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Cannabis Licenses and Due Process Protection

Cannabis Licenses and Due Process Protection

Cannabis Licenses and Due Process Protection

Cannabis Licensing and Due Process

Cannabis Licenses and Due Process Protection

A cannabis license is a legal document that allows the licensee to engage in business in the legal cannabis industry of the state for which the license was granted.

Nowadays, such licenses are a highly valued commodity, with application fees costing tens of thousands of dollars, and in some cases, being able to sell them for millions of dollars.

In this sense, it is important to make a question about the type of rights that people have over these licenses. Specifically, the aim of this post is to answer whether a cannabis license can be considered a property interest, and thus, whether it can receive procedural due process protection.

What can be defined as property interest.

Property interest can be defined as the extent of a person’s or entity’s rights in property. The word “property” signifies a legal relationship between a person and an object.

To put it in even simpler terms, property interest is the right that a person has to control, sell, and/or transfer a property. 

Further, according to the U.S. Supreme Court, property interests are “created and defined by existing rules or understandings that stem from an independent source such as state law rules or understandings that secure certain benefits and support claims of entitlement to those benefits.” A constitutionally protected property interest must be an interest that is securely held, so that it is more than a mere expectation of an interest.

Attributes of property

Generally speaking, we can narrow down the attributes of property to three:

  1. Exclusive rights to determine the use of a resource.
  2. Exclusive rights to the services of the resource.
  3. Rights to exchange the resource at mutually agreeable terms.

However, determining whether a cannabis license can be considered property can be difficult. Like a tobacco or a liquor license, a cannabis license can’t be considered property right away, like a car or a house would be.

And, as mentioned above, property interests are defined by “existing rules or understandings that stem from an independent source such as state law rules or understandings that secure certain benefits and support claims of entitlement to those benefits.”

In other words, whether a license is a property interest or not, will depend solely on the characteristics of the interest granted by a license in a particular state. 

For this, we will focus on a slightly different set of attributes using the same model other authors have used to characterize an analogous commodity: liquor licenses. In this sense, liquor license has four attributes which delineate its property characteristics:

  1. Right to obtain
  2. Right to alienate
  3. Right to renew
  4. State’s right to revoke

These attributes will guide us on whether a cannabis license constitutes a property interest for purposes of procedural due process or takings challenges.

The right to obtain

The substantive conditions established in a state’s statutory framework for issuing licenses give birth to the right to obtain them. A license is not a property interest when a legislation lacks substantive criteria for determining when a license must be given. When the legislative framework establishes specific standards for choosing whether to issue a license, leaving the issuing authority with limited discretion, it establishes a constitutionally protected property interest.

When it comes to awarding licenses, states typically adopt one of four methods:

  1. The state issues a license to any applicant who meets the statutory qualifications. The statute clearly specifies that the license must be granted whenever the qualifications are met. In this case, the applicant’s expectations of receiving a license may create property interest. However, the mere application for a license does not create a property interest if the statute specifies that the license may be denied if certain qualifications are not met.
  2. The state has discretion determining how many licenses should be issued. Due to the limitations on the issuance, the licenses under this scheme have more property characteristics.
  3. The state limits the number of new licenses to a fixed statutory quantity. The numerical limits placed, tend to have more property characteristics than the two mentioned before.
  4. The state operates and/or does not license the private sector. 

The right to alienate

This right is manifested when a state licensing legislation enables licensees to transfer licenses, and license holders can enter the market and earn fair market value for the property interest.

Federal courts have looked at the transferability and market value of licenses in determining whether state-created interests constitute property to which a federal tax lien attaches:

“[A] liquor license will constitute property, within the meaning of federal law [for I.R.S. purposes], if the license has beneficial value for its holder, and is sufficiently transferable.”

A transferable license possesses “intrinsic worth that is subject to bargaining and sale in the marketplace.” As a result, federal courts have considered transferable liquor licenses to be personal property in the past.

Different jurisdictions interpret the element of alienability and the related property interest in the license differently. This variation exists because a license might be deemed an asset for a variety of reasons. Some courts, for example, consider the license as a privilege in cases concerning the licensee’s connection with the government and as property in cases involving the licensee’s relationship with other parties such as creditors or heirs.

However, the monetary value created when a state allows the transfer of a license for compensation does not necessarily justify treating the license as property for all purposes.

The right to renew

The third attribute, the right to renew, may also create a property interest in the license.

The renewal process varies by state, and most licenses are only good for one year. Some states enable licensees to renew without submitting a formal reapplication.

These types of legislation provide strict standards for renewal and allow for renewal rejection only for “good cause.” In these jurisdictions, the licensee comes to assume that his or her license will be renewed automatically. The perpetual renewal procedures allow for shortened and accelerated review processes, as opposed to the strict procedures necessary for initial license granting.

In this sense, a perpetual license may be characterized as property due to the licensee’s entitlement to renewal.

Other states have a renewal system that requires holders to reapply for renewal each year. These statutes forbid the licensee from expecting automatic renewal. As a result, the licensee is denied the claim of entitlement required to elevate the license to the level of constitutionally protected property.

In jurisdictions that use a provisional renewal process, license holders have no reasonable expectation that their license would be recognized as property.

The state’s right to revoke

The fourth and final characteristic, the state’s authority to revoke, is derived from the limitations imposed by legislation on government activities in revocation proceedings.

Some states apply different due process standards for the issuance procedure and the revocation procedure. To cancel or suspend a license in Illinois, for example, due process requirements such as proper notice and an opportunity to be heard are required.

However, in this situation, no property right exists prior to the issue of a license in Illinois, and the application procedure should not be subject to any procedural due process protection.

In contrast, several jurisdictions apply the same due process criteria to both the issuing and revocation procedures. This amount of procedural protection afforded to the licensee during a revocation hearing is a strong indicator of whether the state views the interest as a vested property right or just an expectation of ongoing entitlement.

Although none of the aforementioned characteristics are required for a court to conclude that the license is a property right, their presence helps courts to conclude that the licensee’s interest in the license has reached to the level of a constitutionally protected property interest. These qualities may also have an impact on the due process protection necessary for any state action. The level of constitutional protection afforded to the applicant or licensee grows as the degree of property-like features increases.

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Types of due process

Due process under the Fifth and Fourteenth Amendments can be broken down into two categories: procedural due process and substantive due process. Procedural due process, based on principles of fundamental fairness, addresses which legal procedures are required to be followed in state proceedings.

Relevant issues, as discussed in detail below, include notice, opportunity for hearing, confrontation and cross-examination, discovery, basis of decision, and availability of counsel.

Substantive due process, although also based on principles of fundamental fairness, is used to evaluate whether a law can be applied by states at all, regardless of the procedure followed.

Substantive due process has generally dealt with specific subject areas, such as liberty of contract or privacy, and over time has alternately emphasized the importance of economic and noneconomic matters. In theory, the issues of procedural and substantive due process are closely related. In reality, substantive due process has had greater political import, as significant portions of a state legislature’s substantive jurisdiction can be restricted by its application.

Procedural Due Process Protection

According to the Fourteenth Amendment, no state may “deprive any person of life, liberty, or property without due process of law.” The Due Process Clause entails procedural due process, which ensures proper notice, hearing, and an unbiased decision maker before the government deprives a person of certain protected interests.

Because licensing is regulated under statutory or constitutional provisions, a state or local agency’s refusal to issue licenses, or decisions to revoke or to transfer a license, is a state action which may trigger a claim that the licensee has been deprived of procedural due process.

However, due process protection against state action requires that the action impair a constitutionally protected “liberty” or “property” interest.

For those states which have not yet determined the level of due process required for licenses, an examination of the four property attributes discussed above will help determine the due process protection the state should provide the licensee, or potential licensee, either by judicial decision or legislative action.

There are three circumstances we need to have in mind regarding the extent of the procedural due process protection, namely:

1. Procedural Due Process Required Because the License is a Property Interest

If the licenses are considered property, then the states must offer complete constitutional protection. In this sense, a pre-deprivation hearing and chance to be heard must be provided whenever a licensee’s interest in the license is jeopardized.

To establish whether the license is a property interest, we must consider the four property interest attributes listed above. 

2. Procedural Due Process Required by Type of Licensing Action at Issue and By Legislative Mandate

The majority of states give some due process protection by enacting legislation outlining the procedures that licensees must follow and distinguishing between various licensing acts such as issuance, renewal, and revocation.

Licenses may not reach to the degree of property necessary for the purposes of due process rights to be given. Many jurisdictions, however, provide limited due process protection for some license acts, such as renewal or revocation, by legislation or decision.

In the liquor industry, Georgia and Alabama are examples of states that provide due process protection by legislation. The legislature in Georgia established due process rules for the granting, rejection, suspension, or revocation of a liquor license, but declined to acknowledge the existence of a property interest in the license.

States may also grant limited due process protection through judicial decision. This protection may extend to some, but not all licensing actions.

A liquor license, for example, is not considered property under New Jersey law. This legislative declaration is supported by New Jersey case law, which holds that a liquor license is neither a contract or a property right, but rather a licence or privilege to engage in an otherwise illegal profession. Nonetheless, due process has been required in judicial judgments addressing federal matters. 

3. Procedural Due Process Not Required Because License is Not a Property Interest

When a governmental action impacts a licensing interest, most states require licensees to be given some due process consideration. However, a state that refuses to offer such constitutional protection typically will do so because it refuses to recognize the license as a constitutionally protected property interest for the activity in question.

Determining when procedural due process rights are violated

Procedural due process is breached when a legislative procedure describing the process necessary for a licensing action is not followed, or when a court decides that appropriate notice and hearing have not been provided for an action affecting a protected property interest. Challenges to referendum procedures or local-option elections may likewise violate due process unless the court decides that the action is legislative in nature.

To determine when a procedural due process right has been violated, a court must first evaluate whether the license is a constitutionally protected liberty or property interest under the Fourteenth Amendment, and then assess whether the licensees have received the appropriate level of procedural due process.

Substantive Due Process

The presence of a property right is not required for substantive due process or equal protection. As a result, deciding whether a license is property is not required for assessing constitutional protection under these principles.

As applied to state or municipal regulatory activities, substantive due process guards against state action that is “arbitrary and unreasonable or without proper relation to the legitimate legislative purpose.” There must be a real and significant link between the rules imposed and the prevention of harm to the public’s moral, social, or economic well being.

In other terms: substantive due process is the notion that due process not only protects certain legal procedures, but also protects certain rights unrelated to procedure.

In this case, there are two major things you must look for: 

  1. Did the government pass legislation?
  2. Does that legislation ban rights previously enjoyed by citizens?

If the answer to both is “yes”, we have a substantive due process problem. The resolution of that problem is that no law can be arbitrary. Any law that offends substantive due process must be analyzed by either:

  1. Strict scrutiny
  2. Rational basis test

Choosing which one to apply is based upon the nature of the right. If the right is a fundamental right, you must apply strict scrutiny, any other rights will be analyzed with the rational basis test.

In substantive due process actions, once the plaintiff proves that there is a law that is banning their rights, it is the government’s burden to prove that, if in fact it is interfering with a right, the law is necessary to achieve a compelling government interest.

Main difference between substantive and procedural due process

Substantive due process asks the question of whether the government’s deprivation of a person’s life, liberty or property is justified by a sufficient purpose, while procedural due process asks whether the government has followed the proper procedures when it takes away life, liberty, or property.

For advice on how you can protect your cannabis license, feel free to contact us, and also, visit our blog, Cannabis Industry Lawyer.

RELATED: What are valuation caps?

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What are valuation caps?

What are valuation caps?

What are valuation caps?

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 for valuation caps

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.

RELATED: How to add a new member to an LLC

Free Strategy Session?

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

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...

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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...

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Corporate 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

Ohio Cannabis Lawyer

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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
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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.

How to add a new member to an LLC

How to add a new member to an LLC

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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.
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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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  3. Shareholder litigation
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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.

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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. 

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...

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

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.

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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.

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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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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

 

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.

 

How to add a new member to an LLC

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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...

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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

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