In a previous post we discussed Definitions and Significance of Organizational Culture including the strong influence that organizational culture has on how members behave when carrying out their organizational activities and the role that organizational culture plays in defining the competitive position of the organization in its environment and the way that the organization is perceived by its stakeholders. The report included with this post builds on these themes by discussing steps that can be taken to evaluate and, if necessary, transform organizational culture.
Perhaps the most common source of problems over fees involves misunderstandings with clients over the amount of the fee and expectations regarding payment of the fee. Both types of misunderstandings can be minimized if there is a complete and frank discussion of fees with the client at the outset of the representation. This is particularly true with the small business client who may not have much experience dealing with attorneys and who may have a limited budget for legal services.
To minimize misunderstandings, and to improve collections as a result, it is desirable to fully explain to the client, before any work is done, the basis on which fees will be computed; the mechanics and frequency of billings; and the expectations of the attorney regarding payment of billings. These types of communications are particularly important when consideration is being given to some for alternative fee arrangement (“AFA”). Even though anecdotal evidence indicates that AFAs are used for a relatively small percentage of the work of a typical law firm, a number of firms have committed to trying to discuss AFAs for a majority of their potential engagements and this means that firms should have a set of guidelines, such as the following, in place to assist their attorneys in understanding, explaining and implementing AFAs in appropriate cases:
- Does the law firm have a formal strategy and related programs and policies for using alternative fee arrangements (AFAs)? Some law firms have created policies that attorneys can use to discuss AFAs with clients and have supplemented these policies with training that provides attorneys with additional information and experience on how to walk through the process with clients.
- Does the law firm follow a consistent practice of engaging in a realistic and comprehensive assessment of the work involved in a prospective engagement with the client? It is essential for both sides to identify and acknowledge all of the tasks involved in order to establish realistic goals and budgets and schedules for the engagement. Law firms should pencil out a budget for all of the work before discussing an AFA with the client in order to make sensible decisions regarding the potential benefits and risks of a particular AFA.
- Does each of the parties understand what an AFA is? In general, an AFA is typically defined as anything that is not based on a billable hour or a discounted hour, such as contingency, break-up fee, premium fee, flat fee or budgeted fee arrangements.
- Has the law firm gone through a menu of AFA structures with the client to provide the client with ideas about how they might want to structure the arrangement? Ideas include: a fixed or flat fee for a particular project or series of projects which may be payable in regular installments at the beginning of each month or quarter of the engagement; a fixed or flat fee for a particular stage or stages of a project that is combined with traditional hourly rates for the remainder of the project; a fee cap for all or part of a project; a non-refundable retainer paid at the beginning of the project that is combined with a percentage hold-back from standard rates during the project and an agreement for payment of a multiple of the hold-back at the end of the project if the outcome is a “success” or loss of the hold back if the matter falls short of a “success” (with “success” being carefully defined in advance); a “value” based fee, which is determined by a mutual agreement between the parties regarding the anticipated value of the work in the context of the overall goals and objectives of the client; and/or a blended hourly rate for any one category of timekeeper (i.e., partner or associate) or a single blended rate for all timekeepers regardless of category.
- Do the parties recognize and appreciate the advantages of considering and using an AFA? Conversations regarding a potential AFA should specifically focus on its ability to achieve benefits such as predictability in legal costs for the client; limitation of the client’s total cost exposure; greater risk sharing by the law firm in the total costs associated with the engagement; more creativity from both the client and the law firm with respect to managing costs and setting goals for the engagement; improving attorney-client communications; and reducing misunderstandings and disputes over legal fees and costs.
- Is an AFA suitable for the particular engagement? In general, an AFA make senses for any transaction that includes a series of activities that can be broken out into identifiable segments and pricing arrangements can be established for each segment. An AFA will be more effective when both sides have substantial experience with regard to the particular transaction and understand the time and effort involved and the unforeseen circumstances that might arise. AFAs may also be used for “cookie cutter” transactions or projects; however, even then it makes sense to agree on a range for the fees rather than a fixed amount in order to provide clients with predictability and the law firm with a modest amount of flexibility. A fixed fee for multiple matters of the same general nature is also a common strategy for AFAs.
- Have the parties candidly discussed the objectives of the client in seeking an AFA? Some clients are only interested in reducing costs and shifting all the risk to the law firm, a situation which inevitably leads to problems. The more constructive objectives include budgeting and risk sharing. Risk sharing means that one side may come out better than the other, at least in comparison to a traditional hourly fee arrangement, and both parties need to acknowledge and accept that possible result from the very beginning.
- Does the law firm have a formal mechanism for tracking the success of AFAs? A variety of methods can be used included “ghost billing” that is based on tracking actual time with normal rates and comparing the result to what the client pays under the AFA. Law firms should quantitatively analyze projects after they are done to determine profitability and identify areas for possible improvement.
Discussions with the client should be followed with a letter to the client confirming the discussion. In the alternative, a contract regarding fees, and perhaps the nature of the engagement as well, can be entered into. This process also minimizes the possibility that the fee arrangements will violate applicable ethical and statutory guidelines. See Legal Considerations in the chapter on Collecting Information on Prospective Clients (§§ 1:88 et seq.) in Business Transactions Solutions on Westlaw Next.
Misunderstandings are also minimized if the client is billed for the work on a regular basis. A regular monthly or quarterly itemized bill will inform the client about what is being done on his or her matter and will also provide the client some idea of how much the fee is building up. In addition, regular billings indicate to the client the charges being made while the services are still fresh in his or her mind. It can be much more difficult to justify a bill once the details of the work have been forgotten by the client and attorney.
Often clients fail to understand what the attorney is required to do in relation to their legal matters or how much of the attorney's time will be consumed. The lawyer should take the time to explain to the client, both at the outset and as the work progresses, precisely what the lawyer is doing. In this regard, it may be helpful to send the client copies of all correspondence, pleadings, briefs, and other documents.
Another strategy that might pay dividends is to deliver large bills personally. By sitting down with the client, the attorney can explain each element of the bill and immediately address any questions that the client might have regarding the size of the fee. This conversation will go much easier if counsel has laid the foundation for a large bill by regularly sending progress reports to the client that explain how the project is progressing and the relationship of the various tasks to the overall size of the bill.
For further discussion of AFAs, see the chapter on Collecting Information on Prospective Clients (§§ 1:1 et seq.) in Business Transactions Solutions on Westlaw Next.
Managers have a wide array of choices with respect to management styles and Thornton's 3Ds of Management Styles attempts to simplify the matter by identifying three basic styles: directing (“tell employees what to do”), discussing “ask questions and listen”) and delegating (“let employees figure it out their own way”). Each of these styles has its advantages and disadvantages depending on the situation and the choice determines how managers go about other activities such as communication, goal-setting, decision-making, performance monitoring and establishing rewards systems.
Section 7A of the Clayton Act, which was added by the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the “HSR Act”), provides that certain mergers and acquisitions of voting securities or assets may not take place unless prior notification has been filed with the Department of Justice (DOJ) and the Federal Trade Commission (FTC) and the specified waiting period has expired. The waiting period ordinarily is 30 days (15 days for cash tender offers or bankruptcy sales) but may be either extended or shortened under certain circumstances by the agencies, which also have the right to request additional information or documents regarding the proposed transaction. If such a request is made, the waiting period is extended until 20 days following delivery of all of the supplemental information or documents to the appropriate agency. The HSR Act also applies to formation of certain joint ventures; acquisitions of intellectual property assets, including exclusive licenses; and formation and acquisitions of ownership interests in non-corporate entities (i.e., partnerships and limited liability companies). Cooperation between the participants in a prospective merger during the mandatory premerger waiting period may itself be a violation of the antitrust laws and it is important for the participants to continue operating as separate and independent businesses and competitors in order to avoid “gun jumping” liability.
Under the HSR Act, notification must be provided (unless there is an applicable exemption) if: (1) at least one of the parties (i.e., either the acquiring or the acquired person) is engaged in commerce or in any activity affecting interstate commerce (the “commerce” test”); (2) one party to the transaction has annual sales or assets of at least $100 million and the other party $10 million (the “size-of-person” test) (the $100 million and $10 million thresholds will increase as provided in the indexing procedures described below); and (3) as a result of such acquisition, the acquiring person will hold voting securities or assets worth in the aggregate more than $50 million (increased as provided in the indexing procedures described below) (the “size-of-transaction” test).
Regardless of whether the transaction falls within any of the above-listed requirements, notification is also mandated if the transaction meets the commerce test and, as a result of the acquisition, the acquiring person would hold voting securities or assets worth in the aggregate more than $200 million (increased as provided in the indexing procedures described below). On the other hand, $50 million (increased as provided in the indexing procedures described below) is an absolute floor on reporting — if an acquiring person would not hold voting securities or assets valued at greater than the than applicable threshold in the size-of-transaction test, the acquisition is not reportable.
All of the dollar-amount thresholds described above are subject to indexing commencing in 2005 based on annual changes in the gross national product. Accordingly, by 2015 the thresholds referred to above had increased as follows: $10 million to $15.3 million; $50 million to $76.3 million; $100 million to $152.5 million; and $200 million to $305.1 million. As general rule of thumb, unless a specific exemption applies, notification must be made for all acquisitions valued at more than $76.3 million if either party has at least $152.5 million in annual net sales or total assets and the other has at least $15.3 million in annual net sales or total assets. The size-of-person test is not applicable in cases where the value of the securities or assets being acquired equals or exceeds $305.1 million. A filing fee, ranging from $45,000 to $280,000, depending on the size of the transaction, must be paid in connection with filings under the HSR Act. The thresholds described above are effective for transactions on or after February 20, 2015.
For further discussion of Hart-Scott-Rodino Act filing requirements, including various exception that might apply to remove a transaction from those requirements, see Corporate Mergers Gutterman, Business Transactions Solutions §§ 297:47 et seq.).
An agreement to form a new corporation, sometimes called an “agreement to incorporate”, should be considered as a valuable opportunity to reduce to writing the understanding of the founders regarding the general terms and conditions associated with the formation and initial organization of the new corporation. The content of an agreement to incorporate will vary depending upon the circumstances; however, the matters commonly covered in such an agreement include the names and addresses of the parties; the proposed name of the corporation and a description of the procedures that will be followed to check the availability of the name and reserve it for future use on behalf of the corporation; a description of the proposed purpose and activities of the corporation; a summary of the place or places where it is anticipated that the corporation will conduct its business, including a statement of the procedures that will be followed in order to qualify the corporation as a foreign corporation; a description of the proposed capitalization of the corporation, including subscriptions by the founders; a list of the incorporators, initial directors and officers of the corporation; and a description of the terms of engagement of any persons required to assist in the incorporation process, such as lawyers, accountants or appraisers.
Other matters which might be covered in an agreement to incorporate include a description of the terms of any proposed employment relationship between the new corporation and any of the founders; the general terms of any share transfer restrictions and/or buy-sell arrangements among the corporation and its future shareholders; a description of any proposed purchase of assets by the new corporation, which will be relevant whenever the new corporation is going to take over the operations of a going concern; and a description of the procedures that will be followed in offering shares to persons not otherwise affiliated with the founding group, including the preparation of an offering document, engagement of finders and payment of the fees and expenses associated with complying with any securities law requirements.
The agreement to incorporate is also the place to address specific tax and regulatory issues associated with the formation and operation of the new corporation. For example, if the new corporation is being formed in the US and the founders wish to have it treated as a Subchapter S corporation for federal income tax purposes, the agreement should contain various covenants regarding the steps that will be taken to perfect and maintain Subchapter S status. In the case of regulated businesses it will be necessary to ensure that the corporation can obtain the appropriate license or permit. Compliance with securities laws should also be addressed if shares will be offered to outside parties. Finally, if an existing legal entity, such as a partnership, is being converted to a corporation, agreement should be reached on the assets that will be transferred to the new corporation and the number of shares that the owners of the old entity will receive in exchange and attention must be paid to ensuring that they achieve the tax treatment they are expecting with respect to the conversion.
Matters to Consider in Drafting an Agreement to Incorporate
1. Names and addresses of the parties;
2. The proposed name of the corporation and a description of the procedures that will be followed to check the availability of the name and reserve it for future use on behalf of the corporation;
3. A description of the proposed purpose and activities of the corporation;
4. A summary of the place or places where it is anticipated that the corporation will conduct its business, including a statement of the procedures that will be followed in order to qualify the corporation as a foreign corporation;
5. A description of the proposed capitalization of the corporation, including subscriptions by the parties;
6. A list of the incorporators, initial directors and officers of the corporation;
7. A description of the terms of engagement of any persons required to assist in the incorporation process, such as lawyer, accountants or appraisers;
8. A description of the terms of any proposed employment relationship between the new corporation and any of its organizers and/or promoters;
9. The general terms of any buy-sell arrangements among the corporation and its future shareholders;
10. If the principals wish to have the corporation treated as a Subchapter S corporation for tax purposes, the agreement may contain various covenants regarding the steps that will be taken to perfect and maintain Subchapter S status;
11. A description of any proposed purchase of assets by the new corporation, which will be relevant whenever the new corporation is going to take over the operations of a going concern;
12. When subscriptions will be sought from persons not otherwise affiliated with the founding group, a description of the procedures that will be followed in making the offering, including the preparation of an offering document, engagement of investment bankers and payment of the fees and expenses associated with complying with any securities law requirements; and
13. If an existing business will be incorporated, a description of the assets that will be transferred to the new corporation, the shares that will be issued in exchange for each proprietor's interest and a summary of the tax elections that will be made in connection with the incorporation.
The partners of a professional services firm should be sure to establish detailed procedures for the admission of new partners. A full discussion of the procedures for admission of new owners to a partnership or limited liability company is provided in the chapters covering Issuance of Partnership Interests (§ 50:3) and Issuance of LLC Ownership Interests (§ 61:1) in Business Transactions Solutions on Westlaw Next. While most of the procedures discussed in those chapters apply to professional services and limited liability partnerships, it is obviously necessary to take into account the need for new owners to satisfy applicable professional standards and requirements. One method sometimes used to ease the transition to ownership status is an agreement for admission of an associate to a professional partnership that covers the duties and responsibilities of the associate for a specified trial period prior to an agreed date that the association is promoted to partner status. During the trial period the associate may even be allowed to share in the profits of the partnership as part of his or her compensation package. It is typical for the parties to include non-competition provisions that would be applicable following the termination of the associate’s relationship with the partnership. See Specialty Form at § 55:152 of Business Transactions Solutions or contact firstname.lastname@example.org for a complimentary copy.
March 2015 marks the introduction of separate chapters in Business Transactions Solutions on Westlaw Next relating to the admission of new owners to two important non-corporate entities: partnerships (see §§ 50:1 et seq.) and limited liability companies (see §§ 61:1 et seq.). The admission of a new partner or member, whether at the time the entity is formed or during the operation of the business, is a fundamental change that requires the most careful consideration and time. A variety of factors and characteristics should always be considered including the functional skills of the candidate, the type and amount of contributable assets, level of participation, goals and objectives and the chemistry between the candidate and the current owners.
In a small- or medium-sized business, each principal should be able to contribute significant experience in one or more key functional areas. For example, one or more of the owners should have expertise in product development, procurement and manufacturing, marketing and distribution, finance and accounting, strategic planning and personnel. In some cases, one or more of these activities can be outsourced to outside professionals and vendors, including consultants, attorneys, accountants and payroll services. Strategic alliances can also be used to supplement the core skills and resources of the business.
In assessing a potential new owner, the current ownership group should determine if the candidate's functional skills are complementary. Clearly, if the current owners are particularly strong in the marketing area, a preference in recruiting might be given to an engineer or scientist with proven experience in product development or manufacturing processes. On the other hand, a candidate with a marketing background may not add that much to the current mix and may even create conflicts among the ownership group unless he or she can bring a unique set of contacts or ideas to the company.
While functional skills are important in evaluating a new owner, consideration should also be given to the contributions the owner is willing to make to the business. While new owners are often admitted on the basis of their experience without further contribution of assets, new owners are also a good source for working capital, equipment, facilities and intellectual property rights. For example, a new owner may contribute cash for operations and the owner's rights to patents that might be useful in developing new products to be commercialized by the company. A new owner may also be able to contribute needed equipment or arrange for the equipment to be available to the company under a long-term lease on favorable terms.
The current owners should get a clear idea of how much time and effort the new owner candidate is willing and able to devote to the business affairs of the company. While it is anticipated that all of the partners of a general partnership will be actively involved in the day-to-day management of the partnership business, use of a limited partnership or an LLC allows the parties to plan for different levels of participation. At one extreme, there may be owners who do not have the time or functional skills to be actively involved in the business and who are only looking to be silent financial partners. In that situation, the business will be organized as a limited partnership or a manager-managed LLC and these owners will become limited partners or non-managing members, as the case may be. They will generally have the right to receive regular reports on the progress of the business and special voting rights as permitted by statute on fundamental matters relating to the company (e.g., mergers). Assuming that the new owner will be participating at some level in the day-to-day management and operation of the business, the parties must reach agreement regarding the specific duties and obligations of the new owner. This often takes the form of an employment agreement or a detailed description of the agreed services in the partnership or operating agreement.
Each owner has his or her own personal goals and objectives for participating in the management of the business entity. In general, each owner should be dedicated to the overall success of the business, which may be defined by profitability, development of new products and markets, expansion of the workforce and/or increase in the value of the ownership interests. However, specific goals of an owner may conflict with the objectives of the other owners. For example, if one owner is much older than the others and is looking to retire in the near future, he or she may be less inclined to incur business risks that might endanger his or her ability to liquidate his or her interest on retirement. The other owners may want to take on more risky projects that will increase the value of their interests over the long-term. The divergent interests of the owners may lead to conflicts among the group and make it more difficult to manage the business. Similar issues may arise when owners have different levels of separate personal wealth.
Goals and objectives are also important when adding new owners looking for what is nominally a passive investment interest in the business (e.g., limited partners). While a passive investor is generally relying upon the active managers to conduct the business in a proper fashion, passive investors may have specific financial goals and objectives that need to be taken into account. For example, a limited partner may require that a certain amount of cash must be distributed to the limited partner on a regular basis regardless of whether or not the cash might be better used for internal projects in the business. In any event, the goals of the passive investors should be carefully described in the partnership or operating agreement.
The ownership group of a small- to medium-sized business should expect to spend a good amount of time with one another and to share tasks that might be delegated in a larger organization. The intensity of these relationships means that personal chemistry is a very important element in adding new owners. Ideally, new owner candidates will be well known to the other owners, either from past business relationships or from time that the candidate has spent as an employee in the current business organization. In fact, many businesses will not admit new owners without some trial period to make sure that there is a good fit. If that is not possible, and the candidate has no prior working relationship with the other owners, detailed interviews should be conducted and references should be carefully checked.
Business plans remain an important tool for entrepreneurs regardless the increasing speed of business development and the general sense that spending too much time focusing on the future is a waste of time since so many things can change so quickly. Entrepreneurs and their advisers working on a business plan can benefit from following a business plan drafting worksheet available that includes an extensive list of questions and information that should be answered and provided in a good business plan. The worksheet should not only cover the essential elements of the discussion in the plan but should also serve as a reminder to include (or at least have readily available) important ancillary materials such as financial information, both historical and project; resumes of founders, other senior executives and key employees; credit reports; organizational documents of the applicable business entity; copies of material contracts and other legal documents; personal and professional references; reports relating to company’s industry and other relevant environmental factors; and other background documents referred to in the body of the plan. Please contact me at email@example.com to receive a complimentary copy of the worksheet.