The Loss of a Legal Visionary, An Inspiring Lady and a Friend
I wanted to memorialize the passing of Gail Koff, a long-time client and friend, on August 31st. Gail quietly fought a type of Leukemia for more than 10 years, yet due to her strength and love of life the people around her never thought her final day could be so soon.
Gail was one of the founding partners of Jacoby & Meyers, which started more than 35 years ago as a law firm for the average citizen. Gail had many ups and downs at her firm during that period, but never dropped her focus on trying to improve the world through her legal services. She also spent a great deal of time and energy on the boards of non-profit organizations and educational institutions such as Bank Street College and The Calhoun School.
The New York Times wrote an obituary here. The Wall Street Journal wrote a remembrance piece about Gail here. The Wall Street Journal Law Blog covered her passing here. Death notices in the New York Times are here.
On a personal note, this is the first time I had a client who became a friend pass away and I find myself very saddened by it. Gail was truly an inspiration with her strength, vision, perseverance, commitment to social causes, and love of family, friends and life. I consider myself very fortunate to have known her and will truly miss her.
Rest in peace, Gail.
NASDAQ Closing Bell Ceremony with University of the People
On August 17th, I had a real treat of joining my non-profit, pro bono client, University of the People, for the closing bell ceremony at NASDAQ. UoPeople, the first tuition-free online university, was founded by Israeli education technology entrepreneur, Shai Reshef. You can learn more about this terrific organization that is trying to democratize higher education globally at www.UoPeople.org. You can view the video of the closing ceremony here.
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Hidden Dangers of Independent Contractors – TV Interview with Dorsey Partner Mike Droke
Mike Droke, the head of our Seattle office and the Co-Chair of Dorsey’s Labor & Employment practice, recently spoke on Fox Business News about some of the pitfalls of misclassifying people as independent contractors. Federal tax authorities are increasingly targeting companies that treat people as contractors when they really should be treated as employees. Mike’s interview, linked below, provides a good overview of the topic.
TV interview: Hidden Dangers of Independent Contractors
Seal the Deal?
This post is being filed in my new “Strange (or Interesting) Corporate Laws” category. This one came up in a recent Delaware Supreme Court case entitled Whittington v. Dragon Group, L.L.C.
The general statute of limitations for contract disputes in Delaware is 3 years. However, if the contract in question is “sealed”, then the statute of limitations is 20 years. Not much has to happen for a contract to be “sealed” – for an individual, the court ruled, all it takes is for the word “seal” to appear next to the signature. Those four letters, usually glanced over quickly (if at all) in the signing process, extended the statute of limitations by 17 years.
I am philosophically (and practically) opposed to situations where small, unintended differences result in large, unintended consequences. Four letters, 17 years, is such a situation. Similar differences apply in many other states as well.
The lessons:
- Every word in a contract matters. Therefore, nitpicking sometimes matters.
- The governing law in a contract matters.
- Contractual obligations may be explicit (written expressly in the contract) or implicit (applied by statute or case law, where not covered expressly).
- Careful legal negotiation takes into account all of the above.
Equity Incentive Compensation in LLCs
In a recent post, I recommended that the typical startup should start as an LLC (limited liability company) and remain an LLC as long as possible. One ever-present challenge with LLCs is that most entrepreneurs (present company included) like to try to force-fit corporate concepts and structures into an LLC format. This is not always easy or even possible — pass-through (partnership-style) taxation means that LLC membership interests are very different than corporate stock. These differences have a big impact on equity incentive compensation for employees.
In the corporate context, options are far and away the most common form of equity incentive compensation. In the LLC context, options are rarely used because they have uncertain, and largely unwelcome, tax consequences. So, how do an LLC’s employees get to share in the growth of an LLC’s value?
Capital Interest and Profits Interests
An LLC membership interest can either be a capital interest or a profits interest. A basic capital interest is similar to common stock — it has the right to a proportionate share of the capital, profits and residual value of the LLC. A basic profits interest is just like a capital interest, except that it gets a zero dollar interest in the value of the company on the date of grant. Like capital interests, profits interests share in the profits and residual value of the LLC (other than the initial value on the date of grant). In other words, the profits interest starts out with a zero dollar value and grows in value as the LLC grows in value. In this way, it is most similar to SARs (stock appreciation rights) in the corporate context.
One of the things that routinely causes confusion is that the term “profits interest” is a partial misnomer. The word “profits” in this term includes both actual profits and “value accretion”. Of course, true profits are allocated to members as they are earned. In addition, when an LLC grows in value and an allocation event occurs, the LLC allocates the value accretion as if it were profits. (Note that allocations of value, unlike actual profits, do not automatically result in taxable income for the recipient of the allocation.)
Profits interests are, in fact, a great way to provide equity compensation to LLC employees. Assuming certain tax rules are met, the profits interest is not taxable on the date of grant but still participates in the upside growth of the business. The problem is that an employee who owns a profits interest is a member (owner) of the LLC and, therefore, cannot be treated as an employee for tax purposes (they may still be considered an employee for federal and state employment law purposes). Instead of receiving income reported on the standard W-2 tax form, they receive their income reported on a K-1. This simple difference has several corollaries: (1) the employee has to file quarterly estimated tax payments instead of having taxes withheld from every paycheck; (2) the company does not match FICA payments but instead the employee has to pay ‘both sides’ of the tax; and (3) certain benefits to the employee, such as medical insurance, may be taxable. Generally speaking, an employee who receives a profits interest needs to receive higher compensation in order to have the same after-tax money as an employee who does not hold a profits interest.
Unit Appreciation Rights
An alternative to profits interests for an employee that does not want to have the tax attributes of a member is the issuance of UARs (unit appreciation rights). UARs have similar (not identical, but similar) economic consequences to profits interests, but still allow the employee to be treated as an employee for tax purposes. It should be noted that profits interests give rise to income that is taxed at either ordinary income rates or capital gains rates depending on the source of the underlying company income (typically the sale of the business will create mostly capital gain), while UARs will always give rise to income taxed at ordinary income rates.
A more comprehensive review of the vagaries of profits interests and UARs is beyond the scope of this post, but the key message is that there are effective ways to incentivize employees of an LLC and that care must be taken to determine the optimal way for particular companies and individual employees.
AEP Legal Corner – Independent Contractor or Employer: Getting It Right Is More Important Now Than Ever Before
by Gary M. Gansle, partner in Dorsey & Whitney’s Labor and Employment practice
For far too long, employers have taken a laissez-faire approach to classifying workers as independent contractors in order to help control costs, streamline their organizations, and honor the stated preferences of their workers. However, the cost associated with being undisciplined and incorrect about these classification decisions can be quite expensive, and is likely to get more expensive in the near future given the Department of Labor’s “Misclassification Initiative,” which is designed to identify and reduce employee misclassification.
Go to The Association of Educational Publishers’ Dorsey & Whitney Legal Corner.
What Type of Entity Should Your Startup Be?
In counseling entrepreneurs, one of the first questions that arises is about choice of entity type – in other words, should the entrepreneur’s business be contained in a C corp, S corp, LLC, limited partnership or general partnership, or be structured in some other way? While there are obviously a number of factors that must be considered when answering this question, my answer is – with few exceptions – that an LLC is the best form. This is not yet the universal view, and some excellent attorneys have a different predisposition. So, I’ll lay out my basic reasons here, and I’ll be curious for comments – especially from people with a different viewpoint.
To keep it simple, my reason is that an LLC provides the benefit of limited liability for the owners, pass-through tax treatment (that is, no double tax), and ultimate flexibility in structuring the equity ownership and management rights of owners. No other entity form has this combination of features. Read more
10 Legal Lessons from our ‘Unimaginable Journey’
In Aviad Meitar’s book, An Unimaginable Journey: How Pepsi Beat the Odds in Romania, he recounts his incredible experience in launching, building and selling the Pepsi business in Romania. His focus is on the business lessons and personal highs and lows (mostly highs) of that experience. Although he is also a lawyer (non-practicing), the book does not delve into the legal lessons of our journey.
As the General Counsel of Pepsi Romania from 1991-2006, here are the top 10 legal lessons that I learned, which I regularly have the chance to apply in current representations. Many of these lessons can be gleaned from the stories presented in Aviad’s book. Read more
Dorsey Announces Establishment of Educational Publishing, Technology and Services Industry Group
I’ve been working on this for a year and am excited about my firm’s commitment to this innovative, rapidly growing and essential industry. We have 35 attorneys who have joined the group so far. Please contact me if you’d like to learn more about our ability to add value to your educational publishing, technology or services business.
A copy of the firm’s press release is reprinted below. You can also find it here: http://www.dorsey.com/educ_pub_industry_group_pr/
Jeff Read more
Favorite Quoted Quotes from ‘An Unimaginable Journey’
My friend, business partner and client, Aviad Meitar, just published a very interesting book about our experience in building the exclusive Pepsi-Cola bottler in the country of Romania. We made the first trip to Romania together in January 1991, just 13 months after the revolution that overthrew Ceausescu. Since that incredible first encounter, Aviad always said one day he would write a book about it. Now the book, An Unimaginable Journey: How Pepsi Beat the Odds in Romania, is out, published by Amazon’s subsidiary, BookSurge.
Here’s the independent review from ForeWord Clarion Reviews:
“The journey described by Aviad Meitar is nothing if not intriguing. This well-written and concise eyewitness account of building an American brand in an Eastern European country offers rare insight into how a business can succeed even in the face of the most daunting challenges.”
At the beginning of each chapter, Aviad presents a voyage-themed quote that relates to the story in that chapter. Most of these quotes were new to me, and many seemed both insightful and of general applicability to emerging companies and entrepreneurs. In this first post about this book, I present my favorite quoted quotes: Read more
