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Business Law

Monday, March 23, 2015

Overview: Buy-Sell Agreements and Your Small Business

If you co-own a business, you need a buy-sell agreement. Also called a buyout agreement, this document is essentially the business world’s equivalent of a prenup. An effective buy-sell agreement helps prevent conflict between the company’s owners, while also preserving the company’s closely held status. Any business with more than one owner should address this issue upfront, before problems arise.

With a proper buy-sell agreement, all business owners are protected in the event one of the owners wishes to leave the company. The buy-sell agreement establishes clear procedures that must be followed if an owner retires, sells his or her shares, divorces his or her spouse, becomes disabled, or dies. The agreement will establish the price and terms of a buyout, ensuring the company continues in the absence of the departing owner.

A properly drafted buy-sell agreement takes into consideration exactly what the owners wish to happen if one owner departs, whether voluntarily or involuntarily.  Do the owners want to permit a new, unknown partner, should the departing owner wish to sell to an uninvolved third party? What happens if an owner’s spouse is involved in the business and that owner gets a divorce or passes away? How are interests valued when a triggering event occurs?

In crafting your buy-sell agreement, consider the following issues:

  • Triggering Events - What events trigger the provisions of the agreement?  These normally include death, disability, bankruptcy, divorce and retirement.
     
  • Business Valuation - How will the value of shares being transferred be determined? Owners may determine the value of shares annually, by agreement, appraisal or formula.  The agreement may require that the appraisal be performed by a business valuation expert at the time of the triggering event.  Some agreements may also include a “shotgun provision” in which one party proposes a price, giving the other party the obligation to accept or counter with a new offer.
     
  • Funding - How will the departing owner be paid?  Many business owners will obtain insurance coverage, including life, disability, or business continuation insurance on the life or disability of the other owners.  With respect to life insurance, the agreement may provide that the company redeem the departing owner’s shares (“redemption”).  Alternatively, each of the owners may purchase life insurance on the lives of the other owners to provide the liquidity needed to purchase the departing owner’s shares (“cross purchase agreement”).   The agreement may also authorize the company to use it’s cash reserves to buy-out the departing owners.  
     

Monday, March 9, 2015

Which Business Structure is Right for You?

Which entity is best for your business depends on many factors, and the decision can have a significant impact on both profitability and asset protection afforded to its owners. Below is an overview of the most common business structures.

Sole Proprietorship
The sole proprietorship is the simplest and least regulated of all business structures. For legal and tax purposes, the sole proprietorship’s owner and the business are one and the same. The liabilities of the business are personal to the owner, and the business terminates when the owner dies. On the other hand, all of the profits are also personal to the owner and the sole owner has full control of the business.

General Partnership
A partnership consists of two or more persons who agree to share profits and losses. It is simple to establish and maintain; no formal, written document is required in order to create a partnership. If no formal agreement is signed, the partnership will be subject to state laws governing partnerships. However, to clarify the rights and responsibilities of each partner, and to be certain of the tax status of the partnership, it is important to have a written partnership agreement.

Each partner’s personal assets are at risk. Any partner may obligate the partnership, and each individual partner is liable for all of the debts of the partnership. General partners also face potential personal legal liability for the negligence of another partner.

Limited Partnership
A limited partnership is similar to a general partnership, but has two types of partners: general partners and limited partners. General partners have broad powers to obligate the partnership (as in a general partnership), and are personally liable for the debts of the partnership. If there is more than one general partner, each of them is liable for the acts of the remaining general partners. Limited partners, however, are “limited” to their contribution of capital to the business, and must not become actively involved in running the company. As with a general partnership, limited partnerships are flow-through tax entities.

Limited Liability Company (LLC)
The LLC is a hybrid type of business structure. An LLC consists of one or more owners (“members”) who actively manage the company’s business affairs. The LLC contains elements of both a traditional partnership and a corporation, offering the liability protection of a corporation, with the tax structure of a sole proprietorship (if it has only one member), or a partnership (if the LLC has two or more members). Its important to note that in certain states, single-member LLCs are not afforded limited liability protection.

Corporation
Corporations are more complex than either a sole proprietorship or partnership and are subject to more state regulations regarding their formation and operation. There are two basic types of corporations:  C-corporations and S-corporations. There are significant differences in the tax treatment of these two types of corporations, however, they are both generally organized and operated in a similar manner.

Technical formalities must be strictly observed in order to reap the benefits of corporate existence. For this reason, there is an additional burden of detailed recordkeeping. Corporate decisions must be documented in writing. Corporate meetings, both at the shareholder and director levels, must be formally documented.

Corporations limit the owners’ personal liability for company debts. Depending on your situation, there may be significant tax advantages to incorporating.


Monday, February 23, 2015

How Par Value Affects Start-Up Businesses

Many entrepreneurs are unclear about the “par value” of a stock, and what par value they should establish for their new corporation. Generally, par value (also known as nominal or face value) is the minimum price per share that shares can be issued for, in order to be fully paid. In the old days, the par value of a common stock was equal to the amount invested and represented the initial capital of the company; but today the vast majority of stocks are issued with an extremely low par value, or none at all.

A share of stock cannot be issued, sold or traded for less than the par value. Therefore, incorporators often opt for such a low – or no – par value to reduce the amount of money a company founder must invest in exchange for shares of ownership in a start-up corporation. Regardless of the par value, the company’s board of directors retain the right to sell shares in the company at a higher price.

Some online incorporation services recommend setting par value at zero, however this is not necessarily the best approach and can have unintended consequences. Many corporations want to assign a par value, so that an actual investment (money or services) is necessary in order to acquire ownership in the company. This way, the corporation can generate capital and recoup start-up costs.

Some states restrict the number of shares which may be offered at zero par value, or charge additional taxes or filing fees based on the number of zero par value shares. For example, Delaware corporations can issue up to 1,500 shares at zero par value before additional filing fees kick in.

Zero par value can pose problems at tax time in some jurisdictions. In Delaware, for example, there are two methods of calculating franchise taxes corporations must pay annually. In one example, the same corporation would owe annual tax in excess of $75,000 if the stock had zero par value, as opposed to annual taxes of just $350 with a nominal par value of $.01 per share.

Consider establishing a par value that is above zero and below $.01 per share to minimize the initial investment required from the founders and to protect against potential tax consequences associated with zero par value stock. Some also recommend issuing founder shares at a multiple of whatever par value is, to avoid future complications if the corporation needs to execute a stock split that results in a new share price that is below par value.

Par value has no bearing on the market value of a stock, but is an important decision in the formation of your new enterprise. Consultation with an experienced business or tax lawyer can help you ensure your ultimate decision serves your company well into the future, in terms of raising capital, lowering taxes and retaining control as a shareholder in your corporation.


Monday, February 9, 2015

Should I Incorporate My Business?

The primary advantages of operating as a corporation are liability protection and potential tax savings. Like any important decision, choosing whether to incorporate involves weighing the pros and cons of the various business structures and should only be done after careful research.

Once incorporated, the business becomes a separate legal entity, and assets of the corporation are separated from the owner’s personal finances. As a result, the owner’s personal assets generally can be shielded from creditors of the business.

To maintain this legal separation and avoid “piercing the corporate veil,” the corporation must observe certain formalities, including:

  • Keeping corporate assets and personal assets separate (no commingling of funds)
  • Holding shareholder and director meetings at least annually
  • Maintaining a corporate record book including bylaws, minutes of shareholder and director meetings, and shareholder records
  • Filing annual information statements with the Secretary of State
  • Filing a separate tax return for the corporation

Many business owners are concerned about “double taxation” of income that affects certain types of corporations known as “C-Corporations”.   Double taxation results when the C-corporation has profit at the end of the year that is distributed to the shareholders. That profit is taxed to the corporation, at the corporate tax rate, and then the dividends are taxable income to the shareholders on their personal tax returns. However, the corporate tax and dividend rates can be lower than the individual tax rate that a sole-proprietor would pay on a 1040 Schedule C, and a knowledgeable accountant or tax attorney may be able to advise on how to minimize the burden of double-taxation and indeed pay an effective tax rate which is lower than what a sole proprietor would pay.

For example, a small C-Corporation will likely have a shareholder who is also an employee. Paychecks to the shareholder/employee are, of course, tax deductible to the business. To the shareholder/employee, they are taxable income (as would be the case with a paycheck from any employer). A bonus could be paid to the shareholder/employee in order to lower the corporation’s taxable profit, eliminating the double-taxation. These calculations should be performed by a tax advisor, but shifting income from the corporation to the shareholder/employee (or not, depending on which has the lower tax rate) can be an effective way to lower your overall tax liability. In addition, there are certain advantages that are only available with a C-Corporation, such as full tax-deductibility of medical benefits for a shareholder/employee.

The S-Corporation avoids the double-taxation by offering a tax structure similar to the Limited Liability Company. A corporation with 100 or fewer shareholders can elect to be treated as an S-Corporation. If the corporation is profitable, the shareholder/employee must draw a reasonable salary (and pay employment tax on it), but then all remaining corporate profits flow through to the shareholder’s personal tax return (thereby avoiding the FICA tax on the portion of profits that is taken as a dividend).

An experienced attorney can help you decide which form of ownership is best for your business, help you establish the entity, and ensure the required formalities are observed.


Monday, January 5, 2015

Umbrella Insurance: What It Is and Why You Need It

Lawsuits are everywhere. What happens when you are found to be at fault in an accident, and a significant judgment is entered against you? A child dives head-first into the shallow end of your swimming pool, becomes paralyzed, and needs in-home medical care for the rest of his or her lifetime. Or, you accidentally rear-end a high-income executive, whose injuries prevent him or her from returning to work. Either of these situations could easily result in judgments or settlements that far exceed the limits of your primary home or auto insurance policies. Without additional coverage, your life savings could be wiped out with the stroke of a judge’s pen.

Typical liability insurance coverage is included as part of your home or auto policy to cover an injured person’s medical expenses, rehabilitation or lost wages due to negligence on your part. The liability coverage contained in your policy also cover expenses associated with your legal defense, should you find yourself on the receiving end of a lawsuit. Once all of these expenses are added together, the total may exceed the liability limits on the home or auto insurance policy. Once insurance coverage is exhausted, your personal assets could be seized to satisfy the judgment.

However, there is an affordable option that provides you with added liability protection. Umbrella insurance is a type of liability insurance policy that provides coverage above and beyond the standard limits of your primary home, auto or other liability insurance policies. The term “umbrella” refers to the manner in which these insurance policies shield your assets more broadly than the primary insurance coverage, by covering liability claims from all policies “underneath” it, such as your primary home or auto coverage.

With an umbrella insurance policy, you can add an addition $1 million to $5 million – or more – in liability coverage to defend you in negligence actions. The umbrella coverage kicks in when the liability limits on your primary policies has been exhausted. This additional liability insurance is often relatively inexpensive in comparison to the cost of the primary insurance policies and potential for loss if the unthinkable happens.

Generally, umbrella insurance is pure liability coverage over and above your regular policies. It is typically sold in million-dollar increments. These types of policies are also broader than traditional auto or home policies, affording coverage for claims typically excluded by primary insurance policies, such as claims for defamation, false arrest or invasion of privacy.
 


Monday, December 8, 2014

Do I need a bond for my business?

In many states, certain types of contractors or businesses are required to be bonded. In instances where the law doesn’t mandate bonds, a customer might require that your company be bonded before hiring you. If you are starting a business, it’s important that you understand the concept of bonding so you can determine whether your work need be bonded for legal compliance, or whether it just makes sense for your business model and customer base.

What is a bond?
A bond (often referred to a surety bond) is a guaranteed agreement that specific tasks outlined in a contract will be fulfilled as promised. Generally, surety bonds involved three different parties: the principal, the obligee and the surety. In this arrangement, the principal would be you as an individual contractor or your business as a whole; in this role you have the responsibility to perform the contractual obligation. The obligee, on the other hand, is the party who is the recipient of your service; this may be an individual whose house you are rewiring or a local municipality, if you are working on a big project. Finally, the surety is the insurance company that backs the bond, providing protection if the principal fails.

What are my options?
There are a number of different types of bonds. Business owners and professionals might consider License, Performance, Bid, Ancillary and Payment bonds.

A License Bond – In many states, government agencies will require commercial bonding of individuals in certain industries. In these cases, the purchase of bonds is necessary before an individual can be legally licensed. This is often the case with contractors, auto-dealerships and even auctioneers.

A Performance Bond – This insurance guarantees the satisfactory completion by a contractor. Many customers, big companies or even individuals, will require this.

A Bid Bond – If your company bids on projects, you may consider (or be required) to purchase a bid bond which essentially guarantees that if you are selected as the contractor, you will complete the project in accordance with the terms at which you bid.

A Payment Bond – This insurance guarantees that you will pay all subcontractors and material providers used during a contract project.

An Ancillary Bond – This bond ensures that requirements integral to the contract, but not necessarily performance related, are satisfied. This may include investigating and complying with special local laws during the completion of the project.

Do I need it?
While it may not always be legally required, obtaining surety bonds for your business may just be good practice. In determining whether it’s the right option for you, it’s important to consult a knowledgeable business law attorney who understands local requirements and will be able to help you effectively plan for the future.


Thursday, October 24, 2013

A Stitch in Time... Strategies to Prevent Business Litigation

A Stitch in Time … Strategies to Prevent Business Litigation

A lawsuit can damage more than just the bottom line of your business.  In addition to costing money that could be put to better use, a lawsuit is also an unwelcome distraction for the owner, managers and employees.  It can also do irreparable damage to business relationships and reputation.

It may not be possible to avoid any and all legal conflict during the life of your business, but by considering the following advice, you should be able to minimize the resources you have to devote to litigation – which means more time and money available for your business operations and investments.

  1. Don’t rely on a handshake.  Reduce all business agreements to writing, even if they are with your oldest and dearest friend.  Be clear about terms and expectations.
  2. Keep a written record of all communications.
  3. Keep the lines of communication open, especially when a business relationship starts to sour.  Aggressive communication may be able to cure the damage before a lawsuit becomes necessary.
  4. Don’t put your head in the sand.  If a threat appears that could lead to litigation, respond quickly, thoughtfully and thoroughly.
  5. Check your compliance with relevant government regulations.  Import/export? Check the laws.  Using hazardous materials? Check the regulations. Don’t allow shortcuts.
  6. Create a business culture that rewards employees for reporting violations of any laws or government regulations.  Your employees on the ground can be your best resource for uncovering potential hazards that could lead to litigation.
  7. Put cure provisions and mediation provisions into your contracts with vendors.
  8. Complete a business succession plan to minimize or eliminate disputes over exit strategies.
  9. Conduct regular safety checks of the physical premises, including vehicles used for company business.
  10. Conduct criminal background checks on prospective employees that comply with the law.
  11. Provide regular health and safety training for employees.
  12. Provide ongoing training for human resources personnel.
  13. Review whether your employees are properly classified as hourly or salaried workers to comply with the Fair Labor Standards Act.
  14. Review whether any independent contractors should be reclassified as employees to comply with the Fair Labor Standards Act.
  15. Respond promptly and thoroughly to complaints from employees, customers or vendors.
  16. Use email, the internet, your company website and social networking media with caution.  Assume that any information shared via these platforms will be publicly accessible until the end of time.
  17. Seek outside advice when necessary.  Don’t let your ego be your downfall.  If you don’t understand your legal obligations and rights in a particular circumstance, consult a qualified commercial law attorney.


 


Thursday, August 1, 2013

Limited Liability Company (LLC): An Overview

Limited Liability Company (LLC): An Overview

The limited liability company (LLC) is a hybrid type of business structure, offering business owners the best of both worlds: the simplicity of a sole proprietorship or partnership, with the liability protection of a corporation. A limited liability company consists of one or more owners (called “members”) who actively manage the company’s business affairs. LLCs are relatively simple to establish and operate, with minimal annual filing requirements in most jurisdictions.


The best form of business structure depends on many factors, and must be determined according to your particular business and overall goals:

Advantages

  • LLC members enjoy a limited liability, similar to that of a shareholder in a corporation. In general, your risk is limited to the amount of your investment in the limited liability company. Since none of the members will have personal liability and may not necessarily be required to personally perform any tasks of management, it is easier to attract investors to the limited liability company form of business than to a general partnership.

  • LLC members share in the profits and in the tax deductions of the limited liability company while limiting the potential financial risks.

  • LLCs offer a relatively flexible management structure. The business may be managed either by members or by managers. Thus, depending on needs or desires, the limited liability company can be a hands-on, owner-managed company, or a relatively hands-off operation for its members where hired managers actually operate the company.

  • Because the IRS treats the limited liability company as a pass-through entity, the profits and losses of the company pass directly to each member and are taxed only at the individual level (which may or may not be an advantage to you, depending on the profitability of the LLC and your personal income tax bracket).

  • Members of an LLC have flexibility in dividing the profits and losses. In a corporation or partnership, profits must be divided according to percentage of ownership. However, with an LLC, special allocations are permitted, so long as they have a “substantial economic effect” (e.g. they must be based upon legitimate economic circumstances, and may not be used to simply reduce one member’s tax liability).


Disadvantages

  • Limited liability companies are, generally, a more complex form of business operation than either the sole proprietorship or the general partnership. They are subject to more paperwork requirements than a simple partnership but less than a corporation. Annual filings typically include statement and nominal filing fee payable to the Secretary of State, informational returns to the IRS, and filing of a state tax return.

  • In certain jurisdictions, single member LLCs may not be afforded the same level of limited liability protection as that of an incorporated entity.

Also note that in many states, an LLC is prohibited from rendering “professional services” which can include companies providing services that require a license, registration or certification.   Such professionals typically have to establish a Professional LLC which does not offer limited liability for professional malpractice.
 


Wednesday, July 10, 2013

Which Business Structure is Right for You?

Which Business Structure is Right for You?

Which entity is best for your business depends on many factors, and the decision can have a significant impact on both profitability and asset protection afforded to its owners. Below is an overview of the most common business structures.

Sole Proprietorship
The sole proprietorship is the simplest and least regulated of all business structures. For legal and tax purposes, the sole proprietorship’s owner and the business are one and the same. The liabilities of the business are personal to the owner, and the business terminates when the owner dies. On the other hand, all of the profits are also personal to the owner and the sole owner has full control of the business.

General Partnership
A partnership consists of two or more persons who agree to share profits and losses. It is simple to establish and maintain; no formal, written document is required in order to create a partnership. If no formal agreement is signed, the partnership will be subject to state laws governing partnerships. However, to clarify the rights and responsibilities of each partner, and to be certain of the tax status of the partnership, it is important to have a written partnership agreement.

Each partner’s personal assets are at risk. Any partner may obligate the partnership, and each individual partner is liable for all of the debts of the partnership. General partners also face potential personal legal liability for the negligence of another partner.

Limited Partnership
A limited partnership is similar to a general partnership, but has two types of partners: general partners and limited partners. General partners have broad powers to obligate the partnership (as in a general partnership), and are personally liable for the debts of the partnership. If there is more than one general partner, each of them is liable for the acts of the remaining general partners. Limited partners, however, are “limited” to their contribution of capital to the business, and must not become actively involved in running the company. As with a general partnership, limited partnerships are flow-through tax entities.

Limited Liability Company (LLC)
The LLC is a hybrid type of business structure. An LLC consists of one or more owners (“members”) who actively manage the company’s business affairs. The LLC contains elements of both a traditional partnership and a corporation, offering the liability protection of a corporation, with the tax structure of a sole proprietorship (if it has only one member), or a partnership (if the LLC has two or more members). Its important to note that in certain states, single-member LLCs are not afforded limited liability protection.

Corporation
Corporations are more complex than either a sole proprietorship or partnership and are subject to more state regulations regarding their formation and operation. There are two basic types of corporations:  C-corporations and S-corporations. There are significant differences in the tax treatment of these two types of corporations, however, they are both generally organized and operated in a similar manner.

Technical formalities must be strictly observed in order to reap the benefits of corporate existence. For this reason, there is an additional burden of detailed recordkeeping. Corporate decisions must be documented in writing. Corporate meetings, both at the shareholder and director levels, must be formally documented.

Corporations limit the owners’ personal liability for company debts. Depending on your situation, there may be significant tax advantages to incorporating.


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