Tag: companies

Now is a Good Time to Confirm Your S Corporation Status

On October 11, 2022, the IRS published Revenue Procedure 2022-19 providing taxpayers with liberalized procedures for resolving common S corporation issues. Previously, taxpayers would have needed costly IRS letter rulings for certainty on their S corporation status. The new procedures are simpler and less expensive.

The IRS has separately assured taxpayers that LLCs that are classified as S corporations may also qualify for this liberalized relief.

Inadvertent loss of S corporation status can have significant tax consequences and can make your business a less attractive acquisition target. For example, an S corporation that reverts to a C corporation may be subject to a double layer of tax going back several years. As a result, potential acquirers of any S corporation invariably request representations on the validity of the S corporation status.

The new Revenue Procedure describes common situations that the IRS has historically treated as not affecting the validity of S corporation status or qualified S corporation Qsub status, such as:

  1. One class of stock requirement in the governing provisions (including the concept that commercial contractual agreements are not treated as binding agreements unless a “principal purpose” of the agreement is to circumvent the one class of stock requirement);

  2. Disproportionate distributions inadvertently creating a second class of stock;

  3. Certain inadvertent errors or omissions on Form 2553 or Form 8869;

  4. Missing administrative acceptance letters for S corporation or Qsub elections;

  5. Federal income tax return filings inconsistent with an S election; or

  6. Governing provisions that allow for non-identical treatment of shareholders, such as differing liquidation rights (allowing for retroactive corrections).

For these common situations, there are now simpler and cheaper procedures to preserve S corporation status. For example, for certain small errors such as missing officer signatures, S corporations may follow the same simplified procedures as the late election relief procedures in Revenue Ruling 2013-30. Those procedures do not require a private letter ruling request, but only the original election form with a reasonable cause statement. As another example, if the issue is non-identical governing provisions and no disproportionate distributions were made, the S corporation may simply be retroactively treated as an S Corporation if it meets certain eligibility requirements and keeps a copy of a signed statement in its files.

Shareholders of uncertain S corporations should consider taking advantage of these new relaxed and cheaper procedures for curing S corporation mistakes. Each different type of error has a different cure with specific requirements.

Article By Christie R. Galinski and Samuel L. Parks of Miller Canfield

For more corporate law legal news, click here to visit the National Law Review.

© 2022 Miller, Canfield, Paddock and Stone PLC

Employers, It’s Time to Replace Your Mandatory EEOC Poster

On October 20, 2022, the U.S. Equal Employment Opportunity Commission (EEOC) released an updated version of its mandatory workplace poster that informs employees of their rights and protections.

Employers must post this new version of the poster in their office spaces as soon as practicable.

The latest “Know Your Rights” flyer, which replaces the previous “EEO is Law” poster, must be displayed in all workplaces covered by the agency’s jurisdiction. This includes private sector businesses with 15 or more employees, as well as state and local government agencies, educational institutions, unions, and staffing agencies.

What’s Changed?

The new poster includes several updates from the older version. Some of the main changes are:

  • Clarification that sex discrimination includes discrimination based on pregnancy and related conditions, sexual orientation, or gender identity;
  • Identifies harassment as a prohibited form of discrimination;
  • Provides information about equal pay discrimination for federal contractors; and
  • Uses more straightforward language and formatting.

The poster also includes a QR code for employees with a smartphone or other compatible devices to quickly access the EEOC’s website on how to file a charge of employment discrimination.

What’s Remained the Same?

While the poster has been updated, some of the information included remains the same. The bulletin still outlines the types of discrimination that are prohibited by federal law, such as:

  • Race, color, sex (including pregnancy and related conditions, sexual orientation, or gender identity), national origin, religion,
  • Age (40 and older),
  • Equal pay,
  • Disability,
  • Genetic information (including family medical history or genetic tests or services), and includes
  • Retaliation for filing a charge, reasonably opposing discrimination, or participating in a discrimination lawsuit, investigation, or proceeding.

Actions Employers Should Take

Employers who fail to post the new Know Your Rights poster could face noncompliance penalties from the EEOC. Therefore, businesses must take the time to update their posters as soon as possible.

On October 25, 2022, the EEOC distributed an FAQ stating that employers should remove the old poster and display the new one “within a reasonable amount of time” but did not provide a specific deadline.

The agency recommends that employers post the new flyer in a conspicuous place where employees will see it, such as in a break room or near the time clock.  Covered employers should also consider posting an online notice on their website for remote or hybrid workers.

You can download a copy of the poster here.

Article By Emily G. Massey and Ward and Smith, P.A.

For more labor and employment legal news, click here to visit the National Law Review.

© 2022 Ward and Smith, P.A.. All Rights Reserved.

FinCEN Issues Final Rule on the Corporate Transparency Act Requiring Businesses to Report Beneficial Ownership Information

On September 30, 2022, the U.S. Financial Crimes Enforcement Network (“FinCEN”) published its final rule implementing Section 6403 of the Corporate Transparency Act (“CTA”). The final rule, which will take effect on January 1, 2024, will require “tens of millions” of companies doing business in the U.S. to report certain information about their beneficial owners. The reporting companies created or registered before January 1, 2024, will have until January 1, 2025, to file their initial beneficial ownership reports with FinCEN. Reporting companies created or registered on or after January 1, 2024, will be required to file initial beneficial ownership reports within 30 days of formation.

The CTA was passed by Congress on January 1, 2021, as part of the Anti-Money Laundering Act of 2020 in the National Defense Authorization Act for Fiscal Year 2021. After publishing a Notice of Proposed Rulemaking and receiving public comments, FinCEN adopted the proposed rule largely as proposed, with certain modifications intended to minimize unnecessary burdens on reporting companies.

What Entities are Reporting Companies? The final rule describes two types of reporting companies: domestic and foreign.

  • A domestic reporting company is any entity that is a corporation, a limited liability company, or other entity (such as limited liability partnerships, limited liability limited partnerships, business trusts, and most limited partnerships and business trusts) created by the filing of a document with a secretary of state or any similar office under the law of a state or American Indian tribe.

  • A foreign reporting company is any corporation, limited liability company, or other entity formed under the law of a foreign country and registered to do business in any state or tribal jurisdiction by the filing of a document with a secretary of state or any similar office under the law of a state or American Indian tribe.

What Entities are Exempt? The final rule exempts twenty-three separate categories of entities from the definition of the reporting company. Many of the exempted entities are already subject to federal or state regulations requiring disclosure of beneficial ownership information, such as banks, credit unions, depositary institutions, investment advisors, securities brokers and dealers, accounting firms, governmental entities, tax-exempt entities, and entities registered with the SEC under the Exchange Act of 1934. Additionally, the rules set forth an exemption for “large operating companies” that can demonstrate each of the following factors:

  • Employ more than 20 full-time employees in the U.S.

  • Have an operating presence at a physical office within the U.S.

  • Filed a federal income tax or information return in the U.S. for the previous year demonstrating more than $5 million in gross receipts or sales (excluding gross receipts or sales from sources outside the U.S.)

Finally, under the so-called “subsidiary exemption,” entities whose ownership interests are controlled or wholly owned by one or more exempt entities may also qualify for exemption. If a reporting company was formerly exempt but loses its exemption, it must file an updated report that announces the change and includes all the information required in a reporting company’s initial report.

Who are Beneficial Owners? The final rule requires reporting companies to report each individual who is a beneficial owner of such reporting company. A “beneficial owner” is any individual who, directly or indirectly, either exercises substantial control over the reporting company or owns or controls at least 25 percent of the ownership interests of the reporting company. An individual exercises “substantial control” if such individual:

  • Serves as a senior officer (except for corporate secretary or treasurer)

  • Has authority over the appointment or removal of any senior officer or a majority of the board of directors (or similar body)

  • Directs, determines, or has substantial influence over important decisions made by the reporting company

  • Has any other form of substantial control over the reporting company

Additionally, an individual may exercise substantial control over a reporting company, directly or indirectly, including as a trustee of a trust or similar arrangement, through:

  • Board representation

  • Ownership or control of a majority of the voting power or voting rights of the reporting company

  • Rights associated with any financing arrangement or interest in a company

  • Control over one or more intermediary entities that separately or collectively exercise substantial control over a reporting company

  • Arrangements or financial or business relationships, whether formal or informal, with other individuals or entities acting as nominees

  • Any other contract, arrangement, understanding, relationship, or otherwise

The final rule exempts five categories of individuals from the definition of beneficial owner: (i) minors, (ii) nominees, intermediaries, custodians, and agents, (iii) certain employees who are not senior officers, (iv) heirs with a future interest in the company, and (v) certain creditors.

Who are Company Applicants? In addition to the beneficial owner information, the final rule requires reporting companies created or registered on or after January 1, 2024, to report identifying information about each “company applicant.” A “company applicant” is:

  • Any individual who directly files the document to create a domestic reporting company or register a foreign reporting company with a secretary of state or similar office in the U.S.

  • Any individual who is primarily responsible for directing or controlling such filing if more than one individual is involved in the filing

The final rule provides further clarification as to certain individuals who, by virtue of their formation roles, fall under the definition of “company applicants.” For example:

  • If an attorney oversees the preparation and filing of incorporation documents and a paralegal files them, the reporting company would report both the attorney and paralegal as company applicants.

  • If an individual prepares and self-files documents to create the individual’s own reporting company, the reporting company would report the individual as the only company applicant.

The final rule removes the requirements that i) entities created before the effective date report company applicant information and ii) reporting companies update their company applicant information (except to correct inaccuracies), each of which were set forth in the proposed rules.

When are Initial Reports Due? When an initial report must be filed depends on the status of the reporting company as of January 1, 2024:

  • If Created or Registered on or after January 1, 2024 – It must file a report within 30 calendar days from the earlier of: i) the date on which the company receives actual notice that its creation or registration has become effective, or ii) the date a secretary of state or similar office first provides public notice, such as through a publicly accessible registry, that the company has been created or registered.

  • If Created or Registered Prior to January 1, 2024 – It must file a report not later than January 1, 2025.

What Information Must be Reported? An initial report must include the following information with respect to the reporting company:

  • The full legal name of the reporting company

  • Any trade name or “doing business as” name of the reporting company

  • The street address of the principal place of business of the reporting company (if outside the U.S., the street address of the primary location in the U.S. where it conducts business)

  • The state, tribal, or foreign jurisdiction of formation of the reporting company (a foreign reporting company must also report the state or tribal jurisdiction where it first registers)

  • The IRS Taxpayer Identification Number (“TIN”) of the reporting company (including the EIN of the reporting company, or if a foreign reporting company without a TIN, a tax identification number issued by a foreign jurisdiction and the name of such jurisdiction)

For each company applicant (of a reporting company registered or created on or after January 1, 2024) and each beneficial owner of a reporting company, the following information must be reported:

  • The full legal name of the individual

  • The date of birth of the individual

  • The current business street address (for a company applicant who forms or registers an entity in the course of such company applicant’s business) or residential street address (for all other individuals including beneficial owners)

  • A unique identifying number from, and image of, an acceptable identification document (e.g., a passport)

If a reporting company is directly or indirectly owned by one or more exempt entities and an individual is a beneficial owner of the reporting company exclusively by virtue of such individual’s ownership interest in the exempt entity, the reporting company’s report may list the name of the exempt entity in lieu of the beneficial ownership information set forth above.

When do Companies have to Report Changes? If there is any change with respect to required information previously submitted to FinCEN concerning a reporting company or its beneficial owners, including any change with respect to who is a beneficial owner or information reported for any particular beneficial owner, the reporting company is required to file an updated report within 30 calendar days of when the change occurred.

What are the Penalties for Violations? The final rule provides for a fine of up to $10,000.00 and/or imprisonment of up to two years for any person who willfully: (i) provides or attempts to provide false or fraudulent beneficial ownership information, or (ii) fails to report complete or updated beneficial ownership information to FinCEN. The penalties may also extend to individuals causing a reporting company’s failure to report or update information and senior officials of a reporting company at the time such failure occurs.

What is Coming Next from FinCEN? FinCEN is expected to publish the forms and instructions to be used for reporting beneficial ownership information well in advance of the effective date. FinCEN will further establish a secure nonpublic database for storage of the beneficial ownership information. Finally, FinCEN will issue rules on who may access the information (a limited group of governmental authorities and financial institutions), under what circumstances, and how the parties would generally be required to handle and safeguard the information.

What Should Reporting Companies be Doing Now? Existing companies should begin evaluating whether they are a “reporting company” and if so, determining who are their beneficial owners. Such reporting companies, including any other reporting companies that may be created or registered before the effective date, will have until January 1, 2025, to file an initial report. As noted, reporting companies created or registered on or after the effective date will have 30 calendar days after the date of creation or registration to file an initial report.

Article By Thomas G. Appleman, Arthur L. Griem, and Vera S. Hansen of Miller Canfield

For more financial legal news, click here to visit the National Law Review.

© 2022 Miller, Canfield, Paddock and Stone PLC

NYC Issues Proposed Rules for Its Automated Employment Decision Tools Law

On Friday, September 23, 2022, the New York City Department of Consumer and Worker Protection (“DCWP”) released a Notice of Public Hearing and Opportunity to Comment on Proposed Rules related to its Automated Employment Decision Tool law (the “AEDT Law”), which goes into effect on January 1, 2023. As we previously wrote, the City passed the AEDT Law to regulate employers’ use of automated employment decision tools, with the aim of curbing bias in hiring and promotions; as written, however, it contains many ambiguities, which has left covered employers with open questions about compliance.

The proposed rules are intended to clarify the requirements for the use of automated employment decision tools within New York City, the definitions of key terms in the AEDT law, the notices to employees and applicants regarding the use of the tool, the bias audit for the tool, and the required published results of the bias audit.

The DCWP’s public hearing on the proposed rules and deadline for comments are October 24, 2022. Although the proposed rules may be modified prior to adoption, the following summarizes the key provisions.

“Substantially assist or replace discretionary decision making”

The AEDT Law applies to an automated decision tool that is used “to substantially assist or replace discretionary decision making.” It does not, however, specify the type of activities that constitute such conduct or what particular AI-powered employment tools are covered by the law.

The proposed rules attempt to provide guidance on this issue by defining “substantially assist or replace discretionary decision-making” as one of the following actions:

  1. relying solely on a simplified output (score, tag, classification, ranking, etc.), without considering other factors; or
  2. using a simplified output as one of a set of criteria where the output is weighted more than any other criterion in the set; or
  3. using a simplified output to overrule or modify conclusions derived from other factors including human decision-making.

“Bias Audit”

Pursuant to the AEDT Law, before using an automated employment decision tool, a covered employer or employment agency must subject the tool to a “bias audit” no more than one year prior to the use of the of the tool.  The law explains that “bias audit” means an “impartial evaluation by an independent auditor,” but does not otherwise specify who or what constitutes an “independent auditor” or what the “bias audit” must contain. The proposed rules address these gaps.

First, the proposed rules define “independent auditor” as “a person or group that is not involved in using or developing an [automated employment decision tool] that is responsible for conducting a bias audit of such [tool].” This definition does not specify that the auditor must be a separate legal entity from the creator or vendor of the tool and therefore suggests that it may be acceptable for the auditor to be employed by the organization using the tool, provided the auditor does not use and has not been involved in developing the tool.

Second, the proposed rules state that the required contents of a “bias audit” will depend on how the employer or employment agency uses the tool.

If the tool selects individuals to move forward in the hiring process or classifies individuals into groups, the “bias audit,” at a minimum, would need to:

  1. calculate the selection rate for each category;
  2. calculate the impact ratio for each category; and
  3. where the tool classifies candidates into groups, the bias audit must calculate the selection rate and impact ratio for each classification.

If the automated employment decision tool merely scores candidates, the “bias audit” at a minimum, would need to:

  1. calculate the average score for individuals in each category; and
  2. calculate the impact ratio for each category.

The preamble to the proposed rules makes clear that DCWP intends these calculations to be consistent with the Uniform Guidelines on Employee Selection Procedures (“UGESP”), 29 C.F.R. § 1607.4, and borrows concepts from the framework established by the UGESP in the definitions of “impact ratio” and “selection rate.”

Under the AEDT Law, upon completion of a bias audit, and prior to using the automated employment decision tool, covered employers and employment agencies must make the date and summary of the results of the bias audit publicly available on the careers or job section of their website in a clear and conspicuous manner. The proposed rules clarify that publication may be made via an active hyperlink to a website containing the required information, as long as the link is clearly identified as linking to the results of the bias audit. The required information must remain posted for at least six months after the covered employer or employment agency uses the tool for an employment decision.

Required Notices

The AEDT Law also specifies that employers and employment agencies must notify candidates for employment and employees who reside in New York City as follows:

  1. at least ten business days prior to using an automated decision tool, that such a tool will be used to assess or evaluate the candidate or employee, and allow the individual to request an alternative selection process or accommodation;
  2. at least ten business days prior to use, the job qualifications and characteristics that the tool will use in the assessment or evaluation; and
  3. if not disclosed on the employer or employment agency’s website, information about the type of data collected for the tool, the source of such data, and the employer or employment agency’s data retention policy shall be available upon written request by the individual and be provided within thirty days of the written request.

Covered employers and employment agencies have expressed concern about the practical and administrative difficulties of providing the above notices in the fast-paced environment of today’s recruiting and hiring.

In apparent response to these concerns, the proposed rules clarify that the employer or employment agency may provide the notices required by paragraphs (1) and (2) by:

  1. (a) in the case of candidates, including notice on the careers or jobs section of its website at least ten business days prior to the use of the tool, and (b) in the case of employees, including notice in a written policy or procedure that is provided to employees at least ten business days prior to use;
  2. including notice in a job posting at least ten days prior to using the tool; or
  3. (a) in the case of candidates, providing notice via U.S. mail or email at least ten business days prior to use of the tool; and (b) in the case of employees, providing written notice in person, via U.S. mail, or email at least ten business days prior to use.

In short, under the proposed rule, an employer or employment agency could comply with the AEDT Law by providing the required notice when first posting the job.

With respect to the notice requirement in paragraph (3), the proposed rules state that an employer or employment agency must provide notice to covered individuals by including notice on the careers or jobs section of its website, or by providing written notice in person, via U.S. mail, or by email within 30 days of receipt of a written request for such information. If notice is not posted on the website, the employer or agency must post instructions for how to make a written request for such information on its careers or job section of the website.

Finally, although the AEDT Law requires an employer or employment agency to allow covered individuals to request an alternative selection process, the proposed rules state that nothing requires an employer or employment agency to provide an alternative selection process.

Article By Adam S. Forman, Nathaniel M. Glasser, Robert J. O’Hara, Alexander J. Franchilli, and Ridhi D. Madia of Epstein Becker & Green, P.C.

For more labor and employment legal news, click here to visit the National Law Review.

©2022 Epstein Becker & Green, P.C. All rights reserved.

OSHA Expands Criteria for Severe Violator Enforcement Program

In an announcement that expands the criteria for entry into the Occupational Safety and Health Administration’s (OSHA) Severe Violator Enforcement Program, OSHA has signaled that it is making enforcement a priority and that employers with willful, repeat, and failure-to-abate violations will be subject to significant consequences.

Key Takeaways

  • On September 15, 2022, OSHA announced that it was expanding its criteria for entering employers into its Severe Violator Enforcement Program (“SVEP”). The updated SVEP directive is available here.
  • Previously, entry into the program was limited to cases involving fatalities, three or more hospitalizations, high-emphasis hazards, the potential release of a highly hazardous chemical, and enforcement actions classified as egregious.
  • Now, an employer can be entered into the program in cases involving two or more willful, repeat, or failure-to-abate violations, regardless of the hazard involved. They will continue to be subject to entry in the program in certain cases involving fatalities, three or more hospitalizations, and enforcement actions classified as egregious.
  • In light of this expansion, employers should review their compliance records and current health and safety practices and consider whether further actions are needed to mitigate enforcement risks.

Background

In 2010, OSHA created the Severe Violator Enforcement Program to “concentrate[] resources on inspecting employers who have demonstrated indifference to their OSH Act obligations by willful, repeated, or failure-to-abate violations.” Under the original SVEP, OSHA would designate employers as “severe violators” if they were involved in an enforcement action:

  • Involving a fatality in which OSHA found one or more willful, repeat, or failure-to-abate violations;
  • Involving a catastrophe (three or more hospitalizations) in which OSHA found one or more willful, repeat, or failure-to-abate violations;
  • Involving a high-emphasis hazard in which OSHA found two or more high-gravity willful, repeat, or failure-to-abate violations;
  • Involving the potential release of a highly hazardous chemical in which OSHA found three or more high-gravity willful, repeat, or failure-to-abate violations; or
  • Classified by OSHA as “egregious.”

Employers entered into the SVEP were subject to consequences that included mandatory enhanced follow-up inspections, a nationwide inspection of related workplaces, negative publicity, enhanced settlement provisions, and the potential for federal court enforcement under Section 11(b) of the OSH Act.

Updated Criteria

Under the new criteria, employers will continue to be entered into the SVEP in enforcement actions involving a fatality or catastrophe in which OSHA found one or more willful, repeat, or failure-to-abate-violations and in enforcement actions classified as egregious.

In a departure from the original criteria, cases involving two or more high-gravity willful, repeat, or failure-to-abate violations will also be entered into the SVEP, regardless of whether they are linked to a certain hazard or standard. As a result of this change, OSHA expects that more employers will be entered into the SVEP.

Other Key Changes

In addition to expanding the criteria for entry into the SVEP, OSHA made key changes regarding follow-up inspections and removal from the SVEP.

  • Follow-up OSHA inspections must occur within one year, but not longer than two years after the final order. Previously, there was no required timeframe for conducting follow-up inspections.
  • Eligibility for removal will begin three years after the date an employer completes abatement. Previously, that period began running on the final order date.
  • If an employer implements an enhanced settlement agreement that includes the use of a safety and health management system that follows OSHA’s Recommended Practices for Safety and Health Programs, the employer can be eligible for removal after two years.

Implications

These changes signify that OSHA is prioritizing enforcement and intends to impose significant consequences on employers that repeatedly and/or willfully violate OSHA requirements. Employers should review their compliance records and current health and safety practices and evaluate whether additional action is needed to mitigate the risk for willful, repeat, or failure-to-abate violations and entry into the SVEP.

Article By Jayni A. Lanham and Mark N. Duvall of Beveridge & Diamond PC

For more labor and employment legal news, click here to visit the National Law Review.

© 2022 Beveridge & Diamond PC

Large Corporate Bankruptcy Filings Continue to Decrease through First Half of 2022

Most industry groups saw bankruptcy filings decline from mid-2020 pandemic highs.

New York—Following the spike in large corporate bankruptcy filings triggered by the COVID-19 pandemic, filings in 2021 and the first half of 2022 fell to levels below historical averages, according to a Cornerstone Research report released today.

The report, Trends in Large Corporate Bankruptcy and Financial Distress—Midyear 2022 Update, examines trends in Chapter 7 and Chapter 11 bankruptcy filings by companies with assets of $100 million or higher. It finds that 70 large companies filed for bankruptcy in 2021, down significantly from 155 in 2020 and below the annual average of 78 filings since 2005. In the first half of 2022, only 20 large companies filed for bankruptcy, compared to midyear totals of 43 in 1H 2021 and 89 in 1H 2020. The 20 bankruptcies in 1H 2022 were the lowest midyear total since the second half of 2014.

“U.S. government stimulus programs, low borrowing rates, and high debt forbearance helped disrupt predictions of continued growth in the number of bankruptcy filings,” said Nick Yavorsky, a report coauthor and Cornerstone Research principal. “Looking ahead, however, there are some concerns that increased corporate debt levels, rising interest rates and inflation, and a potential global recession may contribute to an increase in bankruptcy filings.”

In 2021, there were 20 “mega bankruptcies”—bankruptcy filings among companies with over $1 billion in reported assets—a substantial decline from the 60 mega bankruptcy filings in 2020. The first half of 2022 saw four Chapter 11 mega bankruptcy filings, compared to nine in the first half of 2021 and at a pace significantly lower than the annual average of 22 filings in 2005–2021.

Most industry groups saw bankruptcy filings decrease in 2021 and the first half of 2022, including those industries with the highest number of filings following the pandemic’s onset: Mining, Oil, and Gas; Retail Trade; Manufacturing; and Services.

Read the full report here.

Article By Allie Schwartz, Joseph B. “J.B.” Doyle, Nicholas D. Yavorsky, and Diego Vega San Martin of Cornerstone Research

For more bankruptcy legal news, click here to visit the National Law Review.

Copyright ©2022 Cornerstone Research

Practical and Legal Considerations for Extending Cash Runway in a Changing Economy

The funding environment for emerging companies has fundamentally shifted in 2022 for both venture capital and IPOs, particularly after a banner year in 2021. Whether these headwinds suggest significant economic changes or a return to previous valuation levels, companies need to be realistic about adapting their business processes to ensure they have sufficient cash runway to succeed through the next 2-3 years.

This article provides a comprehensive set of tactics that can be used to extend cash runway, both on the revenue/funding and cost side. It also addresses areas of liability for companies and their directors that can emerge as companies change business behaviors during periods of reduced liquidity.

Ways to Improve and Extend Cash Runway

Understanding Your Cash Runway

Cash runway refers to the number of months a company can continue operations before it runs out of money. The runway can be extended by increasing revenue or raising capital, but in a down economy, people have less disposable income and corporations are more conservative with their funds. Therefore companies should instead focus on cutting operating costs to ensure their cash can sustain over longer periods.

As a starting point, companies can evaluate their business models to determine expected cash runway based on factors such as how valuations are currently being determined, total cash available, burn rate, and revenue projections. This will help guide the actions to pursue by answering questions such as:

  1. Is the company currently profitable?
  2. Will the company be profitable with expected revenue growth even if no more outside funding is brought in?
  3. Is there enough cash runway to demonstrate results sufficient to raise the next round at an appropriate valuation?

Even if companies expect to have sufficient cash runway to make it through a potential economic downturn, tactics such as reducing or minimizing growth in headcount, advertising spend, etc. can be implemented as part of a holistic strategy to stay lean while focusing on the fundamentals of business model/product-market fit.

Examining Alternative Sources of Financing

Even though traditional venture capital and IPO financing options have become more difficult to achieve with desired valuations, companies still have various other options to increase funding and extend runway. Our colleagues provided an excellent analysis of many of these options, which are highlighted in the discussion below.

Expanding Your Investor Base to Fund Cash Flow Needs

The goal is to survive now, excel later; and companies should be open to lower valuations in the short term. This can create flexibility to circle back with investors who may have been open to an earlier round but not at the specific terms at that time. Of course, to have a more productive discussion, it will be helpful to explain to these investors how the business model has been adapted for the current environment in order to demonstrate that the new valuation is tied to clear milestones and future success.

Strategic investors and other corporate investors can also be helpful, acting as untapped resources or collaborators to help drive forward milestone achievements. Companies should understand how their business model fits with the investor’s customer base, and use the relationship to improve their overall position with investors and customers to increase both funding and revenue to extend runway.1

If the next step for a company is to IPO, consider crossover or other hybrid investors, understanding that much of the cash deployment in 2022 is slowing down.

Exploring Venture Debt

If a company has previously received venture funding, venture debt can be a useful tool to bridge forward to future funding or milestones. Venture debt is essentially a loan designed for early stage, high growth startups who have already secured venture financing. It is effective for targeting growth over profitability, and should be used in a deliberate manner to achieve specific goals. The typical 3-5 year timeline for venture debt can fit well with the goal of extending cash runway beyond a currently expected downturn.

Receivables/Revenue-Based Financing and Cash Up Front on Multi-Year Contracts

Where companies have revenue streams from customers — especially consistent, recurring revenue — this can be used in various ways to increase short-term funds, such as through receivables financing or cash up front on long-term contracts. However, companies should take such actions with the understanding that future investors may perceive the business model differently when the recurring revenue is being used for these purposes rather than typical investment in growth.

Receivable/revenue-based financing allows for borrowing against the asset value represented by revenue streams and takes multiple forms, including invoice discounting and factoring. When evaluating these options, companies should make sure that the terms of the deal make sense with runway extension goals and consider how consistent current revenue streams are expected to be over the deal term. In addition, companies should be aware of how customers may perceive the idea of their invoices being used for financing and be prepared for any negative consequences from such perceptions.

Revenue-based financing is a relatively new financing model, so companies should be more proactive in structuring deals. These financings can be particularly useful for Software-as-a-Service (SaaS) and other recurring revenue companies because they can “securitize the revenue being generated by a company and then lend capital against that theoretical security.”2

Cash up front on multi-year contracts improves the company’s cash position, and can help expand the base where customers have sufficient capital to deliver up front with more favorable pricing. As a practical matter, these arrangements may result in more resources devoted to servicing customers and reduce the stability represented by recurring revenue, and so should be implemented in a manner that remains aligned with overall goal of improving product-market fit over the course of the extended runway.

Shared Earning Agreements

A shared earning agreement is an agreement between investors and founders that entitles investors to future earnings of the company, and often allow investors to capture a share of founders’ earnings. These may be well suited for relatively early stage companies that plan to focus on profitability rather than growth, due to the nature of prioritizing growth in the latter.

Government Loans, Grants, and Tax Credits

U.S. Small Business Administration (SBA) loans and grants can be helpful, particularly in the short term. SBA loans generally have favorable financing terms, and together with grants can help companies direct resources to specific business goals including capital expenditures that may be needed to reach the next milestone. Similarly, tax credits, including R&D tax credits, should be considered whenever applicable as an easy way to offset the costs.

Customer Payments

Customers can be a lifeline for companies during an economic downturn, with the prioritization of current customers one way companies can maintain control over their cash flow. Regular checks of Accounts Receivable will ensure that customers are making their payments promptly according to their contracts. While this can be time-consuming and repetitive, automating Accounts Receivable can streamline tasks such as approving invoices and receiving payments from customers to create a quicker process. Maintenance of Accounts Receivable provides a consistent flow of cash, which in turn extends runway.

To increase immediate cash flow companies should consider requiring longer contracts to be paid in full upon delivery, allowing the company to collect cash up front and add certainty to revenue over time. This may be hard to come by as customers are also affected by the economic downturn, but incentivizing payments by offering discounts can offset reluctance. Customers are often concerned with locking in a company’s services or product and saving on cost, with discounts serving as an easy solution. While they can create a steady cash flow, it may not be sustainable for longer cash runways. Despite their attractive value, companies should use care when offering discounts for early payments. Discounts result in lower payments than initially agreed upon, so companies should consider how long of a runway they require and whether the discounted price can sustain a runway of such length.

Vendor Payments

One area where companies can strategize and cut costs is vendor payments. By delaying payments to vendors, companies can temporarily preserve cash balance and extend cash runway. Companies must review their vendor agreements to evaluate the potential practical and legal ramifications of this strategy. If the vendor agreements contain incentives for early payments or penalties for late payments, then such strategy should not be employed. Rather, companies can try to negotiate with vendors for an updated, extended repayment schedule that permits the company to hold on to their cash for longer. Alternatively, companies can negotiate with vendors for delayed payments without penalty. Often vendors would prefer to compromise rather than lose out on customers, especially in a down economy.

Lastly, companies can seek out vendors who are willing to accept products and services as the form of payment as opposed to cash. Because the calculation for cash runway only takes into account actual cash that companies have on hand, products and services they provide do not factor into the calculation. As such, companies can exchange products and services for the products and services that their vendors provide, thereby reserving their cash and extending their cash runway.

Bank Covenants

In exercising the various strategies above, it is important to be mindful of your existing bank covenants if your company has a lending facility in place. There are often covenants restricting the amount of debt a borrower can carry, requiring the maintenance of a certain level of cash flow, and cross default provisions automatically defaulting a borrower if it defaults under separate agreements with third parties. Understanding your bank covenants and default provisions will help you to stay out of default with your lender and avoid an early call on your loan and resulting drain on you cash position.

Employee Considerations

As discussed extensively in our first article Employment Dos and Don’ts When Implementing Workforce Reductions, the possibility of an economic downturn not only will have an impact on your customer base, but your workforce as well. Employees desire stability, and the below options can help keep your employees engaged.

Providing Equity as a Substitute for Additional Compensation.

Employees might come to expect cash bonuses and pay raises throughout their tenure with an employer; in a more difficult economic period this may further strain a business’s cash flow. One alternative to such cash-based payments is the granting of equity, such as options or restricted stock. This type of compensation affords employees the prospect of long-term appreciation in value and promotes talent retention, while preserving capital in the immediate term. Further, to the employee holding equity is to have “skin in the game” – the employee now has an ownership stake in the company and their work takes on increasing importance to the success of the company.

To be sure, the company’s management and principal owners should consider how much control they are ceding to these new minority equity holders. The company must also ensure such equity issuances comply with securities laws – including by structuring the offering to fit within an exemption from registration of the offering. Additionally, if a downturn in the company’s business results in a drop in the value of the equity being offered, the company should consider conducting a new 409A valuation. Doing so may set a lower exercise price for existing options, thus reducing the eventual cost to employees to exercise their options and furnishing additional, material compensation to employees without further burdening cash flow.

Transitioning Select Employees to Part-Time.

Paying the salaries of employees can be a major burden on a business’s cash flow, and yet one should be wary of resorting to laying off employees to conserve cash flow in a downturn. On the other hand, if a business were to miss a payroll its officers and directors could face personal liability for unpaid wages. One means of reducing a business’s wage commitments while retaining (and paying) existing employees is to transition certain employees to part-time status. In addition to producing immediate cash flow benefits, this strategy enables a business to retain key talent and avoid the cost of replacing the employees in the future. However, this transition to part-time employees comes with important considerations.

Part-time employees are often eligible for overtime pay and must receive the higher of the federal or state minimum hourly wage. And if transitioned employees are subject to restrictive covenants, such as a non-competition agreement, they might argue their change in status should release them from such restrictions. Particularly since the COVID-19 pandemic, courts have shown reluctance to enforce non-competes in the context of similar changes in work status when the provision is unreasonable or enforcement is against the public interest.

Director Liability in Insolvency

Insolvency and Duties to Creditors

There may be circumstances where insolvency is the only plausible result. A corporation has fiduciary duties to stockholders when solvent, but when a corporation becomes insolvent it additionally owes such duties to creditors. When insolvent, a corporation’s fiduciary duties do not shift from stockholders to creditors, but expand to encompass all of the corporation’s residual claimants, which include creditors. Courts define “insolvency” as the point at which a corporation is unable to pay its debts as they become due in the ordinary course of business, but the “zone of insolvency” occurs some time before then. There is no clear line delineating when a solvent company enters the zone of insolvency, but fiduciaries should assume they are in this zone if (1) the corporation’s liabilities exceed its assets, (2) the corporation is unable to pay its debts as they become due, or (3) the corporation faces an unreasonable risk of insolvency.

Multiple courts have held that upon reaching the “zone of insolvency,” a corporation has fiduciary duties to creditors. However, in 2007 the Delaware Supreme Court held that there is no change in fiduciary duties for a corporation upon transitioning from “solvent” to the “zone of insolvency.” Under this precedent, creditors do not have standing to pursue derivative breach of fiduciary duty claims against the corporation until it is actually insolvent. Once the corporation is insolvent, however, creditors can bring claims such as for fraudulent transfers of assets and for failure to pursue valid claims, including those against a corporation’s own directors and officers. To be sure, the Delaware Court of Chancery clarified that a corporation’s directors cannot be held liable for “continuing to operate [an] insolvent entity in the good faith belief that they may achieve profitability, even if their decisions ultimately lead to greater losses for creditors,” along with other caveats to the general fiduciary duty rule. Still, in light of the ambiguity in case law on the subject, a corporation ought to proceed carefully and understand its potential duties when approaching and reaching insolvency.

1 Diamond, Brandee and Lehot, Louis, Is it Time to Consider Alternative Financing Strategies?, Foley & Lardner LLP (July 18, 2022)

2 Rush, Thomas, Revenue-based financing: The next step for private equity and early-stage investment, TechCrunch (January 6, 2021)

Article By Natasha Allen, David W. Kantaros, Nikhil T. Pradhan, and Graham P. MacEwan of Foley & Lardner LLP

For more financial institutions and banking legal news, click here to visit the National Law Review.

© 2022 Foley & Lardner LLP

Which Business Entity is Right For You: Sole Proprietorship, Partnership, LLC, C-Corporation, or S-Corporation?

Introduction

Are you getting ready to launch your business? Or maybe you’re currently operating one and wondering what legal structure is best to use. There are a number of different legal entities to choose from. And each has its own set of pros and cons.

To determine which business entity is the best fit, you’ll want to see which one most applies to your situation and then carefully go over the pros and cons. It’s also a great idea to speak with your tax professional and an attorney.

Some things that will affect your decisions, and your long-term success, are liability protection, taxation, the complexity of management, annual requirements, and the ability to raise money from investors, if applicable.

What are the options?

New businesses in the US have a choice of five basic structures:

  • C-Corporation
  • LLC (Limited Liability Company)
  • S-Corporation
  • Sole Proprietorship
  • Partnership (aka General Partnership)

You’ll want to learn about each business structure and decide which best suits your needs. We’ll explain each type below and will also go over how they are different from each other.

Corporation (aka C-Corporation)

  • A Corporation is a separate legal entity created by state law. A Corporation is formed by filing a document called the Articles of Incorporation. This document is filed in the state where the entity is doing business and is filed with the Secretary of State or a similar government agency.
  • A Corporation must designate a Registered Agent in order to receive service of process and state correspondence.
  • By default, a Corporation is taxed under subchapter C of the Internal Revenue Code. This is often why Corporations are referred to as C-Corporations.
  • On the other hand, a Corporation can elect to be taxed as an S-Corporation (aka being taxed under subchapter S of the Internal Revenue Code) by filing Form 2553 with the IRS.
  • If the Corporation is taxed in its default status (taxed as a C-Corporation), the Corporation will face double taxation. Essentially, the Corporation is taxed at the corporate level on its profits. And then the Shareholders are taxed again, at the individual level, after they receive distributions (their share of profit).
  • C-Corporations are also responsible for paying state corporate income tax, if applicable, where they are domiciled and/or transacting business.
  • Corporations also have statutory requirements, such as electing a board of directors, designating corporate offers, holding annual meetings, and recording meeting minutes.
  • Corporations are not commonly used by small business owners. Instead, they are used by larger companies or tech startups often looking to raise venture capital from investors.

LLC (Limited Liability Company)

  • An LLC, aka Limited Liability Company, is a separate legal entity created by state law. An LLC is often formed by filing a document called the Articles of Organization. However, depending on the state, this form is also known as the Certificate of Organization or Certificate of Formation. This document is filed in the state where the entity is doing business and is filed with the Secretary of State or a similar government agency.
  • An LLC must also designate, and maintain, a Registered Agent. A Registered Agent must be located in the state where the LLC is formed. For example, if an LLC is formed in Texas, it must designate a Registered Agent in Texas.
  • The LLC is unique when it comes to tax treatment by the IRS. This means, there is no “LLC tax classification”. Instead, the LLC is taxed based on the number of owners. Alternatively, the LLC can make an election with the IRS, requesting to be taxed as a Corporation (C-Corporation or S-Corporation).
  • An LLC with one owner is known as a Disregarded Entity. This simply means the IRS “looks through” the LLC; looks at who the owner is, and taxes the individual or company accordingly. For example, if an American taxpayer is the single owner of an LLC, the LLC will be taxed as a Sole Proprietorship. If the LLC is owned by two or more people, the LLC will be taxed as a Partnership. And if the LLC is owned by another company, it will be taxed as a branch/division of the parent company.
  • And alternatively, the LLC can elect to be taxed as either a C-Corporation (by filing Form 8832) or an S-Corporation (by filing Form 2553).
  • LLCs taxed as Sole Proprietorship, Partnerships, and S-Corporations are all known as pass-through entities. This means there is no corporate-level taxation (company-level taxation). Instead, the taxes flow through to the owners and are reported and paid on their personal tax returns.
  • In the more uncommon setup – an LLC taxed as a C-Corporation – the LLC would face double taxation, just like a regular Corporation would.
  • And while an LLC may be able to be used for estate planning purposes, it’s often wiser to have your LLC owned by your trust(s). Of course, it’s best to speak with an estate planning attorney on such a matter.
  • In summary, for many small business owners, LLCs are the “best of all worlds”. They receive liability protection, just like a Corporation, but they are, by default, pass-through tax entities. And if the LLC would like to be subject to corporate tax treatment by the IRS, the LLC can make the necessary election. Said another way, while providing liability protection to its owners, the LLC can pretty much choose how it would like to be taxed.
  • LLCs also have more flexible management options and don’t have as many formal, and annual requirements, such as Corporations.
  • LLCs are the most popular type of business entity in the United States, mostly because of their flexibility and the personal liability protection they offer to owners.

S-Corporation (aka S Corp)

  • An S-Corporation is unique because it is not a legal entity, like an LLC or a Corporation. Instead, it’s a tax election made with the IRS.
  • It’s easier to think of it this way: The S-Corporation tax election “sits on top of” a state-level entity, such as an LLC or Corporation.
  • This is one of the most common myths with S-Corporations. People think you can just “form” an S-Corp. You simply cannot. There is no state or federal filing to “form” an S-Corp. Instead, one must first form an LLC or Corporation, and then timely file Form 2553 with the IRS to request to be taxed under Subchapter S of the Internal Revenue Code.
  • Once the IRS grants the elective status, it’s common to refer to the entity as an S-Corporation and its owners as Shareholders.
  • For most, the primary reason to explore S-Corp tax treatment is to save money on self-employment taxes.
  • Owners of an S-Corporation must take a “reasonable salary” (which is subject to self-employment taxes), but any remaining profit can be taken as a distribution (which isn’t subject to self-employment taxes). And that’s the main appeal of S-Corporations right there.
  • It’s important to keep in mind that with an S-Corporation, you must regularly run payroll, withhold taxes, file quarterly payroll returns (federal and state), hire a bookkeeper (or manage your own books), keep an accurate balance sheet (since it’s required to be filed with the IRS), file a corporate tax return (Form 1120S, K-1s for shareholders/owners, and any additional Schedules), and hire an accountant if you don’t have one already.
  • All of the above costs money. And those costs – which average $2,000 – $4,000 for small business owners – need to be compared to the potential self-employment tax savings; in order to make sure the S-Corp tax treatment makes sense.
  • S-Corporations can be owned by US citizens, US trusts (depending on how they’re taxed), US estates, US resident aliens, and US tax-exempt organizations.
  • S-Corporations cannot be owned by Non-US residents (aka non-resident aliens), foreign companies, C-Corporations, Partnerships, financial institutions, or insurance companies.
  • If you’re considering having your entity taxed as an S-Corporation, it’s important to speak with an accountant to make sure the extra cost – and additional filing requirements – are worth the self-employment tax savings. Having your business entity taxed as an S-Corporation can be a good idea for some, but isn’t necessarily a good idea for everyone.

Sole proprietorship

  • A Sole Proprietorship is an informal “business structure” with one owner.
  • There is no paperwork to file with the Secretary of State, or a similar government agency, to create a Sole Proprietorship.
  • You simply are a Sole Proprietorship once you engage in business activities, or engage in activities with the goal of making money.
  • A Sole Proprietor can do business under their own name or they can file a DBA (Doing Business As) Name. For example, John Doe can do business under his name, John Doe, or he can file a DBA called “John’s Painting Company”.
  • The advantage of a Sole Proprietorship is that they are easy to set up.
  • And taxes are pretty straightforward with a Sole Proprietorship. The owner will simply file a Schedule C and report their business income (or loss) on their personal tax return.
  • The largest disadvantage of Sole Proprietorship is that there is no liability protection for the owner. In the eyes of the law, the owner and their business are one and the same. If the business is involved in a lawsuit, the owner’s personal assets (home, cars, bank account, etc.) could be used to settle business debts and liabilities.
  • Another disadvantage of a Sole Proprietorship is that if you eventually form an LLC or Corporation, there is no official “conversion” filing. So you basically have to start all over again – filing paperwork with the state, getting an EIN (Federal Tax ID Number), opening a business bank account, etc. So if you’re on the fence, between an LLC or Sole Proprietorship, for example, it’s often easier to just form an LLC.
  • However, if you believe your business has a low liability risk and you don’t have money to form an LLC or Corporation, starting your business as a Sole Proprietorship may be the best method to getting your business off the ground.

General Partnership (aka Partnership)

  • A General Partnership (Partnership) is pretty much a Sole Proprietorship with 2 or more people. Said another way, it’s an informal “business structure” with multiple owners.
  • In most states, there is no paperwork to file with the Secretary of State, or a similar government agency, to create a General Partnership (there are few states though that require General Partnerships to register).
  • A Partnership can do business under the names of the owners or it can file a DBA (Doing Business As) Name.
  • The advantage of a General Partnership is that it is easy to set up.
  • Partnership taxes are not as straightforward as with a Sole Proprietorship though. For instance, the Partnership must file a Form 1065 and issue K-1s to the partners. Then the partners report their K-1 income on their personal tax returns.
  • The largest disadvantage of a Partnership is that there is no liability protection for the owners. Again, in the eyes of the law, the owners and their businesses are one and the same. If the business is involved in a lawsuit, the owner’s personal assets (home, cars, bank accounts, etc.) could be used to settle business debts and liabilities.
  • While a Partnership may be a good way to save money and get a business off the ground, most people quickly shift to a legal business entity, like an LLC or Corporation.

Choosing the best entity structure for your business

  • Generally speaking, the LLC is the most adaptable corporate structure, and for that reason the most popular choice in the U.S. The LLC can pretty much choose how it would like to be taxed by the IRS, all while providing its owners’ personal liability protection.
  • Having said that, some owners may elect for their LLC to be taxed as an S-Corporation to save money on self-employment taxes.
  • Or larger businesses (or those raising money) may prefer to form a Corporation, especially if they have large healthcare expenses.
  • And while Sole Proprietorships and General Partnerships may be good to start off with, owners may quickly outgrow them or not feel comfortable with the lack of personal liability protection.

Conclusion

Choosing the best legal entity for your business is a game of weighing the pros and cons. Things to consider are liability protection for the owners, tax treatment by the IRS, and the reporting requirements, among other things. Typically, larger companies or those raising money from investors opt for the Corporation, while most small business owners choose to form an LLC.

Article By Matt Horwitz of LLC University

For more corporate and business legal news, click here to visit the National Law Review.

© Copyright 2010 LLC University

Monkeypox Outbreak Declared a Public Health Emergency

On August 4, 2022, the Biden administration declared the monkeypox outbreak a public health emergency. This comes at a time where the number of cases in the United States are rapidly rising and with cases found in almost every state. This declaration primarily affects testing and vaccination. The government’s focus on vaccination has primarily been on health care workers treating monkeypox patients and men who have sex with men. The declaration follows the World Health Organization’s (WHO) declaration last month of monkeypox as a public health emergency of international concern.

The information affecting the workplace is still somewhat limited. The U.S. Centers for Disease Control and Prevention (CDC) recommends that people with monkeypox remain isolated at home or in another location for the duration of the illness, which typically can last two to four weeks.

It is still not known if monkeypox can be spread through respiratory secretions. Accordingly, a well-fitting mask and frequent handwashing are likely important preventive measures.

Monkeypox can spread to anyone through close, personal, often skin-to-skin contact, including:

  • via direct contact with monkeypox rash, scabs, or body fluids from a person with monkeypox;

  • by touching objects, fabrics (clothing, bedding, or towels), and surfaces that have been used by someone with monkeypox; and

  • possibly through contact with respiratory secretions.

Employers may wish to educate their employees about monkeypox, including that employees with concerns should consult their physicians or health department, and may wish to inquire about testing and vaccination. Employers may also wish to consider how they will handle absences of up to one month, if remote work is not a possibility and/or when remote work is a possibility. Knowledge is often a way to avoid panic in the workplace and both the CDC and WHO have excellent fact sheets on their websites. State health agencies are likely to have them as well.

It may also be worthwhile to consider how to protect employees who are required to handle linens used by other people, people who are frequently in close contact with others for extended periods, or who come into close physical contact with others. For example, in its monkeypox congregate settings guidelines, the CDC recommends that personal protective equipment (PPE) be worn when cleaning the area where an individual with monkeypox has spent time.

The CDC also stated in its monkeypox congregate settings guidelines that “[e]mployers must comply with [the Occupational Safety and Health Administration’s] standards on Bloodborne Pathogens…, PPE…, Respiratory Protection…, and other requirements, including those established by state plans, whenever these requirements apply.”

Public health officials are emphasizing the fact that anyone can get monkeypox. The current outbreak is most prevalent among men having sex with other men, but can spread to anyone. Employers may want to stay attuned to any harassment or discrimination in the workplace resulting from misinformation about the disease.

Ogletree Deakins will continue to monitor and report on developments with respect to monkeypox.

Article By Katherine Dudley Helms of Ogletree, Deakins, Nash, Smoak & Stewart, P.C.

For more labor and employment legal news, click here to visit the National Law Review.

© 2022, Ogletree, Deakins, Nash, Smoak & Stewart, P.C., All Rights Reserved.