Friday, September 8, 2017

What's in a Name (of a Texas company)?

"What's in a name? That which we call a rose
By any other name would smell as sweet."

- Spoken by Juliet in Romeo and Juliet (Act II, Scene II), by William Shakespeare

Sometimes, it seems the hardest part of forming a new company can be picking its name - as if all of the good names have already been taken! And historically, Texas law has done company organizers no favors by preventing companies from using names which are the same as, or "deceptively similar" to, names of existing companies doing business in Texas. At times, the Texas Secretary of State has taken a broad view of names which it considered deceptively similar - further narrowing the field of available names. But thanks to the 85th Texas legislature, picking a name for a Texas company is about to get a little easier.

House Bill 2856, which becomes effective June 1, 2018, will amend the Texas Business Organization Code (TBOC) to permit new filing entities (such as corporations, limited liability companies, limited partnership, etc.) and foreign entities registering to do business in Texas to use any name which is "distinguishable" from the names of all other companies formed, registered, or reserved for use in Texas.

In short, Texas companies will soon be able to have "deceptively similar" names, so long as the names are "distinguishable" from one another.

The change will make Texas law more uniform with the requirements established in other states, including the State of Delaware (see Section 102(a)(ii) of the Delaware General Corporation Law). It is hoped that this change will facilitate the formation of new business entities and expedite the registration of out-of-state business entities to transact business in Texas.

Perhaps all those newly formed or registered Texas companies will soon be humming a Jim Croce tune:

"Like the pine trees lining the winding road
I got a name, I got a name."

Then again, maybe not.

Regardless, I view this change as a positive one for Texas corporate law.

Monday, August 21, 2017

SmartVest Presentation: "Ins and Outs of Term Sheets"

Last week I had the honor of making a presentation as part of SmartVest, a Startup Investor Series sponsored by TECH Fort Worth. I presented "Ins and Outs of Term Sheets," discussing some of the common terms found in Series A investment term sheets. The presentation was a lot of fun to give, primarily because the accredited investors in attendance asked a lot of really great questions.

Thanks to TECH Fort Worth for including me in this valuable educational program for the startup investment community.

Wednesday, August 9, 2017

Takeaways from SEC's Access to Capital and Market Liquidity Report to Congress

Yesterday, the United States Securities and Exchange Commission’s (the SEC's) Division of Economic and Risk Analysis published its Report to Congress on "Access to Capital and Market Liquidity." The Report is available here.

The Report attempts to assess, among other things, the impact of the Dodd-Frank Act, on access to capital for consumers, investors, and businesses.

A few interesting takeaways from the Report:

New Rule 506(c) has been a disappointment.  That's my conclusion, not the SEC's, but the numbers speak for themselves.

Rule 506(c) permits companies to engage in "general solicitation" in connection with private placements of securities strictly to "verified" accredited investors. The traditional Rule 506 (now re-numbered Rule 506(b)) prohibits issuers from engaging in general solicitation, but it permits up to 35 non-accredited investors and has a looser "reasonable belief" standard (as opposed to "verified" under Rule 506(c)) for confirming an investor's accredited investor status.
The premise of Rule 506(c) was that companies would have greater access to capital if they could solicit funds broadly from any accredited investor rather than limiting investment to investors with which the company has a preexisting relationship (those that could be reached without engaging in general solicitation) as required under Rule 506(b).

But overwhelmingly, companies raising capital through Rule 506 have continued to use Rule 506(b) rather than taking advantage of the newly created Rule 506(c).  The Report indicates that during the period from the effectiveness of Rule 506(c) (September 23, 2013) through December 31, 2016, issuers reported raising an aggregate of $108 billion using Rule 506(c) as compared to $4.2 trillion raised through Rule 506(b).

That means less than 3% of all capital raised through Rule 506 took advantage of the new Rule 506(c)!

Regulation Crowdfunding has been a disappointment.  Again, that's my conclusion, not the SEC's, but once gain the numbers speak for themselves.

Regulation Crowdfunding permits issuers to raise up to approximately $1 million over a 12-month period in small amounts from a large number of investors over the Internet. The SEC's sanctioning of equity crowdfunding received a lot of hype and attention in the business press at the time of its adoption.

Unfortunately, during the period from the date Regulation Crowdfunding, went effective on May 16, 2016 through December 31, 2016, only 156 companies have taken advantage of Regulation Crowdfunding, by conducting a total of 163 crowdfunding offerings nationwide. Of those offerings, only 28 issuers successfully met their minimum target capital raise. And of those successful offerings, the median amount of capital raised was only $171,000. 

And the aggregate amount of all capital raised through crowdfunding under Regulation Crowdfunding nationwide during 2016 was only $8.1 million!  I wouldn't be surprised if publishers spent more than that amount on paper and ink writing articles about how significant the crowdfunding revolution was going to be.

Regulation A offering are showing some signs of life.  

Regulation A (Reg A) previously allowed companies to raise up to $5 million in a 12-month period. But issuers virtually never took advantage of the traditional Reg A, in part because the dollar limits under Reg A were so low. The JOBS Act required the SEC to adopt rules increasing the dollar limits on Reg A offerings. Those new rules (dubbed Reg A+) now permit offerings up to $20 million (under Tier 1 of the new Reg A) or up to $50 million (under Tier 2 of the new Reg A) in a 12-month period.

The market has certainly noticed. From 2005-2016 issuers typically conducted only about 14 Reg A offerings per year, raising an aggregate of approximately $163 million per year. During the period from the date Reg A+ went effective on June 19, 2015 through December 31, 2016, there were 97 Reg A offerings seeking to raise an aggregate of $1.8 billion.

Although the SEC does not have access to the precise amount of funds actually raised in such offerings, the SEC estimates that 56 issuers raised an aggregate of approximately $315 million during this period. 

Conclusions.

I should caution that all of the trends reported in the Report and summarized above are early, and it is certainly possible that any or all of Rule 506(c), Crowdfunding, and Reg A+ will show gains in popularity as issuers and investors grow more comfortable and more experienced with each of these exemptions from the registration requirements under the Securities Act. But preliminary results certainly have not been encouraging for any of these new or amended exemptions. 

  

Thursday, August 3, 2017

Surprising Quirks of Texas Nonprofit Corporation Governing Documents

How do the governing documents (certificate of formation and bylaws) of a Texas nonprofit corporation differ from those of a Texas for-profit corporation?

Quite a bit, actually. Below is a non-exclusive list of ways in which the certificate of formation and bylaws of a Texas non-profit corporation often differ from those of a Texas for-profit corporation. Some of these differences may be surprising to those who more frequently deal with for-profit corporations.

1.  Fewer restrictions on the name of a nonprofit corporation.  Section 5.054 of the Texas Business Organizations Code (TBOC) requires that the name of a Texas for-profit corporation include the word “company, corporation, incorporated, or limited” or an abbreviation of one of those words, such as “Inc.” or “Co.” There is no such requirement for a Texas nonprofit corporation.

2.  More restrictions on the purpose of a nonprofit corporation. Section 2.001 of the TBOC provides that a Texas for-profit corporation is generally permitted to have any lawful purpose. Section 2.003 of the TBOC restricts any Texas corporation (whether nonprofit or for-profit) from engaging in certain prohibited purposes, such as unlawful activities or operating as a bank, trust company, savings association, insurance company, cemetery association (with certain exceptions), or abstract or title company. Section 2.002 of the TBOC limits a nonprofit corporation to only one or more of the following purposes:

               a.  Serving charitable, benevolent, religious, eleemosynary, patriotic, civic, missionary,                              educational, scientific, social, fraternal, athletic, aesthetic, agricultural, or purposes;
               b.  Operating or managing a professional, commercial, or trade association or labor union;
               c.  Providing animal husbandry; or 
               d.  Operating on a nonprofit cooperative basis for the benefit of its members.

      Section 2.010 of the TBOC also restricts the permissible activities of a nonprofit corporation.

     Moreover, a nonprofit corporation desiring status as an organization exempt from federal income tax under Section 501(c)(3) of the Internal Revenue Code (the Code) must comply with Section 501(c)(3) of the Code, which requires nonprofit corporations to be “organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals.”

     In its Instructions to Form 1023 (Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code), the Internal Revenue Service (IRS) suggests including the following language as the nonprofit corporation’s purpose to ensure compliance with the purpose requirement in Section 501(c)(3) of the Code: “The organization is organized exclusively for charitable, religious, educational, and scientific purposes under Section 501(c)(3) of the Internal Revenue Code, or corresponding section of any future federal tax code.”

    3.  May have no members or no board of directors. Every for-profit corporation has at least one shareholder and at least one director, but under Section 22.151(a) of the TBOC, a nonprofit corporation need not have any members – it may be managed exclusively by the nonprofit corporation’s board of directors. Alternatively, Section 22.202 of the TBOC provides that a nonprofit corporation may have no board and may instead be managed exclusively by its members. If the nonprofit corporation elects to have no members or no board of directors, Section 3.009(1) of the TBOC requires a statement to that effect in the nonprofit corporation’s certificate of formation. 

4.  Must have at least three directors.  If a Texas nonprofit corporation elects to have a board of directors, it must name at least three people to serve as directors of the corporation under Section 22.204 of the TBOC. For-profit corporations are only required to have at least one director under Section 21.403 of the TBOC.

5.  Action by written consent of less than all directors.  Sections 6.201 and 21.415(b) of the TBOC permit the board of directors of a Texas for-profit corporation to take action by unanimous written consent in lieu of holding a formal meeting of the board, but only if the written consent is signed by all of the directors. On the other hand, Section 22.220 of the TBOC permits the board of a nonprofit corporation to take action by written consent signed by the number of directors necessary to take the action at a meeting in which all of the corporation’s directors are present (typically, a majority), if non-unanimous written consents are authorized in the nonprofit corporation’s certificate of formation or bylaws.

6.  Board committees generally must have at least two members and only a majority of the committee need be directors.  The board of a Texas for-profit corporation may establish a board committee composed of one or more directors under Section 21.416(a) of the TBOC. If a Texas nonprofit corporation wishes to establish a board committee, it must comply with Section 22.218(b) of the TBOC, which requires that the board committee consist of at least two persons. That Section permits persons who are not otherwise directors be named to the committee so long as at least a majority of the committee members are directors of the nonprofit corporation. A nonprofit corporation which is a religious institution may establish committees composed entirely of non-directors.

7.  President and Secretary cannot be the same person. A Texas for-profit corporation is required to have a President and a Secretary under Sections 21.417 of the TBOC, but such offices may be held by the same person under Section 3.103(c) of the TBOC. Conversely, Section 22.231(a) of the TBOC requires that the offices of President and Secretary of a Texas nonprofit corporation be held by different persons.

8.  Directors may vote by proxy.  Section 22.215 of the TBOC permits a director of a Texas nonprofit corporation to permit someone else to vote on the director’s behalf by granting a proxy to the other person, if proxy voting is permitted by the nonprofit corporation’s certificate of formation or bylaws. There is no analogous provision applicable to Texas for-profit corporations.  Directors of a for-profit corporation must vote for themselves - either in person, by written consent, or via electronic means, such as attending a meeting via teleconference.

9.  Liquidating distributions for charitable purposes. A Texas for-profit corporation exists for the financial benefit of its shareholders, and after all of its creditors have been paid or reserved for, liquidating distributions from a for-profit corporation are to be made to the corporation’s shareholders under Section 11.053(c) of the TBOC. On the other hand, nonprofit corporations exist only for one or more of the non-profit purposes described above. Upon liquidation of a nonprofit corporation, Section 22.304(a)(2) of the TBOC generally requires that any assets of the nonprofit corporation remaining after all creditors have been paid must be paid to one or more 501(c)(3) organizations. For the nonprofit corporation itself to qualify as a 501(c)(3) organization, the nonprofit corporation must include a provision in its certificate of formation requiring that liquidating distributions will be made for charitable purposes. 

The IRS’s Instructions to Form 1023 suggest the following language to meet the dissolution clause requirement in Section 501(c)(3) of the Code: “Upon the dissolution of this organization, assets shall be distributed for one or more exempt purposes within the meaning of Section 501(c)(3) of the Internal Revenue Code, or corresponding section of any future federal tax code, or shall be distributed to the federal government, or to a state or local government, for a public purpose.”

Saturday, July 15, 2017

Texas Secretary of State’s Form of Certificate of Formation

Mother, should I trust the government?” – Pink Floyd

That question answers itself, does it not?

I’m pretty sure Pink Floyd did not have form documents promulgated by the Texas Secretary of State’s office in mind when those lyrics were written. Nonetheless, it’s a helpful reminder that you often get what you pay for when it comes to free legal forms. Or perhaps the economic maxim of TANSTAAFL (“There ain't no such thing as a free lunch”) would be a more suitable reference.
 
Regardless, for those looking to incorporate a Texas for-profit corporation, I do not recommend using the Texas Secretary of State’s form of Certificate of Formation (Form 201), which is available on the Secretary of State’s website here.   

What’s so bad about Form 201?  Well, nothing is horrible about it – you could certainly file it (and pay the related filing fee) and have yourself a functioning Texas for-profit corporation. But an experienced Texas corporate lawyer is likely to suggest a using a form of Certificate of Formation that includes other helpful provisions in addition to the minimum required provisions dictated by the Texas Business Organizations Code (TBOC).

For example, Form 201 does not include any of the following provisions which are common for Texas for-profit corporations:

Director Exculpation.  As a rule, directors do not like to be subject to potential personal liability in connection with their service as a director of a corporation. So Texas corporations often elect to take advantage of Section 7.001 of the TBOC, which permits a Texas corporation to exculpate (relieve from liability) its directors from liability to the corporation or its shareholders. They may achieve director exculpation by adopting a director exculpation provision as part of the corporation’s Certificate of Formation. The basic Form 201 does not include a director exculpation provision, though one could elect to supplement the basic Form 201 by adding such a provision (or any of the other provisions discussed below). Our clients typically elect to include a director exculpation provision in their Certificate of Formation when forming a new Texas corporation.

Mandatory Indemnification of Directors and Advancement of Expenses. Likewise, directors typically think it’s a good idea to have corporations on which they serve indemnify (cover the costs of) directors from potential liability arising from their service as a director. While exculpation relieves directors of liability to the corporation and its shareholders, indemnification protects directors from claims made by third parties. Section 8.101(a) of the TBOC permits Texas corporations to indemnify its directors who gets sued by a third party because of their service as a director so long as the director (1) acted in good faith, (2) reasonably believed that his or her actions taken in an official capacity were in the corporation’s best interest, (3) reasonably believed that his or her actions in all other cases were not opposed to the corporation’s best interests, and (4) in the case of criminal proceedings, did not have reasonable cause to believe his or her conduct was unlawful.

Section 8.103(c) of the TBOC permits a Texas corporation to adopt a provision as part of its Certificate of Formation which makes permissive indemnification mandatory.  That means that once it has been determined that a director has met the 4-part standard described in the previous paragraph for a corporation to be permitted to indemnify a director, then the corporation would be required to provide such indemnification for the benefit of the director.

Of course, sometimes it is unclear at the outset of a suit against a director whether or not the director has met the standard for permissive indemnification. Meanwhile, the director may be incurring substantial expenses in defending himself or herself against third party claims. In cases where it has not yet been determined if the director has met the standard for permissive indemnification, Section 8.104(a) of the TBOC permits Texas corporations to advance expenses to directors in connection with their defense of a claim, so long as the director provides a written statement confirming that (1) the director believes he or she has met the standard for permissive indemnification, and (2) the director will repay any expenses advanced if it is ultimately determined that he or she has failed to meet the standard for permissive indemnification.    

Section 8.104(b) of the TBOC permits corporation to adopt a provision in part as part of its Certificate of Formation requiring the corporation to advance expenses to directors who have provided the written confirmation described in the previous paragraph. As one might expect, directors of Texas corporations typically think it is a good idea to include such an advancement of expenses provision in the corporation’s Certificate of Formation.

Action by Written Consent of less than all Shareholders.   Let’s say you want to amend the corporation’s Certificate of Formation to change the name of the corporation. As with any other amendment to the Certificate of Formation, that change requires the approval of the corporation’s shareholders. If all shareholders are willing and able to sign a written consent approving the name change, then shareholder approval is fairly simple. But let’s further assume that all shareholders fully support the name change, but one of the shareholders, holding only 1% of the corporation’s outstanding shares of stock, is on vacation and is unable to sign a written consent approving the name change. What then? Well, if the name change is important and the corporation does not have a provision in its Certificate of Formation authorizing shareholder action by less than unanimous consent, the only way the corporation may change its name is to call a meeting of the shareholders to approve the name change. Such a meeting must be done in compliance with applicable notice, quorum, proxy, and other provisions of the corporation’s bylaws and relevant provisions of the TBOC. Finding a time and place convenient for an adequate number of shareholders to attend in person or by proxy may be difficult.  On the other hand, a corporation with a Certificate of Formation that includes a provision permitting shareholder action by less than unanimous written consent of its shareholders (as permitted by Section 6.202 of the TBOC) can very easily circulate a written consent to its shareholders requesting approval of the name change.  Once signed by a sufficient number of shareholders, the name change may proceed. 

Section 6.204 of the TBOC provides that a corporation need not provide advance notice to shareholders of shareholder action taken by written consent, so depending upon the advance notice of a shareholder meeting required in the corporation’s bylaws, the right of shareholders to take action by written consent can be important when timing is critical for a matter requiring shareholder approval.

Of course, that’s just of few of the possible Certificate of Formation provisions ignored by the Secretary of State’s Form 201. A Texas corporation might elect to include all sorts of other provisions in its Certificate of Formation, including provisions authorizing preferred stock, providing for preemptive rights, providing for cumulative voting rights, electing status as a “close corporation,” or adopting other provisions which may be appropriate for some Texas corporations.

Bottom line, careful consideration should be given to the options available to a new corporation before just grabbing Form 201 and filing away.

Friday, June 30, 2017

360 West Magazine Top Attorney 2017

I'd like to thank 360 West Magazine for including me in their list of "Top Attorneys 2017"(their annual list of our region's best attorneys)!  This year, I was named in the practice areas of Business Law and Civil Law and Transactional.  

The complete list is available here.  

Monday, April 3, 2017

Regulation Crowdfunding Inflation Adjustments

Limits on the amount of capital that companies can raise through equity crowdfunding just grew a tad.

On March 31, 2017, the Securities and Exchange Commission (SEC) adopted amendments to Regulation Crowdfunding which adjust dollar thresholds and limits to account for inflation.

Specifically, companies that raise capital through equity crowdfunding are now permitted to raise up to $1,070,000 per 12-month period (up from $1 million).

The inflation adjustments also impacted other dollar limits and threshold throughout Regulation Crowdfunding.  For example:


  • The threshold for assessing a crowdfunding investor's annual income or net worth to determine investment limits applicable to such investor increased from $100,000 to $107,000;
  • For a crowdfunding investor whose income or net worth is below the new $107,000 threshold, the maximum amount of securities that can be sold to such investor in a crowdfunding offering has increased from $2,000 to $2,200 [or, if greater, 5% of the lessor of (i) the investor's annual income or (ii) the investor's net worth]; and 
  • The maximum amount that any investor can invest in all crowdfunding offerings in any 12-month period has increased from $100,000 to $107,000.

The SEC was required under the JOBS Act of 2012 to adjust the limits and thresholds under Regulation Crowdfunding to account for the impact of inflation.  Further adjustments are required at least every five years.