The Dawn of the I-502 Era

Posted: January 26th, 2015 | Author: | Filed under: I-502 Marijuana, Small Business Topics | Comments Off on The Dawn of the I-502 Era

My law firm, particularly through my partner Heather Wolf, has taken the lead in coming to grips with the subtleties and nuances inherent in the new Washington marijuana legislation, and it’s been quite a ride for marijuana investors, licensees and their professional advisers!

One of the areas that I have become involved in as a business attorney is the funding of newly-licensed marijuana production and processing operations.

The problem is simple. Banks are extremely reluctant to make loans to I-502 operations, whilst license holders are desperate for operating capital to build out facilities to comply with the terms of their licenses. Then, because there are a limited number of licenses in existence and a lot of folks who want to invest in 1-502 operations, the folks with the funds aggressively seek out licensees to invest in.

As a result of this dynamic, we typically see either investors who end up with horribly-structured investments with little knowledge of what they are getting into, or, cash-poor, desperate licensees who literally give away the farm through lack of planning. To make matters considerably worse, the investment transactions are all too often in violation of federal and state securities laws and almost never involve any sort of agreement between the founders and new investors.

If you are an I-502 licensee or potential investor in an I-502 operation, proceed with caution.

Death of Common Sense

Posted: November 2nd, 2009 | Author: | Filed under: Small Business Topics | No Comments »

I blogged (fairly) recently about the death of good ‘ol common sense, but a recent transaction I was involved in reinforced my (sometimes) jaundiced view of humans’ ability to interact with one another using plain common sense.

We had a willing buyer and willing seller.  We had a price.  We identified who was buying what and how payment was to be made.  So the parties had it all pretty much figured out.

Six weeks later, the parties walked away from the deal in abject frustration, considerably poorer as a result.  What happened? 

The buyer wanted to use a standard purchase form that covered a multitude of risks and scenarios that in often simply bore no relation to the business that was being acquired.  This left the seller in the position of trying to convince the buyer that the standard form was inapplicable in many cases, which in turn prompted further investigative questions by the buyer to parse out the seller’s objections.  Rather than working with a document that was tailored specifically to the agreed terms, the standard form approach left the seller frustrated, often mystified, and put to the cost of needlessly trying to convince the buyer that one of the remote risks identified in the standard form was simply not applicable. This led to the buyer becoming increasingly suspicious, trust rapidly eroded and the deal died.

The real tragedy was that it didn’t have to be that way.  This was a classic case in my view of trying to commoditize a transaction; and it highlights the pitfalls of the one-size-fits-all approach.  Had the parties brought some plain common sense to bear, I believe this outcome could have been avoided.

Buy-Sell Agreements

Posted: July 31st, 2009 | Author: | Filed under: Small Business Topics | 1 Comment »

“Do we need a Buy-Sell agreement?”.  The fact that clients ask this question is a great sign; it shows that they are at least aware of the fact that where there are two or more owners of a business or legal entity, they should always have a plan that describes clearly what will happen if something happens to one of them, or if he or she wants out of the relationship.  

This plan is often called a “Buy-Sell” agreement, and I can honestly say that it can be one of the most difficult and demanding documents to put together, but also one of the most essential.  

Now I’m the first to agree that there are many form documents available to consumers these days that require little input beyond a basic set of Q&A prompts (such as simple wills or real estate documents), but I would not place buy-sell agreements in this category.

The reason these documents are tricky is that you have a host of interlocking variables to think through (I imagine it would be a bit like writing computer code – if this, then that, and so on).  For example, let’s say you have two business owners who both are actively involved in running the business.  There are a host of different circumstances that could result in one of the owners leaving the business, and which the owners should at least be aware of.  These include death, disability (you can’t work), divorce (a non-working spouse is awarded the business), bankruptcy, retirement, voluntary sale, forced sale by creditors, and resignation as an employee.

Once the owners have identified the circumstances that they believe may apply to them, they need to think about how to deal with the departing owner’s interest in the business in each of the circumstances they have identified.  Again, they are a number of variables to choose from.  For example, if an owner were to die, the business could either be forced to buy the interest from the deceased owners’ estate, which would put cash into the estate for the benefit of the deceased owner’s heirs, or have the option to do so.  Allowing the spouse of a deceased owner to become an owner where he or she may have little experience in running the business may prove to be disastrous, so the owners need to think this through carefully.  The same type of decision would need to be made for each of the other circumstances I mentioned above.

Once the owners have decided how to handle the different circumstances, they would need to figure out how to value the interest of a departing owner if he or she will be bought out, and how to pay for it.  In the case of death, life insurance is most often used to fund a buyout, but in other circumstances, the owners may wish to pay a departing owner over a number of years to protect the business’ cash flow.  Where a departing owner is to be paid over time, he or she may want some collateral to insure timely payment.

Finally, buy-sell agreements should form an integral part of any family succession plan where families may be contemplating transferring a business to the next generation.  Although the context here may be a little different, the basic issues are pretty similar. 

I have really only touched on the basic issues in this post, but as you can see, it can be pretty tricky to get this document to read simply and clearly, and yet still cover the basics.  I strongly urge all business owners to make sure that they have a buy-sell type agreement that they understand, and if they don’t, they should seek professional input.  

Legalease, and Why Lawyers Do It

Posted: July 7th, 2009 | Author: | Filed under: Small Business Topics | 2 Comments »

For as long as I can remember, people have complained that they cannot understand legal documents.  And I can’t blame them, because so often it’s absolutely true.  For example, take the following fairly typical wording:

      “The parties hereby agree and confirm with one another that immediately subsequent to the incorporation of the Corporation, all assets owned by them shall be transferred to the Corporation by Bill of Sale or Assignment, as the case may be, free of all liens, mortgages, security interests or other encumbrances, in consideration for which the parties shall caused the Corporation to issue to the parties shares of its Common Stock in the proportion that their respective contributions of assets bears to all assets contributed”.

Aside from the fact that it’s not clear who must transfer assets and the needless capitalization of common nouns, there is nothing much wrong, technically, with this wording.  But you could also say:

            “Immediately after the company is formed, the parties must transfer all their assets to it, free of any liens, in return for a proportionate number of company shares.”

So why do lawyers write this way?  For a combination of reasons: first, that’s the way it’s been done for a long time, and if you write differently, you separate yourself from the herd, which is scary for most lawyers; second, many lawyers are lazy – it’s easier for them to find a “standard form” than to think through the issues for themselves; third, many lawyers have simply never been trained to write simply or translate legal concepts into plain English; fourth, I think lawyers often gratify their own egos by using legalese; and lastly, lawyers tend to believe that if they simplify language, they must be leaving something out which exposes them to the threat of litigation (ironically, it’s the agreements that say too much with language that no-one understands that are often the most contentious and litigated).

When I started practicing, I was fortunate enough to be assigned to a very senior, eminent lawyer who reviewed each and every document and letter that I wrote during a two year apprenticeship.  He literally used to interrogate me about my choice of phrases and use of words, strike through most of my language with a red pen and instruct me to try again.  He drummed into me that one should use short paragraphs and short sentences.  Replace technical words with simple ones that non-lawyers understand.  Use the active voice wherever possible so that the reader knows who has to do what.  Describe carefully who has to do something, when it must be done, how it must be done and where it must be done.  Never use words you don’t understand.

It’s the hallmark of a competent lawyer to be able to distill the very essence of any transaction or task to its essentials, and then write these down so that his or her client understands them.  After all, isn’t that the very essence of lawyering?

Incorporating a Small Business

Posted: June 26th, 2009 | Author: | Filed under: Small Business Topics | 1 Comment »

Why should a new business incorporate, and what sort of legal entities are available?  This is a question I hear all the time in my business law practice. 

In most cases, using a legal entity to carry on a business makes good sense.  It helps protect the personal assets of the individual business owners from creditors of the business, and helps provide a mechanism to raise capital to fund the business. 

The two legal entities that most people choose from here in Washington are the corporation and the limited liability company (or LLC).  The choice always boils down to many factors, not the least of which is tax.  Small business owners generally want to minimize taxes, which points to using either a corporation that qualifies for “S-corporation” status, or an LLC; both of these entities essentially tax the business operations just once, in the hands of the individual business owners.  Individuals can own corporations and LLC’s, and operate their businesses through them as single owners.  The LLC is generally considered to be the best entity to use to own real property.

Forming legal entities in Washington is generally pretty straightforward, although where you have a corporation, you have some choices that you should think about during the set-up phase which can have important consequences, such as how you vote for directors, lowering the voting threshold for big decisions, and so on (the standard, downloadable forms typically ignore these). 

Once the entity is formed, additional steps must be taken to confirm that the business owner is also the shareholder or member of the chosen entity and that any existing business assets (or real property) are properly transferred to the entity – this is something that business owners who do their own incorporating often overlook.  The new entity must also be registered for federal, state and local tax purposes. 

Probably the most important document that is often overlooked or not well though through is the buy-sell agreement, as it is commonly known.  This document should always be used where you have more than one business owner.  It describes how the entity will be managed, who will provide funding for it, and what happens if an owner wants to sell out (or dies, gets divorced, files bankruptcy and so on). 

There are many incorporation forms available to consumers.  This can be a cost-effective way to set up a new entity, but I would always recommend having a trusted professional review “standard” forms to make sure they work in a specific case.

Raising Capital

Posted: June 19th, 2009 | Author: | Filed under: Small Business Topics | 4 Comments »

Many clients that come to see me have great ideas, but they need money to get started.  Typically, they are young and entrepreneurial, don’t have personal financial resources and banks won’t touch them.  Can they go out and ask people to give them money to develop their ideas?

Yes they can, provided they follow the federal and state securities laws and regulations.  These can be quite complicated, and this is obviously not the right place to analyze them in detail.  In simple terms though, the securities laws and regulations are designed to protect an unsuspecting public from the reach of unscrupulous promoters who go out and try to raise capital through public solicitations.  The law forbids this, and requires any public offering to be “registered” with federal and state regulators, which is extremely expensive and beyond the reach of fledgling businesses. 

However, the law does allow investments to be made in a private context without formal registration (private offerings) where the parties know one another and the investors have a thorough knowledge of the business in which they propose to invest.  The trick is to make sure that private offerings stay private, and that the investors are given all the information they need to make an informed investment decision. 

There are a number of different formats that may be used when it comes to putting together the investment structure.  For example, preferred shares are popular with sophisticated investors, whilst investments made by close friends or family members often involve loans, common shares or some combination.  Simple is always better!

Anyone looking to raise money privately should consult with someone who works in this practice area to make sure they remain on the right side of the law.  If they don’t, investors may have the right to get their money back if the business doesn’t do as well as they may have liked, with fairly dire consequences for the entrepreneur and the business.