Lesson 2.3.1 by yaohongm


									Part 1: Instructions
   GP>>>Corporation                      GP>>>>LLC
   No adverse tax issues.         No adverse tax issues.
                                   Pship-Pship for tax
   §351 tax-free exchange.         purposes.
   Bob and Andrew                 No taxable gain or loss
    contribute Pship interest       since business will
    for stock. Edward-$$$           continue.
                                   Bob and Andrew
   Basis booster for A & B.        contribute Pship interest
   Sub S possibility.              for stock. Edward-$$$
   Flexible tax year.             Basis booster for A & B.
                                   Same calendar tax year.
   Fringe Benefits.
Compu Devices has annual revenues of $250,000, with
   operating expenses of $200,000; and partnership assets
   valued at $300,000.
Proposed basis in the owners respective contribution is as

   Andrew's partnership interest has a basis of $210,000.
   Bob's partnership interest has a basis of $90,000.
   Edward's contribution of cash has a basis of $125,000,
    if the entire amount is contributed as equity.
Party    Issue                         Solution
        -No add. Contribution         Debt; veto, opt out, preemptive rt.
Andrew                                 License vs assignment
         -Patent protection
         -Salary                       Fringe benefits, bonus
         -Control                      Veto power, majority
         -No add. Contribution         Debt; veto
Bob                                    Shop right, ownership
         -Patent protection
         -Salary                       Fringe benefits, bonus
         -Control                      Cumulative voting
         -Additional contribution      low-cost debt, add. investors
Edward   -Assurance re profitability   min. debt-equity;
         -Vote on major decisions      Unanimous or supermajority vote
         -Accelerate repayment-2d      Special conditions
         round                         Preemptive right
         -No dilution
Party    Contribution                  Tax Effect in Conversion
        -Partnership interest (70%)    Tax-free exchange property for
Andrew                                 stock; $210K basis rolls over to corp.
                                       unless challenge to value (50:50)

          -$50K Personal L/C            Recourse vs. Nonrecourse
         -$30,000 CD (collateral)      Bank approval to transfer
                                        Indemnification from company, if
                                       Co. should substitute $30k CD with
                                       company assets.
         Patents-License vs            License-K right to royalties, corp.
         assignment                    deduct cost, No transfer
                                       Assignment-Tax-free, $250K basis
Party   Contribution                  Tax Effect in Conversion
       -Partnership interest (30%)    Tax-free exchange property for
Bob                                   stock; $90K basis rolls over to corp.
                                      unless challenge to value (50:50)

        -Sweat equity (services)       Signing bonus problem for control
                                      test and recognized income to Bob;
                                      Contribute 10% property to avoid
                                      problem, (e.g. pship interest);
                                      Right to future profits tied to
                                      performance benchmarks.
        IP (R&D)                      Work in progress—very hard to
                                      value. Should wait until completed
                                      e.g., 2nd round. Who owns it? .e.g.
                                      Work for hire
Party    Contribution                Tax Effect in Conversion
        -$125,000 cash, less         Tax-free exchange property for
Edward                               stock; Basis equals amount of cash
         amount construed as debt.
                                     as equity.

         -Debt                       No assumed shareholder debt;
                                     Terms of repayment, Collateral

         Additional contributions    No assumed shareholder debt;
                                     convertible debt to protect vs. dilution
                                     and allow more control during second
   Triggers:
     - Death
     - Employment Termination
     - Expulsion
     - Disability
     - Bankruptcy, Divorce
     - Voluntary Stock Exit
    - Death: Important for Andrew & Bob via insurance.
     - Employment Termination: Definitely for Andrew;
   Installment, perhaps wrapped with owner deferred
     - Expulsion: Tough with only three. Require other
   two vote. Payout same as employment termination.
     - Disability: Same as employment termination.
     - Bankruptcy, Divorce: Yes for Bob, given interest of
   the wife in participation.
   - Voluntary Stock Exit: Min. vesting period. Impact on
   employment remains. Staged exit program-installments.
Step 1: Answer CWB Question  Identify 10
   issues checklist related to client that need to be
   addressed for an Operating Agreement OR a
   Shareholder Agreement.
    Use General & Private facts to prioritize the issues.
    Use form document to ensure basic coverage.
    Check applicable CA statute re provisions.
    Keep a copy to share with team member.
Step 2: Meet with group, identify client, select
  team member, and select a team leader (who
  will summarize major points in BBS, keep track
  of attendance and advise of any issues)
   Divide up issues with team member.
   Create one checklist of critical issues.
Step 3: Meet with team member to agree upon
  issues, select opening position, negotiating
  points & strategy, bottom line.
   Identify top 3-5 critical issues to focus on for
   Divide up issues with team member.
   Identify opening position, negotiating strategy, and
    bottom line for each issue.
   Each team send via email to PJ bottom line.
Step 4: Meet with group to agree upon the critical
  issues for the negotiation and who will
  negotiating with whom.
   Goal is to achieve bottom line for each issue.
   Identify issues where likely consensus.
   Break into subgroups for the negotiation.
   Try not to negotiate with team member but divide
    up issues and negotiate simultaneously.
Step 5: Meet with group to select template for drafting
   the agreement and assign who drafts what sections.
   Work on draft.

    Rely upon forms in CWB or linked from website.
   Persons who negotiated sections should oversee
    drafting of those sections.
   Document should not exceed 12 pp., 1 1/2 lines
    spacing, double between sections with subject
   Include Id no. and client for each group member.

     Don’t include any term you don’t understand
Step 6: Circulate document among members for
  comment. Reconcile any issues.
   Turn in one document that everyone will sign.
   Everyone in the group will receive one grade.
   PJ will give you comments on work.
Step 7: Take feedback and revise agreement.

     Make any modifications as a result of feedback from
Part 2: Drafting Tips
1) Establishes meeting of the minds re ownership,
   control, exit, and operation.
2) Ensure compliance with IRC, state and federal
3) Provide a process for resolving future issues,
   disputes, disposition.
4) Protect interests of the parties.
1.   Use forms solely as a guide.
2.   Use simple language.
3.   Recognize the preexisting partnership.
4.   Anticipate the need for a second round.
5.   Include contingency for additional
6.   Value equity interests
7.   Confidentiality is key for IP.
8.   Keep management structure simple.
   Definitions-Narrow or broad scope, Essential terms
   Formation-Purpose, term, Additional Members
   Capitalization-Contributions, Caps, Loans, Liability
   Allocation of Profits & Losses -Adjustment in Capital accounts
   Distributions- Profits and losses, Retention
   Administration -Management, Control, Duties & Taxes
   Transfers -Notices, Consents, Effect (Buy-sell)
   Dissolution & Liquidations –Triggers and Events, Winding up
   Liability & Indemnification – Limits, Conditions, Contributions
   General Provisions- Meetings, Notices, Amendments, Remedies,
    Choice of Law
   Interest for future services okay.
   No professional LLCs.
   Disassociation need not trigger a dissolution.
   Minimum Franchise Tax.
   Default taxed as partnership.
   Definitions & recitals- Check statute to conform.
   Shares at issue- Name, class, no. shares.
   Capitalization-Contributions, Caps, Loans, Liability
   Disclosures-Legal counsel, record owners, indemnity for wrongful
    Buy-Sell provisions- Triggers, formula for valuation, conditions.
   Administration -Management, Control, & Duties (limits also)
   Qualifications, Special rights, Preferences – Related to shares.
   Legends on Certificates- Restrictions or limits.
   Interested Transactions – Approval, liability, & process.
   Process for Approvals, Ratifications Self-Dealing – Limits,
    Conditions, Contributions
   General Provisions- Meetings, Notices, Amendments, Remedies,
    Choice of Law
   No interest for future services. (§ 409)
   No. of shareholders capped at 35. (§158)
   Close corporation w/o Board okay.(§300)
   Delegation to management co. okay. (§300)
   Change from close corp. if at least 50%-2/3rd vote (§300)
    Threshold for control is 50%. (§160)
    Restrictive rights must be in Articles. (§204)
   Cumulative voting by directors in classes. (§301.5)
   Removal of director with and without cause. (§303-304)
   Self-dealing transactions-full disclosure of material facts and
    disinterest ratification. (§310, 315) (No personal loans w/o
    shareholder approval)
   Redeemable shares (§402)
   Employee stock option plans (§408)
   Conversion from GP to LLC and Corp: Contribution of
    Services to Corp and satisfying the control test for a corp. that
    is not required for LLC
   Management- LLC- Managers and members: allocated
    control to managers over some issues and members for
    fundamental; Corp.-Board where you can assign committees,
    or provide veto power.
   Taxation of earnings: Double tax (corp) vs pass-thru (LLC) No
    deferred or future contract rights.
   Exit strategy: LLC-redemption is allocated to other persons
    per interest or agreement. Nothing called treasury since
    taxation upon receipt. Issue is whose money we use.
     Corp.-Redemption by corp and cancel, reissue, treasury
    shares; Distribution to shareholders is considered a
    constructive dividend.
    Fringe benefits: LLC –death and disability
    okay, but nothing like ESOP, Future rights.
   Gain on Distributions: LLC: Adjusted basis
    so less tax; Capital gains okay for both.
   Funding buy-sell: LLC-no retained earnings;
    Corp.-more options re insurance and
    deferred compensation.
   Transferability-LLC restrictions limited to
    economic rights; Corp.-freely transferable
    unless impose restrictions.
   Equity-Vote: LLC can be disproportionate;
    Corp-must follow equity interest.

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