The High-touch Legal Services® Blog • For Startup Companies » Startup

How Can I Have Reverse Vesting in an LLC?

Dana — Mon, 16 Jan 2012 16:51:13 +0000

I recently received, via Quora, a private question about setting up an LLC membership interest (rather than shares of a corporation) with reverse vesting (see Rewarding Key Personnel: Restricted Stock or Options?). That question, and my answer, are reproduced below with minor editing.

Q. I am starting a company and forming as an LLC. My co-founder will received a reverse-vested membership percentage. I’ve found plenty of sample restricted stock agreements, but nothing for LLCs and memberships. Do you have any suggestions where I can find a sample agreement?

A. Sorry, I know of no such document. I believe there are two somewhat-related reasons why this is the case:

Reverse vesting is common in a corporation, rare in an LLC.
Whereas corporations have well-defined structures, LLCs can wander far afield in their Operating Agreements, meaning that one cannot expect to find and rely upon supposedly-standard language.

Please pardon my directness: You cannot do this properly on your own. If your objective in choosing an LLC is to save money, given the reverse-vesting requirement you probably will be better off with a corporation.

Dana H. Shultz, Attorney at Law +1 510 547-0545 dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.

Is there Any Reason to Form a General Partnership?

Dana — Sat, 17 Dec 2011 03:34:51 +0000

A short while ago, I answered a Quora question about whether and why a startup might want to form a general partnership. The question and my answer are reproduced, with emphasis added, below.

Q. What are some of the reasons a business might organize itself as a general partnership? Considering all the liability risk that general partners might potentially face, why not organize as a limited liability company? Was there an era when the general partnership was an attractive form and, if so, why?

A. The LLC is a fairly recent invention – ~20-30 years old, depending on the state (assuming you are asking in the U.S.).

Pre-LLC, the attraction of the general partnership was simplicity and lack of formal requirements in comparison to the corporation – though, as you note, at the price of unlimited personal liability.

The LLC was invented to carry through (most of) the simplicity of the partnership, adding the limited liability of a corporation – if you will, a hybrid of the two.

In my practice, I have formed many corporations and LLCs for clients; I have never formed a general partnership.

WSJ: Angel Investors are Getting Harder to Sell

Dana — Thu, 15 Dec 2011 22:18:01 +0000

In an article published today (Chasing the New Angel Investors), the Wall Street Journal discusses why entrepreneurs must work ever-harder to persuade angel investors to invest.

According to the article, although seed and startup angel investment has increased, there are several reasons why that money is more difficult to attract:

Since the recession, many angels have become more demanding, looking for proof of marketplace acceptance rather than a hunch that it exists.
Angel groups, which syndicate deals among their members, have a more-formal review process that may involve discussions by dozens of potential investors.
With less venture capital available, angels are more concerned about whether a company can grow to profitability or a successful exit.

The article’s advice for entrepreneurs: Have something to show, know your business thoroughly, and polish your pitch.

SVASE East Bay Series 11/16/11: What’s Hot – What VCs Like and Why

Dana — Thu, 10 Nov 2011 19:06:49 +0000

The evening of Wednesday, November 16, the Silicon Valley Academy of Startup Entrepreneurs (SVASE) will present “What’s Hot – What VCs Like and Why” as part of its East Bay Series. Here is the event description:

To build a fundable company, you need to know the areas that investors are focusing on. Venture capitalists specialize in identifying important and lucrative opportunities before they become trends. So, what are VCs intrigued by today? Where will their money be invested? What is the effect of recent economic conditions? Learn what you will need to build a company that capitalizes on the latest developments.

Panel members will include:

Brent Ahrens, Canaan Partners
Cindy Padnos, Illuminate Ventures
Randy Hawks, Claremont Creek Ventures

The event will take place at the beautiful Crow Canyon Country Club and will include a tasty buffet dinner.

SVASE East Bay Series 10/19/11: VCs Uncensored

Dana — Fri, 14 Oct 2011 18:50:06 +0000

The evening of Wednesday, October 19, the Silicon Valley Academy of Startup Entrepreneurs (SVASE) will present VCs Uncensored as part of its East Bay Series. Panel members will include:

Carl Showalter, General Partner, Opus Capital
Xander Mahony, Investment Professional, Draper Fisher Jurvetson

Event description:

Hear directly from venture capitalists on what they love, hate and worry about when working with entrepreneurs. Our panel will discuss mistakes they see entrepreneurs make, pitfalls they help companies avoid, and the challenges of rapidly growing a business. They will talk about valuing companies, negotiating deal terms, raising additional rounds, replacing CEOs, and much more. This lively and candid discussion will open your eyes to the world of VCs and will help you better understand and work with them.

The event will take place at the beautiful Crow Canyon Country Club and will include a tasty buffet dinner.

How can I Invest More Money in My Corporation?

Dana — Wed, 12 Oct 2011 02:37:57 +0000

This post is based on a Quora question in which a user who already had invested money in his corporation wanted to know how he can invest an additional amount. My answer, reproduced below almost verbatim, starts by summarizing the steps for an initial equity investment.

Let’s assume you did your startup paperwork properly: The board of directors approved issuing some or all of the corporation’s authorized shares to you in exchange of payment of certain consideration; you deposited that consideration into the corporation’s bank account; the secretary recorded your share ownership on the corporation’s share transfer ledger and issued a share certificate to you.

When you contribute additional funds to the corporation, you probably either:

Will be issued more shares (though, in my experience, this is less likely because founders often issue all of their shares up-front) through a process like that described above, or
Will make a loan of the additional amount to the corporation, in which case you should prepare an appropriate loan agreement and promissory note (if you expect to make additional contributions in the future, it probably makes sense to enter into a revolving loan agreement with a schedule of contributions and repayments that is updated from time to time).

Photo credit: Arjun Kartha via stock.xchng

WSJ: Rent a Desk, Rather than an Office

Dana — Wed, 05 Oct 2011 14:32:22 +0000

In an article yesterday (Can’t Afford an Office? Rent a Desk for $275), the Wall Street Journal observed that use of shared workspaces – renting a desk in an open space, rather than renting an office – is increasing throughout the United States.

Such resources have been used for many years by technology startups here in the San Francisco Bay Area. The article specifically cited Plug and Play Tech Center in Sunnyvale (which is exploring expansion to other cities).

The major appeal is the lower cost of renting a desk – either a specific one, or whichever happens to be available when you need it – rather than an office. But there also is the side benefit of being near many other small companies that can be potentially valuable business contacts.

The increasing demand for shared workspaces means that, in the right areas, they can be good for landlords, too. According to the article, in San Francisco shared workspaces have a lower vacancy rate, and command higher per-square-foot rent, than do traditional offices.

Can an Undocumented Immigrant Form a Corporation?

Dana — Fri, 09 Sep 2011 01:19:24 +0000

This post is based on a question that I answered on OnStartups.com. The short answer is “Yes, an undocumented immigrant can form a corporation.” The rest of this post is adapted from the full answer that I provided.

You can form a corporation – no problem. I have helped dozens of foreign clients (non-citizens, no social security number) go through that process.

With a bit of effort, you can obtain an Employer Identification Number for the corporation. Please see Foreign Company Alert: Obtaining an EIN may be your Biggest Challenge in the U.S.

Your greatest limitation will be that you cannot legally work for the corporation without a work visa – which, I suspect, you will not be able to obtain because your undocumented status would become known. And if you were to raise funds, you would be legally obligated to raise this fact, likely frustrating your efforts.

However, (1) you can be a director of the corporation (please see Visa Basics for Foreign Entrepreneurs, Part 2: What Constitutes Work?), (2) the corporation can hire employees and independent contractors, and (3) the corporation can enter into contracts to carry out its business objectives.

The situation you are describing may be unusual here in the Bay Area, but it is not all that unusual in the Southwestern U.S. I was interviewed by a writer in Arizona who told me that it is quite common for undocumented immigrants there to form LLCs so they can obtain an EIN and, thus, be able to accept payments legally and pay taxes.

Printing Legends on Share Certificates – Why and How

Dana — Fri, 26 Aug 2011 00:18:52 +0000

Sample Share Certificate with Legend from Attorneys Corporation Service, Inc.

Last year, I wrote about the importance of placing appropriate legends on corporate share certificates (Why Do We Need a Corporate Records Book?) and limited liability company membership certificates (Should My LLC Issue Membership Certificates?). This post provides more details about why legends are required and how they can be printed on the certificates. (Although I will use corporation-specific terminology below, the considerations are similar for LLCs.)

The legend that routinely appears on my clients’ share certificates (I have the company that prints the certificates include it) is one stating that the shares have not been registered under state or federal securities laws. The reason: To put the shareholder on notice that, under applicable securities laws, the shares cannot be transferred unless certain circumstances are satisfied. Here is an example:

THIS SECURITY HAS NOT BEEN REGISTERED OR QUALIFIED UNDER THE SECURITIES ACT OF 1933 OR THE SECURITIES OR BLUE SKY LAWS OF ANY STATE AND MAY BE OFFERED AND SOLD ONLY IF REGISTERED AND QUALIFIED PURSUANT TO THE RELEVANT PROVISIONS OF FEDERAL AND STATE SECURITIES OR BLUE SKY LAWS OR IF AN EXEMPTION FROM SUCH REGISTRATION OR QUALIFICATION IS APPLICABLE.

If the shares are subject to contractual restrictions on transfer that were agreed to at the time the shares were issued, then it is important to include the legend specified in the agreement. The reason: A third party who receives a certificate without the legend and without knowledge of the restrictions may not be bound by them! Here is an example:

SALE, TRANSFER, PLEDGE, ENCUMBRANCE, HYPOTHECATION, OR DISPOSITION OF THE SHARES REPRESENTED BY THIS CERTIFICATE IS RESTRICTED BY THE PROVISIONS OF A COMMON STOCK PURCHASE AGREEMENT AMONG THE SHAREHOLDER AND THE COMPANY OF _______ __, 201_. ALL PROVISIONS OF THE AGREEMENT ARE INCORPORATED BY REFERENCE IN THIS CERTIFICATE. A COPY OF THE AGREEMENT MAY BE INSPECTED AT THE PRINCIPAL OFFICE OF THE CORPORATION.

Because this legend is prescribed by the applicable agreement (the printer’s standard-form legends typically will not suffice), I add it myself using MS Word.

Sometimes it is difficult to find room on the front of a certificate for all required legends. In that case, legends can be placed on the back, and there should be a legend along the line of the following on the front:

TRANSFER OF THE SHARES REPRESENTED BY THIS CERTIFICATE IS RESTRICTED. SEE LEGEND ON REVERSE SIDE.

Why Do We Need a Corporate Records Book?

LLC Accounting – Allocations vs. Distributions

Dana — Wed, 10 Aug 2011 21:55:14 +0000

An entrepreneur who was trying to prepare a limited liability company (LLC) Operating Agreement on his own (apparently using someone else’s as a template) was puzzled by the concept of “sharing losses”. I could tell right away that he was not familiar with two fundamental concepts of LLC accounting: Allocations vs. distributions.

Before going further, I need to make two disclaimers:

This post is not about taxes.
The following discussion is extremely simple, addressing only the most basic considerations. One of the great things about LLCs is that the members can agree to make allocations and distributions in any way they desire to meet their business needs. As a result, LLC accounting can be far more complex than the following might suggest.

Each member has a capital account that represents his equity in the LLC. At the time he becomes a member, he makes a capital contribution (cash or property) to the LLC; the value of that contribution becomes the value of his capital account.

Over time, as the LLC operates, profits and losses are allocated to members: Profit allocations increase members’ capital accounts; loss allocations decrease capital accounts.

If the LLC has available cash (or other property), it may make a distribution to members. The value of the distribution reduces each member’s capital account.

Example: Assume that A is one of two members of an LLC and that the Operating Agreement specifies that the members will make equal capital contributions and will receive equal allocations and distributions.

If A’s initial capital contribution is $25,000, then his capital account will have a value of $25,000.
If the LLC has a loss of $100,000 during the first year, then one-half of that amount ($50,000) will be allocated to each member at the end of that year, and A’s capital account will have a value of -$25,000.
If the LLC has a profit of $200,000 during the second year, then one-half of that amount ($100,000) will be allocated to each member at the end of that year, and A’s capital account will have a value of $75,000.
If the LLC has $50,000 available cash to distribute, then one-half of that distribution ($25,000) will go to A, and his capital account will have a value of $50,000.

Photo credit: Paige Foster via stock.xchng