TAKING INVESTMENTS FROM Friends & Family

Seeking initial company funding through friends and family is a popular strategy. You need startup cash and you're cool handing over some company shares to a willing investor - sounds easy! However, many founders are unaware that raising money in this fashion implicates Federal Securities Regulations under the Securities and Exchange Commission (SEC), or how to comply with those rules. That's a mouthful, but here are some basics: 

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SECURITY REGISTRATION

Generally, taking a cash investment in exchange for equity in your company creates a security, which must either be registered with the SEC or qualify under one of the exemptions to registration. Security registration can be a long and expensive process, so most start-ups seek to fall under an exemption when raising money. 

 

COMMON EXEMPTIONS

One common exemption is to raise capital from an accredited investor, which include individuals with a net worth of over $1 million or an annual income greater than $200K. So if your investor meets this criteria, a security registration may not be necessary. Other exemptions are also available, including for investors who are actively involved in the operations of the company. However, even when using these exemptions, official forms may need to be filed with the SEC. 

So, whenever you take an investment or give someone equity in your company, you should always consult with an attorney to ensure you structure the investment properly and are in compliance with all regulations. 

 

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This blog is for informational purposes only and should not be relied upon as legal advice. 

Should You Incorporate in California or Delaware?

The corporate laws of your state of incorporation will govern your internal business operations. You do not need to incorporate in California just because that's where your business is located. Indeed, many publicly traded U.S. companies, regardless of location, are Delaware corporations. There are many good reasons why businesses chose Delaware law. That does not necessarily mean that Delaware is right for you. 

Why is Delaware So Popular? 

More than 65% of Fortune 500 companies are incorporated in Delaware. But, why?

Delaware's Court of Chancery was established in 1792. Having such a long history, Delaware General Corporations Law (DGCL) is built on an enormous body of case law covering expansive corporate issues. This makes Delaware corporate laws deeply sophisticated and relatively predictable.

Although Delaware's business incorporation fees are lower than most other states, the large quantity of business filings make them the state's 2nd largest source of revenue. Recognizing this economic importance, Delaware legislatures stay on top of modern corporation and tax laws and regularly adjust their statutes to accommodate business trends. 

Benefits of Delaware Corporate Law

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  • In-depth consideration of corporate issues. 
  • Highly experienced business judges.  
  • Expedient and well-reasoned opinions. 
  • Predictable legal outcomes. 
  • More flexibility for corporate management. 
  • Protection for management's decisions. 
  • Protection for owner's personal assets. 
  • Preferred by venture capital investors. 

 

So, Why Incorporate in California? 

For small business owners located in California, incorporating in Delaware—or any foreign jurisdiction—has drawbacks that may outweigh the advantages. You will still need to register in California regardless of where you incorporate. California based corporations incorporated in a foreign jurisdiction are still required to pay California franchise tax, so there may be more of a tax burden than a benefit. Further, you will need to keep up with regular filings in both states. 

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If an out-of-state corporation is located in California,  the California Corporations code may still enforce California law in some circumstances..

Fortunately, California has replicated much of the DGCL, bringing many of the benefits of Delaware registration to the West.

Picking the right state for your entity is an important step in forming a business. Consult with an experienced attorney to ensure you make the right choice for your venture. 

 

 

 


This blog is for informational purposes only and is not legal advice. 

Using work-for-hire agreements with independent contractors

Businesses commonly engage consultants, freelancers, or independent contractors to produce proprietary content for their business -- also known as intellectual property. This can include logos, branding, copy, websites, coding, inventions, trade secrets, and other protectable content. 

Generally, businesses are not required to offer independent contractors the same rights and benefits that apply to employees, such as minimum wage, overtime pay, and insurance.  

However, unbeknownst to many entrepreneurs and small business owners, if you engage in a “work-for-hire” agreement that grants you or your business all ownership rights to content created by a contractor, a California law requires you to treat that individual as an employee for certain purposes. 

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These statutory "employees” are entitled to both workers compensation and unemployment insurance pursuant to California Labor Code, Section 3351.5(c) and 621(d) and 686 of the California Unemployment Insurance Code. However, there are work-arounds that allow business owners to take full ownership to contractor created content without creating an employee relationship through the creation of an "assignment" agreement.

We recommend you check out your agreements with your workers and make sure you are using the right language for your circumstances. 



Have questions regarding your compliance or rights under work-for-hire agreements?
 

Protect Your Confidential Information with an NDA

Entrepreneurs often need to share confidential information about their business. This may happen when you are forming a new business partnership, outsourcing projects, hiring new employees, or seeking outside funding.

Confidential information can include business strategies, financials, customer or vendor lists, trade secrets, unpublished patent applications, or any other information you want to keep private. 

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It is important to protect your business’s sensitive information before it is shared with others. To do this, you may want to use a non-disclosure agreement (NDA) to ensure that the party receiving your confidential information is obligated to respect your confidence and not use the information without your permission. 

Among other terms, an NDA should identify the person(s) to whom information may be disclosed, what information is considered "confidential," and the restrictions on the use of the information. The clearer these terms are the better.

NDAs can be unilateral/one-sided agreements for situations where only one side is sharing confidential information. Or, they may be mutual, for situations in which both sides intend to share sensitive information.

However, in some instances it can be challenging to get the receiving party to sign an NDA, and NDAs can be challenging to enforce if they are too broad or vague or if the infringement is unclear. We always recommend working with legal counsel to prepare a proper NDA and advise on the best way to protect your confidential information.

Switching entities for funding

Should you start off as an LLC and switch to a C-Corporation for funding?

Some new businesses intend to seek venture capital or eventually desire to become a publicly held company. Generally, venture capital investors will only invest in corporations, not LLCs, and public companies must be in the form of a C-corporation. However, this does not necessarily mean that you must start your business off as a corporation, as there are some downsides. 

C-corporations are required to hold board meetings, keep minutes, and are subject to double taxation. If you register your corporation in Delaware but are conducting business in California, you will be subject to taxes in two states. While this may be the preferred structure for businesses that need venture funding early-on, for other businesses with less immediate funding needs, this may unnecessarily burden your growth. Becoming a C-corporation too early can divert the founders’ time and resources when the main focus should be on growing the business.

Therefore, entrepreneurs may want to consider forming an LLC or other entity and only switch when the business requires outside investment to scale. At that point, you can perform a statutory conversion. California has streamlined this process for LLCs by allowing conversion to a corporation mainly by filing a single document with the Secretary of State. However, note that other steps may be necessary to line up your LLC's affairs with the new business structure, which can be burdensome depending on your level of activity. 

While this may not be the best approach for every venture, for some it can help facilitate growth in the short term with the flexibility to expand in the future. It is always best to consult with an attorney and an accountant early on to discuss your individual goals and the best long-term strategy for your business. 

 

Need help? Schedule a free consultation.

 

 

This blog is for informational purposes only and is not legal advice.