In the first edition of goodnews, we referred to it as our “highly occasional” newsletter, and we’ve certainly lived up to that commitment. Eleven months later, here we are again. Why so long? Simply, because clients come first – and they’ve been coming fast. Since the first edition, goodcounsel has been busy: helping two executives spin-off a startup they incubated within their multinational company; representing a Chicago-based retail business in a successful effort to secure private equity financing from an outside investment firm; advising a hospitality company in the restructuring of its expanding “brew and view” chain; assisting a local produce delivery company with their first-ever acquisition; helping a couple of young artists form a company to hold gallery events; and counseling scores of entrepreneurs and their young companies across a wide variety of matters, from HIPAA compliance to intellectual property licensing. And the proverbial “much more.”
As goodcounsel enters its third full year in business, we can confidently assert that our model of legal services resonates strongly with entrepreneurs, emerging companies and others who are seeking alternatives to old models of legal representation. Goodcounsel is innovating a practice model involving fewer lawyers, less paper, efficient use of technology, a strong orientation to value and, most importantly, a business mindset that can only come from direct experience in business. Our smart, focused, fairly priced legal services allow our clients to spend their time and money on what is most important: building the business. It’s not just us saying it. Our clients seem to agree.
Internet and cloud-based services have been fueling transformation across a variety of industries, and the same should be true for legal services. Goodcounsel is always on the watch for opportunities to use technology to make its practice more efficient and pass those benefits along to its clients. Giving you a peek behind the curtain: Goodcounsel uses the Google Apps platform for e-mail and calendaring, Clio for practice management (timekeeping, matter management and invoicing), DocuSign for e-signing of documents, QuickBooks Online for bookkeeping, and Dropbox for cloud document storage. We are currently experimenting with the services “document automation” provider DraftOnce to generate client documents more efficiently. (Know of other great web-based efficiency tools? Let us know.) With traditional hourly billed services, a practice would have little incentive to innovate for efficiency. Goodcounsel favors fixed-fee engagements, and these efficiency tools allow us to propose attractive fee arrangements for our clients.
Our friends do interesting things
If you are a fashionable young woman looking for cutting-edge style (or you are just related to one), you have to know about trendsetting Chicago-based retailer Akira. You can shop in any of their 16 Chicago-area stores or online.
First Stop Health, your ”personal online medical advice service,” is up and running. Plans start at $14.95 per month.
Seth Kravitz, Technori founder and multiple entrepreneur, shares the news that Bow Truss, the new Chicago coffee roaster that he co-founded up in Lakeview, has opened its first retail store location in River North. If you enjoy a good cup of coffee, you owe it to yourself to stop in. And of course, good coffee is better with good bread. Hewn Bakery will open at 810 Dempster (Evanston) in early June, selling hand-forged artisan breads. Find them now on Facebook, soon at hewnbread.com. And finally, on the subject of good things to eat, there is Irv and Shelly’s Fresh Picks. Fresh Picks delivers local and organic produce, grass-fed meat, dairy and eggs — right to your door. If you care about the quality of your food and the sustainability of the system in which it was produced, you should take a look. Newly formed Delectable Odysseys offers travel adventures through the lens of culinary experiences. The “Tuscan Adventures” tour has spots open in June, July and September… The Prospective Series orchestrates “pop-up” curated art shows at venues around Chicago featuring local artists, where you can purchase high-quality original pieces for your home or office. The first event is March 6. Details here… Dog owners: Green Paws Chicago provides a comprehensive, professional set of services, including walking, boarding, grooming and breed-specific nutrition.
ThunderBurst Media provides white-label products and services that media companies and publishers can sell directly to their existing customers, including Local SEO, Social Media, Reputation Management, Mobile website creation, Google Places & Yelp, and Custom Facebook Pages… MarkITx has launched its online exchange for IT equipment, modeling itself on the Kelley Blue Book model from the automotive market… Cojoin is preparing a new marketing analytics platform for launch in May 2013. Follow them on Twitter here… Ox&Pen has rolled out its new iOS mobile app, for universal local rewards… Congratulations and good luck to my friends at Veragae, formerly Integration Point Management, on the rebranding of their healthcare IT and services company.
Illinois Angel Tax Credit
Administered by the Illinois Department of Commerce and Economic Opportunity (DCEO), the Illinois Angel Investment Credit Program provides tax credits of up to 25 percent for investors of up to $2 million in qualified new business ventures. Interested businesses, which must be principally engaged in innovation and located in Illinois, must apply to the DCEO for qualification. $10,000,000 in credits are allocated per year, and are distributed on a first-come, first-served basis. In previous years, credits have run out early in the year, so interested companies should apply promptly.
After much back and forth last year, the JOBS Act passed Congress and was signed into law by President Obama. Of greatest interest to early-stage companies, the “crowdfunding” provisions found in Title III of the Act permit issuers to raise up to $1 million during any 12-month period comprised of small investments, including investments by those whose income or net worth would not otherwise qualify them as traditional “accredited investors.” The catch is that this fundraising must be done through crowdfunding intermediaries or “portals,” which are intended to provide a degree of protection for investors. The final language of the bill sets out the high-level rules (Goodwin Proctor has a nice summary), but left many issues to the Securities and Exchange Commission (SEC) to flesh out through the administrative rulemaking process, including: the manner of calculation of investor net worth; issuer disqualification criteria; exclusion of crowdfunding investors from the 500-investor threshold under the Exchange Act of 1934; the exemption of crowdfunding intermediaries from the broker-dealer regulations of the 1934 Act; and, critically, whether companies that raise more than $500,000 will have to provide investors with audited financial statements. This process was to have been completed within 270 days of the bill’s passage, but this deadline has come and gone, and the SEC is still working on it. Given that proposed regulations are subject to a 90-day comment period before being finalized, it may not be late 2013 or even 2014 until the first crowdfunding investments can occur. The New York Times tells the story here.
OMG: Don’t send that text!
Thought you just had to worry about complying with the CAN-SPAM Act for your e-mail marketing campaigns? The CAN-SPAM Act is starting to look like a treat, compared to the lesser-known Telephone Consumer Protection Act. The TCPA (text here) covers unwanted “calls or transmissions made using an automatic telephone dialing system” — in other words, recorded phone messages, faxes or text messages. CAN-SPAM is enforced only by the government (primarily the FTC), and as a practical matter, you are unlikely to face severe penalties for inadvertently sending out an e-mail that the recipient does not want, as long as that message is not deceptive and allows the recipient to opt out. The TCPA, by contrast, can be enforced by private plaintiffs via class-action lawsuits, and those lawsuits are increasing significantly, according to recent statistics. This means that those unwanted text messages you send might earn you a day in court opposite a plaintiff’s lawyer. A Jiffy Lube franchisee that had sent out texts to 1.9 million class members agreed to a settlement of $47 million. Don’t let this happen to you. Make sure that any text or phone campaign strictly complies with TCPA. Goodcounsel friend and lawyer David Almeida of Sedgwick LLP, who has handled numerous TCPA cases, offers this helpful TCPA guidance for non-lawyers.
Worth a read
Jeff Hyman’s interview on Technori contained some of the most cogent and thoughtful advice for entrepreneurs that I’ve read in a long time.
Many goodcounsel clients start off in businesses as limited liability companies, enjoying the flexibility and tax-efficiency that this type of entity offers. A lesser known but quite significant advantage of LLC’s is the ability to provide incentive equity in the form of “profits interests.” A profits interest allows an LLC to give service providers option-like equity without the need for those individuals to put money at risk in order to obtain favorable long-term capital gains tax treatment. Consider the following:
In the traditional example, a company issues options to a new employee priced at the company’s then-fair market value of $1 per share. Issuance of the options has no current tax impact, however, if the employee exercises the options when the company is later acquired at a price of $3 per share, the gain or “spread” of $2 per share will be taxed to the employee at short-term capital gains rates – 35 percent for high income filers. This is because the holding period for the equity starts upon exercise of the options, not their issuance. Wouldn’t it be better for the employee to exercise the options and hold the underlying equity for a year, in order to receive long-term capital gains treatment at the time of sale? Of course. But this requires the optionholder to come out of pocket to pay the exercise price and to take the risk that during that year, the equity loses its value. Few employees will take that risk, and will instead hold the options until a profitable exit is at hand, swallowing the significantly higher tax rate as the price of reducing the risk.
In an LLC, a profits interest is economically equivalent to an option. If a unit of LLC equity has a value of $1, a profits interest issued at that moment comes with a right to participate only in those proceeds of a liquidity event that are in excess of that dollar. (This “hurdle amount” is the economic equivalent of an option’s exercise price – both serve to ensure that the optionholder participates only in the economic value he or she participates in creating.) But unlike an option, which is not “property” (in the view of the IRS), the profits interest is property, and therefore the capital gains holding period begins to run upon issuance – and the employee never has to come out of pocket with cash. In the previous example, when the company sells for $3 per share, the profits interest holder would receive his or her share of the proceeds beyond the $1 hurdle amount, or $2 per unit, and (assuming at least a year had elapsed between issuance and the sale) these proceeds would be taxed at long-term capital gains rates.
What should you consider before issuing profits interests? First, you have to be an LLC, so you have to be comfortable that this is the right entity for you, your business and your investors. Next, consider that profits interests are not the easiest form of incentive equity to explain. The typical employee understands what an option is; odds are they’ve never heard of a profits interest. But my view is that if their incentive equity grant is significant, their tax savings from a profits interest stands to be worth a great deal – enough for them to take a few minutes to understand how this works for their benefit.
The most significant negatives arise from the fact that a profits interest holder in an LLC is an equity owner, and therefore is ineligible to be paid as a regular W-2 employee. Instead, the company must report all compensation on a form K-1 (relating to the partne. This has negative ramifications regarding the employee’s responsibility for self-employment taxes and the deductibility of company contributions toward healthcare and other benefits. These are issues that should be discussed with tax and legal advisors before making a decision about the proper form of incentive equity.
A little help from your friends?
So you want to raise $50,000 from a few friends to help take your company to the next level. Just cash the checks, and that’s the end of it, right? Not so fast.
Any time your company takes money, whether in return for equity (ownership) or in the form of a loan, it has issued a “security” — whether you give your investors a fancy certificate or not. This means that you have to think about something called “securities law.” And not just one securities law, either, but federal securities law and the securities law of every state where the nice folks who gave you money reside. The danger is that the Securities and Exchange Commission, or their state government counterparts, takes a look at your fundraising activity and says that you have engaged in a public offering of securities. That’s something you are not allowed to do without complying with the Securities Act, something that few small companies can afford to do.
Is taking money from your friends really a public offering? Or is it more properly characterized as a private offering that is exempt from federal securities law? Well, that depends. Did you drop a little mention on your website that your company is interested in taking on investors? This kind of general solicitation makes the offering quite public. (Do not do this, by the way.) Did you only talk to the two friends who ultimately invested? That seems rather private. It can be subjective and ambiguous, but fortunately federal law establishes certain “safe harbors.” If you comply with the safe-harbor rules — for example, limit your fundraising to investors of a certain net worth and don’t make public solicitations — a simple, free federal safe-harbor filing can give you the peace of mind that your little fundraising round won’t land you in a heap of trouble. (This federal filing typically “preempts” state laws, relieving you of the burden of thinking about those as well.)
Goodcounsel prides itself on its practicality, and you might sensibly question the degree of legal risk involved in a small “friends and family” round. In general (and we don’t have to tell you that this is not legal advice, right?), probably very little. The ocean is big and the SEC has bigger fish to fry. The way that this is likely to become an issue, however, is if you lose one of your friends’ money. Now he is a former friend, and even though you told him the investment was risky, he still is looking to be relieved of his loss. He may be entitled to rescission (a.k.a. getting your money back) if he can show that you failed to comply with securities law — and the kicker is that despite the fact that your company is a limited-liability business entity, you would have to repay him from your personal funds.
So while the risk of SEC scrutiny is low, the risk of your losing some of your investors’ money is not. And since goodcounsel can help you keep the costs of compliance down (and since, as described above, crowdfunding portals will soon be available for raising small rounds in a legally exempt manner), it is worth carefully considering whether operating in the gray area outside of a recognized safe-harbor is worth the risk. Talk to goodcounsel about this when you are ready.
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