Many attorneys don’t think of corporate governance as an important part of their practices, but corporate governance likely weaves its way into your career or your clients’ matters more often than you think. And most attorneys (and their malpractice insurers) cringe at the thought that they might be practicing securities law.
However, if your clients are businesses, this information is essential. If your clients are individuals who may own or invest in businesses, a basic understanding of what corporate governance and securities law entails will enable you to recognize potential problems and add unexpected value. In addition, as an attorney who is an owner or potential partner of a law practice, it is in your benefit to understand how corporate governance applies to you and your firm.
Business Licenses
Everyone doing business in Washington must obtain a business license. I work with sole proprietors, including contract attorneys and other professionals, who don’t realize that they must have a business license. If you’re a professional and contracting out to third parties, at the end of the year you’ll be issued a Form 1099 that reports to the Department of Revenue and IRS how much was paid to you by that company. Business and occupation (B&O) taxes are owed to the State and the reported Form 1099 amounts must show up on your personal tax return.
Similarly, all businesses must obtain city licenses in the city where they are located, as well as every city where the company conducts business. The city licensing requirements can be onerous for companies that have offices or job sites all over the Puget Sound region, but a company may incur penalties for not obtaining a license in each city where it is working.
It’s easy to believe that government agencies don’t communicate with one another; but trust me, when it comes to collecting taxes, they seem to all come together to ensure compliance and collection. Remember to ask sole proprietors whether they’ve taken these necessary steps.
Corporate Documents
A primary reason why individuals create business entities is to protect the owners’ assets from the liabilities or potential risks posed by business operations. The Internet makes it easy for these individuals to jump online and create their companies — a few clicks and a credit card results in a new company nearly instantaneously.
Many people figure, “Why do I need to pay a lawyer big bucks to do this?” Of course, the online filings are not the core value they are getting from their business attorney. Rather, the business lawyer advises them on the type of entity most prudent for the business, as well as the startup and ongoing maintenance requirements that must be performed for the liability protection to hold up under scrutiny.
After the initial online filings are completed, a business entity is required to maintain certain records. A corporation is required to have organizational and annual meetings, adopt bylaws, elect a board of directors and officers, and maintain records of these meetings and other corporate documents.
Unfortunately, for do-it-yourself, cost-conscious businesspeople, no one tells them about these requirements when they set up their companies. Nowhere do the online filing documents specify that a corporation, or even a limited liability company, must comply with certain formal document maintenance rules or, more importantly, why it must comply with these rules.
If a company fails to comply with these formalities, an adjudicating body or governmental authority can “pierce the corporate veil” and reach to the individual owners’ assets to satisfy claims. The liability protection is lost.
Yet when I mention these requirements to smaller business clients, most say, “Yeah, but the business is only me — I don’t have to do all these things.” The response is, “Yes, you do.” The law applies equally to the one-person corporation as to Microsoft. So, when the topic of business ownership arises, be sure to ask the questions about corporate requirements, such as separation of personal and business assets and maintenance of corporate formalities.
Securities
Many of us don’t believe our practices even begin to border on securities laws, but these regulatory issues pop up more often than you would think. It is very common for small business owners to ask friends and family to invest in their businesses or, these days, in a real estate venture.
Your clients may be the business owner or the family or friends. Often in these situations, it’s not a lot of money being invested and Uncle Joe doesn’t mind helping out with $10K. However, by taking anyone else’s money, even Uncle Joe’s, the business owner is treading into securities law territory.
A corporation’s stock is the most common example of a security. What is often overlooked are promissory notes, options to buy into the business, interests in limited liability companies or limited partnerships, and passive investments in real estate. Each of these interests is a security and either must be registered with the Securities and Exchange Commission and each investor’s state prior to sale or be exempt from these registration requirements.
Registration is the process that companies go through when they “go public.” However, registering and operating as a public company is prohibitively expensive, and generally unnecessary and undesirable for most small businesses. The business owner just wants to raise some cash to grow the business — and what’s the big deal? It’s only Uncle Joe. But in order to do so legally, you must find an exemption to the registration requirements for that transaction.
To qualify for one of the most commonly used exemptions, Rule 506 under federal Regulation D, the investor must be “accredited,” which means that he or she has (a) income of $200,000 (or $300,000 with their spouse) for the last two years or (b) a net worth of more than $1 million. That being said, there are many different state and federal exemptions, each with different offering limitations, investor qualification criteria and filing requirements.
The process of subscribing an investor to a purchase of a security under an exemption requires disclosures to investors regarding the company and its capital structure, the details of the investment, the myriad of risks associated with the investment, including that the investment is highly speculative, and essentially spelling out the many ways that they might lose their money. Needless to say, the requirements for compliance with the securities laws are rigorous and, while they can seem expensive to implement, they are far more expensive to correct if ignored.
So, the next time you hear someone talking about a great investment opportunity that they’ve jumped into, or that they’re getting money from Uncle Joe, ask whether anyone has looked at the securities implications of the transaction for them.
Your Contribution
I raise these issues because they are commonplace examples of corporate governance and securities law requirements often overlooked by individuals and business owners as they go about their entrepreneurial ventures. An astute non-business attorney with a baseline knowledge of these matters can serve clients, colleagues or friends, who are plowing forward with these ventures, by asking the right questions and providing guidance (and referring them to a business or securities lawyer, if appropriate), that ultimately may protect them from liability due to their own actions.
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Michelle Hayden Bomberger is the founder of Small Business Legal Services PLLC. She has a J.D. and MBA from Northwestern University and provides business and legal counsel for small businesses. She may be reached at 425-646-2360 or michelle@sblslaw.com. A special thanks to Eugenie Rivers of Rivers Business Law for her contributions to this article.
