Category Archives: Business Law

Joining Stamford Law Practice – Martin LLP

Hello blog readers. Time to publicly announce my next stop on the professional journey, hopefully a long and fruitful one:

I am joining Martin LLP as a partner in their corporate practice.

Located in Stamford, CT, Martin is a bit of an anomaly in the legal field – so I may fit right in - as a smaller firm, headquartered outside of New York City, yet with a strong and sophisticated client base. As they say on their website (martinllp.net), Martin represents a wide spectrum of clients in the corporate arena, including growth companies, start-up companies, private equity, venture capital and other investment firms, families and individuals. They also have tax, ERISA, real estate and litigation attorneys to round out their practice.

Although I am not officially transferring my practice for a full four weeks ahead, on April 22, 2014, I expect that my blog posts here may be winding down as I wrap up, ramp up and continue to serve clients in the meantime. Feel free to contact me for more information, and I will post my new address, phone and email here once it is available. Thanks again for your support as readers, clients and friends!

-Anne Marie

 

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Outside General Counsel Arrangements: Is 2014 the Year?

shutterstock_168666830

An out-of-the-box New Year’s Resolution: engaging outside General Counsel.

Is 2014 the year?

If you have ever worked for a company or organization with a General Counsel, you know the positive results that an effective one can bring. Successful General Counsels (GCs) not only offer legal advice but also give helpful business input based on their experience structuring relationships and transactions. If your company or organization has grown to the level that it would benefit from ongoing legal advice but you cannot afford a full-time, internal GC, this may be the year to consider an outside general counsel arrangement.

For a corporate-minded, outside GC, here are examples of matters that could be included in the arrangement:

- Review of contract provisions with your business partners.

- Advice on corporate and website/social media policies, corporate governance matters, board of directors policy and practice.

- Routine filings as requested.

- Consultation on employment issues and review of associated agreements.

- Review of subpoenas, summonses, complaints, or claims served upon you and advising you on the same; advise regarding potential legal actions you may contemplate taking. (This is where the phrase “I’ll call my lawyer” originated.)

- Consultation on purchase or sale of business assets or real estate, negotiating and reviewing the same.

Outside GCs can be hired on a retainer arrangement, whereby you engage the attorney for some amount of time each month (for example) for a flat fee, which can prove economical than an hourly rate. Additional work, as needed, can be provided as and when agreed.

Think of all the times in the life of your business that you have said, “I wish I had a lawyer to look at this.” If there have been enough of those times in the past year, it may be that you have reached a tipping point: a level of growth that should be applauded and corporate responsibility that should be reviewed. This is not a short-term investment; it is an intelligent one for a business or organization that intends to stay current and compliant over the long term.

Law Office of Anne Marie Segal is located in Stamford, Connecticut, provides legal counsel to businesses and individuals in Connecticut and New York and advises select national and international clients. Please visit www.amscounsel.com for more information.

None of the information posted on this site constitutes legal advice or forms an attorney-client relationship, and there may be facts not discussed here that are relevant to your situation. This is a public forum. Please do not post confidential or fact-specific information regarding your legal questions on this site.

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Section 83(b) Election for StartUp Founders

So they don’t get hit with a tax crunch that could be entirely avoided with timely planning, founders of U.S. startups should be aware of Section 83(b) of the Internal Revenue Code. Here’s a post about what Section 83(b) does, when it should be elected and why it is important.

Corporate founders generally enter restricted stock purchase agreements that provide for their stock to vest over a number of years. Under a vesting schedule, the company has the right to repurchase any unvested stock at cost upon the founder’s separation from the company. The right to repurchase generally lasts for a period of three to five years, provided that the founder continues to provide services to the company.

One common arrangement is a four-year vesting period with a one year cliff. In this case, at the end of the first year a founder would receive 1/4 of the shares, and the remaining 3/4 vest monthly in equal portions over the remaining 36 months. However, founders can mix and match such grants to reflect each founder’s relative investment in and importance to the organization.

Whether it is a “four year with one year cliff” arrangement or another milestone or time-based vesting trigger, restricted stock keeps the founders engaged and involved, since they do not acquire certain rights in the stock, such as the right to sell, until the stock vests. As a result of such vesting restrictions, the IRS views the acquisition of the stock for tax purposes as the date it is released from the restrictions.

shutterstock_161329046 (tax vice)

No/Minimal Tax Upon Purchase; Tax Upon Vesting

In a typical startup, the founder purchases “cheap stock” at a low fair market value, which minimizes taxes at stock issuance. A common pre-money valuation is, for example, five million shares at $0.001 per share (one tenth of a penny), with the founders contributing a total of $5,000.00 for the shares issued to them. This assumes that there is no need for a significant cash investment to fund operations.

Founders/employees then earn their equity over time in exchange for their longevity with and services to the company. When the stock is released from restrictions (i.e., becomes fully vested), there is a taxable event. At this point, if the company is successful, the value of company stock on a post-money valuation may have significantly increased. For example, those five million shares may later be worth $1.00 per share, for a total fair market value of $5,000,000.00. If the founders’ equity contributions were diluted by, for example, a Series A preferred stock round of $4,000,000.00, the total increase in value to the founders’ shares would be $995,000.00 (i.e., the then-current $1,000,000.00 value of the founders’ stock less their $5,000.00 initial investment).

If the founders’  restricted shares all vest as of a single $5,000,000.00 vesting date in the example above, taxes would be owed collectively by the founders on the full amount of $995,000.00. Of course, if the shares vest over time, the valuation of the company will fluctuate over time, resulting in an accounting headache. In either case, it is a potential tax nightmare. This may be true even if transfer restrictions (other than vesting) or market forces dictate that the founder cannot liquidate his or her shares.

What is an 83(b) Election?

To know what purpose Section 83(b) serves, you first need to understand Section 83(a) of the tax code. Under 83(a), if an individual receives property in exchange for services, he or she pays tax on the excess of the fair market value of the property over the purchase price. This makes sense in the context of a consultant, for example, who may be wholly or partially compensated in kind (i.e., other than cash) by means of a stock grant or discounted purchase price.

A founder who has to earn his or her shares over time is also treated by the IRS as a service provider under 83(a). In other words, if the ownership of the shares must be forfeited when the founder’s relationship to the startup terminates, the IRS views the shares as having been granted in exchange for services.

Section 83(a) does not impose an immediate tax. Instead, such grants of restricted shares are only taxed when they are no longer subject to “a substantial risk of forfeiture”.

Under 83(b), a special, one-time irrevocable tax election may be filed within 30 calendar days (with no exceptions) of the date of the initial stock grant with respect to shares that have a substantial risk of forfeiture. The founder or other service provider thereby elects to pay tax (if any) upfront on the difference between the fair market value at issuance and the purchase price. This difference, often called the “spread”, is usually at or close to zero.

Note that 83(b) elections are not applicable to stock grants that are unrestricted or in those special cases where the company has the right to buy back a founder’s shares at fair market value (rather than the purchase price).

In the absence of an 83(b) election for restricted stock, a founder is liable for taxes on the increase of any vested stock – the difference between the purchase price and the fair market value on the vesting date. If shares vest over a number of months, this means there is a taxable event in each month that shares vest, tied to the fair market value as of the vesting date. This is true even if the shareholder continues to hold the shares. In addition, the holding period for long term capital gains does not begin until the shares are vested.

By contrast, with an 83(b) election in place, the founder incurs no taxable income as the shares vest over time. Only capital gains tax (on the gain) would be payable upon sale, with a holding period commencing on the date of the stock issuance.

83(b) Not For Everyone in All Situations

Elections under Section 83(b) do not benefit all holders of restricted stock. For example, an employee in a mature startup may be issued restricted stock at a steeply discounted price and will likely not want to take an immediate tax hit on the spread between the market value of the stock and the discounted price paid. If the company then fails, a substantial tax was then paid for no actual benefit. Second, there are tax complications that can arise if some of the founders contribute property (such as IP) in addition to cash.

Timing of an 83(b) Election

83(b) elections must be made in the 30-day time period following the stock grant. The election should be mailed via certified mail to the IRS Service Center where an individual normally files his or her tax returns. There are a number of formalities that need to be followed, including reporting the election on an end-of-year return, that are outside the scope of this blog post.

Founders or others holding restricted stock should consult a tax advisor or business attorney to fully understand the pros and cons of unvested stock and the 83(b) election as well as the procedures for making one.

Law Office of Anne Marie Segal is located in Stamford, Connecticut, provides legal counsel to businesses and individuals in Connecticut and New York and advises select national and international clients. Please visit www.amscounsel.com for more information.

None of the information posted on this site constitutes legal advice or forms an attorney-client relationship, and there may be facts not discussed here that are relevant to your situation. This is a public forum. Please do not post confidential or fact-specific information regarding your legal questions on this site.

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Steve Jobs, Rules and Changing the World

In one of my LinkedIn groups, I was greeted today by a Steve Jobs quote:

The people who think they are
crazy enough to change the world,
are the ones who do. 
- Steve Jobs

True enough. Intrigued, I searched for a longer version. Here is what I found:

Here’s to the crazy ones, the misfits, the rebels, the troublemakers, the round pegs in the square holes… the ones who see things differently — they’re not fond of rules… You can quote them, disagree with them, glorify or vilify them, but the only thing you can’t do is ignore them because they change things… they push the human race forward, and while some may see them as the crazy ones, we see genius, because the ones who are crazy enough to think that they can change the world, are the ones who do. (emphasis added)

shutterstock_160729910 (look both ways)

I laughed inside when I saw the part about rules. Yes, Mr. Jobs, I appreciate your quote. Actually, I am one of the people who is crazy enough to think I can change the world (at least most days), yet as a lawyer much of my professional life is about rules and our relationship to rules.

So, Mr. Jobs (as if you could answer me), as someone who lives with and by rules and even writes rules in various contexts, am I not part of the club that can push the human race forward? In fact, can an attorney ever be? Or can we look at this another way? Can rules actually help the innovators, even the troublemakers?

Let’s start here: am I fond of rules? Yes and no. Rules offer safety. They give a clear set of expectations. At least when the rules are clear.

When my son was in the lower grades, he read No Rules for Michael along with others in his class, a book by Sylvia A. Rouss. The classroom then tried the same experiment as the one in the book, a day without rules. The book’s and my son’s class both learned the same lesson: without rules, everyone fights all the time, because rules help us relate to each other in a calm and orderly way. Yes, there needs to be a leader and followers, but without this structure, we often face chaos. Yes, this causes a conundrum for those who like to set their own rules, but as another popular quote makes clear:

Your rights end where my nose begins.

-versions of the above attributed to Abraham Lincoln and Oliver Wendell Holmes, among others

In summary, here’s my thought: rules have their place, but too many rules choke off creativity and innovation. So while I appreciate rules, I certainly don’t love them for the sake of rules. Regulation has its place, and what we should focus on as a society is not increasing the rules, but giving more thought to what we are trying to accomplish and how to write them so they are fair, targeted and easy to follow. Both in the schools and on the streets, as well as in the legislature.

Much of my job as a lawyer is figuring out what rules mean, how they apply to situations and what to do if there is no clear answer in a rule.

Much of my job as a lawyer involves figuring out what rules mean, how they apply to situations and what to do if there is no clear answer about where another person’s “nose begins”. In conversations with clients, I often use the stop sign example. It is easy to make rules about how to stop at a stop sign. You stop before a cross-walk, a certain number of feet behind the sign if there is no cross-walk, etc. It is relatively easy for the enforcer (police) to know whether someone follows those rules. Much more difficult is how to mandate complex reporting requirements, monitor compliance with contracts and other rules that do not lend themselves to a bright line analysis or easy monitoring.

Another important part of my work is to help individuals with private rule-making – what are the rules that govern relationships among private parties? These are the contracts and company policies that serve as rules for how we interact with each other. To some degree, we make up these rules as we go along. They are in some cases bound by public rules and in other cases open to interpretation and choice among the parties.

Rules, in fact, can move a society forward or hold us back, depending on the nature of the rule. The Civil Rights Movement in America, for example, was not a movement to get rid of rules that separated and subjugated some members of our society. It was instead a movement to make new rules ensuring equality. In the absence of new rules, nothing would have changed, because nothing would have compelled forward-thinking among those with outdated attitudes and beliefs.

As Thanksgiving approaches, I have been thinking about the laws (rules) in my life that I am most thankful for and those that have most changed the world. I plan to write a post later this month including some of them. I would love to have your input now or later on your thoughts about rules or if there are important rules that have touched your life.

This post is one in an occasional series about the interplay of legal practice and everyday life. Anne Marie Segal is admitted to practice law in New York and Connecticut and represents clients worldwide.

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