Serving on a board of directors of a non-profit entity(1) is an opportunity to improve your community and help others, but it comes with certain obligations.

Each non-profit entity, in general, must have a board of directors(2).  There must be at least one director, but the number can be changed as provided in the by-laws(3).  Directors are elected by the members of a company, and unless the by-laws specify otherwise, the director(s) has a one year term and can be re-elected for five successive one year terms(4).  If the by-laws provide, the directors can be broken into groups and have their terms “staggered”.  For example, there may be two directors elected for a one year term and three directors elected for a two year term.  Directors may be removed with or without cause by the members(5) or by a court decision that the director who is being removed has engaged in fraudulent conduct, grossly abused the position, or inflicted harm on the entity(6).  Directors are responsible for appointing and/or removing officers (7).

The Board of Directors have responsibilities.  Generally, unless the by-laws otherwise provide, the BOARD is vested with all authority to act on behalf of the entity, and all of the affairs of the entity are managed under the direction of, and subject to the oversight of the BOARD(8).  The officers only have such authority as allowed to them by the by-laws or resolution by the Board(9). Stated alternately, the Board is ultimately responsible for actions of the officers and actions of the entity.  Unless it is unreasonable to do so, the Board may rely on officers to perform those responsibilities assigned to them(10).  As to particular actions/votes on resolutions, every director is required to act: in good faith, in the best interests of the entity, based on the same care “…person in like circumstances would reasonably believe appropriate…”, and based on appropriate inquiry under the facts and circumstances of the matter under consideration(12).  In making their “inquiry” directors can rely on the representations and reports of officers, employees, lawyers and CPAs employed by the entity(13).

There is personal liability for directors(14).  Directors are liable if they receive an improper financial benefit from the entity.  This can be a transaction where the director has a direct or indirect interest.  There is no liability(15) if the transaction was “fair” at the time it was entered into, or if it was approved by the Board after the director’s interest in the transaction was disclosed and was approved by the Board WITHOUT the vote of the interested director(16).  A director will also be liable if they intentionally inflict harm on the entity.  This could arise from intentionally inflicting harm on the entity and/or intentionally withholding information from the Board(17).  Directors are personally liable if their actions violate criminal law, such as assault or embezzlement.

If you serve on the board of a non-profit entity and need assistance with, or review of, your by-laws, or if you would like further information about board operations and responsibilities, contact the Kreamer Law Firm, P.C. at 515-727-0900 or at www.kreamerlaw.com.

[1] This article will only address non-profit corporations. Trust operate somewhat differently and are primarily governed by the terms of the trust establishing the entity.

[1] Iowa Code 504.801(1) Trusts operate somewhat differently

[1] Iowa Code 504.803

[1] Iowa Code 504.804 and 805

[1] Iowa Code 504.808

[1] Iowa Code 504.810

[1] Iowa Code 504.841(1) and Iowa Code 504.844(2)

[1] Iowa Code 504.801(2)

[1] Iowa Code 504.842

[1] Iowa Code 504.831(3)

[1] Iowa Code 504.831(1) and (2)

[1] Iowa Code 504.832((1)(b)(4)

[1] Iowa Code 504.831(5)

[1] Iowa Code 504.901

[1] Iowa Code 504.833

[1] Iowa Code 504.836

[1] Iowa Code 504.831(2A)

Just because someone may be a majority owner of a company does NOT mean the company can do whatever they please.  Minority owners have substantial rights and remedies to protect their interests.  Minority owners may not feel in control, but this does not mean they do not have power. 

 

A minority owner, in the context of business, is someone who holds less than 51{7643a07be85def2dedbecc56bad3bab67e83a7c22b809f3c7a47a1fa73b8911c} interest in the company, and this may be a group or an individual.  It’s an identification of who does not have the majority of the ownership.  The minority owner, is to some measure, the opposite of the majority owner.  Normally, the minority shareholders come to be when there is an entrepreneur who has a brilliant dream and is able to convince others to invest in him/her.  The entrepreneur than sells interest of the business to those people who want to participate, and they buy-in to a minority interest, leaving the entrepreneur “in control”.

 

In a Limited Liability Company (LLC), there are two types of structure.  One type of structure is member management and the second type is manager managed.  In a member managed LLC, everyone who owns a piece of the company gets to vote.  They get to run the business electively as members.   If there is no specification in an operating agreement that the LLC is to be managed by managers (or if there is no operating agreement) ALL members have equal rights to management of the company.  In a manager managed LLC, the operating agreement specifies that there will be managers.  The managers may, but do not have to be, members.  The members are the ones who vote to elect a manager.  Conversely, the manager managed LLC must have directors and those directors are charged with running the company.  This is important because ultimately, it is the directors or managers responsibility to run the company.

 

Corporations are set up a bit differently.  In a corporation, all management is vested in (one or more) directors.  In corporations and manager-managed LLCs, the directors/managers are elected by shareholders/members.  There are exceptions to this though.  Unless there is a contrary provision in the articles of incorporation or operating agreement, directors/managers are elected one at a time and are removed by a majority vote.  Unless there are special provisions in the Articles of Incorporation or Bylaws each share gets one vote.  Voting in a LLC is controlled by its operating agreement.  Directors and managers are charged with the operation of the company, which means they hire, fire and determine the salaries for employees (which also includes officers).

 

There are opportunities for abuse of minority owners.  Areas in which problems may occur are sometimes seen in salaries.  The directors who are representing the majority owners decide they need excessive salaries and/or benefits.  A director could also decide to withhold distributions (dividends).

 

We also see that when a business gets sold, we find that the sale price can sometimes include different types of considerations for the majority owner or for the officers of the company.  If there is a lousy manager, their dealings could fall under the Business Judgement Rule.  The Business Judgement Rule is if in good faith the manager is exercising their judgement, the fact that things didn’t quite work out as anticipated, is not exactly the type of thing that is designed to be a protection for the minority owner.  On the other hand, if the manager is advertently acting or engaging in self-indulgence, then you have a situation whereby the Business Judgement Rule factors in.  It is important who runs the company, because everyone who runs the company gets an equal vote in the company.  What is meant by this is, if you have two directors, and one director is represented by the majority, and the second director is the minority owner, they each get one vote in making decisions, so it is an indirect link between ownership, capital accounts and voting rights.  More importantly, you have to look at what the applicable documents define the role of the manager(s) or director(s).

 

There can be protection for minority owners which would be written as provisions in the bylaws or operating agreement.  All shareholder/members have the right to access, inspect, and copy business records.  These records include minutes of meetings and financial and accounting records.  The directors, managers and officers have a duty to the company and ALL owners.  Their actions must be in good faith, in reasonable belief of the director /officer to be in the best interests of the corporation, and there must be a reasonable basis for decisions being made.  Otherwise, the minority owners can sue for damages or injunctive relief if directors or officers fail to meet this level of care.  When it comes to the sale of substantially all assets or dispositive merger, the sale requires unanimous consent of the LLC members.

 

There is a different type of protection for corporations.  In a corporate setting, they have what is called a shareholder that votes against action to be taken.  Shareholders who vote against the sale or dispositive merger^[1] have the right to have their shares purchased by the corporation at “fair value” and if necessary can get their legal fees paid by the corporation.   This provides a right for the majority to buy-out a minority, but it does have to be at fair market value, whatever it may be at the time, by statute.  This is one of the differences between Corporations and Limited Liability Companies.

 

In a Samson option to dissolve a business, a court can order the dissolution under certain circumstances.  One situation is when directors/managers are deadlocked in the management of the corporate affairs, and the shareholders are unable to break and the deadlock is injurious to the corporate business affairs.  Another condition may be if the directors, managers, or those in control of the company have acted, are acting, or will act in a manner that is illegal, oppressive, or fraudulent.  A court may also dissolve a business if the company’s assets are being misapplied or wasted.

 

When a company is dissolved, it cannot carry on ANY business EXCEPT as appropriate to liquidate its business assets and activities.  After all creditors are paid, the assets are distributed to owners (pro-rata).  There are some assets, like intellectual property, that may have to be valued and distributed “in-kind” to owners.  For corporations, in lieu of a judicial dissolution, the remaining shareholders can purchase the complaining shareholder’s shares at “fair value”.

 

What is to be learned by this, is don’t cheat minority partners.  Make sure there is a clear agreement among all the parties as to what their rights are going in.  For instance, how do directors get picked, how do operating agreements get amended, who gets what and when do they.  These are important things to question and think about.

 

Contact the Kreamer Law Firm, P.C. at 515-727-0900 or info@kreamerlaw.com if you need assistance dealing with co-owners of your company from a West Des Moines lawyer who knows business law.  Kreamer Law Firm also specializes in Wills, Trusts, Estate Planning, Powers of Attorney, and Probate issues.  Give us a call today. We get things done®.

[1] Abuse could be selling on terms which wind up benefiting the majority shareholders; or refusing to sell on terms which could benefit minority shareholders. A dispositive merger is where the company owned does not survive.

[2] Iowa Code 489.407(1)(a)

[3] Iowa Code 489.407(3)(f)

[4] Iowa Code 489.407(1)

[5] Iowa Code 489.407(2)(a) and (b)

[6] Iowa Code 490.803(2)(a) Can be changed by vote of Shareholders

[7] Iowa Code 490.801(2)

[8] Iowa Code 490.803(3), Iowa Code 489.407(3)(e)

[9] Iowa Code 489.407(2)(c), Iowa Code 490.803(3), and Iowa Code 490.808

[10] Iowa Code 490.721(1)

[11] Iowa Code 489.110(1)

[12] Iowa Code 490.801(2)

[13] Iowa Code 490.1602(1) and Iowa Code 489.410

[14] Iowa Code 490.830(1), Iowa Code 490.84.(1) and Iowa Code 489.409

[15] Directors, managers, and officers have a duty to make decisions with the care that a person in a like position would reasonably believe to be appropriate. See Iowa Code 490.830(2), Iowa Code 490.831, Iowa Code 490.832(3), Iowa Code 489.409(8). This confers some responsibility to investigate the factual basis for the decisions being made.

[16] Iowa Code 490.831, Iowa Code 490.842(3) and Iowa Code 489.701(2).

[17] Iowa Code 490.1301 et. seq.

[18] Iowa Code 490.1331

[19] Iowa Code 489.407(2)(d) and (3)(d). The impact of an operating provision varying this requirement (per Iowa Code 489.110) is unclear.

[20] Iowa Code 490.1430(2) and Iowa Code 489.701(d) and (e)

 

 

 

To successfully raise capital, you must be prepared to do so, recognize the sources of capital, be aware of the costs of the funds, be in compliance with securities laws, and have a back end strategy. 

Be Prepared:

One thing investors want to make sure of is that they are going to get their investment back with a return on their investment.  They way that is going to be generated is through business operations.   Accordingly, they want some certainty that you, yourself, as the business owner, have thought through the business, have thought through its operations and activities, to the point that you can produce a business plan.  Another thing to include in your business plan is a marketing plan with a projection and a plan of what you THINK the future will bring.  Every investor realizes that a projection is just that.  It’s an assumption, it’s a possibility of what could happen.  The fact that you have projections means you have thought through what is reasonable for your business and what is reasonable for investors to expect in return for their share.

The best time to raise capital for your business is when you don’t need it, not when you are worrying about debt.  Having a track record is extremely important.  It may be easier to raise capital at the front end when there is a big promise of a business, or sometimes when you have a good track record established.

Sources of Capital:

There are several sources of capital.  One source of capital we call angel investors.  These are individuals who want to have an investment in the business, either because they like the kind of business you are in or they want to promote the type of activity the business is involved in.   These are generally people who are named individuals who many people know. The second type of investor or source of capital are out of state or out of market competitors.  If you are running a business where you have out of state competitors who want to get into the state but don’t know how to break in, sometimes you can create a strategic alliance which allows for a capital investment in your business.  This is a cheap entry into the business and they can leverage your expertise.  Another kind of investor is Venture Capital investor, sometimes called a mezzanine investor.  A venture capitalist is looking for a company that looks like it will go public soon; it’s past the startup phase.  Some people refer to them as vulture capitalists, because there are times when these types of investors swoop in and take the best part of the company.  There is a final group called heroic investors, which are generally comprised of family and friends. A family or a friend should be treated as any other investor.  They still need the same type of protections as any other investor would need, so you need to treat them as true investors.

Cost of Capital:

Something to also think about is the cost of capital.  There are many ways to compute the amount of capital in return for the amount of money, which can be more of an art than a science. Many entrepreneurs over-value their business.  One of the things you should be aware of when raising capital for your business is capital return is always going to be more expensive than borrowing, so if you can, go to a bank and borrow money.  An investor is at greater risk in the capital, because the debts get paid before the return on investments.  Another thing to be aware of is who is putting the money in.  Different types of investors require and demand different types of returns.  For instance, an angel investor is probably someone who is an economic investor who is saying they would like a reasonable amount of rate of return and wants to look forward to some kind of back end profit.  A venture capitalist is looking for a big score when the company goes public.  There is no money more expensive than family money.  It’s expensive, in part, because of the emotional cost that this money has.  If you borrow capital from a multi-millionaire, they want a return on their investment.  You know where they stand.  If you get are loaned money from a relative, that person may want to know why you are going out to eat, why are you driving that type of car, why are you vacationing so long, what are the hours of the store, etc. and they are going to be more emotional.  Most of our clients find that when they are raising capital, and where it comes from, may not be as important as the fact that it is available because of the business needs and its operations.

There is another cost in addition to an economic cost.  That’s a managerial cost.  Some clients think they can raise money for the business and continue to run it just as they were running it before.  That is not normally the case.  What generally happens, is the investor will want to have a say in how things are run with the business.  They will want information annually, if not quarterly.  They will especially want financial, operational and background data.  The investors want communication.  Investors who are receiving a return in their investment usually need a lot less information when things are working well.  When things aren’t going so well, suddenly, everyone wants to know what’s going on with everything.  If people make a large investment, relative to their portfolio, they want a lot more information than somebody who doesn’t have a substantial proportional risk.

Investors commonly want to be a part of a Board of Directors or a Manager.  It is extremely important to have by-laws and operating agreements to define the rights.  Some issues may be resolved and decided by a majority vote and other issues may require unanimous consent.  How votes are counted is extremely important.  Normally, each manager/director has an equal vote.  Sometimes, voting is based on capital account (investment) or the number of shares or units.  There may be times when a deadlock occurs.

 

Securities Laws:

There are security laws to keep in mind.  The shares or units of your company will probably be considered a “security” like stocks on the New York Stock Exchange.  Your company would be considered the “issuer”.  If or when it comes to selling part of your business, you may or not have to register.  There are both state and federal securities laws which require issuers fo securities to make extensive disclosures to buyers who will not be actively involved in investigating the issuer’s company and industry prior to investing.  These disclosures are in writing, are designed to protect buyers from dishonest sellers, and MAY have to be filed with governmental agencies.  They are fundamentally designed to protect investors from unscrupulous issuers of securities.  They are also designed so that if the deal is memorialized in some type of writing.

There are exceptions to the need for filing full disclosure documents.  There is a small offering exemption, inter-state offerings, private placements, and “good deal” exemptions.  Generally, you will need either a prospectus or private placement memorandum or some type of circular offering for larger offerings (not for friends who may want to invest).  Whether or not you are going to do one of these securities registrations, you need to provide written documentation of what your business and marketing plan is, financial statements and a FULL DISCUSSION OF POTENTIAL RISKS Of LOSS OF INVESTMENT. Make sure you put EVERYTHING in writing.

Back End Strategy:

One type of back end is where you have a buy/sell agreement which specifies how and in what circumstances an investor can or must sell back their investment.  When certain events occur, the company may buy out the investor, the company may go public, or there is some other kind of planned back-end.  These buy/sell agreements are extremely important because otherwise, there is no way for a company to get rid of an investor (i.e. for the entrepreneur who started the business) and to really gain control of the business again.  A buy/sell agreement may be either mandatory (must buy/must sell) or permissive.  In either one, you should establish a pricing formula and terms of payment.  If you fail to plan, you plan to fail. When you begin to plan on raising capital, you should look at what you think the end result will be and how it’s going to play out.

Raising capital is more of a process than an event.  It’s something that takes many steps.  You’ve got to be ready, you have to recognize the sources of capital, be aware of who’s providing the capital, look at the legal constructs around it, and finally, you have to have a back end plan.

When your business is ready to raise capital, contact Kreamer Law Firm, P.C. at 515-727-0900 or via e-mail at info@kreamerlaw.com for experienced legal assistance.

 

 

 

 

 

Part One of the Dynasty Family Business covered necessary characteristics a family business needs to become a Dynasty Family Business, and was posted on May 24, 2017.  In this second part, the passage of ownership will be explained.

The “live forever plan” has not yet been shown to be successful.  For a family business to be dynastic, there must be a successful transition of ownership or a passage of ownership.  A lifetime transfer of ownership allows a donor to “see” how the transferee acts as an owner.  This causes the family member who becomes an owner to have some “skin in the game”, which can impact their actions and perceptions.

When the time comes to sell the business their are important factors to keep in mind.  If a shareholder sells stock or membership units, the sale can create a taxable event for the seller.  If a shareholder sells stock or membership units at a discount, the sale can create a gift to the buyer.  The purchase of newly issued stock at a discount may create compensation for the Buyer.  In regards to the purchases and sales of the business, there is no need to transfer the whole company at once.  You could create a series of Options, an installment sale, or you could transfer part of the business during your lifetime and the other part after passing.  These payments could be made over time creating a retirement income.  All sales among family members or sales by the company of newly issued stock/membership units to a family member should be memorialized in a stock purchase agreement.  By doing this, it will provide representations and warranties on which the buyer can rely.  This is critical when the Buyer is paying over a period of time and/or the Buyer has rights to acquire more in the future.  This can be used to refute allegations of a gift, provides evidence of basis for the buyer, and this can promote family harmony by providing evidence of a “real” transaction rather than favoritism.  Until the transferee owns ALL the stock/membership units, there should be a Buy/Sell Agreement whereby the Seller (which could be the Company) can reclaim the stock/membership units in case the transferee dies, becomes disabled, quits or is terminated.  Gifting the company can remove assets from a donor’s taxable estate at a discounted value, could create a future tax problem for the transferee (they take the donor’s basis), and could cause disproportionate gifting (or perceived disproportionate gifting) which could create family discord.

Some choose to transfer ownership post mortem.  An agreement like this may be made during a lifetime and can take effect after passing.  It is important that plans such as this be in writing and in a way to fully express all of the terms of the transaction.  This could be funded in whole or in part by insurance, it can provide liquidity for an estate, and this could “equalize” the estate if there are multiple beneficiaries.  A Will or Revocable Trust can contain provisions to sell the stock/membership units.

When bequests are made, the recipient takes fair market value as “basis” for tax purposes.  Disproportionate bequests can create family discord: “fair” is not always “equal”; and “equal” is not always “fair”.

Absence of a Will or Trust can create problems.  It can lead to a discounted sale or closure of the business, which in turn can cause valuable employees and clients to leave the business, and can cause the termination of a franchise agreement.  When there is no Trust or Will, the Executor/Trustee runs the business until distribution of the stock/membership interest.  In the absence of a family agreement, the Spouse gets 50 – 100{7643a07be85def2dedbecc56bad3bab67e83a7c22b809f3c7a47a1fa73b8911c} and any share that does not go to the Spouse is divided between the children equally.  All beneficiaries are entitled to their pro-rata share of ALL assets of the deceased, including the stock/membership units.   Recipients may not be qualified to make necessary business decisions.

Dynasty Family Business does not just happen.  They have certain characteristics which set them apart form those family businesses which close or pass outside of the family.  To successfully establish a Dynasty Family Business, documentation of the transfer of the ownership of your business within your family is critical.

Please contact our office at 515-727-0900, or at info@kreamerlaw.com when you are ready to form your business to become a Dynasty Family Business.

 

 

Again, I go on air to discuss with Michael Libbie the final part of our Three-Part Interview on “What Happens to Your Business If Anything Happens to You?” This time we’re discussing who will have the power to make the decisions for your business if you can’t.

Click the link below to watch the podcast, and if you need legal help with any business questions or concerns, please feel free to email us at info@kreamerlaw.com or call us at (515)727-0900.

http://insightadvertising.typepad.com/insight_on_business/2015/01/business-decisions-who-has-the-power.html

The client who comes prepared for meetings with their attorney save significant amounts on their legal fees. This is because the attorney can work much more efficiently to address your needs.

The nature of the preparation is dependent on the type of matter involved, but, at the very least, you should consider writing out a list of questions and/or issues to be discussed. This will help you “focus” the discussion, stay on track, and avoid forgetting something which needs attention.

If we were asked to assist you in the formation of your business, we would urge you to consider the following:

1. The business name
2. Principal address of the business
3. Names, addresses and social security numbers of all “owners”
4. How much (as a percentage of the total equity) each owner will own
5. What each owner will contribute to the business in return for their ownership
6. Names, addresses, and titles of officers
7. If the business will be leasing space, a copy of the lease
8. If the business will have employees how many and when the first payroll will be paid (you are considered an employee of a corporation of which you are an owner; you are NOT an employee of a limited liability company in which you are an owner)

We strongly recommend, but do not require, that you prepare a business plan. The biggest value a written business plan is that it will cause you to think through the business on a practical logistical level. A “completed” business plan should include:

1. A marketing plan
2. A projection of revenue and expense, and
3. An analysis of the Strengths, Weaknesses, Opportunities and Threats (a S.W.O.T. analysis) which you may confront in your business.

Although there are several business plan software packages available, we HIGHLY recommend you work with a nearby Small Business Development Center (“SBDC”), which is a governmental entity charged with assisting entrepreneurs.

The adage “time is money” is particularly true when working with your attorney. By spending some of your time preparing for your meeting with your attorney, you could save a substantial amount of money.