An abbreviated version of this article will appear in the American Bar Association’s Business Law Today, Fall 2017 Edition.

Is your startup brand so strong that consumers tattoo the logo on their arm? Or so hard to pronounce that investors, vendors and customers are disinclined to do business with you?

"Hello, my name is..." nametagAccording to a study published in the peer-reviewed academic journal Venture Capital, your company name matters even more than you think.  The study, entitled “The Effect of Company Name Fluency on Venture Investment Decisions and IPO Underpricing,” found that a startup’s name can seriously affect how a company is perceived by investors and customers alike.

Names that are easily pronounced, such as Uber and Lyft, are preferred by both early and late-stage investors. They tend to be offered more money, whether its through crowd funders, angel investors, VCs or IPO investors.  The study also found that “uniqueness” is virtue, but only with early-stage investors.  According to the study, since very little is known about a company in the early stages, unique names give the impression there is something special about the company.

On the other hand, difficult names “evoke cues of unfamiliarity and create a perception of high novelty, which is valued by these pre-venture stage investors,” according to the study. The study cautions, however, that novelty wears off by later stages, when unique names can make more risk-adverse investors feel uncomfortable.

This study adds to the list of impacts that name can have on a venture, including:

  • An easy to pronounce and remember company name could get you more funding and customers as you grow
  • Company names and logos which are “unique”, “unobvious” and/or “novel” when associated with your services get stronger trademark protections faster with the USPTO
  • Securing 360-branding including a web domain, Instagram and Twitter handle, and an issued trademark on the name and logo early in the process with the help of an IP attorney saves cost and time as you roll out your product

Often founders launch or pivot on a name only to realize the Instagram account or web domain is taken, causing confusion in the market and requiring expensive litigation or licensing deals to consolidate your brand.  A strategic approach to choosing your company name ensures a consistent and easy brand association across digital and print media as well as adding to your successes with investors and customers, saving you time and money as you go to market.

In an Alert published on Thursday, Andrea Ravich provides an update on changes to Minnesota corporate law regarding limited liability companies (LLCs) that will take effect in January 2018, and notes action items for companies to ensure compliance.

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An overhaul of Minnesota corporate law on limited liability companies, or LLCs, that was phased in over three years will take full effect in January 2018. The new act differs significantly from the old act, but is modeled after the Revised Uniform Limited Liability Company Act and is similar in many ways to LLC laws in Delaware and other states.

Action Items Prior to January 1, 2018

Now is the time for Minnesota companies to ensure compliance. Within the next 120 days, LLCs should:

— Confirm that your LLC is registered and in good standing with Minnesota Secretary of State (file annual reports and/or renewal, as applicable).
— Review your LLC’s existing governing documents (i.e., any agreements between the members). Unless your LLC adopts a new operating agreement in writing, its current governing documents will continue in effect under the new act.
— With guidance of legal and tax counsel, consider whether there may be any opportunities to update, clarify and/or amend your LLC’s existing membership agreement.

To read Andrea’s full discussion of the impending changes, please visit the Fox Rothschild website.

Andrea L. Ravich is an associate in the firm’s Corporate Department, resident in its Minneapolis office.

Changes to the Illinois Limited Liability Company Act that took effect on July 1, 2017 may impact either your current Illinois LLCs or your future ventures. The changes generally conformed Illinois law more closely to a model law for limited liability companies drafted by the National Conference of Commissioners on Uniform State Laws that has already been adopted by 15 states and the District of Columbia.

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Among the changes to the Illinois law are:

Default Member Management
An LLC will now be member-managed by default unless there is explicit language in the operating agreement stating that the LLC is to be manager-managed. Similar to Delaware, you are no longer required to specify in an LLC’s Articles of Organization whether it will be member-managed or manager-managed, but instead are only required to provide information regarding each manager and each member with management authority.

Oral Operating Agreements
Oral and implied operating agreements are now permitted and are also expressly exempted from the statute of frauds.

Designating Specific Authority of Members and Managers
Illinois LLCs can now establish or limit the authority of a member or manager to transfer real estate or enter into other transactions on behalf of the LLC by filing a document with the Illinois Secretary of State.

Waiver of Fiduciary Duties
With the exception of the duty of care, fiduciary duties may be restricted or eliminated by including clear and unambiguous language in the operating agreement. The operating agreement can now alter the duty of care so long as it does not authorize intentional misconduct or a knowing violation of law.

Limitation of Member’s or Manager’s Liability
An operating agreement can now eliminate or limit a member or manager’s liability to the LLC and the other members, unless such liability relates to a breach of certain specified fiduciary duties, a financial benefit to which such member or manager is not entitled, an intentional infliction of harm on the LLC or another member, or an intentional crime.

Elimination of Assumed Agency Status
A member of an LLC is no longer considered an agent of the LLC solely as a result of being a member.

Access to Books and Records
The provision regarding rights of members to inspect the books and records of an LLC has been revised to clarify the distinct rights held by members, disassociated members and transferees, and to permit LLCs to impose reasonable conditions and restrictions on access to information.

Authorized Signatories for State Filings
Documents to be filed with the Illinois Secretary of State may now be signed by any person authorized by the LLC, not just a manager or member, provided that both the name and title of the person signing are typed or printed where indicated on the applicable form. In addition, digital signatures will now be accepted by the Illinois Secretary of State.

Conversion and Domestication
Illinois now allows the conversion of a general partnership, limited partnership, business trust or corporation into an Illinois LLC, and vice versa. Prior to the changes to Illinois law, an entity other than a partnership could only convert to an Illinois LLC through a multi-step process involving a merger. Now, the converting entity simply files Articles of Conversion with the Illinois Secretary of State. The revised Act will also permit a foreign LLC to become an Illinois LLC through the filing of Articles of Domestication with the Illinois Secretary of State.

Please note that the summary above is not comprehensive, and is only intended to provide an overview of some of the significant changes to Illinois LLC law. Accordingly, we recommend that you consult with legal counsel to determine how the changes to Illinois law may affect your current Illinois LLCs or any Illinois LLCs that you may wish to form in the future.

An incentive plan is a tool used to motivate and reward employees to grow a business and exceed goals. A common form of an incentive plan for startups is an equity incentive plan. An equity incentive plan rewards key employees with equity, which is ownership in a company. Equity can be a company’s stock if it is a corporation or its membership interest if it is a limited liability company. For startups, equity incentive plans can be a great way to motivate and retain early employees when the company does not have the financial resources to pay high salaries or large bonuses.

The concept behind the equity incentive plan is that employees are given equity when the value of the company is relatively low (because the company is just getting started and not yet profitable), but as the company grows and becomes profitable, the value of the equity grows and the holders realize large financial gains. The two most common forms of equity incentive plans are restricted stock and stock options.

Restricted stock is exactly that, stock in the company that is restricted by the company in some form. The most common restriction is “vesting”. Vesting is the process where the employee gains ownership of the stock over a period of time, most often a number of years. Vesting protects the company because it incentivizes employees to stay with the company instead of leaving for a different job. Depending on the details in the plan documents, if an employee leaves before his or her restricted stock has fully vested, he or she forfeits some or all of the restricted stock. For example, a startup may give an early employee 50 units of restricted stock in the company as a bonus but with the restriction that the stock does not “vest” with the employee for three years. If the employee leaves one year later, the company retains the restricted stock because the employee did not complete the three-year vesting process.

Stock options are the right to buy a certain number of shares of stock in the company at a set price, regardless of the current value of the stock. For startups, stock options can be another great way to reward and incentivize key employees. Most stock option plans include a vesting period like the restricted stock discussed above. Once vested, stock options allow the holders to realize financial gains if the company’s value has increased since the stock options were granted. For example, if the current value of a share of stock for a company is $10, the company can grant a stock option to an employee to purchase 100 shares of company stock at that $10 value. Once the employee’s stock option has vested, he or she would have a set period of time in order to exercise the option. If during the employee’s option period the value of a share of stock rises to $20, the employee can use the stock option to purchase the allotted 100 shares of the stock at the $10 option value and create a $1000 gain based on the option price paid versus the current value of the stock.

Both restricted stock plans and stock options allow startups to reward employees without jeopardizing the current financial status of the company. With the expectation that the company will succeed and grow in value, equity incentive plans can be a great benefit to both the employee and the company.

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Ethan Zook writes:

As was alluded to in a prior blog post, one of the major changes that has been enacted through Pennsylvania’s Act 170 is the ability, through the operating agreement, to contractually vary fiduciary duties of members and managers in Pennsylvania limited liability companies.

What Fiduciary Duties?

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There are two major fiduciary duties to be aware of: the duty of care and the duty of loyalty. The fiduciary duty of loyalty is comprised of five subsections which can be summarized as follows:

  1. account to the company and hold as trustee for it any property, profit or benefit derived in the conduct or winding up of the company’s activities;
  2. do not use the company’s property for personal gain;
  3. do not appropriate a company opportunity for personal gain;
  4. refrain from engaging in self-dealing with the company; and
  5. refrain from competing with the company in the conduct of the company’s activities and affairs.

The duty of care is to refrain from engaging in gross negligence, recklessness, willful misconduct or knowing violation of law. Lastly, there is an obligation of good faith and fair dealing to be aware of, however, it is not a fiduciary duty.  Rather, it is treated as a contractual obligation, and as will be discussed, can be contractually altered by the operating agreement.

A member of a member-managed limited liability company owes to the company and the other members the fiduciary duties of loyalty and care. Managers of manager-managed limited liability companies owe to the company and the members those same duties.

Contracting Around Fiduciary Duties

The Act gives tremendous deference to the operating agreement, the main governing document for Pennsylvania limited liability companies.  If not manifestly unreasonable, the operating agreement may alter subsections 1), 2), and 4) of the duty of loyalty stated above.  Subsections 3) and 5) can be eliminated altogether.  Further, if not manifestly unreasonable, the operating agreement may also identify types of activities that do not violate the duty of loyalty, may freely alter the duty of care, and may prescribe the standards by with the performance of the contractual obligation of good faith and fair dealing is to be measured. Any other fiduciary duty can be altered or eliminated though the operating agreement, if not manifestly unreasonable.

Manifestly Unreasonable?

In any dispute regarding the reasonableness of the terms of the operating agreement, courts will decide whether those terms are manifestly unreasonable as a matter of law. That determination will be made as of the time the challenged term became part of the operating agreement by considering circumstances existing only at such time. This does not shed much light on what will be considered manifestly unreasonable under the terms of the Act. Instead, for now, we are left with intuition in deciding what is manifestly unreasonable.

Despite the ambiguity surrounding “manifestly unreasonable”, the Act makes it clear what fiduciary duties can be altered and eliminated. With that, it has become more important than ever to review the operating agreements of investment, potential partner, and current parent and subsidiary companies to see how loyal that company has chosen to be to itself and its members.

Ethan Zook is an associate in the firm’s Corporate Department, resident in its Exton office.

Once you have made the decision to incorporate your business, and gone through the formation process, it can feel like your company is ready to take on the world. However, there is one important item that cannot be neglected: the minute book. A minute book is the living official record of a business and contains all of the important documents to reflect the business’ history.

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Maintaining organized records in a minute book is critical for any business.  For example, when a company seeks a new loan, raises funds via new investors, or becomes the target of an acquisition, it must undergo due diligence and produce its minutes to prove it has complied with both regulatory and its own self-governing documents such as its charter and bylaws.

The minute book begins with a business’ incorporation documents, including its articles of incorporation and bylaws (or articles of organization and operating agreement, if it’s an LLC). As time passes, and if the minute book is properly maintained, it will contain the documents that, among other things: authenticate compliance with governing documents via board and equity holder consents; confirm the company’s officers, directors and/or managers, who may resign or be replaced from time-to-time; and substantiate the capitalization of the company by memorializing changes in equity ownership.  Having a complete and current record streamlines any due diligence process and increases the company’s credibility from the very beginning.

Furthermore, the minute book will contain the “minutes” from the company’s annual and special board and equity holder meetings. The minutes are a written description of what took place at the meetings and serve to memorialize the actions taken by those in attendance during the meeting.  These records are valuable for preserving institutional memory, ensuring compliance with the company’s constitutional documents, and substantiating board or shareholder actions and processes if challenged later.

A corporation that commits to maintaining its minute book can save substantial time, money, and stress when it is called for review. On the other hand, neglecting to document the corporation’s history as it occurs can leave the company stuck trying to piece together years, if not decades, of information when the pressure is on to produce the records.

Pennsylvania legislation known as Act 170 (the “Act”), which went into effect earlier this week, represents a comprehensive revision to the existing laws of partnerships and limited liability companies.  The Act amends Pennsylvania law on corporations and unincorporated associations and adopts the Uniform Partnership Act, Uniform Limited Partnership Act and Uniform Limited Liability Company Act and is effective in two stages:

  • On February 21, 2017 for all entities that file on or after February 21, 2017; and
  • On April 1, 2017 for all existing entities unless such entities elect to be governed by the Act.

Below is an overview of some of the most significant changes to Pennsylvania laws governing business entities included in the Act.

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New Nonprofit and Benefit Entities

The Act authorizes nonprofit limited partnerships and limited liability companies and also creates benefit limited liability companies, companies that are intended to be operated and governed for the dual purpose of generating profit while also having a material positive impact on society or the environment. Pennsylvania is only the third state to authorize benefit limited liability companies, joining Maryland and Oregon.

Transfer of Interests and Governance Rights

Absent a provision in the partnership or operating agreement to the contrary, the only interest in a partnership or limited liability company that may be transferred is the partner or member’s Transferable Interest. The Transferable Interest is the financial interest in the entity that entitles the holder to receive distributions, but does not include any voting or management rights. A transfer of the Transferable Interest does not cause disassociation of the transferor and does not entitle the transferee to participate in the conduct of the company’s activities and affairs, to have access to records or other information, or compel or dictate the timing of distributions.

Charging Orders

Similar to the rights of a transferee, the sole method by which a judgment creditor can extract any value from a debtor’s interest in a partnership or limited liability company is by way of a charging order, which gives the creditor a lien on the debtor’s Transferable Interest in the entity. As discussed above, this only provides the creditor with the right to receive distributions and does not include any management rights. Additionally, the creditor’s right to distributions excludes “amounts constituting reasonable compensation for present or past service or payments made in the ordinary course of business under a bona fide retirement plan or other benefits program.”  If the charging order does not satisfy the creditor’s judgment in full, the creditor may foreclose on the debtor’s interest, but a purchaser at a foreclosure sale will not become a partner or member and will only obtain the Transferable Interest. The exception to the foregoing is in a single member limited liability company, in which case the purchaser obtains the debtor’s entire interest, the debtor is disassociated as a member, and the purchaser becomes a member with full governance rights.

Full Shield Protection for Partners

The existing law on partnerships was amended to replace the former ‘partial shield’ protection for partners and replace it with ‘full shield’ protection by removing language that implied that a partner in a limited liability partnership or limited liability limited partnership could be liable for any act of a person under the supervision and control of the partner even if the partner had no responsibility to supervise or control the act giving rise to the liability.  As a result of the revised language, partners are now only liable for their own negligence or wrongful acts.

Elimination or Alteration of Fiduciary Duties

The Act also includes significant changes with respect to the ability of partners or members to eliminate or alter certain fiduciary duties through careful drafting of the operating or partnership agreement. This topic will be discussed in more detail in a follow-up post.

Ethan Zook writes:

Business Taxation
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Starting a business can be both exciting and stressful for any new entrepreneur, and perhaps nothing adds more initial stress than the word “taxes.”  Understanding how a business will be taxed is among the many considerations entrepreneurs need to keep in mind when choosing a type of business entity for their company.  Below is a basic overview of the types of business entities typically used by entrepreneurs and a brief discussion of related tax considerations that entrepreneurs should keep in mind.

  • Sole Proprietorships: A sole proprietorship is an unincorporated business owned by one owner who is referred to as a “sole proprietor.”  A sole proprietor reports income or losses from the business on his or her personal tax return and the business itself is not taxed.  Because income and losses pass through the business to the owner without being taxed at an entity level, this type of tax structure is often called “pass-through taxation.”
  • Partnerships: A partnership is generally defined as an association of two or more persons to carry on as co-owners of a business.  Much like sole proprietorships, partnerships experience pass-through taxation whereby the owners report income or losses from the business directly on their personal income tax returns, often based on each owner’s percentage of ownership in the business.  Unlike sole proprietorships, however, a partnership must file an information return, known as a Form 1065, which lets the government know about its annual income or losses.
  • Corporations: Corporations are formed under state law and are generally subject to what is commonly referred to as “double-taxation.”  Double taxation is effectively the opposite of pass-through taxation and requires that both the entity and its shareholders pay tax on each dollar of income.  For example, if a corporation reports positive earnings in any given year, it will generally be required to pay taxes on those earnings at the entity level.  In turn, when the corporation distributes some or all of those earnings to its shareholders, they must report those amounts on their personal tax returns and pay taxes on those amounts.  However, if a corporation meets certain criteria relating to, among other things, the type of stock it issues to its shareholders and the number and type of shareholders it maintains, it may elect to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code.  A corporation that makes this election is known as an “S Corporation.”  S Corporations have the benefit of avoiding double-taxation and are taxed on a pass-through basis, whereby any earnings at the entity level are passed through to the individual shareholders, much like partnerships.
  • Limited Liability Companies (LLCs): For tax purposes, LLCs are perhaps the most versatile form of entity.  LLCs are formed under state law and are owned by “members.”  In cases where an LLC has only one member and unless the member elects otherwise, the LLC will be treated as a “disregarded entity,” meaning that the LLC will be disregarded for tax purposes and any income or losses of the LLC will be passed through to the members who then pay taxes on those amounts, much like a sole proprietorship.  If there are two or more members of an LLC, the LLC and its members have the ability to elect whether the LLC will be taxed as a partnership or even as a corporation.  LLCs having at least two members will typically elect to be taxed as partnership and receive the benefit of pass-through taxation.  Why would an LLC elect to be treated as a corporation and subject itself and its members to double taxation for tax purposes?  There are many reasons, but this election is often seen in cases where an LLC desires to keep a significant amount of retained earnings in the LLC.

Please note that the above is a general summary of federal tax considerations for an entrepreneur to consider when choosing an entity.  State tax considerations, along with other topics such as protection from individual liability and ease of administration, should also play an  important role in making this decision.  It is crucial that an entrepreneur have a general understanding of the types of entities available and their tax treatment so that he or she can work more effectively with legal and financial advisors to make informed decisions.

For more information, visit the IRS Choosing a Business Structure page and their Limited Liability Company (LLC) page for small businesses and self-employed individuals.

Ethan Zook is an associate in the firm’s Corporate Department, resident in the Exton, PA office.

Philadelphia Magazine just published an article I wrote examining common legal issues for startups. In it, I provide a checklist for founders looking to establish their businesses while minimizing or avoiding common legal headaches later on. Here’s an excerpt:

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Startup founders make countless decisions about their businesses. Here’s a list of 10 legal issues that can make-or-break their businesses:

1. Choice of Entity. Although many factors go into determining whether to form a startup as a corporation or an LLC, two important factors are the startup’s funding and hiring plans. A startup will typically form as a corporation if founders expect to raise venture capital (generally $1 million or more), as VC firms often prefer to invest in a corporation to avoid the pass-through profits and losses of the LLC being attributable to the individual partners of the VC firm. Further, if founders intend to incentivize employees through the issuance of stock options, a startup will typically form as a corporation, as a stock option plan of a corporation is typically less expensive to put in place and easier to administer than a profits interest plan of an LLC.

To continue reading, please visit the full article on the Philadelphia Magazine website.

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Copyright: tang90246 / 123RF Stock Photo

Are you currently working with your attorney or accountant to form a new business entity or make other important business filings in Delaware in the near future?  Are you closing a merger or acquisition involving Delaware business entities over the next week or two?  If so, be advised that the Delaware Secretary of State’s office will replace its current Delaware Corporation Information System (DCIS) with a new computer system during the upcoming Labor Day weekend.

As part of this upgrade process, the DCIS will be unavailable for a total of 4 days beginning on Thursday, September 3, 2015, at 4:30 p.m. EST.  All web services, including corporate and UCC filings, document retrievals, and business searches, will be unavailable during this 4 day period.  All priority submissions must be received by the state by 12:00 p.m. EST on September 3rd.

The Delaware Secretary of State’s office is treating the outage as an “extraordinary event” for corporate filings, meaning that documents received during this period will be not be processed until the office reopens on September 8th but will retain the original filing date.  However, be aware that this “extraordinary event” treatment will not apply to UCC filings.  The state will offer “emergency filing procedures” for a fee of $7,500, but even with this extra fee, you can expect delays processing these requests.

Here at Fox, we strongly encourage you to adjust any closings or other deadlines that may be affected by this system upgrade accordingly.  If you have UCC filings that are scheduled to lapse during the period beginning on September 3rd and ending on September 7th, you should continue them prior to the outage in order to ensure that your lien positions remain in place.

For more information about this upgrade, please visit the Delaware Division of Corporations website.