Module 9: Drafting Organizational Agreement

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Module 9 Drafting Organizational Agreement

• Part 1 Instructions

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Compu Devices Conversion

• GPgtgtgtCorporation
• No adverse tax issues.
• 351 tax-free exchange.
• Bob and Andrew contribute Pship interest for
  stock. Edward-
• Basis booster for A B.
• Sub S possibility.
• Flexible tax year.
• Fringe Benefits.

• GPgtgtgtgtLLC
• No adverse tax issues.
• Pship-Pship for tax purposes.
• No taxable gain or loss since business will
  continue.
• Bob and Andrew contribute Pship interest for
  stock. Edward-
• Basis booster for A B.
• Same calendar tax year.

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Compu Devices Contribution

• Compu Devices has annual revenues of 250,000,
  with operating expenses of 200,000 and
  partnership assets valued at 300,000.
• Proposed basis in the owners respective
  contribution is as follows
• Andrew's partnership interest has a basis of
  210,000.
• Bob's partnership interest has a basis of
  90,000.
• Edward's contribution of cash has a basis of
  125,000, if the entire amount is contributed as
  equity.

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Compu Devices Facts
Party Issue Solution
Andrew -No add. Contribution -Patent protection Debt veto, opt out, preemptive rt. License vs assignment
-Salary -Control Fringe benefits, bonus Veto power, majority
Bob -No add. Contribution -Patent protection Debt veto Shop right, ownership
-Salary -Control Fringe benefits, bonus Cumulative voting
Edward -Additional contribution -Assurance re profitability -Vote on major decisions low-cost debt, add. investors min. debt-equity Unanimous or supermajority vote
-Accelerate repayment-2d round -No dilution Special conditions Preemptive right

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Compu Devices- 351 Transfer
Party Contribution Tax Effect in Conversion
Andrew -Partnership interest (70) Tax-free exchange property for stock 210K basis rolls over to corp. unless challenge to value (5050)
-50K Personal L/C -30,000 CD (collateral) Recourse vs. Nonrecourse Bank approval to transfer Indemnification from company, if liable. Co. should substitute 30k CD with company assets.
Patents-License vs assignment License-K right to royalties, corp. deduct cost, No transfer Assignment-Tax-free, 250K basis

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Compu Devices- 351 Transfer
Party Contribution Tax Effect in Conversion
Bob -Partnership interest (30) Tax-free exchange property for stock 90K basis rolls over to corp. unless challenge to value (5050)
-Sweat equity (services) Signing bonus problem for control test and recognized income to Bob Contribute 10 property to avoid problem, (e.g. pship interest) Right to future profits tied to performance benchmarks.
IP (RD) Work in progressvery hard to value. Should wait until completed e.g., 2nd round. Who owns it? .e.g. Work for hire

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Compu Devices- 351 Transfer
Party Contribution Tax Effect in Conversion
Edward -125,000 cash, less amount construed as debt. Tax-free exchange property for stock Basis equals amount of cash as equity.
-Debt No assumed shareholder debt Terms of repayment, Collateral
Additional contributions No assumed shareholder debt convertible debt to protect vs. dilution and allow more control during second round.

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Compu Devices

• Triggers
• - Death
• - Employment Termination
• - Expulsion
• - Disability
• - Bankruptcy, Divorce
• - Voluntary Stock Exit

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Compu Devices

• Triggers
• - Death Important for Andrew Bob via
  insurance.
• - Employment Termination Definitely for
  Andrew Installment, perhaps wrapped with owner
  deferred compensation.
• - Expulsion Tough with only three.
  Require other two vote. Payout same as
  employment termination.
• - Disability Same as employment
  termination. Confidentiality
• - Bankruptcy, Divorce Yes for Bob, given
  interest of the wife in participation.
• - Voluntary Stock Exit Min. vesting period.
  Impact on employment remains. Staged exit
  program-installments.

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Exercise

• Step 1 Answer CWB Question ? Identify 10 issues
  checklist related to client that need to be
  addressed for an Operating Agreement OR a
  Shareholder Agreement.
• Use General Private facts to prioritize the
  issues.
• Use form document to ensure basic coverage.
• Check applicable CA statute re provisions.
• Keep a copy to share with team member.

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Negotiation Strategy

• Step 2 Meet with group, identify client, select
  team member, and select a team leader (who will
  summarize major points in BBS, keep track of
  attendance and advise of any issues)
• Divide up issues with team member.
• Create one checklist of critical issues.

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Negotiation Strategy

• Step 3 Meet with team member to agree upon
  issues, select opening position, negotiating
  points strategy, bottom line.
• Identify top 3-5 critical issues to focus on for
  negotiation.
• Divide up issues with team member.
• Identify opening position, negotiating strategy,
  and bottom line for each issue.
• Each team send via email to PJ bottom line.

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Negotiation

• Step 4 Meet with group to agree upon the
  critical issues for the negotiation and who will
  negotiating with whom.
• Goal is to achieve bottom line for each issue.
• Identify issues where likely consensus.
• Break into subgroups for the negotiation.
• Try not to negotiate with team member but divide
  up issues and negotiate simultaneously.

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Drafting Templates

• Step 5 Meet with group to select template for
  drafting the agreement and assign who drafts
  what sections. Work on draft.
• Rely upon forms in CWB or linked from website.
• Persons who negotiated sections should oversee
  drafting of those sections.
• Document should not exceed 12 pp., 1 1/2 lines
  spacing, double between sections with subject
  headings.
• Include Id no. and client for each group member.
• Dont include any term you dont understand

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Portfolio

• Step 6 Circulate document among members for
  comment. Reconcile any issues.
• Turn in one document that everyone will sign.
• Everyone in the group will receive one grade.
• PJ will give you comments on work.

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Portfolio

• Step 7 Take feedback and revise agreement.
  
• Make any modifications as a result of feedback
  from professor.

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Module 9 Drafting Organizational Agreement

• Part 2 Drafting Tips

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Purpose of Written Agreement

• 1) Establishes meeting of the minds re ownership,
  control, exit, and operation.
• 2) Ensure compliance with IRC, state and federal
  regulation.
• 3) Provide a process for resolving future issues,
  disputes, disposition.
• 4) Protect interests of the parties.

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Drafting Tips

1. Use forms solely as a guide.
2. Use simple language.
3. Recognize the preexisting partnership.
4. Anticipate the need for a second round.
5. Include contingency for additional contributions.
6. Value equity interests
7. Confidentiality is key for IP.
8. Keep management structure simple.

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Operating Agreement-Use Checklist

• Definitions-Narrow or broad scope, Essential
  terms
• Formation-Purpose, term, Additional Members
• Capitalization-Contributions, Caps, Loans,
  Liability
• Allocation of Profits Losses -Adjustment in
  Capital accounts
• Distributions- Profits and losses, Retention
• Administration -Management, Control, Duties
  Taxes
• Transfers -Notices, Consents, Effect (Buy-sell)
• Dissolution Liquidations Triggers and Events,
  Winding up
• Liability Indemnification Limits, Conditions,
  Contributions
• General Provisions- Meetings, Notices,
  Amendments, Remedies, Choice of Law

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California LLCs

• Interest for future services okay.
• No professional LLCs.
• Disassociation need not trigger a dissolution.
• Minimum Franchise Tax.
• Default taxed as partnership.

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Shareholder Agreement-Use Checklist

• Definitions recitals- Check statute to conform.
• Shares at issue- Name, class, no. shares.
• Capitalization-Contributions, Caps, Loans,
  Liability
• Disclosures-Legal counsel, record owners,
  indemnity for wrongful disposition.
• Buy-Sell provisions- Triggers, formula for
  valuation, conditions.
• Administration -Management, Control, Duties
  (limits also)
• Qualifications, Special rights, Preferences
  Related to shares.
• Legends on Certificates- Restrictions or limits.
  
• Interested Transactions Approval, liability,
  process.
• Process for Approvals, Ratifications Self-Dealing
  Limits, Conditions, Contributions
• General Provisions- Meetings, Notices,
  Amendments, Remedies, Choice of Law

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California Close Corporation

• No interest for future services. ( 409)
• No. of shareholders capped at 35. (158)
• Close corporation w/o Board okay.(300)
• Delegation to management co. okay. (300)
• Change from close corp. if at least 50-2/3rd
  vote (300)
• Threshold for control is 50. (160)
• Restrictive rights must be in Articles. (204)
• Cumulative voting by directors in classes.
  (301.5)
• Removal of director with and without cause.
  (303-304)
• Self-dealing transactions-full disclosure of
  material facts and disinterest ratification.
  (310, 315) (No personal loans w/o shareholder
  approval)
• Redeemable shares (402)
• Employee stock option plans (408)

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Differences in LLC and Shareholder Agreement

• Conversion from GP to LLC and Corp Contribution
  of Services to Corp and satisfying the control
  test for a corp. that is not required for LLC
• Management- LLC- Managers and members allocated
  control to managers over some issues and members
  for fundamental Corp.-Board where you can assign
  committees, or provide veto power.
• Taxation of earnings Double tax (corp) vs
  pass-thru (LLC) No deferred or future contract
  rights.
• Exit strategy LLC-redemption is allocated to
  other persons per interest or agreement. Nothing
  called treasury since taxation upon receipt.
  Issue is whose money we use.
• Corp.-Redemption by corp and cancel, reissue,
  treasury shares Distribution to shareholders is
  considered a constructive dividend.

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Differences in LLC and Shareholder Agreement

• Fringe benefits LLC death and disability okay,
  but nothing like ESOP, Future rights.
• Gain on Distributions LLC Adjusted basis so
  less tax Capital gains okay for both.
• Funding buy-sell LLC-no retained earnings
  Corp.-more options re insurance and deferred
  compensation.
• Transferability-LLC restrictions limited to
  economic rights Corp.-freely transferable unless
  impose restrictions.
• Equity-Vote LLC can be disproportionate
  Corp-must follow equity interest.