A leading business law firm in Denver, Colorado
Contact Us

Category: All

PAT LINDEN RECOGNIZED BY LAW WEEK AS COLORADO’S BEST M&A LAWYER FOR 2020

Posted on by PLinden

We are pleased to announce that Pat Linden received the Barrister’s Best award from Law Week Colorado (Law Week), an elite annual publication of the “best of the best” in the legal profession in Colorado. For 2020, Pat was selected as “Best M&A Lawyer”.

This isn’t Pat’s first time being recognized on the Barrister’s Best list. In 2019, he was selected as Colorado’s “Best Private Equity Lawyer”, and in he was also previously recognized as Colorado’s best M&A lawyer in 2018. Law Week described Pat as “an entrepreneur for entrepreneurs” who is “active with like-minded business people who are making moves.” Law Week also specifically noted Pat’s breadth of practice given his 2019 recognition for his work in private equity.

For nearly twenty years, Pat’s practice has concentrated on commercial transactions. He represents companies, investors and entrepreneurs across a broad variety of early stage, venture capital (VC), private equity (PE) and M&A deals. Pat has represented many of the leading companies, investors and senior executives in the Rocky Mountain region on virtually all aspects of their investment and M&A transactions, ranging from seed stage investments for hundreds of thousands of dollars to PE and M&A deals reaching $700 million.

The Barrister’s Best list is based on a poll of votes from Law Week readers and input from editorial staff in identifying and recognizing Colorado’s top lawyers by practice area. Law Week is Colorado’s only newspaper published specifically for lawyers, law firms, corporate counsel and the judiciary. It is written and edited by award-winning journalists and lawyers with long-standing credibility in the legal marketplace.

Understanding and Structuring Board Observer Rights

Posted on by PLinden

Board Observer Rights

Venture capital firms and other equity investors commonly request the right to have an observer attend the board of director meetings of their portfolio companies. A board observer isn’t a director and therefore doesn’t have voting rights, generally doesn’t have a fiduciary obligation to the company or its shareholders, and typically doesn’t have the same right to indemnification to the same extent as actual members of the board of directors.

There is also no statutory or common law right that ensures investors will have the right to participate in board meetings, to have an observer attend board meetings, or to receive the information provided to board members.

Rather, these types of rights and obligations among the company, the investor and the observer are grounded solely in contractual agreements negotiated (or not negotiated) by the parties. Accordingly, there should be some thought and analysis around the creation and negotiation of these rights and obligations.

Investor Considerations

In some situations, a VC firm that is a major investor (i.e., investing over a certain dollar threshold in the financing round) with the right to appoint one or more members to a portfolio company’s board of directors may desire an ‘observer’ to attend board meetings, along with the VC’s director representative, as a way to train a more junior associate in the VC firm and/or to provide administrative support for the director representative (who may be serving on multiple boards).

In other situations, a VC that’s investing a comparably smaller amount than other investors (and who therefore does not have an actual representative member on the board directors) may desire an observer simply to obtain more information about its investment or to be able to provide input on the affairs and strategies of the company.

Regardless of the underlying investor reasons, since investors don’t have board participation rights without these types of specifically negotiated contractual commitments of the company, it’s common for investors to negotiate for them.

Company Considerations

The company will want to consider the reasoning behind the investor’s request, as well as any potential negative impacts of having the influence of an additional person (albeit in a nonvoting capacity) present during the board’s discussions and deliberations.

And practically speaking, the lead investor will want to sign off on any other investor having the right to a board observer. Still, it is typical for a company to give certain major investors board observer rights, subject to certain company-protective provisions.

For example, the company will almost always make this right subject to the major investor maintaining a certain number or percentage of shares of preferred stock purchased at the initial closing of a financing round.

The agreement defining board observer rights will provide that the observer doesn’t have voting or veto rights over matters presented to the board of directors. It’s also standard that an observer be subject to confidentiality and non-disclosure obligations to the company.

Other company protections that are typically considered non-controversial include the right of the company to exclude the board observer from certain discussions and information if the observer’s attendance or access to information could result in a conflict of interest, or if the VC firm holding the observer right has a position in a competitor to the company, etc.

Conclusion

Every investment is unique. Companies and investors alike need experienced and practical legal counsel to structure optimal win-win outcomes. The attorneys at Linden Law Partners have decades of experience representing both companies and investors across all aspects of venture capital and other equity investment transactions. Contact us today to discuss how we can help.

 © 2020 Linden Law Partners, LLC. All rights reserved.

Linden Law Partners Represents Colorado Mechanical Systems (CMS) in Successful Acquisition by Reedy Industries

Posted on by PLinden

Congratulations to our clients at Colorado Mechanical Systems Inc. (CMS), a private company based in Centennial, Colorado that provides commercial HVAC, refrigeration and plumbing services. It was acquired by Reedy Industries, Inc. (Reedy), a leading Midwest commercial and industrial HVAC and building control services company. Linden Law Partners represented CMS and its ownership on all aspects of the transaction.

Joshuah F. Skinner, President of Colorado Mechanical Systems, Inc. said this of Linden Law Partners:

“Pat Linden and the rest of team at Linden Law Partners played a vital and critically important role in getting our deal to the agreed upon terms and ultimate closing day finish line in selling my business in September, 2020. They were great sounding boards, who provided invaluable insight and recommendations throughout the entire process. I’m confident that you will find them to be valued partners in any future M&A dealings. Undoubtedly, the attorneys at Linden Law Partners earned my trust and friendship and I would highly recommend this firm to any selling business owner looking for a strong partner!”

Ready Industires - Colorado Mechanical Systems LLC

You can read the press release published by NewsWire here.

Accredited Vs. Non-accredited Investors: Avoiding The Pitfalls

Posted on by PLinden

When seeking investors, entrepreneurs and business owners may be approached by individuals, including friends and family, who do not qualify as “accredited investors” under securities laws. Depending on where a business is in its lifecycle, accepting funds from these types of individuals may range from appealing to essential, or a business owner may simply desire to include them in the investment opportunity.

However, CEOs and business owners should understand that accepting investments from non-accredited investors is often impractical for a few reasons. Can Non-Accredited Investors Invest in an LLC? We explain the basics below.

Background

Any offering or sale of securities (e.g., shares of stock or LLC membership interests) in the United States is subject to the requirements of the Securities Act of 1933. Under the Securities Act, the offering must be registered with the SEC unless it qualifies for an exemption from registration.

A registration statement is impractical for most private companies due to the onerousness of the required disclosure documentation and the associated expenses. Therefore, most companies typically rely on Rule 506 of Regulation D (Reg D) of the Securities Act, which provides the most commonly used exemptions to registration.

However, Rule 506 provides for heightened disclosure requirements, similar to what is required in a public offering, if you sell securities to non-accredited investors.

What is an Accredited Investor?

Accredited investors are generally high-net-worth individuals or institutions. Accredited investors are normally good for businesses raising capital because they typically have experience making investments in the past, have the financial means to make the investment, and are less likely to raise as many issues or concerns as less experienced or less financially sophisticated investors might.

Under Rule 501 of Regulation D of the Securities Act, an accredited investor is:

  • an individual with a net worth of at least $1 million, not including the value of his or her primary residence;
  • an individual with income exceeding $200,000 in each of the two most recent calendar years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year;
  • certain qualifying trusts, banks, insurance companies, registered investment companies, business development companies, small business investment companies, employee benefit plans, and tax exempt entities;
  • a director, executive officer, or general partner of the company selling the securities; or
  • an enterprise in which all the equity owners are accredited investors.

On August 26, 2020, the SEC adopted amendments that expand the definition of “accredited investor”. These changes will take effect 60 days following publication in the Federal Register. Once the amendments are implemented, accredited investors will include:

  • Couples meeting the requirements of “spousal equivalents”, who will be permitted to pool their assets for purposes of satisfying the accredited investor joint income or joint net worth thresholds.
  • Individuals holding professional certifications, designations, or other credentials, as designated by the SEC by written order. The SEC has so far designated holders in good standing of Series 7, Series 65, and Series 82 licenses as qualifying individuals.
  • Individuals who meet the definition of a “knowledgeable employee” (as defined in the Investment Advisers Act) of a private investment fund, such as a private equity or venture fund, with respect to investments in that fund.
  • SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies.
  • Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that own “investments” (as defined in the Investment Company Act) in excess of $5 million and that were not formed for the specific purpose of investing in the offered securities.
  • Any “family office” with at least $5 million in assets under management and its “family clients” (as those terms are defined in the Investment Advisers Act).

The Challenges Presented by Non-accredited Investors

Private companies, in particular startups and other early-stage companies with cash flow constraints, benefit from being able to raise money in reliance on an exemption under the Securities Act in order to avoid the burden and expense of registering the offering with the SEC and state securities commissions.

However, companies selling securities in an offering that includes non-accredited investors must, in order to comply with SEC regulations, provide those investors essentially the same information that would be required under Regulation A or registered offerings, which means the requirement that comprehensive disclosure and offering materials must be provided to investors that includes extensive financial and other company information (similar to what would be required for an IPO to be registered with the SEC).

So, while opening up investments to non-accredited investors such as family and close friends can seem like a good idea to entrepreneurs looking to bolster their early-stage companies’ capital resources, the time, effort, and expense involved in complying with SEC requirements can be cost-prohibitive and, simply, not worth it. 

A Note on Crowdfunding

Since May 16, 2016, the SEC has permitted companies to offer and sell securities through certain crowdfunding platforms under Regulation Crowdfunding. Although accredited investor status is not required, certain requirements must be met to qualify for the crowdfunding exemption, including investment limits based on investor net income and net worth and filing Form C with the SEC (as well as continuing annual reporting requirements).

While the costs of meeting these requirements may steer some startups and early-stage companies away from the crowdfunding exemption, it can be an attractive option for companies seeking to raise smaller amounts from alternative or broader-reaching financing sources, including non-accredited investors.

Contact Us

Linden Law Partners understands the challenges entrepreneurs experience when attempting to raise capital. The legal representation we provide to businesses is thorough and focused; through it all, however, we never lose sight of the ultimate goal, which is to put your company in the best position to succeed and provide you with the advice, strategy and approach to do so. Contact us here or call us at 303-731-0007.

Selecting the Ideal Private Equity Partner: 5 Tips

Posted on by PLinden

You’re ready to sell your business or bring on a major investor, have hired a knowledgeable investment banker to manage the process, and now you’re entertaining one or more offers from interested private equity (PE) firms.

Choosing The Right Private Equity Partner:

Choosing the right PE partner is one of the most critical decisions for any founder or CEO, and the relationship will be for the long haul. Before you sign up for the highest valuation offered, we’ve outlined five key considerations for founders and CEOs in choosing the right PE partner for your business.

1. Determine the resources the PE firm can offer your specific business.

In addition to ensuring the PE fund will have appropriate (and accessible) capital available after the closing, the right PE investor will have resources to help your business execute its strategic plan and maximize value.

Look at the gaps you need to fill in your business and flesh out exactly how a particular PE firm is positioned to help you bridge those gaps. For example, do they have a wide-reaching network or industry-specific contacts for developing partnership opportunities or relationships or certain expertise or transaction experience that address your business’s current needs, future plans, and desired cost savings?

You should also understand how they implement their growth strategies. Some PE firms will have more rigid protocols they expect all of their portfolio companies to adhere to, while others will take a more individualized approach on a company-by-company basis. Some PE firms are highly acquisitive, while others focus more on building from within each portfolio company. Analyze how their approach fits with your business.

2. Understand the management style of the PE firm. 

Before choosing a PE firm, learn how each potential firm manages their portfolio companies, and whether their management style aligns well with yours. What will their level of involvement be with your business? Do they micromanage? Do they plan on replacing executive management? Or do they take a more hands-off approach? How do they communicate?

To help you assess management style (as well as the many other due diligence items we describe in this article), obtain references for other founders and CEOs who have partnered with the firm, including references of portfolio companies that weren’t successful.

3. Get to know the individual partners you’ll be working with. 

While you may be drawn to the overall branding or general approach of a PE firm, you’ll work closely with only one or two partners. Get to know these individuals. Do you like them? Can you envision building a productive long-term working relationship with them? How well do your personalities and management styles mesh?

These are important questions to ask because you’ll be spending a significant amount of time together in the future. If upfront you find there’s poor rapport or your personalities or styles don’t match well, it’s probably a sign to keep looking for a better fit.

4. Evaluate the PE firm’s track record for businesses of your size. 

Generally, you’ll want to assess the PE firm’s performance over the short- and long-term, and specifically with respect to businesses of your size.

Some factors to consider include the success of the PE firm’s funds during both strong and weak economic cycles (if they have sufficient history), the fund’s capital resources, whether the firm has experienced high turnover among its partners (related to point 3 above, if you find someone you are excited to work with but you find that partners don’t tend to stay on long-term, that could raise a red flag), and the type and number of transactions the firm has completed in your market-size.

5. Obtain a clear understanding of the fund’s investment horizon and exit strategy.

Make sure you know how long you have to execute your strategic plan. Having an investment horizon that is too short for your business could result in undue pressure to achieve revenue or earnings milestones that are unrealistic. Or, perhaps you’re seeking to remain involved with the business for a longer term, or you envision a quicker exit.

In any case, discussing the investment horizon with each prospective PE partner is needed to determine whether your mutual vision and interests are aligned. Most PE acquisitions where the founders remain involved post-acquisition are “second bite at the apple” opportunities (meaning the founders retain a minority equity stake in the hopes of obtaining a second return on investment with the PE acquirer when it subsequently resells the business or goes public).

Conclusion

Just as important as performing your due diligence on potential PE investors is having a knowledgeable M&A attorney experienced with private equity transactions. Linden Law Partners has years of experience advising businesses and their stakeholders on all aspects of sale transactions to private equity firms.

Get in touch with us at 303-731-0007 to discuss your options.

Oliver Luck vs. Vince McMahon: Key Takeaways For Executives/Companies Negotiating Employment Agreements (as published in Forbes)

Posted on by PLinden

The recently filed Oliver Luck v. Vince McMahon lawsuit is a high-profile case between nationally known businessmen (particularly McMahon), but there are everyday takeaways that can serve any company or executive well when negotiating high-stakes employment contracts. Namely, Luck v. McMahon illustrates how important the “cause” (and often related “good reason”) definitions and their associated payout and recovery provisions are in employment contracts for both companies and executives.

Short Case Overview

On April 16, 2020, Oliver Luck, the former commissioner and CEO of the now defunct XFL professional football league, sued Vince McMahon, the owner of the XFL and chairman and CEO of WWE, for breach of contract. Luck’s employment with the XFL was terminated on April 9, 2020, and the XFL holding company that was the party to the contract has since filed for chapter 11 bankruptcy.

The XFL alleges that Luck’s termination was for cause as a result of:

1. A failure to devote substantially all of Luck’s business time to the XFL following the COVID-19 outbreak.

2. Luck’s gross negligence in permitting the XFL to sign wide receiver Antonio Callaway without informing McMahon, allegedly in violation of XFL’s policy against hiring players with questionable or problematic backgrounds.

3. Luck’s misuse of his company-issued cellphone for personal matters.

Luck, of course, is disputing each of these claims in turn with his own set of facts, arguing that the XFL’s claims were “pretextual and devoid of merit” and that the termination of his contract was wrongful and “without cause.”

Luck seeks damages of $23.8 million, which he is contractually owed if terminated “without cause.” Conversely, Luck is owed little to nothing for a “cause” termination. Notably, Luck also obtained a personal guarantee from McMahon of the XFL’s payment obligations under the contract.

Luck’s contract, along with other executive contracts, was rejected in the XFL’s bankruptcy case. However, because of the personal guarantee from McMahon, Luck can seek recovery directly from McMahon, who is a billionaire.

The Implication Of ‘Cause’ In Executive Employment Contracts

Most executive employment contracts lay out negotiated reasons or occurrences that give the company a right to terminate the executive’s employment for cause. Typically, the termination of an executive’s employment without cause will trigger severance and potentially other payment or benefit obligations. However, a termination with cause typically means the executive receives little to no compensation post-termination.

Therefore, a thoughtfully negotiated and well-drafted definition in employment contracts regarding what is and is not “cause” is critical for both companies and executives. Companies will generally seek more broad and subjective definitions, while savvy executives will attempt to narrow the meaning.

For executives, in particular, terms that are subjective or open-ended, such as “failure to comply with directives ascribed by the board” or “failure to achieve company success as determined in discretion of board,” will make it easier for the company to validly claim a cause termination under nebulous circumstances.

The most well-advised executives with the leverage to command it will often narrow cause to circumstances that would be highly difficult for the company to invoke. For example, limiting cause to “fraud,” “felonious conduct” or some other egregious action that is unlikely to occur provides executives with heightened assurances that if they are terminated for general performance or business reasons, they will still receive their negotiated severance or other termination benefits.

The contract must also set out specified payment obligations for termination scenarios. Virtually any termination, with or without cause, will provide for payment of accrued benefits through the termination date. But other payment types, such as bonuses, accelerated vesting of equity interests and healthcare reimbursements, are highly negotiable.

In employment contracts between founders and acquiring companies in M&A deals (in which, for example, a financial or strategic buyer purchases a startup and employs the founders post-acquisition), the executive/former founder should negotiate for the acceleration of payments owed to the founder as part of the acquisition transaction if they are terminated by the acquiring company without cause after the deal closes.

Examples of these types of accelerated payments may include purchase price earn-outs, promissory notes or vesting of rollover equity.

When Considering A Guarantee Of Payment

Luck was smart to negotiate for a personal guarantee of payment from McMahon, especially given the amount at stake and the business risk Luck was taking with the XFL in lieu of other lucrative and more surefire positions likely available to him.

Executives might consider negotiating for corporate guarantees from parent companies with ample resources in cases where established companies purposefully set up new entities for new business lines (which happens all the time as part of customary corporate legal structuring).

If the contract is with a newly established entity, regardless of the overall financial wherewithal of a larger corporate conglomerate, the risk of actual payout of severance benefits is greater absent a guaranty by a parent or other corporate affiliate with a stronger balance sheet. Given the current economic climate, expect more hotly contested negotiations over personal and corporate-level guarantees in executive employment contracts.

Parting Thoughts

While no contract is so ironclad to be immune from a lawsuit, Luck v. McMahon provides a timely reminder for companies and executives to take a closer look at the scenarios under which their employment contracts can be terminated and the companies’ payment obligations arising from those different scenarios. Given the current economic climate, executive employees should also investigate how to mitigate the financial risk of obtaining separation benefits in the event of their termination without cause.

Dissolution Considerations for Co-Founders of Startups

Posted on by PLinden

The Importance of Mandatory Dissolution Provisions in Agreements Among Co-Owners

When co-founders of a startup are forming their entity and putting their founder agreements together, one issue that is often overlooked concerns the resolution of deadlocks or dissolving the business if the co-founders are unable to co-exist. By the time many founders figure out the importance of this issue, the honeymoon phase of their relationship with their co-founder(s) has worn off and the ability to extract themselves from the business (or their co-founder(s)) has become significantly more difficult and expensive.

While buy-sell provisions are standard in written agreements among co-founders to address deadlocks or separation, in practice they are often of limited value and rarely utilized. The valuation methodologies in buy-sell provisions are frequently dated and they sometimes lack the mechanical detail necessary for a founder to trigger without simply instigating interpretive disputes with other co-founders.

For example, we recently saw a buy-sell provision in a contentious situation where it was not clear whether events triggering the buy-sell had occurred, and therefore subject to competing interpretations between the co-founders.

Nor should founders rely on judicial dissolution statutes under state corporate, partnership or limited liability company acts as a practical avenue to dissolve their business relationship. Many of these judicial dissolution statutes require costly litigation to be utilized and even then, there is often no section of the statute requiring a judge to formally dissolve the business.

However, unlike an impractical buy-sell provision or an arcane judicial dissolution statute, a mandatory dissolution agreement among co-founders is intended to provide the principal co-founders with a right to dissolve the business in a relatively cost-effective and pre-agreed upon manner from the outset (and likely when the co-founders are thinking more objectively than is often the case when their relationship may have soured).

Think of this like a pre-nuptial agreement among business partners. This dissolution arrangement should be negotiated and written at the beginning of the relationship (not the end) and should be included in the body of the operating or partnership agreement (for LLCs and partnerships) or the shareholders agreement (for corporations). We sometimes advise that a separate “Dissolution Agreement” be attached as an exhibit to the shareholders or operating/partnership agreement.

Key Provisions for Dissolution Considerations Agreements

Appointment of a Liquidating Trustee* and Authority to Wind Up. The liquidating trustee is responsible for carrying out the winding up of the business. Typically, one co-founder is appointed the liquidating trustee, but there can be more than one and the co-founders can agree to take on shared responsibilities.

Regardless, the principal co-founders should all agree on the specific wind-down procedures, and when and how they are to occur. *As a quick note, reference here to a “liquidating trustee” is a term of art – I am simply referring to the person or persons authorized to take wind-up actions required for a dissolution (in practice that person might be a general partner, manager, CEO, etc.).

Accounting; Financial Statements; Taxes. The co-founders should agree on who the accountant will be to prepare the final books and taxes for the business, and it is advisable to agree that they will be prepared and filed in accordance with the historical custom of the business. This helps eliminate the ability for co-founders to argue over accounting and tax items where prior custom has existed.

There should be a deadline date by which the accountant for the business is required to make final tax filings in order to prohibit any one co-founder from unnecessary procrastination or otherwise attempting to prevent or delay the final completion of financial and tax matters.

Capital Contributions. The co-owners should include a provision that requires the payment of certain additional capital contributions in connection with various creditor obligations and expenses and other payments during the winding up process, and the process for calling and making those contributions.

Division of Company Assets. The dissolution agreement should establish how distributions of cash and other business property will be handled during the winding up period and upon final liquidation. Typically, distributions of cash would be handled in accordance with the applicable distribution provisions contained in the operative agreements among co-founders (such as an operating agreement).

Consideration should be given to whether distributions should be limited (or prohibited) during the dissolution period while vendors or creditors are owed money. Depending on the situation, the division of other business property may be in a manner that differs from percentage ownership or historical distributions. If so, this should be spelled out.

Non-Disparagement and Restrictive Covenants. A mutual non-disparagement clause is advisable, but non-compete and non-solicit agreements are generally not included to allow each co-founder to continue in the business for his, her or its own account following (but not before) the termination of the company or partnership.

Costs and Expenses of Winding Up. The agreement should specify how all costs and expenses arising out of the wind-up process will be split among the co-founders, and deadlines for their payment should be established. These costs would typically be split based on the ownership percentages of the co-founders and/or however historically split among them pre-dissolution.

Indemnification. Each co-founder should be obligated to indemnify and hold harmless the other co-founders for all losses incurred because of the indemnifying co-founder’s breach or failure to perform any of its duties and obligations under the dissolution agreement.

Dispute Resolution. As is prudent with any other contract, the parties should specify a forum for dispute resolution, whether a court venue, arbitration, or the assignment of disputes to a third party, such as an independent accounting arbitrator for any disputes over the final preparation of the financial statements or tax returns. We also normally advise on the inclusion of an attorneys’ fees recovery provision by a prevailing party which is helpful to hold each co-founder’s feet to the fire in ensuring that it does what it is obligated to do under the dissolution agreement.

Conclusion

A mandatory dissolution agreement can provide co-founders of a closely held business with a relatively streamlined, cost-effective and balanced manner of exiting when the business is not working out or the co-founders are not getting along. While the parties are always free to agree to a different deal outside of the dissolution agreement, when no such deal can be struck, the dissolution agreement will provide a baseline from which the founders can separate equitably and efficiently.

Linden Law Partners has extensive experience advising companies and business owners on all aspects of dissolution considerations and the agreements around them. Contact us here for help.

Overview of Equity Incentive Compensation for Startups and Early Stage Companies

Posted on by PLinden

Hiring and keeping talented employees is a challenge for many businesses, but in particular for startups and early-stage companies that are more limited in the amount of cash flow they can commit to competitive salaries. One way to bridge this gap is with equity incentive compensation. Broadly speaking, equity incentive compensation refers to the grant by a company to its key employees and service providers of an ownership stake.

For startups positioned to realize significant potential growth in the value of their companies, this type of compensation can be especially appealing to employees and service providers who see the potential of “getting in on the ground floor”. But more than just luring top talent, equity incentive compensation can help any company achieve the following:

1. More strongly align the interests of, and incentivize high-level performance from, key employees or service providers;

2. Build employee loyalty and develop a more authentic sense of purpose; and

3. Save and redeploy early stage cash that would otherwise have to be spent on salaries or contract labor.

Types of Employee Equity Incentive Plans for Private Companies

Equity incentive compensation can take many forms for private companies, with each presenting a unique set of advantages and disadvantages. While the optimal types and structures for any given company will depend on its particular business circumstances, below is a summary highlighting some of the most popular kinds of equity incentives used by many private companies today.

Stock Options. Stock options are a well-known form of equity incentive compensation that can be utilized by corporations. The holder of a stock option has the right to buy stock of the company at a set price, called the “exercise price”, for a certain period of time (typically ten years) beginning when the stock option vests.

The exercise price usually is equal to the fair market value of the stock at the time the stock option is granted. Stock options almost always vest over time (typically 3-4 years) to help motivate the recipient to continue to be employed with the company longer term. The holder becomes an actual shareholder of the company only when the stock option is exercised and the stock underlying the option is purchased for the exercise price.

Stock options can be attractive to holders if the company expects substantial growth and/or a liquidity event (sale) down the road at an increased value. However, if there is no appreciation in the company’s stock over time, then the option provides the holder with no financial benefit. The holder of a stock option must also have the cash necessary to pay the exercise price to convert the options to actual shares of stock.

As a practical matter, stock options of a private company are almost always converted only at the time of some liquidity event, such as a sale of the company or an IPO, and then the exercise is “cashless” (meaning the exercise price is taken off the top of the proceeds the option holder would otherwise realize had he or she actually paid the cash exercise price, converted the options to shares, and then concurrently sold them at a profit as part of the liquidity event).

Restricted Stock. Restricted stock is an actual grant of shares of stock, but for a period of time (a “restricted period”) the shares (1) can typically be repurchased by the company for a set price, (2) are subject to forfeiture by the holder without payment upon the occurrence of certain events, such as when the holder’s services to the company terminate prior to vesting in full, and (3) are subject to restrictions on transfer or resale.

Because the holder will become a shareholder on the grant date, he or she will normally have the right to vote and receive dividends. Restricted stock can incentivize holders since they should theoretically become similarly aligned with the company’s other shareholders immediately upon the initial grant.

The holder isn’t required to pay anything (or only a minimal amount) at the time the stock is granted, and depending on the value of the stock at the time of grant, he or she may realize a substantial long-term tax benefit by making an IRS Section 83(b) tax election.

Profits Interests. Profits interests are the most common form of equity compensation used today by partnerships and limited liability companies. Profits interests are awarded to key employees and service providers in exchange for his or her contribution of services to the company (in lieu of being required to make a cash or other tangible capital investment as would be the case for a traditional equity investor).

A profits interest is technically an ownership interest that gives the holder the right to a share of future profits and appreciation of the company, but the holder is not entitled to participate in the capital and accumulated profits or value of the company as of the initial grant date.

For example, if the “hurdle” or “threshold” value of the profits interest holder’s participation was $3 million, it means the holder’s profits interest only begins to share in the company’s distributions or sale proceeds after the initial $3 million of value has been paid to its founders and/or cash equity investors. Please see our profits interest blog for additional information and key considerations around granting profits interests specifically.

Other. Other equity-based forms of incentive compensation include restricted stock units, stock appreciation rights, phantom stock, and long-term cash incentive plans.

Conclusion

A properly structured equity incentive compensation plan can help innovative companies stand out from their competitors when it comes to hiring and retaining key talent. However, various legal and business considerations, including important tax considerations, are critical when determining the best plan and structure for a particular company. Linden Law Partners has many years of experience counseling entrepreneurs and businesses on the intricacies of equity incentive compensation. Contact us here for help.

Timeless and Timely M&A Due Diligence Considerations

Posted on by PLinden

Due diligence is an important and expected part of any merger or acquisition (M&A) transaction. The due diligence process gives the buyer the opportunity to identify any operational or legal risks that may exist with the seller or its business prior to entering into a purchase agreement and closing the transaction.

Further, any specific issues (that do not arise to the level of terminating the transaction) identified during due diligence will typically be accounted for in the purchase agreement through the negotiation of terms such as the purchase price, representations and warranties, closing conditions, and post-closing indemnification obligations of the seller.

Typical Scope of M&A Due Diligence Considerations

The scope of M&A due diligence and a buyer’s exact requests will vary based on the specific transaction. While not exhaustive, summarized below are some of the general areas almost always covered by a buyer’s due diligence requests:

1. Business Organization. A seller will need to provide its corporate records concerning its formation and good standing, governing documents (e.g., articles or certificate of incorporation or organization, bylaws, operating agreement), share ownership, and capitalization.

Other items can include records pertaining to jurisdictions where the seller conducts business or owns or leases real property, and documentation in connection with any equity or debt financings, securities issuances, stock repurchases, or material acquisition or disposition transactions.

2. Accounting/Financial. Requests under this general category will include copies of tax returns for certain periods (typically the prior 2-5 years), financial statements, and documentation pertaining to loan or other debt arrangements. Sellers will also be asked to include any information pertaining to any past or pending tax proceedings or controversies.

Other types of reports or statements requested may include budgets, accounts receivable aging reports, an accounts payable list, and other documentation detailing the income, expenses, and liabilities of the business.

3. Operations, Customers, Business Insurance, Etc. A buyer will want to review a seller’s customer, vendor, and supplier agreements, marketing and sales plans and arrangements, other contracts material to the business, as well as commercial liability and property insurance policies and claims.

Information regarding real and personal property, including inventory (if applicable), of the seller will be required. Information technology and systems and disaster recovery information is also typical. Other requests will vary depending on the seller’s line of business.

4. Human Resources. Buyers will ask for employee, salary, and bonus information, employment agreements, independent contractor information and agreements, collective bargaining and other labor contracts, health, welfare, and safety practices and policies, and OSHA, EEOC, and other employee-related complaints and proceedings.

Also included under this category will be summaries and copies of the Company’s employee benefit plans, including 401(k), medical, dental, disability, and life insurance plans and benefits.

5. Legal and Compliance. This area of due diligence covers all litigation matters, required permits, licenses, and other government and regulatory approvals, intellectual property disclosures and related USPTO filings, environmental compliance, and any other specific legal or regulatory matters applicable to the business.

How COVID-19 May Affect the Due Diligence Process

Due to the uncertainties created by the global pandemic, buyers are likely to approach M&A deals with greater scrutiny than before. As such, buyers may seek detailed information in areas that implicate potential disruptions to the seller’s business, the seller’s financial capability to weather the economic fall-out from COVID-19, and other risks to the target business arising from COVID-19.

Specific due diligence areas that a buyer may want to examine more closely include material contracts with customers, vendors, and suppliers (including the seller’s ability to perform under such contracts as well as termination and force majeure provisions), the seller’s debt obligations and ability to repay, business insurance policy coverages and exclusions, compliance with state and local public health orders,

Compliance with privacy laws that may be implicated (such as if sensitive employee or customer information has been or will be disclosed due to COVID-19), and employee health, safety, and welfare policies and related measures being taken by the seller.

Conclusion

Linden Law Partners has represented sellers and buyers in hundreds of M&A transactions across a variety of industries. We have extensive experience guiding our clients through the ins and outs of the M&A due diligence process. Contact us today for help.

COVID-19 and Material Adverse Change (MAC) Clauses in M&A Deals

Posted on by PLinden

What is a MAC Clause?

A ‘material adverse change’ clause (a ‘MAC’ clause or sometimes called a ‘material adverse effect’ or ‘MAE’ clause) is a risk allocation provision which commonly appears in merger, stock or asset purchase agreements as part of an M&A transaction. The two primary functions of a MAC clause are to (1) provide the buyer with a costless cancellation right if during the period that occurs after the definitive acquisition agreement has been signed but before closing there is a material adverse event that negatively impacts the target company, or its business or value, and (2) qualify some or all of the seller’s representations and warranties (‘reps’) made in the definitive agreement.   

What Does a Typical MAC Clause State and How Does it Work?

The typical MAC clause is defined as any development, event, change, condition or state of facts which has had, or would reasonably be expected to have, a material adverse change (or effect) on the business, assets, financial condition or results of operations of the subject party. However, and for the benefit of the seller, most MAC clauses will also specifically exclude effects related to things like (1) general economic, financial, credit or other broad industry or market conditions at large, and (2) political conditions, acts of war or terrorism, natural disasters or acts of God.

In a deal cancellation context, if an event included in the definition of the MAC clause occurred between signing and closing, the buyer has the legal right to terminate the consummation of the transaction without liability to the seller (note that usually even the most well-drafted MAC rep will be highly contested and subject to dispute by the parties as to whether the event constitutes a MAC occurrence or carve-out like “general economic conditions”, etc.).

In a seller representation and warranty context, a MAC event can impose liability on the seller if there is a breach of a seller’s rep around a MAC event. For example, if a seller with unionized employees made a “No MAC” rep, closed the transaction, and after the closing a labor strike occurred based on facts or events in motion pre-closing, the seller would have likely breached the rep (this assumes such an event was not carved out from the MAC definition as a specific exclusion for which the buyer could not claim a breach). Although the deal has closed in this example and therefore cannot be terminated, the seller would have breached the MAC rep, giving rise to a viable indemnification claim by the buyer. This is one of many examples of how a MAC rep might come into play depending on the business or industry of the specific seller.

The Likely Impact on Material Adverse Change (MAC) Clauses Due to COVID-19

Historically, most MAC clauses have not included ‘diseases’ or ‘pandemics’ as specific carveouts from the type of negative events for which buyers can otherwise recover from sellers. However, this is likely to change forever due to the COVID-19 pandemic, just as terrorism carveouts became common following the events of September 11, 2001.

A seller will want to carve out the effects of COVID-19 (or any disease or pandemic) as part of the risk allocation process of an M&A transaction. Buyers will also need to think through and address their own protections as part of MAC clause in the COVID-19 deal world.

Conclusion

The practical effects and considerations of MAC clauses in M&A deals have become even more important and top-of-mind ‘overnight’, if you will, and may be permanent long after the COVID-19 pandemic has subsided. The attorneys at Linden Law Partners are specialists on every legal aspect of M&A transactions and positioned to help clients successfully navigate the post COVID-19 deal landscape. Contact us here for help.