Rimon Law Blog

Forming an LLC or a corporation is an important first step to achieving tax benefits and protection from liability.  In order to preserve these important benefits, however,  it is very important that your company is maintained properly. Otherwise, you run the risk that the separate nature of your company will be ignored by the IRS or a court of law.   While there is no substitution for the sound advice of experienced counsel, a few simple steps will help ensure that you reap the benefits of your LLC or corporation for as long as they exist. The minimum requirements for maintaining corporations and LLCs is that they must:  1) maintain adequate capitalization; 2) keep clean financial and legal records; and 3) be treated as separate and distinct from its owners.

Maintaining Adequate Capitalization

Maintaining adequate capitalization means that the company must be financially prepared to cover the risks it is taking.  If a company is a high-risk company that has high potential of being sued (for example, a hospital) then it is required to have enough money in its bank account to cover such an eventuality.  The existence of insurance is an important consideration, since a company that is insured can cover its capitalization requirement by having enough liquid assets to cover the insurance deductible if and when a claim is brought against it.

Keep Clean Financial and Legal Records

Keeping financial and legal records of a corporation or a limited liability company starts from the day it is formed.  The charter (Articles of Incorporation or Formation), the bylaws/operating agreement, and the organizational consents must be carefully drafted and understood by the owners, managers and directors of the company.  They must then be adequately signed and preserved in a corporate binder.  Then, for the entire lifespan of the company, the rules of these documents must be adhered to.  Such rules may include annual shareholder meetings with corresponding minutes and resolutions by the board of directors or shareholders whenever necessary.  As a rule of thumb, whenever the company makes an important decision, it is prudent to make sure it is authorized by the appropriate parties, and properly documented.

Further, corporations and LLCs are legally required to keep and maintain clean financial records of the business, monitoring every dollar that comes in and out.  These formalities are often ignored by smaller companies where the shareholder(s), manager(s) and the director(s) are often the same people.  However, it is crucial that these formalities be observed. Otherwise the IRS or a court of law might find the company to be a mere shell and ignore it at the precise moment you wish to rely upon its liability or tax protections.  This is why both an accountant and a lawyer are important to maintaining a corporation or an LLC.

Keep Your Company Separate from its Owners

If your company maintains clean financial and legal records, you have mostly accomplished the last requirement of keeping your company separate from its owners .  However, you must also take careful measure to ensure that the owners do not mix their funds with those of the company. The owners’ personal expenses and the company’s expenses must be kept separate and distinct.  Further, the owners, managers and directors of the company must sign all of the company’s legal documents as representatives of the company and not in their individual capacities (i.e. as president of the company and not just by the individual personally).  Similarly any personal legal documents should not bear the name of the company.  If there is any confusion as to how an agreement should be framed, consult an attorney to avoid unnecessary future liabilities.

An LLC can be treated as an S-Corporation for tax purposes if it makes an S-Corporation election as long as the entity meets the IRS criteria to be taxed as an S-Corp, files an S-Corp election and gets approved by the IRS to be taxed as an S-Corporation. Without an S-Corporation election, single member LLCs default to be taxed as sole proprietors and a multi-member LLCs defaults to be taxes as partnership since they are considered “disregarded entities”. However, if a single or multiple member LLC agreement meets the IRS criteria to be classified as a small business corporation, the S-corporation election is filed and gets approved by the IRS, then for tax purposes, not legal purposes the entity is an S Corp not a LLC.

Many small business owners incorporate their businesses not only for legal protection, but also to reduce owners’ payroll taxes through S-Corp tax election with the IRS. One advantage of an S-Corp is that it gives business owners the ability to reduce their self employment taxes. Any small business owner who has not made an S-Corp election and uses Schedule C for their personal tax return for 2010 is subject to both employer and employee FICA and Medicare payroll taxes at 15.3% up to $106,800, 2.9% Medicare for Schedule C net income greater than $106,800, and California SDI for 1.1% up to 93,316. If a business owner pays himself/herself a “reasonable salary”, the rest of the net income is not subject to these payroll taxes.

Dow Jones VentureSource is one of the most popular nationwide venture capital date reports in the United States. VentureSources published its latest data on the development of venture capital investments in the third quarter of 2009. Below are some overviews observed by VentureSource.

- With 616 venture deals and $5.1 billion invested, Q3 is a 6% drop over Q2;
- IT investment barely outpaces health care;
- Web2.0 investments surpassed the software sector for first time on record;
- Medical device investments nearly match biopharmaceuticals;
- Corporations investing instead of acquiring, commitments to VC-backed firms surpasses 2008 total;
- $5 million median deal size on par with Q1&Q2, but still lowest since 1999.

It is undeniable that the investments and fundraising by venture capitalists remained at low levels in 3Q’2009, but there is room for optimism as the economy is picking up slowly and Nasdaq continued to improve. In addition, with regard to the largest U.S. deals overall in 3Q’2009, eight deals are conducted in California, such as Facebook, Tesla Motors, and Pacific Biosciences of California, etc.

The United States Court of Appeals for the Second Circuit, in a September 10, 2009 ruling, held that an employer can be held liable for discriminatory hiring decisions made by its independent contractors. The case involved an independent contractor acting on behalf of the employer, telling the plaintiff that “they were looking for someone younger”.

The Second Circuit ruled that, even if the hiring decision is made by the authorized independent contractor, the employer was still responsible for the discriminatory hiring decision by the independent contractors. In a worse scenario, even if the independent contractor does not have the actual authority but the applicant thought that it did (“apparent authority” in legal terms), the employer is still liable.

Considering the harsh economy and fewer job opportunities these days, employers should be more cautious since the job applicant is more inclined to sue if he/she cannot get the job. Employers should avoid asking job applicant questions such as race, religion, national origin, gender and age, etc during the interview process; when entering into the independent contractor contract, it is a good idea to add an indemnification clause asking the independent contractor to indemnify the employer for any liability arising from the hiring process conducted by the independent contractor.

Lots of young entrepreneurs in Silicon Valley these days hope to begin their business, let people know their companies, and furthermore, draw the attention of venture capitalists, who will devote money to their new enterprise.

Something that an entrepreneur must keep in mind is something that he must give up to VCs when getting money from them – most commonly stock of the new company. Generally, a venture capitalist asks for “preferred stock” from the entrepreneurs; the owner of preferred stock enjoys shareholder rights superior to the shareholders of common shares.

Most types of preferred stock are designed to convert into common stock (for example, one share of preferred stock converts into five shares of common stock), either at the discretion of the investors (voluntary conversion) or when some preset threshold is reached (automatic conversion, for example, in a public offering scenario). Thus, the conversion condition, time of conversion (voluntary or involuntary), and the conversion rate, is always one of the most fiercely argued clauses in the investment negotiations between VCs and entrepreneurs.

Of course, another major issue to consider before seeking venture capital is the loss of control of your company. When VCs invest, they want to make sure their investments are secure, so they often require a seat on the board of directors and certain voting rights. This means an entrepreneur effectively has a new boss. This can be a good thing since VCs often add experience and credibility to the company. However, this often causes power struggles between the entrepreneur and the venture capitalists.

Clean Tech is generally considered to include multiple advanced technologies in four economic sectors: energy, waste, materials, and transportation. These technologies break down in categories such as energy generation and storage, water and wastewater, air and environment, etc. There is no clear-cut definition for a “Clean-Tech” Company, but as shown by its name, a clean-tech company should be a company equipping its core business with clean technology. As a related concept, Clean-tech Law contemplates a diverse set of legal issues related to the commercialization of clean technology, and the more traditional legal areas of clean technology law include intellectual property, patent law, licensing, litigation, and federal state legislative and regulatory issues.
According to reports prepared by Cleantech Group, compared to other industry sectors, clean tech now draws the most venture investments of any sector, recently surpassing software or biotechnology. However, since maintaining a healthy cash flow is one of the primary concerns of almost every company, and the venture investments in the clean technology industry sectors have fallen sharply in recent days, finding an alternative fund raising channel is vital to the survival of technology companies.
Media reports have now described Washington as the new driver of clean tech company growth. Obama’s energy plan calls for a $150 billion investment in clean technologies for over 10 years, aggressive targets for greenhouse emission reductions, and programs to promote energy efficiency, low-carbon biofuels, and renewable energies. Applications for government funds made available by the recent American Recovery and Reinvestment Act.

As an alternative form of fund raising, applying for federal government grants might be a good choice for many clean tech companies nowadays, especially when the other channels of fund raising, such as venture investment and bank loans, is difficul to obtain. While the business plan submitted to the venture capitalists or bank is money-making oriented, government funding application should focus on the environmental impact of the technology development by the clean tech companies. It is not an easy task; it is a great challenge requiring a new kind of brain-storming by the management of clean tech companies and consultation with experts on clean tech law and policy.