You can protect the value of your privately-held company by working with your lawyer to make strategic business and legal decisions and by ensuring that your legal documents are consistent in implementing those decisions. Many privately held companies face similar legal issues and all can benefit from developing a legal plan to help protect company assets, both tangible and intangible. Use the following information as a roadmap when considering your company's legal issues and driving your company's business plan.
Your company's legal structure provides the framework for conducting your business operations. It is critically important that you take into account your long-range business, legal and tax planning goals when developing your company's legal structure. Three primary choices for your company's legal structure include: (1) limited liability company/tax partnership; (2) corporation/ tax C corporation; and (3) corporation/ tax S corporation. Each alternative offers advantages, which you should consider in light of your long-term business strategy. In certain circumstances, a mature company may change its company structure in order to take advantage of benefits provided by the new structure.
PROTECTING COMPANY INTANGIBLE ASSETS
You and your executive team can protect your company's intangible assets through a combination of legal contracts and protective filings. You may choose to protect intellectual property through patent, trademark and copyright filings. You will often need to protect your company's intellectual property through protective contract provisions in license agreements and other customer or vendor agreements. Contracts with your employees also provide important safeguards, including noncompetition agreements, confidentiality provisions and assignment of invention agreements, to assist in preserving company value.
RAISING CAPITAL FOR GROWTH INITIATIVES
Growth oriented companies often look to private equity groups for additional investment. Legal documentation defines the investors' rights and shields the company from exposure. You may need to amend your company's operating agreement or corporate by-laws to define the new investors' economic rights. The operating agreement or shareholder agreement may provide contract rights that limit transfers of any new stock or securities that are issued in connection with the investment. Your company may need to issue a private placement memorandum and subscription agreement in order to comply with applicable securities laws and regulations and to protect your company from potential securities related claims.
Several common investment structures for a private investment include preferred stock or units, common stock or units, participating preferred stock or units, convertible promissory notes and warrants (options to acquire stock or units in the future for a defined exercise price). Common issues that arise in the course of investor negotiations include investor rights in company governance (e.g., board seat, veto rights over certain defined actions and voting rights), future equity dilution if new investors or key employees are issued equity, future adjustments to investor equity based on post-investment performance, and staged investment structures (i.e., the investors contribute additional post-closing funds as goals are achieved).
You can use an employee incentive equity or compensation plan as a tool to protect the value that key employees provide to your business. Equity plans can include sales or grants of stock or units, options to acquire equity in the future and specially tailored cash bonus plans. Some cash bonus plans may provide special payouts on the successful sale of a company, which provides management a powerful incentive to remain with a company through the completion of a transaction. Vesting provisions help protect a company from risk that it will have to make a payment if the employee chooses to follow another opportunity or does not satisfy performance goals.
One frequently used tool to incentivize a key employee is a profits interest. A profits interest is normally attractive to an employee because, if structured properly, the employee is not taxed at the time of grant and future payments on exit can qualify for capital gain treatment if the company is sold at a profit. Meanwhile, if a company does not increase in value or produce operating profits after the grant, its pre-existing owners will not experience economic dilution.
CORPORATE GOVERNANCE AND SHAREHOLDER AGREEMENTS
Executives and owners should periodically review your company's operating agreement, By-Laws and any applicable shareholder agreements to ensure that your company's and its stakeholders' interests are properly governed in light of current events, business strategies and legal developments. Operating and shareholder agreements often provide rules that limit or prohibit shareholders from transferring equity to certain parties, provide options or requirements that a company purchase equity from the owners in certain circumstances, such as termination of employment, death, disability, or bankruptcy, and require a company to make cash distributions to shareholders or partners if a company is a tax flow-through entity.
Defending and/or settling disputes with third parties in a cost efficient manner, potentially including former employees or governmental regulatory agencies, directly protects your company's cash resources as well as its (and your) reputation. Creating an employee handbook with appropriate legal provisions can reduce the probability and impact of litigation with former employees.
OTHER KEY CONTRACTS
Other key contracts often include finance-related contracts with lenders (e.g., promissory notes, security agreements, inter-creditor agreement, etc.), lease agreements with landlords, and key vendor and customer agreements. Contract terms must protect company access to critical assets and resources.
Companies that are poised for growth often accelerate their growth process through acquisitions of smaller companies that will add a critical market segment, technology or other component to the business. Legal due diligence and review of the target company's contracts and legal rights (including the strength of intellectual property protection) helps the acquirer measure the value of the target's business. Legal negotiation and documents play a key role in accomplishing the acquisition, including preparing and negotiating a letter of intent, drafting and negotiating the purchase contract and designing contracts with key employees of the target company.
A privately-held company's likely exit strategy should influence all of its legal decisions. Common exits include a sale to a strategic or financial buyer, management buyout, partial sale through a company recapitalization transaction, transfer to a family member or members, initial public offering and sale to an ESOP (employee stock ownership plan).
Your privately-held company's executive team can use strategic legal planning to maximize and protect the value of your company's tangible and intangible assets and to support your company's overall business strategy.
Originally published in THE BUSINESS GUIDE
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.