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Updated & Expanded Coverage of Joint Ventures in Business Transactions Solutions

The May 2015 Business Counselor Update includes updated and expanded coverage of one of the most well-known and important forms of strategic alliances: joint ventures.  The library in Business Transactions Solutions now includes four chapters on the subject beginning with Structuring and Negotiating Joint Ventures (Ch. 248) and then continuing with chapters focusing on the life cycle of a joint venture: Formation of Joint Ventures (Ch. 249), Managing and Operating Joint Ventures (Ch. 250) and Termination of Joint Ventures (Ch. 251).  Each chapter has an extensive library of forms and checklists and detailed commentary and practical aspects of setting up a joint venture and managing it successfully.  Key topics includes categories and purposes of joint ventures, letters of intents, formation and operation agreements, ancillary agreements between the joint venture and the parties for various types of support to the joint venture, documentation for assignment of a joint venture interest, and dissolution agreements.  To see the materials log on to Westlaw Next and search for Business Transactions Solutions.


Management Development and Training in Africa

Africa, like most developing regions around the world, has suffered from shortcomings in the area of management development and training.  Efforts to develop a unique and effective set of management principles for Africa have often been hampered by misconceptions about the region.  For example, it has often been assumed, even in the face of extensive anthropological evidence to the contrary, that the traditional ideas, institutions and beliefs that existed in Africa prior to colonization were little more than primitive.  Acting as if African history did not begin until the colonies were established, those seeking to assist Africa in its development efforts have often ignored the deep-rooted social and cultural traditions and norms that have existed in Africa for centuries, as well as the unique ways that the community organized economic and political activities.  Another issue, of course, is the paternalistic emphasis on age that prevails among African organizations and which has clearly impeded the development of management development and training programs.  Traditionally, senior managers in Africa moved to their positions “through the ranks” largely based on tenure as opposed to training and education.  As a result, organizations generally saw little reason to devote resources to training younger workers in management techniques when it would be years before they reached a level where they would be exercising managerial authority and it was assumed that by that time they would have learned all they needed to know through the aging process and observation of their elders.  Finally, until recently there have been relatively few undergraduate or graduate business programs in business administration in Africa and only a small percentage of the graduates of Africa universities have chosen to specialize in business-related fields.  This report explores some of the important issues surrounding management developing and training in Africa.


IRC Section 409A & Valuation of Equity Incentives

Internal Revenue Code Section 409A ("Section 409A"), which was enacted in October 2004 as part of the American Jobs Creation Act of 2004 and generally became effective on January 1, 2005, dramatically changed the rules governing “non-qualified deferred compensation arrangements” and impacted a wide range of plans and arrangements, including bonus arrangements (annual, performance-based, multi-year, and contingent signing bonuses); severance plans and arrangements; individual employment agreements; discounted stock option plans and stock options with additional deferral features; and stock appreciation rights, phantom stock, and restricted stock unit plans.  Section 409A imposes significant restrictions on distributions, deferrals and changes in the timing of election and in the form and timing of benefit payments and calls for a 20% additional tax on the recipient (as well as penalties similar to interest) unless specific requirements set out in Section 409A and the related regulations are satisfied. As a result, companies have been required to undertake substantial reviews of their covered equity compensation plans and arrangements and consider the need to make changes in their policies and procedures including ensuring that the material terms of all non-qualified deferred compensation arrangements are set forth in writing.

One area of concern for private companies has been the impact of Section 409A on stock options since, if such options are identified as having been granted at below “fair market value,” they would be treated as non-qualified deferred compensation and thus subject the grantee to taxation when the options vest as well as triggering the additional 20% penalty. With respect to non-statutory stock options, companies must verify that they have been granted at an exercise price at (or above) fair market value. With respect to options that are intended to qualify as incentive stock options (“ISOs”), companies must double-check to confirm that the stock that will be issued upon exercise of the ISO was properly valued at the time the option was granted to conform to the ISO requirements and thus fall outside of the restrictions that might otherwise apply under Section 409A.

In response, such companies must be prepared to clearly and carefully document the steps taken to value employee stock options including the factors taken into account by the board of directors in determining the fair market value of the underlying common stock at the time the decision was made to grant the option. The Regulations relating to Section 409A require employers or other service recipients to use a “reasonable valuation method” to determine the value of stock underlying compensatory option grants. While, in general, reasonableness will be based on the relevant facts and circumstances as of a specified valuation date, the IRS has announced that it intends to consider the following factors to test the reasonableness of a proposed valuation method: the value of the company's tangible and intangible assets; the present value of the company's future cash flows; the market value of stock or equity interests in substantially similar businesses that can be determined readily by objective means; the effects of any control premiums and/or marketability discounts; and/or whether the proposed valuation method is used for other material purposes by the company, its stockholders, or creditors; and other relevant factors.

Private companies are not be required to incur the expense of obtaining an independent valuation from an outside expert; however, they nonetheless should be prepared to demonstrate that input has been received from persons with significant knowledge and experience in valuing illiquid securities (e.g., a board member affiliated with a venture capital company or senior in-house finance or accounting personnel with valuation experience).  Such companies may, of course, obtain a “Section 409A” valuation report from an outside expert and incorporate that report into the minutes and related resolutions for meetings of the board of directors and/or audit or compensation committees at which option grants were considered and approved.  See Specialty Form appearing at § 171:337 in Business Transactions Solutions on Westlaw Next.


Mining Client Information for Valuable Ideas for Your Own Business

Professional services providers, such as law and accounting firms, have evolved into complex and sophisticated business enterprises as competition from similar firms and other companies using new technologies has threatened their traditional positions in the marketplace.  Law and accounting firms, as well as consultants and engineers, generally begin their client relationships with the collection of information about the business activities of the prospective client and the key leaders of the client (i.e., the founders, outside executives and key employees).  In the first instance this information is used to develop a profile of the professional needs of the client and drive discussions regarding the scope and terms of the professional relationship between the parties.  However, professional service providers should not ignore ancillary uses of the information collected from clients, always keeping in mind that such information must be maintained in confidence.  Information provided by clients regarding the markets in which they are engaged can assist service providers in developing new services that might be useful to participants in those markets.  In addition, understanding how clients have structured some of their key business relationships can provide service providers with ideas that they can use when providing counseling to other clients, assuming of course that the information received from clients can be used in a manner that does not compromise trust and confidentiality.  Finally, professional service providers can benefit from observing how their clients choose to organize and manage specific functions and lay out and monitor their own strategic business plans.


D&O Questionnaires for Public Companies & Private Placements

When preparing a registration statement for a public offering of securities or periodic report required under the Securities Exchange Act of 1934, as amended, counsel will rely heavily on the information provided in questionnaires circulated to officers, directors and principal shareholders (i.e., shareholders that beneficially own 5% or more of any class of the company’s securities). While the requirements for each form or registration statement may vary, each document must include a wide range of detailed information regarding officers, directors and principal shareholders, including biographical information on officers and directors, a description of shareholdings, and compensation for senior executives. The primary focus of the questionnaire is to obtain objectively verifiable information, not opinions from the respondents regarding the company's business activities or internal controls. For example, while directors should presumably be aware of the existence of disclosure controls and procedures, background information on that topic is best collected through interviews and observations, as well as copies of written policies adopted by the board of directors. The questions should, of course, be adapted to the company's particular circumstances and line of business. If the company is subject to other types of regulation, additional questions may be inserted into the questionnaire to collect information that may be of interest to regulators other than the Securities and Exchange Commission.  For example of questionnaires that can be used for public companies, see the Master Forms appearing at §§ 151:138 and 290:90 in Business Transactions Solutions on Westlaw Next.

An abbreviated form of a public company questionnaire should also be used by private companies in conjunction with any private placement memorandum, prospectus, business plan, or other document containing disclosures about a proposed or existing business entity to facilitate full disclosure and satisfy due diligence requirements. A number of the questions may be inapplicable where the entity is yet to be formed; with minor revisions, however, the form may be used in conjunction with a pre-incorporation agreement.  See the Master Form appearing at § 152:167 in Business Transactions Solutions and the fuller discussion in Offering and Disclosure Documents (Ch. 152).


Innovation in Emerging Markets

The future of comparative management studies must embrace opportunities to analyze and understand new management practices that are developing around the world.  Of particular interest to me have been the startling developments in China, India and other developing and emerging countries that had largely been ignored by early comparative management theorists.  In fact, it's one of the main reasons that I've launched this blog focusing specifically on growth-oriented entrepreneurship in developing countries.  

A good place to start is a special report published in The Economist several years ago on “Innovation in Emerging Markets”.  Among the topics introduced in the report that certainly warrant further study are new business models in emerging markets, innovation systems and the strategies selected by firms in emerging countries seeking to grow quickly in their domestic markets and in foreign markets that have typically been left to Western companies.



Drafting Worksheet for Clients’ Business Plans

Business counselors often get asked to assist their clients with drafting their business plans and the attorney should be prepared for this request by having 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 can be sent to the client and then used as a basis for ongoing discussions regarding the content of the plan and as a reminder to the client to include 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.  For further discussion, see § 22:51 in Strategic Planning (Ch. 22) in Business Transactions Solutions on Westlaw Next or contact me at to receive a complimentary copy of the worksheet.


Seed Financing from Wealthy Individuals and Angel Investors

Wealthy individuals have always been benefactors of fledgling businesses, particularly when a company is involved in an area in which the individual has substantial prior experience.  In addition, so-called “angel” investors, who are high net worth individuals, often businesspeople or professionals with high incomes or individuals from wealthy families, may have an interest in participating in high-risk/high-return investment opportunities.  This report provides an introduction to some of the key characteristics of angel investor preferences and contributions to a firm and describes several financing structures might be appropriate for the company and the members of an angel investor group.


SEC Adopts Final Rules for New Regulation A+ Exemption

Regulation A is long-standing, albeit relatively little used, exemption from the registration requirements of the Securities Act of 1933 that allows qualified issuers to offer and sell up to $5 million of securities in any 12-month period, including no more than $1.5 million of securities offered by security-holders of the company, provided that certain relatively complex disclosure requirements are satisfied.  Title IV of the JOBS Act included a mandate to the SEC to promulgate a rule or regulation that would add a class of securities to the securities exempted from registration pursuant to § 3(b) of the Securities Act.  The SEC adopted the final rules for this exemption, which appear as § 3(b)(2) of the Securities Act (15 U.S.C.A. 77c(b)(2)) and is often referred to as “Regulation A+” on March 25, 2015 (to become effective 60 days after publication in the Federal Register).  The final rules for Regulation A+ provide for two tiers of offerings: 

  • Tier 1, which would consist of securities offerings of up to $20 million in a 12-month period, with not more than $6 million in offers by selling security-holders that are affiliates of the issuer.
  • Tier 2, which would consist of securities offerings of up to $50 million in a 12-month period, with not more than $15 million in offers by selling security-holders that are affiliates of the issuer.

In addition to the limits on secondary sales by affiliates, the rules also limit sales by all selling security-holders to no more than 30 percent of a particular offering in the issuer’s initial Regulation A offering and subsequent Regulation A offerings for the first 12 months following the initial offering.

For offerings of up to $20 million, the issuer can elect whether to proceed under Tier 1 or Tier 2.  Both tiers would be subject to basic requirements as to issuer eligibility, disclosure, and other matters, drawn from the provisions of Regulation A.  Both tiers would also permit companies to submit draft offering statements for non‑public review by SEC staff before filing, permit the continued use of solicitation materials after filing the offering statement, require the electronic filing of offering materials and otherwise align Regulation A with current practice for registered offerings.

In addition to these basic requirements, companies conducting Tier 2 offerings would be subject to other requirements, including: a requirement to provide audited financial statements; a requirement to file annual, semiannual and current event reports; and a limitation on the amount of securities non-accredited investors can purchase in a Tier 2 offering of no more than 10 percent of the greater of the investor’s annual income or net worth.

Eligibility for the Regulation A+ is limited to companies organized in and with their principal place of business in the United States or Canada.  The exemption is not be available to companies that:

  • Are already SEC reporting companies and certain investment companies.
  • Have no specific business plan or purpose or have indicated their business plan is to engage in a merger or acquisition with an unidentified company.
  • Are seeking to offer and sell asset-backed securities or fractional undivided interests in oil, gas or other mineral rights.
  • Have been subject to any order of the Commission under Exchange Act Section 12(j) entered within the past five years.
  • Have not filed ongoing reports required by the rules during the preceding two years.
  • Are disqualified under the “bad actor” disqualification rules.

The rules exempt securities in a Tier 2 offering from the mandatory registration requirements of Exchange Act Section 12(g) if the issuer meets all of the following conditions:

  • Engages services from a transfer agent registered with the Commission.
  • Remains subject to a Tier 2 reporting obligation.
  • Is current in its annual and semiannual reporting at fiscal year-end.
  • Has a public float of less than $75 million as of the last business day of its most recently completed semiannual period, or, in the absence of a public float, had annual revenues of less than $50 million as of its most recently completed fiscal year. 

An issuer that exceeds the dollar and Section 12(g) registration thresholds would have a two-year transition period before it must register its class of securities, provided it timely files all of its ongoing reports required under Regulation A. 

In light of the total package of investor protections included in amended Regulation A, the rules provide for the preemption of state securities law registration and qualification requirements for securities offered or sold to “qualified purchasers,” defined to be any person to whom securities are offered or sold under a Tier 2 offering.

For further discussion, log on to Westlaw Next and search for § 151:187 of Business Transactions Solutions.