Do you really need 10 million shares for your company? Probably not.

1233px Van Speyk by Dominicus Franciscus du Bois

For the lazy among you, I’ll summarize this post in a single sentence: If you’re incorporating in Delaware, don’t authorize more than 5,000 shares of stock unless you absolutely, positively have to. If you absolutely, positively have to issue more, check with a lawyer to make sure you’re right about that.

There’s a fashion in Delaware corporations these days whereby companies authorize millions (or tens of millions) of shares in their Delaware corporation because “we might get VC money one day” or “we’re looking for an investor.” Indeed, many online online incorporation services have 10 million shares set as the default (even those working with law firms who should know better). Aside from the fact that only a tiny percentage of companies are ever going to get even a sniff of VC money, it’s irresponsible because of the way Delaware calculates its annual franchise tax.

First of all, the franchise “tax” isn’t really a tax in the proper sense, it’s really just a fee for the privilege of forming a Delaware company, and it’s intended to be more expensive for “bigger” companies, where “bigger” means more investors. There are two ways of calculating the tax, the Authorized Shares Method and the Assumed Par Value Method, and you pay the lower of the two taxes. The Authorized Shares Method is very simple – you pay a certain amount of franchise tax for the number of shares which are authorized when you form the company, from a low of $175 for companies with 5000 shares or fewer up to a maximum of $200,000. It doesn’t matter whether the shares are issued, or even if they are all issued to one person, the mere act of authorizing the shares creates the tax obligation.

The Assumed Par Value Method uses the number of issued shares and the total assets of the corporation to come up with an “assumed par value,” which is then used to calculate the franchise tax, starting at $400 and going up to a maximum of $200,000 (even if the formula results in a higher tax calculation). If all of the shares are issued, it’s no problem, although it seems kind of silly to issue 10 million shares to a sole shareholder. If you don’t understand this, however, and you issue only a few shares (or, as often happens with companies formed over the internet, you forget to issue any shares at all) the Assumed Par Value calculation results in a very high franchise tax, even for companies with relatively little in assets.

By starting out at 10 million shares, most business owners effectively wipe out the opportunity to pay the minimum tax under the Authorized Shares Method. If that same business owner forgets to issue shares, or issues too few shares, they may also end up with a franchise tax due of tens or hundreds of thousands of dollars. If you didn’t need those shares in the first place, that’s a significant cost for no benefit whatsoever. To make things worse, fixing the unnecessary problem can cost thousands in legal fees and, in many cases, will still require the payment of pro-rated franchise taxes for the period before the correction.

For example, a company which issues 100 out of 10 million shares, with only $1,000 in assets would pay the lower of $85,165 per year under the Authorized Shares Method and $200,000 under the Assumed Par Value Method. That’s an awful lot of money for a company with only $1,000 in assets. That same company would pay $175 in franchise tax if they had only issued 1,000 shares. If you want to check out the calculations or download an Excel calculator to play with the numbers, check out the franchise tax calculations page of the Delaware Corporations website.

If you’re really in the market for venture capital money, work with a lawyer to make sure your company is set up properly for that purpose. It’s worth the extra money. Otherwise, 5,000 shares (or 1,000, or maybe even 10 shares) is more than enough.

Image courtesy of Wikimedia Commons, public domain

Business Travel During the COVID Recovery

US border notice large

Now that the US is seeing lower coronavirus infection rates and higher vaccination rates, the big question for many European businesspeople is whether they can enter the United States for business and under what circumstances? After all, for many foreign companies with US operations, it has been over a year since they’ve been able to hold in-person meetings or otherwise see their business locations and colleagues in the United States. As great as Zoom is, that’s a long time, especially for smaller and mid-sized companies which rely on personal interaction to keep their businesses operating smoothly.

In total there are four different proclamations governing travel into the United States by foreign nationals, with a host of different exceptions and caveats (which you can read about here and here). Unfortunately, the exceptions applicable to foreign nationals who don’t otherwise have a visa (and for many who do) are quite limited, and typically require that the object of the entry involve “vital support for critical infrastructure, … humanitarian travel, public health response, and national security”. Business travelers who don’t fall under one of the enumerated categories can apply for their own individual National Interest Exception, but obtaining those NIEs hasn’t been easy.

Even worse, contrary to what you might expect, as the coronavirus situation in the US has improved it has actually become much more difficult to enter the US from Europe. On March 2, 2021 the Department of State issued new travel restrictions on European travelers which make it much more difficult to obtain an NIE for normal business purposes, doubling down on the specific categories listed above. Even assuming the business traveler qualifies for the NIE, it takes additional time to prepare and process a successful application even as approval rates have declined, limiting the usefulness of the NIE for most business travelers.

As countries outside of Europe gain better access to the US, an alternative remains to travel to a country outside of Europe which is not subject to the same restrictions (such as Mexico) and “quarantine” there before entering the US. It doesn’t seem terribly logical, but spending time at a resort in the Caribbean may be the best (or only) way for certain business travelers to enter the United States right now.

Or you can wait a little while longer. Rumor has it that entry from Europe will be easing up again shortly.

Hat tip to David Spaulding and Jonathan Grode of Green & Spiegel, image courtesy of WMakaristos, Public domain, via Wikimedia Commons

It’s that time of year again … franchise tax filings are due!

There are a lot of reasons to incorporate in Delaware, and one of them is favorable tax treatment. There is, however, one corporate “tax” to be aware of for owners of Delaware corporations, and that’s the annual franchise tax filing. For most corporations, it’s little more than a fee for Delaware companies with their operations outside of the state, but the calculations themselves can be somewhat complicated. Failure to timely file results in a penalty of $200 plus interest accruing at 1.5% per month, and filings and payment can be made online with the Delaware Division of Corporations. Failure to file and pay the franchise tax fee for a year or more will result in the state declaring the company charter void or, eventually, repealed.

Most non-public companies use what’s called the “Authorized Shares” method of calculating the tax, which is based solely on the number of shares authorized. That tax is calculated as follows:

Delaware franchise tax rates

As noted, companies with fewer than 5,000 shares will always pay the minimum tax of $175 plus the filing fee of $50, since that’s the minimum amount possible.

Some companies (primarily companies with larger numbers of shares) may benefit from using the alternate calculation method, called the Assumed Par Value Capital Method. Basically, that method looks at both the number of shares issued and the total gross assets, and starts out at a minimum of $400 going up to $200,000 (or $250,000 for “Large Corporate Filers”). For more detail on that method, check out the Delaware Division of Corporations’ website.

Don’t confuse the franchise tax filing with the registered agent fee, which also typically becomes due around the same time of year. The registered agent fee is paid to a private vendor to serve as a sort of “official mailbox” for legal service and other compliance documents, and is required for all companies which do not have a physical presence of their own in Delaware. Failure to maintain a registered agent may also lead to suspension or repeal of the company charter.

The franchise tax form is pretty easy to complete for most companies, and is an annual reminder not to authorize more shares than you need (unless you like paying taxes).

New Remedy for Small-time Copyright Owners

Tucked away in a corner of the December 2020 COVID relief bill was the CASE Act, a law relating to copyright infringement. Of course, because copyright has so much to do with pandemic relief.

Anyway, the CASE, or Copyright Alternative in Small-Claims Enforcement, Act attempts to “streamline” copyright enforcement by creating a sort of small claims court within the US Copyright Office to handle smaller copyright infringement cases. Damages in this small claims court, called the Copyright Claims Board, would be limited to actual damages or statutory damages of up to $15,000. Total damages awarded by the Board cannot exceed $30,000. Damage awards can take into account whether the defendant has agreed to stop any infringing activity and destroy copies of infringing materials, so cooperation is probably the name of the game once you’ve received one of these complaints.

Adjudication of copyright matters before the Copyright Claims Board is voluntary, however, once an action has been initiated the defendant in a case must opt-out within 60 days or they waive their right to defend the case in court. Although the process is less formal than a “normal” lawsuit, it’s still complicated enough that many non-lawyers may struggle to understand and follow the procedures.

The Copyright Claims Board is intended to provide a venue for individual artists and smaller companies to pursue copyright claims which would be cost-prohibitive in a normal federal or state court. The “judges” will be full-time employees with copyright and legal experience, and who will be appointed by the Librarian of Congress in consultation with the Register of Copyrights.

The Act was widely supported by large arts organizations, but it was also subject to harsh criticism by others, including the Electronic Freedom Foundation (EFF). The EFF claims that the CASE act will lead to harsh penalties “for sharing a meme or making a video, with liability determined not by neutral judges but by biased bureaucrats.” While there is a limited right to appeal, EFF is concerned that the combination of copyright-inclined bureaucrats and complex guidelines will result in an unfair to the average internet user.

I’ll cover the process in more detail in a later post, but it will be interesting to see how well received this simpler – but not simple – copyright dispute resolution process is with copyright holders.

Like it or not, the future of the practice of law is in the cloud.

640px Word processors at NIHE 1

I was recently asked about law firm technology by a colleague who is leaving our firm, and instead of just answering her I thought I’d write a blog post about it. What follows is a brief overview of what I was using with my firm before and a few thoughts about what I’d do if I were starting a firm today.

Infrastructure. As a long-time Apple user and privacy wonk it pains me to say this, but especially for smaller firms you just can’t beat the value of G-Suite. For $6 per user per month you get most of your IT infrastructure – e-mail (with a custom domain), calendaring, video chat, storage, groups (which you can use to address mail to multiple people at the same time or as a bulletin-board for open issues), a notes application (where I “write down” my time), and all sort of other goodies – on a completely portable platform. That’s powerful.

Oh, and there’s Google docs as well, which I don’t really use unless a client asks, but which offers a lot of functionality. It even looks to me like Sites might be sufficient for many small-firm websites, in lieu of a third-party provider.

Even better, for an additional $10 ($20 if you want to get fancy) you can add telephone numbers with Google Voice, and replace those $50 per month landlines. We actually switched to a Comcast VoIP a while back, and I don’t dislike it, but the ease of use and one-stop shopping with Google is a significant benefit for a lawyer who is also the firm’s IT person. That’s not to say G-Suite can’t be tricky to configure, but it’s easier than dealing with systems and hardware from multiple vendors.

Yes, there are privacy (and other) issues, but to be honest many of the issues which plague Google are present in other systems as well. There are definitely documents you shouldn’t maintain online, and you also need to make local backups of critical docs. As with all cloud services, it’s important to make good choices about when not to use the cloud.

Document Creation and Editing. In the interest of full disclosure, as a transactional lawyer I often have to exchange complex documents with lawyers who are wedded to MS Word, so while I think it is an overly-complicated piece of bloatware with a reprehensible UI, I have no choice but to use it. If you need the Microsoft apps, then use them, by all means.

That being said, when I don’t have to use Word, I prefer Apple Pages, since it’s relatively light-weight and has all of the features I need. The same applies to Excel and PowerPoint, although I’m not much of a presentation kind of guy. Google docs is an option, certainly, but I’m a bit old school in that I like to know that my documents and apps reside somewhere I can actually use them when the internet connection is gone.

Billing. Ok, this one I struggle with. We started with RocketMatter back in 2010, and were fairly early adopters for the then-fledgling case management system. The good? RocketMatter made time entry, billing, and trust account management much, much more efficient than it had ever been and, before G-Suite, the calendar function was very useful. The not so good? At $65 per user, it’s expensive, and most of the other functionality has never been terribly useful for us. The to-dos are essentially useless, I hate timers, and the other “collaborative” tools aren’t really collaborative.

The add-on features I might have been interested in – intake forms, for example – are only available at an additional cost, and it’s hard to even get concrete information about those features without signing up for a free trial. I understand you sometimes have to learn by doing, but I’m not building a bunch of forms just to find out if the service will work for me.

Again, I don’t think you can go wrong with RocketMatter, but if I were to do it again I’d see if QuickBooks online offered adequate time entry functionality and kill two birds with one stone.

Accounting. We currently use QuickBooks desktop versions, in large part because our accountant understands it. I’d probably switch to QuickBooks online if I were doing it again, although I’m sure there are some much better alternatives around than there were when I last looked into it. Ultimately, if you’re going to use an accountant (which I strongly recommend) make sure you use something they are comfortable with.

Collaboration. This is last on the list not because I think it’s not important – in fact, I think it’s the most important item on here, because it brings a whole new dimension to a lawyer’s practice. It’s last because it takes some commitment to use properly, and part of that involves getting your clients onboard. I love Basecamp for a lot of reasons, but the most important are:

  • correspondence is threaded and tied to a specific task;
  • files are exchanged securely;
  • tech-wary clients don’t have to use the interface, a simple e-mail will suffice;
  • you can add as many different companies (clients) and contacts as you’d like, and limit each project to the intended contacts; and
  • it’s easy to back up the whole environment in HTML format, so you can access all of the old project threads (but not files!) offline.

Basecamp is particularly useful on mobile devices, since pulling together relevant e-mails in a mail client can be a chore, but on Basecamp everything is right where you need it, in a single thread. I could go on … if you’d like me to, let me know in the comments and I’d be happy to oblige.

Disclaimer: This is largely what we used at our old firm, and to be honest on some level I miss that. That being said, some of the complicated systems the new firm has, and which I don’t enjoy, are in place for a good reason (I’m talking to you, iManage). Others are simply the standard choice for corporate IT across the country and have been for ages (I don’t understand how Microsoft has prevailed with such god-awful user interfaces across the years). Still, I think a further move towards the cloud is inevitable, especially for small firms, and if I were on my own I’d be all about it.

Photo via WikiCommons by UL Digital LibraryNo restrictions

Time to talk about officers

Black and White photo of managers

When it comes to the day to day work of a stock corporation in the US, neither the board nor the shareholders are typically involved – they don’t sign agreements, give orders, or do much of anything all. Instead, they appoint officers, who are responsible for the day to day operations of the corporation, and who typically operate with relatively little oversight outside of annual or semi-annual meetings.

Most jurisdictions require three officers: President, Secretary, Treasurer, although those officers may also hold additional titles such as CEO, CFO, or similar. Additional officers are not uncommon, particularly in larger companies, and may include Vice Presidents, Assistant Secretary, and an Assistant Treasurer. Other titles, such as CEO, CFO, and Manager are permitted, and can be used in conjunction with the above officer positions, but in most cases the company must still appoint all three legally required officer positions. Even where those specific positions are not mandated by law, it’s typically better to use those titles (in addition to other titles if desired), since many forms will ask for the signature of one or more of those officers.

In the typical closely held corporation, the president is the highest ranking official, vested with the broadest possible powers. The president is generally held to have implied actual authority, by virtue of his office, to engage in ordinary business transactions, such as hiring and firing non-officer level employees and entering into contracts in the normal course of business. The president does not usually have the authority to bind the corporation to contracts which are not in the ordinary course of business, such as contracts for the sale of real estate or the sale of all of the corporation’s assets. Where the president who is also responsible for the long-term strategic direction of a corporation (and may also be a board member), the title Chief Executive Officer was traditionally added. Of course, CEO sounds pretty cool, so that historical practice has been replaced by a plethora of random CxO titles ranging from Chief Vision Officer and Chief Knowledge Officer to Chief Heart Officer.

The Secretary is responsible for maintaining the corporate records, and typically handles legal matters as well. The authorities and duties of the secretary should be clearly defined in the bylaws. As a result, the secretary is often an attorney, whether general counsel or outside counsel. In firms with an in-house legal team, outside counsel may act as assistant secretary, and in some cases third-party service providers provide secretarial services for a fee. The Secretary has authority to certify the records of the corporation, including resolutions of the board of directors. That’s often important for US subsidiaries of German companies, since a secretary’s certification can be used in place of documents which don’t otherwise exist under the US legal system. The appointment or election of a secretary is a statutory requirement in many states.

The treasurer has usually the ultimate responsibility for the management of the corporate funds, and will be the primary interface between the corporation and its accountants, bookkeepers, and banks. The treasurer is responsible for overseeing the corporation’s funds, as well as the preparation of financial reports and budgets and the filing of tax returns. The treasurer may also be CFO.

Any officer can typically hold one or more officer positions. We typically don’t recommend that a single person hold all three positions, since the unavailability of that individual makes it very difficult to enter into contracts or perform other corporate actions.

Image courtesy of Wikimedia Commons, 1964, Unknown photographer

That social media account is valuable, until you try to transfer it.

Wikimedia The Scream by Edvard Munch 1893 Nasjonalgalleriet

The internet is is a social-media driven marketing platform, driven by technologies which seek to move consumers to specific branded content and humans who try to corral that technology as best they can. Billions of dollars are spent in the chase to build an online brand, and those brands are feverishly protected. What happens, then, when the time comes to cash in? The problem is that most of the drivers behind online brands aren’t really under the control of the brand owner, and for all of the money invested in those online brands there’s a surprising lack of clarity as to how (and if) those brands can be transferred. In some sense, social media accounts are like a piece of stolen artwork – incredibly valuable, but difficult to cash in on.

While lawyers here in the US often refer to social media accounts as “property,” that property right is limited by the provider’s right to limit your use of or control over that account. In many cases, the provider’s terms of service do not permit the transfer (or “assignment” in legal-speak) of those accounts without their consent (or, in some cases, at all).

So, for example, if your company has an instagram account which is key to the product’s marketing, your company’s rights to that account are limited to the rights granted in their terms of service. That’s where things get interesting – according to the terms of service with Facebook (owner of instagram) you “cannot transfer your rights or obligations under this agreement without our consent.” If you make that transfer anyway, by simply passing on the password and user id, instagram could suspend or terminate the account, leaving you with a whole lot of nothing.

There are often other terms which are disadvantageous to business transfers, including terms prohibiting the commercial use of the account (as is the case for Tik Tok, for example). Most if not all of those clauses allow for immediate termination, meaning any valuation in a transfer is pretty much a house of cards that could be destroyed at any time.

There aren’t really many workarounds, either, and none are foolproof. You could, for example, have the original owner keep the account, but sign an agreement which allows you to control of the account (so it would basically be that owner’s account in name only). That’s probably not a great option for either party, though, since the original owner has clearly decided to exit the business and doesn’t necessarily want to be saddled with obligations going forward, and you probably don’t want to be dependent on them for an eternity. That may also run afoul of some provider’s terms, which often prohibit sharing passwords and ids. Another alternative would be for the old owner to terminate the account and for you to register it, but even assuming you succeeded in obtaining the new account, you’d have to start from scratch in terms of followers which destroys the value of the transfer.

If the entire business is to be transferred, you have another option. Instead of purchasing the assets of the business, which would require a transfer of the contract with the provider, you can purchase the shares in the target business. You can then continue to run the account under the original business, even if you clear out all of the assets after the sale. That, however, may give rise to other unpleasant risks going forward, since a purchase of the shares brings any open liabilities with it as well.

The problem is that under regular property law principles you can own the account, but on the internet that ownership right is subject to the whim of the provider. As a result, the value of that ownership right is limited and unpredictable, since all of the above options could result in termination under the terms of most social media providers. That said, for many it seems to be a risk worth taking.

Shareholder and Board of Directors

As part of our short series on forming a US corporation, it’s important to understand the management structure, since there are significant differences between those structures in Germany (and many other countries) and the US. First, we’ll start with the shareholders and board of directors.

The Shareholders are the owners of the company (Aktionäre) and, in a C Corporation, hold shares much like they might in a German Aktiengesellschaft. There can be as many shareholders as there are shares, or shares can all be held by a single person or entity. The shareholders exercise power over the corporation by appointing the Board of Directors, which in turn appoint officers to handle the daily activities of the corporation. Thus, the exercise of power by the shareholders over the corporation is indirect, and unless the shareholder is also an officer the shareholder cannot sign contracts or direct the daily operations of the company. Of course, by threatening to remove the board of directors the shareholders can influence the actions of the board and the officer they appoint, but that influence is exerted indirectly rather than directly.

A word of caution – a lot of startups in the US are quick to give equity, and some Germans, in an effort to accommodate US partners, may decide to do the same. While this is certainly permissible, giving up even minority ownership in your US subsidiary should be done cautiously, if at all, and should be linked to mutual goals which ensure that the partnership is a lasting one.

Board of Directors
The board of directors (Aufsichtsrat also does not directly manage the company – rather, they appoint officers and provide the officers with an overall strategic direction for the company. German clients in particular often get confused about this, because the “director” or “managing director” in a German GmbH is usually authorized to act directly on behalf of the company, whereas the director in a US stock corporation is not. If one of the board members is also expected to act on behalf of the company then he or she should also be appointed to an appropriate officer position.

Although most states allow as few as one board member, a board of at least three members will ensure that the corporation can act if one of the board members becomes unavailable or incapacitated. It is always better to have an odd number of board members to prevent ties, even within closely held corporations.

Many companies have a chairman of the board, who presides over board meetings. Generally the board is required to have at least one meeting annually, although additional meetings may be called to address specific issues between annual meetings.

Obtaining your company’s US tax number

Excerpt, IRS Form SS-4

One of the most important steps in the formation of a new company is the application for an Employment Information Number (EIN, or also FEIN). The EIN is a unique nine-digit number assigned by the Internal Revenue Service (IRS) to business entities operating in the United States. Originally, the EIN was limited to reporting employment-related taxes, but it has since become a more generalized identification number for US corporations. Changes in the law since 2001 have made it impossible to get a bank account without one, and have also made much more difficult to obtain without a US Social Security Number (SSN, the US equivalent of an individual tax identification number).

For the average US citizen or holder of a US SSN or other US tax identification number, the EIN is simple to get. The application can be completed online and the EIN is provided immediately. Since you can’t save your online application session, it’s typically best to download and fill out the IRS Form SS-4 (pdf) so you can be certain you have all of the necessary information available.

Without a US tax number, however, the process becomes more complicated. Applications without an SSN can be filed by mail, fax, or telephone, but processing takes significantly longer. The IRS website claims response times as low as four days for faxed EIN applications or four weeks for mail. That used to be true, but in our experience processing time over the past few years can and sometimes does take far longer than that. Unfortunately, addressing those delays can be extremely difficult, since IRS agents typically can’t provide any additional information about applications once submitted.

Unfortunately, due to these delays, sometimes companies are tempted to call on a business partner or even friend to submit the EIN application on the company’s behalf. The IRS frowns on the use of these “nominees,” as they are called, stating that the responsible party on Form SS-4 must be a person who “controls, manages, or directs the applicant entity and the disposition of its funds and assets.” If you’ve already filed for an EIN using a nominee, you can (and probably should) update the company’s information by filing Form 8822-B

Part of an occasional series of posts on starting your business in the US.

Incorporating in the United States

Mabbett Railway Chair Manufacturing Company share certificate 1867

A while ago, I wrote an article on choosing the state of incorporation for your US company. Now that you’ve decided where your company will be located (probably Delaware), the next step, of course, is to incorporate:

  1. First, you file a brief document (the Articles of Incorporation or, in Delaware, Certificate of Incorporation) outlining the basic structure of the company (typically name, initial corporation address, number of shares authorized, and often some sort of provisions for indemnification of officers and directors. Once the Articles are stamped by the state the corporation is in existence.
  2. The person who filed the Articles (called the incorporator) appoints the first board of directors and enacts the first bylaws (basically, the rules of operation of the company) in a written “Consent of the Incorporator.” The incorporator is a bit of an odd concept, since he or she has all power or responsibility for the company once formed, but is often a third party service provider not in any way related to the company. The position is really a temporary vehicle to effect the incorporation and the appointment of the board of directors, and the incorporator will typically resign right after formation.
  3. While not technically a corporate document, the incorporator will also typically file for a federal tax ID (commonly referred to as an Employer Identification Number or EIN). This can be a royal pain for non-US companies, but I’ll get to that in a later post.
  4. At this point the corporation has the beginnings of a structure but no owner or officers. The board of directors (similar to the German Aufsichtsrat) meets or signs a written consent appointing officers for the corporation, issuing stock to the shareholders, and if no bylaws have been put in place, enacting bylaws. The Board will typically also pass resolutions directing the officers to carry out some of the tasks necessary to make the company fully operational, such as opening bank accounts, signing a lease for an office, appointing counsel and an accountant, and signing other necessary documents or agreements.
  5. The Shareholder(s) may, but need not, sign a consent confirming the appointment of the board and ratifying any of the actions taken by the board.

The company is now fully functional, and can operate under the direction of the officers without further documentation. Note that the officers fulfill a role similar to the German Vorstand, but with significant differences. The signed documents are placed in a corporate minute book, which should be maintained for the life of the corporation.

After the initial incorporation, most jurisdictions require that the shareholder and board hold at least one meeting per year and maintain written minutes of that meeting in the corporate minute book. The board should also consider a meeting or written consent approving any transactions which impose a significant cost on the corporation, obligate the corporation for a long period of time, or which fundamentally change some aspect of the corporation’s operation or structure. More on that in a future post.

Part of an occasional series of posts on starting your business in the US.