stock Warrant Purchase Agreements

Stock Warrant Purchase Agreements

Stock Warrant Purchase Agreements What is a stock warrant? According to Investopedia, warrants are derivatives that give the right -but not the obligation- to buy or sell a security at a certain price before expiration. The price at which the underlying security is...

Virginia Cannabis Lawyer

Virginia Cannabis Lawyer

Virginia Cannabis Lawyer Earlier this year, Virginia voted to legalize adult-use marijuana becoming the first southern state to do so. Under the newest legislation on the matter, home cultivation and personal possession will become legal as of July 2021, but retail...

Thomas Howard

Thomas Howard

Real Estate Lawyer

Whether this is your first land use issue or most recent, our office has helped people and businesses alike.

Thomas Howard was on the ball and got things done. Easy to work with, communicates very well, and I would recommend him anytime.
R. Martindale

How to add a new member to an LLC

How to add a new member to an LLC

Generally speaking, to add a new member to any LLC, you must first follow the operating agreement or the state law regarding LLCs. Though there are some additional things to take into consideration. Most operating agreements lay out how to add a new partner on their...

Subscription Agreements

Subscription Agreements

A subscription agreement is an investor's request to become a member of a limited partnership (LP). It also serves as a two-way warranty between a corporation and a new shareholder (subscriber). The company intends to sell a specific number of shares at a fixed price...

Stock Warrant Purchase Agreements

Stock Warrant Purchase Agreements

Stock Warrant Purchase Agreements What is a stock warrant? According to Investopedia, warrants are derivatives that give the right -but not the obligation- to buy or sell a security at a certain price before expiration. The price at which the underlying security is...

Virginia Cannabis Lawyer

Virginia Cannabis Lawyer

Virginia Cannabis Lawyer Earlier this year, Virginia voted to legalize adult-use marijuana becoming the first southern state to do so. Under the newest legislation on the matter, home cultivation and personal possession will become legal as of July 2021, but retail...

Ohio Cannabis Lawyer

Ohio Cannabis Lawyer

Ohio Cannabis Lawyer Are you from the buckeye state and want to establish a cannabis business? Having a good cannabis lawyer in Ohio makes the difference between getting a license or not. Even though Ohio’s medical marijuana market had a bumpy start, the market has a...

Michigan Cannabis Lawyer

Michigan Cannabis Lawyer

Michigan Cannabis Lawyer Are you from the great lake state and want to start a cannabis company or need assistance with an existing one? You probably need a Michigan cannabis lawyer. As the cannabis industry gets more recognition and the market expands, recreational...

Need A Business Lawyer?

Call our law offices with your legal questions for help on:

  1. real estate contracts
  2. business contract disputes
  3. Shareholder litigation
  4. cannabis business
  5. fraud actions
  6. mechanic's liens

 

Business Succession Planning with Trusts

Business Succession Planning with Trusts

Business Succession Planning with Trusts

Free Strategy Session?

For a quick assessment of your needs – let’s talk to discuss how Trusts can help your business. 

Business Succession Planning with TrustsBusiness Succession Planning with Trusts

Understanding how a trust can help with your business succession is key to assuring your financial stability, both in planned transitions and unplanned transitions of your business. 

You may be looking ahead to retirement and wondering how best to transition out of your business and smoothly turn it over to a successor or want to ensure that at your death your legacy continues.

Start anticipating the future of your business. Here is all the information you need to start planning your business succession with trusts.

What is a Trust

Before understanding how business succession planning with Trusts works, you have to know what a trust is.

A trust is a fiduciary arrangement that allows a third party, called a trust, to hold assets on behalf of one or more beneficiaries.

The terms of a trust decide exactly when and how the assets that have been placed into a trust, which is referred to as “funding the trust”, will pass to the named beneficiary or beneficiaries of the trust.

Parts of the trust:

A trust generally consists of the following:

  • A grantor: The one to create the trust.
  • A trustee, acts as the legal owner of the assets that are placed into the trust. The trustee has other important duties, such as filing taxes for the trust, and distributing the assets of the trust in accordance with the terms of the trust.  You can have more than one person act as trustee, choose your trustee wisely
  • One or more beneficiaries: The person or group of people that the trust is meant to benefit. The beneficiary of the trust does not have to be a person, it can be a business or even a charitable organization.
  • Trust assets: Are what is used to fund the trust, whether it be cash or real estate or anything else of value.
  • Purpose: The intent behind creating it, whether it be tax avoidance, creditor protection, asset management or another purpose.

Free Strategy Session?

For a quick assessment of your needs – let’s talk to discuss how Trusts can help your business. 

Why Do You Need a Trust For Y Business

Without a trust, your business could come to a screeching halt in your absence. You’ve likely poured blood, sweat and tears and a lot of money into creating your successful business. The last thing that you want is for it to fail in your absence.

Let’s look at this scenario:

If you were to pass away from a catastrophic illness, such as cancer, or after a lengthy battle  in the hospital with COVID, money from your business, meaning both liquid assets (such as cash in the business checking account) and non-liquid assets (such as real estate) owned by the business could have to be used to pay your outstanding medical bills. 

Properly protecting business assets in a trust can keep your business from having to satisfy your personal debts as a properly established trust can protect your business assets from creditors.

A trust is an important part of a business succession plan, and its importance should not be overlooked. Trusts have played an important part of business succession planning for years. A trust can provide tax avoidance, protection from creditors, probate avoidance and management of business assets.

Some business owners wish to avoid probate- the process of probate is public record. By establishing a business trust, you can protect your business’ privacy, which could be crucial in some industries.

Related Link: Cannabis Business Plan

Free Strategy Session?

For a quick assessment of your needs – let’s talk to discuss how Trusts can help your business. 

What is a business succession plan

Now that you understand how a trust can protect your business, let’s talk about how a trust can help with your business succession plan.

A business succession plan is just that- A plan, preferably, a written one, that lays out a plan for your business to continue after you retire, or after you sell it to a new owner or business partner, or even after you pass away.

 

Why do you need a Business Succession Planning with Trusts-3business succession plan? 

A well-thought business succession plan can assist in a smooth transition from one business owner to another. A comprehensive business succession plan can help with that smooth transition by minimizing taxes, transition costs and interruptions to the business which could easily lead to lost revenue.

About 40% of businesses end up being run by 2nd generation owners. A business succession plan that includes a trust can help the business stay successful throughout the second, third, fourth or more, generation of owners.

Types of Trusts

  • Revocable trust or 
  • Irrevocable trust. 

A revocable trust will allow you, as grantor, to control the assets that are used to fund the trust. Remember, you have to place some sort of asset into the trust in order to fund the trust. Whether that is deeding a piece of real estate from your name into the trust, depositing cash or investments into an account in the name of the Trust, or even some other type of asset, like a vehicle, you must fund the trust. 

A revocable trust keeps these assets in your control, and you will be able to “dissolve” or end the trust at any time that you desire to. Once you die, a revocable trust will generally become irrevocable. Assets in a revocable trust do avoid probate however, they generally do not avoid taxes nor do they generally provide protection from creditors as these assets are still in your control.

An irrevocable trust is one that once it is established any assets put into the trust will be out of your control and you will not be able to change the terms or dissolve the trust at will.

Assets that have funded an irrevocable trust also avoid probate just as assets used to fund a revocable trust, but by putting your business assets into an irrevocable trust, the trust will be able to avoid taxes at your death, and they will be protected from claims by creditors, creating a better outlook for your business. 

There are many different types of trusts. Some are better for business succession planning than others. You should consult an attorney before deciding what type of trust is right for your situation. Every situation is unique. However, common types of trusts used in business succession planning include:

  • Irrevocable life insurance trust (ILIT)
  • Grantor Retained Annuity Trusts
  • If your business is set up as an S Corp, The Qualified Subchapter S Trust, or “QSST” 
  • Electing Small Business Trust (ESBT).

An ILIT keeps the proceeds from the decedent’s taxable estate while providing liquid assets to the beneficiary of the trust. This cash infusion could be used to continue day to day operations of the business during the transition period from decedent to the new owner. 

A Grantor Retained Annuity Trust is an irrevocable trust that will transfer your business assets upon your death, and this transfer would not be subject to estate taxes. During your lifetime, the assets that have been used to fund this trust will pay you an annuity income. This effectively passes on rapidly growing business assets to your children. The grantor retains control of these assets during the term of the annuity, which is usually 2-5 years. However, if you die during the annuity terms ends, because you retained control over them, the assets are considered part of your estate and subject to taxation. 

A Qualified Subchapter S Trust, or QSST, and is a way to pass ownership of S Corporation Stock. This can allow for the owner of a business to control the business even after death through the directions left for the Trustee. There are several specific requirements in order to establish a QSST. Among those are: 

  • there must only be one beneficiary of this type of trust, 
  • the beneficiary must receive all of the trust income annually
  •  any principal distributed must be distributed to the beneficiary.
  •  A grantor of a QSST should appoint a non-beneficiary trustee for the purposes of making trust distributions.

And the other type of trust that can hold S corporation stock is the Electing Small Business Trust (EBST). An EBST is more flexible than a QSST in that it can have more than one beneficiary, and the trustee has discretion in making distributions.  There are differing tax treatments for QSST and EBST, so consult an attorney when establishing these trusts. 

We hope this Business Succession Planning with Trusts post has helped you to see a few of the varying ways that as a business owner you need a trust as part of your business succession plan. Here at Collateral Base we have an estate planning attorney that is ready to help you plan for the successful transition of your business.

 

 

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  1. real estate contracts
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  3. Shareholder litigation
  4. cannabis business
  5. fraud actions
  6. mechanic's liens

 

When Is An LLC Needed

When Is An LLC Needed

When Is An LLC Needed

Want to Get your LLC Drafted?

When is an llc neededWe want to help you out on your business journey and explain to you when a corporate liability shield, like an LLC or corporation is needed or not.

As small business owners it can be extremely valuable to find guidance in what you should be doing for your business and when.

We are going over when you need to get a liability shield for your business.

There is no requirement that you create an LLC before you go into business, it can be a smart move and highly recommended sometimes but is not necessary to have your business running.

You can just start sending out invoices and creating value from your labor or sales of goods. Start helping people and charge appropriately.

Needing or not to create an LLC will depend on the type of business you own and its structure.

If you are wondering if you should have an LLC for your business and if the benefits will outweigh the cost and hassle of setting one up, this will definitely interest you:

 

Want to Get Your LLC Drafted?

What is an LLC

 

LLC stands for limited liability company. It’s a business structure that provides a business with limited liability. Although the structure is similar to corporations, the LLC is easier to establish and simpler to maintain.

The key aspect of LLCs is that it  provides protection to the LLC owners by limiting the owner’s personal liability

Meaning that debts owed by the business, and other claims, like liens and lawsuits, are limited to the assets of the business itself, and in no case to the owner’s.

Therefore the personal assets of the business owners, under most circumstances, are protected and cannot be pursued.

Be careful, that does not mean owners are protected from negligence or  illegal acts committed in the name of the LLC.

 

What would an LLC do for your business?

 

An LLC gives your business a legal identity on it own. It becomes a separate “person” in the eyes of the law and it can own money, have a bank account, make agreements, buy property, sue and be sued.

Not having an LLC means that you and your business aren’t legally separate, and everything you own is at risk if your business is facing liens lawsuits or others

 

Does My Business Need an LLC?

The first thing you should do to see if it is time to start an LLC is: examine your business. Ask yourself these questions:

 

  • Do you have partners?
  •  Do you have high risk transactions?
  • Do you sell food?
  • How about anything where you have locations that could be sites of slips and falls?

 

If you need to form an LLC yet or not will mostly depend on your liability and taxes.

when is an llc needed

Many businesses are sole proprietors, so they cannot have all the disputes that partnerships can. Therefore, they are less likely to need an LLC until we look at what they are doing and how much they are making.

 

How about your blog that you have monetized with advertisements and merch, or online courses.  Does that business need an LLC?  Not until they are making tens of thousands of dollars a year.

 

In that case the transactions are all at a low price point.  A few dollars for online ads and some sales of merchandise money. There is not much risk there. Someone is not going to have a slip and fall on your website. No one is going to get food poisoning from your online course. There is no liability benefit from splitting the cash flows away from the owner.

 

In this situation, it does not make sense to form an LLC until you get enough money each year to get hit on taxes so much that it makes more sense to become an s-corp so that you can work for yourself and get a paycheck from your own company and earn lower tax on the dividends. But that’s a tax question that can change over time.

 

What if you are the sole proprietor of a bar & restaurant? You need an LLC immediately. You have huge risks. Slip and falls, food poisoning, over serving a customer that gets in a car accident on the way home from your place. An LLC allows the owner to be a legally separate person than the cash flows.

 

How about an independent contractor that does home improvements? Then you want the liability shield because your job to redo a kitchen and bath could be 40 grand or more. You want that to be the company’s problem, not the owners. Large transactional liability is another reason to form the LLC. So if you are in enterprise sales, get an LLC.

 

Finally, partners complicate things far more. When you break up the ownership all sorts of things arise. How do partners exit the business; how do new people get into the business; what duties do the owners have to the business; and much more. Multiple owners of any business, as far as I’m concerned, always should have an LLC.

 

Want to Get Your LLC Drafted?

Key Points to consider when doubting to create or not an LLC

 

  • You need an LLC when you have premises liability, brick and mortar stores.
  • You need an LLC when you have transactional liability. Protect the big fat contract checks.
  • You need an LLC when the tax man says you earn too much as a sole proprietor so get an accountant.
  • You need an LLC when you have partners. Be smart, have an exit plan before you start with any partners.

 

How to Start an LLC 

Now that you know when you need an LLC – let’s talk about how to form one.  Make sure you you follow us for future content! 

Filing with the State

If you are a small business, it would probably make more sense to start your LLC in your home state.

But you should know that there are other states to fill your LLC that may be more favorable  due to beneficial tax laws and business infrastructures. 

If you serve a local demographic you should file in that state, but for cyber or internet type of business the location has no real importance and you could research the state regulations that fit your business model best.

Each State has its own process when it comes to filing the articles of organization for an LLC.

Most of them offer to file online making the process easier, otherwise, you’ll have to fill out the articles of organization by hand and send it to your Secretary of State’s Office.

 

Determining If You Want To Be Manager or Member Managed

There are two forms of management for an LLC, it can be managed by the members or managed by a manager:

manager-managed LLC: Creates a manager role separated from the ownership. The manager has the authority to decide on the day to day operations. But the owners have authority for higher level decisions.

Member-managed LLC: the owner or one of the owners is the manager and handles operations accordingly.

 

Getting a Registered Agent

A Registered Agent is a person that could be a member of the LLC, or a third-party who acts on behalf of the LLC to collect legal notices from the State or other. 

The registered agent needs a physical address in the State in which the company is registered. 

If you do decide to incorporate an LLC in a different state from where you live, you will need to find a Registered Agent that resides in the same state where you incorporated your business. 

 

Drafting an Operating Agreement 

Next step is to draft your LLC Operating Agreement which is intended to be kept for internal record-keeping. This is where the ownership percentage of the company is outlined. Here are a few important things you should include in your LLC Operating Agreement:

  • Names of all Members and all their signatures
  • Members’ Percentage Interests and Capital Contributions
  • Date of Annual Meetings

Once your LLC Operating Agreement is complete, each Member should have a copy.

 

Getting an FEIN Number

A FEIN is a Federal Tax Identification Number, also heard of as an Employer Identification Number (EIN), is issued to companies that do business in the United States. It iis a unique nine-digit ID number, like a security number but for companies. 

  • A FEIN is a way for government entities to identify and track businesses tax and financial activities.
  • A FEIN is required to file tax returns, and to set up accounts to offer benefits to employees

Not every small business needs a FEIN, but the following do:

  • Any business with employees.
  • Any business that operates as a corporation or a partnership.
  • Any business that pays employment, alcohol, tobacco or firearms tax returns.

You can apply for a FEIN

  • By phone.
  • By fax or mail:
  • On the IRS website

Even if your business is not required to have a FEIN, you may decide to get one. There is no charge, and you never know when your business circumstances change.

 

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Whether this is your first land use issue or most recent, our office has helped people and businesses alike.

Thomas Howard was on the ball and got things done. Easy to work with, communicates very well, and I would recommend him anytime.
R. Martindale

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Call our law offices with your legal questions for help on:

  1. real estate contracts
  2. business contract disputes
  3. Shareholder litigation
  4. cannabis business
  5. fraud actions
  6. mechanic's liens

 

How To Stop Check Kiting Scams

How To Stop Check Kiting Scams

How To Stop Check Kiting Scams

How To Stop Check Skitting ScamsCheck kiting is one of the many ways your financial securities can be violated.

 

It constitutes a type of bank fraud very popular in the early 2000’s, that was in its majority shut down by a regulation called check 21 act. 

Even though not as common as it used to be, check kiting is still present in many fraudulent transactions. Here we explain to you everything there is to know about this illegal procedure 

 

Definition of Check Kiting

Check kiting is the fraudulent procedure of deliberately issuing  a check for which there is not sufficient money to pay the stated amount.

The scheme usually involves several checking accounts at different banks. In effect, a bank deposits accessible money into an account while waiting for cash to be processed from an account at another bank when in actuality the other account holds no money.

Check kiting is always intentional. Those engaged in kiting have a detailed understanding of the bank’s timing, and will take advantage of it to withdraw cash just before the bank discovers that there is something wrong,  keeping ahead of the funds-clearing mechanism.

Check kiting schemes have resulted in multi-million dollar losses.

Elements to Check Kiting:

  • Having checking account A, and checking how to stop check skiting scamsaccount B from different banks,
  • Writing a check from checking account A, for which there is not sufficient cash in the payer’s account.
  • Deposit the fraudulent check in checking account B.
  • Withdraw the funds from checking account B.

 

Examples of Suspicious Circumstances That could lead to check kiting

 

This examples have been provided by regulatory agencies to help the identification of suspicious transactions that may indicate check kiting:

  •  Several accounts with similar names, owned or controlled by the same individual
  •  Regular or excessive drawings against uncollected funds
  •  Frequent daily negative ending balances or overdrafts
  •  Deposits of large checks drawn on nonlocal banks or foreign banks
  •  Frequent, large deposits drawn on the same institution
  • A large number of check deposits each day
  • A large proportion of cash in an account that has not yet cleared the paying bank
  • Deposits being made through multiple bank branches
  •  A low average daily balance in relation to deposit activity
  •  A low collected funds balance in relation to the book balance
  •  A volume of activity or large debits and credits inappropriate in relation to the nature of the business

Is check kiting the same as playing the float.

 

You may have heard of the expression playing the float, and don’t worry it’s not the same as check kiting.

Float refers to the amount of time it takes for money to move from one account to another. Meaning, Playing the float is the process of writing a check with no bank balance covering it, expecting the fund to be in the bank when the check clears.

In the past, it was easier to play the float, because the period of time between when a check was written by the payer and when the funds were transferred to the payee was longer. The Check 21 law had the practical effect of shortening that opportunity.

There is a fine line between playing the float and actual check kiting. Check kiting is the illegal act of knowingly writing a check from a bank account without sufficient funds and depositing it into another bank account. While playing the float is taking advantage of the funds-clearing time period to have to receive the sufficient funds to cover the check.

Check kiting is a fraud, playing the float is not. Playing the float doesn’t result in harsh penalties, while check kiting does.

 

Check 21 Act

 

Check 21 law, is a federal law to combat check kiting that became effective on October 28, 2004.

The Check Clearing for the 21st Century Act, or Check 21, is designed to enable banks to handle more checks electronically, instead of moving the original paper checks from the bank where the checks are deposited to the bank that pays them, making check processing faster and waymore efficient.

Check 21 act may seem like a very subtle and expected change, but its consequences are enormous.

It meant that not only could banks exchange the images between themselves, customers could deposit an image instead of a paper check as well.

Since its passing, the services have evolved exponentially, and the necessary computer hardware has improved and become less expensive and more available for all americans.

More importantly, Check 21 has allowed us to receive and have access to our funds sooner.

 

How to prevent Check Kiting

 

The entity harmed by check kiting is mostly the bank that has allowed funds to be withdrawn from the new checking account without first waiting for funds to arrive.

Banks fight  this by not allowing funds to be withdrawn from an account until a certain number of days have passed, by which time the lack of funds in the payer’s account will have been discovered.

But any individual could be subject to check kiting, as well. Here are some tips to prevent becoming a victim of check kiting:

1 . Only accept checks for the exact amount owed to you.

  • If a customer offers you a check for more than the amount they owe, then asks you to give them cash for the difference, and you accept and then the check is returned by the bank, you can become a participant in a check-kiting scheme unintentionally .
  • For online transactions a check kiter might send you payment, then inform you that they “accidentally” overpaid you. They’ll ask for you to pay the difference by wiring transfer or cash.

 

2. Wait until the check clears to refund the overpayment.

  • If someone overpays you with a check and wants a refund, tell them that you’ll gladly do it after the check clears.
  • Refuse to pay any refund until the check no longer says “pending” in your bank account.

 

3. Look into checks that clear your bank account out of sequence.

  • Checks out of sequence might indicate that someone has stolen a checkbook and is using your bank account for a check-kiting scheme.
  • Checks out of sequence could also indicate that someone has ordered checks on the account starting at a different number than the ones you’re currently using.

 

4. Restrict access to company checks if you’re a business owner.

  •  A check kiter can use your company checks for its check-kiting scheme without your knowledge
  • Keep all blank checks in a locked safe with restricted access.

How To Stop Check Skitting ScamsPenalties to Check kiting

Penalties for check kiting always vary depending on the case, but millions of dollars cases can end with sentences of more than 10 years in prison and enormous  fines. Smaller or first-time infractions can result in harsh penalties.

 

Thomas Howard

Thomas Howard

Real Estate Lawyer

Whether this is your first land use issue or most recent, our office has helped people and businesses alike.

Thomas Howard was on the ball and got things done. Easy to work with, communicates very well, and I would recommend him anytime.
R. Martindale

How to add a new member to an LLC

How to add a new member to an LLC

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Stock Warrant Purchase Agreements What is a stock warrant? According to Investopedia, warrants are derivatives that give the right -but not the obligation- to buy or sell a security at a certain price before expiration. The price at which the underlying security is...

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Virginia Cannabis Lawyer Earlier this year, Virginia voted to legalize adult-use marijuana becoming the first southern state to do so. Under the newest legislation on the matter, home cultivation and personal possession will become legal as of July 2021, but retail...

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Ohio Cannabis Lawyer Are you from the buckeye state and want to establish a cannabis business? Having a good cannabis lawyer in Ohio makes the difference between getting a license or not. Even though Ohio’s medical marijuana market had a bumpy start, the market has a...

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Michigan Cannabis Lawyer Are you from the great lake state and want to start a cannabis company or need assistance with an existing one? You probably need a Michigan cannabis lawyer. As the cannabis industry gets more recognition and the market expands, recreational...

Need A Business Lawyer?

Call our law offices with your legal questions for help on:

  1. real estate contracts
  2. business contract disputes
  3. Shareholder litigation
  4. cannabis business
  5. fraud actions
  6. mechanic's liens