General Corporate/M&A Matters

It’s always entertaining to tell younger attorneys about the inefficient ways that lawyers did their jobs back in the day, without modern technology (and probably extremely boring for the younger attorneys to hear those stories). For example, as a junior attorney, I recall that email was just starting to come into common usage, and the job of the paralegal often involved early evening distributions – sending out FedEx distributions of revised drafts of documents before the 9pm overnight delivery cutoff. One aspect of current legal practice that will likely be looked at in the coming years as equally antiquated is the obtaining of manual signatures on contracts.

This Slate Explainer has a short but informative history of the use of signatures on legal documents. Technology has made the process somewhat more streamlined (fax machine, then PDFs), but signatures remain a practical impediment to quick completion of agreements. In 2016, there are still delays when a party cannot immediately sign an agreement as a result of being, for example, traveling without access to a scanner. Attorneys with good organizational skills know to obtain and hold onto signature pages from a client who is about to travel ahead of a closing, but there is more stress and scrambling than there needs to be.

Fortunately, the technology is improving further, as we speak, via electronic signature services like DocuSign. The federal ESIGN Act, enacted in 2000, provided broad recognition of the validity of electronic signatures, which paved the way for these types of services. They allow parties to sign agreements easily via any internet-enabled device, without a scanner or fax machine, so really the only time an agreement can’t be signed is if the signatory is on a plane and doesn’t want to spring for wi-fi or is deep in the wilderness. My clients are increasingly requesting that these services be used, and I expect them to be widely adopted in the coming years. And the coming generation of new corporate attorneys can laugh at the likes of me for having spent time chasing down manual signatures.

Although it has historically been relatively easy for companies to enforce non-competition agreements against employees in New York State, compared to, say, California, where such provisions are unenforceable, the New York Attorney General’s office has recently been cracking down on broad use of non-competes on lower-level employees.

Although the two types of provisions are often conceptually lumped together, it’s important to distinguish non-competes from non-solicitation agreements. With non-competes, although companies have valid business reasons for wanting their employees to refrain from leaving and starting a competitive business, potentially using the trade secrets they have learned on the job, as a matter of public policy, they are frowned upon for reducing worker mobility and harming economic growth. Non-solicitation provisions, on the other hand, which prevent departing employees from taking other employees or customers with them to their new venture, don’t raise the same policy concerns and, accordingly, are not the focus of the New York initiative.

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Increased Scrutiny of Non-Competes in New YorkRead More »

The well-known venture capital firm, Andreessen Horowitz, is now recommending to its portfolio companies that employees who hold vested stock options and leave the company have a much longer period following departure in which to exercise the option. As noted in the Andreessen article, the typical stock option will permit exercise within 90 days following departure. Andreessen is recommending that the period be extended to 10 years.

The rationale for this change is that, upon departure, many employees simply do not have the cash needed to exercise the option and then to pay the taxes that are imposed upon exercise. If the company is still private, the employee will likely not have the ability to immediately sell the shares following exercise, which would otherwise solve the cash flow issue, at least as to the taxes. By extending the period in which the employee can exercise, there is time for the employee to raise the funds to pay the exercise price and taxes, or even better, for the company to be sold or go public, allowing the employee to immediately realize value on the option. Alternatively, the company might fail sometime during the 10 years following departure, in which case the employee will be happy not to have forked over money for a share purchase and taxes and nothing to show for it.

This is an unambiguously better deal for employees, though the Andreessen post details some tweaks companies can make to the grants to protect itself. One might wonder why a VC firm is advocating a pro-employee change in terms. I think the answer is that a 90-day exercise period poses significant practical issues for employees who don’t have much ready cash and it therefore could discourage potential employees from joining a startup and not practically being able to realize value in an equity grant. By extending the period to 10 years, companies can potentially increase the pool of qualified employees.

Steven Davidoff Solomon, the New York Times DealBook’s Deal Professor, highlights an academic paper that he and others wrote, advocating tenure voting for public companies.  The basic concept is that the longer you hold a company’s shares, the more voting power you have when the company conducts shareholder votes.  The purpose is to incentivize long-term holding and accordingly dilute the voting power of activist shareholders that buy up a block of shares, immediately agitate for change that helps them in the short term, and then unload the shares, to the ultimate detriment of the company.  In fairness, I should note that the activist investor community contests this characterization of what they do, arguing that the changes they demand are beneficial to the companies in the long-term as well.  I will not wade into that argument but simply assume for the sake of this post that as a policy matter, we should try to encourage a long-term orientation among shareholders. …

Tenure Voting for ShareholdersRead More »

The Wall Street Journal recently detailed the increasing willingness of service providers to startups to accept the startup’s equity as payment for services.  With the startling growth of so-called unicorns, private companies like Uber that have achieved stratospheric valuations, there is a hope among many vendors that they’ll get lucky with one or more of the startups in which they accept equity.  I previously wrote on this topic, focusing specifically on law firm payment arrangements.  That post mainly addressed the possible conflicts of interest that can be associated with equity compensation, but for today I want to focus on whether it makes sense, as a business matter, for service providers to accept equity.

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Should Vendors Agree to Be Paid in Equity?Read More »

When I assist clients in setting up entities, one of the threshold matters, of course, is the selection of a name for the entity.  Once that is settled, and the entity is set up, many clients assume the job is complete as far as protecting the business name, unaware that protection of the name for purposes of trademark law involves a completely separate legal analysis and process.  The purpose of this post is to briefly explain the difference.

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The Distinction Between Entity Name and TrademarkRead More »

In my practice, the question of classification of service providers as employees or independent contractors has come up with increasing frequency.  This probably results from the increasing amount of freelancing in the economy in recent years. It’s also been in the mainstream news recently, with highly publicized actions against Uber and Lyft for alleged misclassification of their drivers. A classification of a worker as a contractor is generally preferred by companies, as it eliminates a wide range of costs and legal protections available only to employees, e.g., unemployment insurance, workers compensation, tax withholding, minimum wage and overtime laws. Because of this, federal and state regulators are increasingly scrutinizing classification issues, and employers need to be aware of this and be careful and conservative in their classification decisions. …

Employee vs. Independent ContractorRead More »

Companies looking to compensate their employees and other service providers in equity will often employ stock options or restricted stock (for corporations) or profits interests (for LLCs). An alternative approach that should be considered is to offer so-called “phantom” equity, which is essentially a deferred compensation plan, where the employee receives cash payments that are calculated as if the employee had received an equity grant. (A similar alternative is stock appreciation rights, or SARs, but I will focus on phantom equity here.)

For example, the recipient could receive a cash payment at the time the company is sold that’s equivalent to the distribution that would have gone to someone receiving 1% of the company’s common equity at the time of the grant. There can be other triggering events besides a sale, depending on the plan, including regular company distributions of earnings. Like true equity, the plan can have vesting, repurchase and similar provisions seeking to incentivize the recipient’s continued employment with the company for a lengthy time. So, the employee receives the benefits of equity without the parties having to go through the trouble of documenting an actual issuance of equity. Unfortunately, the term “phantom” seems to imply that it’s somehow fake equity, meaning employees can be skeptical of the concept, so it takes some explanation.

Like any employee compensation plan, phantom equity plans need to be carefully structured using the advice of a qualified tax professional, seeking among other things to avoid issues with Section 409A deferred compensation penalties. As I do not myself have such expertise, I’ll leave out discussion of tax consequences here, except to note that a disadvantage of phantom equity from the employee’s perspective is that the cash payments are taxed as ordinary income, not capital gain, though the tax is assessed only if and when the cash is paid, not when the phantom equity is granted.

One advantage of phantom over true equity is that it’s generally easier to document, saving on legal costs (wait, why am I writing this?). Recipients of phantom equity will not need to be directly accounted for in operating or stockholder agreements, making simpler the mechanics of drafting provisions such as share transfer restrictions, management, and distribution of company earnings. Outside investors may prefer the simpler capital structure, though of course they would take into account the company obligations inherent in the phantom equity when valuing the company and their investment.

From the company’s perspective, phantom equity also avoids creating new shareholders or members that have statutory rights under state law, such as the right to examine records, which as a practical matter are not valuable to the typical service provider.