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(1)Presentation: Date: Event:. Practical Aspects of Entity Formation February 5, 2013 SMU Cox School of Business ABOUT THE PRESENTER Liza Farrow-Gillespie. Attorney Liza Farrow-Gillespie is a partner with the law firm of FarrowGillespie & Heath LLP. Ms. Farrow-Gillespie practices in the areas of business transactions, estate planning and probate, taxation, elder law, and nonprofit organizations. Before founding the firm in June 2007, Liza served as permanent briefing attorney for the late Hon. Barefoot Sanders, United States District Judge for the Northern District of Texas. Ms. Farrow-Gillespie is a former litigation associate at Cohan Simpson Cowlishaw and Wulff LLP, now merged with Jackson Walker LLP; and is a 1992 honors graduate of the University of Texas School of Law (Dean’s Award; Order of the Coif; executive editor of the Texas Law Review). An avid blue-water sailor, Liza co-captained a six-year sailing circumnavigation (1998-2004), during which she and her husband crossed three oceans and visited six continents on a 17meter sailboat. Ms. Farrow-Gillespie is a former professional musician (Screen Actors Guild, AFTRA), and currently enjoys playing at Dallas venues with the LCD Jazz Trio (lcdjazztrio.com). Liza serves on the board of directors of No Child in Pain Foundation and the Dallas Area Parkinsonism Society, and she is a Trustee of the Dallas Opera. Ms. Farrow-Gillespie is a frequent speaker in the community and guest lecturer at the SMU Cox School of Business on topics including elder law, business succession planning, estate planning, state and federal taxation, and a wide variety of issues affecting nonprofit organizations. She has been married to Alan Farrow-Gillespie, M.D., since 1984.. Farrow-Gillespie & Heath LLP | 1700 Pacific Avenue | Suite 3700 | 214-361-5600 | info@fghlaw.net www.fghlaw.net. A Women’s Business Enterprise in Downtown Dallas.

(2) Awards and Events •. Speaker, “Business Succession Planning,” Oak Cliff Chamber of Commerce (upcoming). •. Co-sponsored Diversity Summit, Dallas Bar Association, November 2012. •. Co-sponsored Dallas County Democratic Committee event, November 2012. •. Co-sponsored Lambda Legal annual women's brunch, April 2012. •. Spoke on panel at Women's Forum meeting of the Texas General Counsel Forum, January 2012. •. Participated on program for investiture of United States Attorney, Northern District of Texas, November 2011. •. Co-sponsored Annie's List annual luncheon at Westin Galleria, October 2011. •. Presented asset protection planning seminars at NBI event, August 2011. •. Elected as a Fellow of the Texas State Bar Foundation, January 2011. •. Named to the Board of Trustees of the Dallas Opera, July 2010. •. Sponsored annual luncheon of Attorneys Serving the Community, benefitting YWCA of Dallas, June 2010. •. Named to the editorial board of the NAELA Journal, published by the National Academy of Elder Law Attorneys, October 2009. •. Sponsored and participated in the program of the annual Justice Is Served dinner for the benefit of Dallas CASA, October 22, 2009. •. Presented "Successful Elderlaw Planning for You and Your Aging Loved Ones" at the Women's Business Council Southwest, August 4, 2009. •. Presented continuing legal education topics at NBI Institute "Estate Planning and Recovery for Elderly Clients," July 24, 2009. Farrow-Gillespie & Heath LLP | 1700 Pacific Avenue | Suite 3700 | 214-361-5600 | info@fghlaw.net www.fghlaw.net. A Women’s Business Enterprise in Downtown Dallas.

(3) •. Presented "Advising the Elderly Client" at a Dallas Bar Association continuing legal education event, June 19, 2009. •. Spoke at unveiling ceremony for official portrait of the late Hon. Barefoot Sanders at the federal courthouse, Northern District of Texas. About the Firm. The law firm of Farrow-Gillespie & Heath LLP provides smart legal representation in employment law and litigation, wealth preservation, family law, corporate law, and nonprofit organizations. The firm’s commitment is to deliver cost-effective excellence to each and every client. Located in downtown Dallas, Farrow-Gillespie & Heath LLP is rated AV™ Preeminent®, the highest rating awarded to law firms, and is a Women’s Business Enterprise (WBE), certified by the Women’ Business Council-Southwest. As of March 2013, the firm consists of ten attorneys (all female) and a support staff of four.. Practice Areas . Employment Law – litigation and arbitration defense, internal investigations, audits, noncompetition agreements, severance negotiations, employee handbooks, HR training. . Commercial Litigation and Arbitration – contract disputes, shareholder actions, business torts, employment disputes. . Mediation – employment (English/Spanish). . Corporate Law – contracts, business formation, mergers and acquisitions, deal structuring, commercial leases, investment due diligence. . Wealth Preservation – estate planning and probate, trusts, asset protection planning, elderlaw, fiduciary representation, trust administration, estate administration. . Family Law – complex divorce and property settlements, child custody, guardianships. . Nonprofit Organizations – formation, governance, counsel. disputes,. business. disputes,. bilingual. mediation. For more information, please visit www.fghlaw.net.. Farrow-Gillespie & Heath LLP | 1700 Pacific Avenue | Suite 3700 | 214-361-5600 | info@fghlaw.net www.fghlaw.net. A Women’s Business Enterprise in Downtown Dallas.

(4) Practical Aspects of Entity Formation and Structure Liza Farrow-Gillespie Farrow-Gillespie & Heath LLP 1700 Pacific Avenue, Suite 3700 Dallas, TX 75201 214-361-5600. www.fghlaw.net.

(5) Practical Aspects of Entity Formation and Structure . Formation: step-by-step guide. . Governance: common pitfalls in the company’s governing document. . Structuring the deal to achieve the owners’ goals.

(6) Entity Formation  General Partnership  Limited Liability Company  Series LLC  Corporation ◦ C-Corp ◦ S-Corp  Limited Partnership http://www.sos.state.tx.us/corp/sosda/index.shtml.

(7) Why Texas?  Established Business Organizations Code and body of law – where silent, follows Delaware law  Texas lawyers know Texas law  Foreign entities must register to “transact business” in Texas ($750)  Availability of “Series LLCs”  Low taxes (franchise tax 1% or less, threshold $1,030,000; no personal income tax)  Litigation venue  Contraindications – Delaware may be better if: ◦ Major privacy concerns ◦ Large revenue ◦ Not doing business in Delaware.

(8) General Partnership Formation  TSOS: No filing  Operating Agreement: Oral agreement okay  Liability Protection: None  Pitfalls: Partnership by conduct ◦ Definition: “An association of two or more persons to operate a business as co-owners for a profit.” ◦ Mutual liability ◦ Fiduciary duties ◦ “Not a partner” agreement a good idea.

(9) Limited Liability Company Formation Checklist: ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦. Check name availability Obtain agent for service of process File Certificate of Formation with TSOS (Form 205) Pay fee ($300 + 2.7% credit card fee) Obtain EIN Number . https://sa1.www4.irs.gov/modiein/individual/index.jsp. . (800) 829-4933. Receive Certificate of Registration Receive franchise tax number Complete online franchise tax questionnaire Create and sign operating agreement.

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(13) Why Manager-managed?  Add more owners/investors. Members.  Allows “silent partner”  Retirement  Business succession planning  Litigation avoidance ◦ Minority member oppression ◦ Fiduciary duty claims. Managers.

(14) Limited Liability Company Governance  Annual filling with state comptroller (May 15) ◦ Public Information Report ◦ Franchise tax return (or “no tax due” statement).  NO meetings or minutes required  NO share certificates required.

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(16) Series LLC. B. LLC (A). C.        . D. Sub-LLCs – unlimited number No separate registration Firewalled from each other and from mothership Can have different members Can have different managers Can file a single franchise tax/PIF report Must have separate EINs for federal tax purposes Case law is not developed – liabilities are unclear. E.

(17) Series LLC Formation ◦ Formation is same as for LLC ◦ Must keep separate books and records ◦ Magic language (supplemental provision in articles of formation):. “Pursuant to Subchapter M of Title 3 of the Texas Business Organizations Code, this. limited liability company is a Texas Series LLC and may establish one or more designated series of members, managers, membership interests, and/or assets that: (i) has separate rights, powers, or duties with respect to specified property or obligations of the limited liability company, or profits and losses associated with specified property or obligations; or (ii) has a separate business purpose or investment objective. The debts, liabilities, obligations, and expenses incurred, contracted for, or otherwise existing with respect to a particular series shall be enforceable against the assets of that series only, and shall not be enforceable against the assets of the limited liability company generally or any other series; and none of the debts, liabilities, obligations, and expenses incurred, contracted for, or otherwise existing with respect to the limited liability company generally or any other series shall be enforceable against the assets of a particular series.”.

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(21) Corporation Formation Checklist: ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦. Check name availability Obtain agent for service of process File Certificate of Formation with TSOS (Form 201) Pay fee ($300 + 2.7% credit card fee) Obtain EIN Number . https://sa1.www4.irs.gov/modiein/individual/index.jsp. . (800) 829-4933. Receive Certificate of Registration Receive franchise tax number Complete online franchise tax questionnaire Create and sign bylaws Purchase or create stock certificates, and issue.

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(25) Corporate Governance  Annual filling with state comptroller (May 15) ◦ Public Information Report ◦ Franchise tax return (or “no tax due” statement).  Must have annual shareholder meetings (with written minutes) or written “consent in lieu of meeting”  Must have directors’ meetings (with written minutes) or written “consent in lieu of meeting”  Must keep stock ledger for share transfers.

(26) S-Corp Election 1. < 100 shareholders 2. Individuals only. (plus estate, some trusts, some charities). 3. US citizens or resident aliens 4. One class of stock 5. All shareholders must consent in writing.

(27) Limited Partnerships ◦ Minimum of two persons or entities ◦ General Partner has liability ◦ Limited Partner has NO liability ◦ “Gold standard” for private equity investment. ◦ Bulletproof liability shield ◦ No minority shareholder rights.

(28) Limited Partnership Formation Checklist: Step 1 -- Create General Partner entity ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦. Check name availability Obtain agent for service of process File Certificate of Formation with TSOS Pay fee ($300 + 2.7% credit card fee) Obtain EIN Number  . https://sa1.www4.irs.gov/modiein/individual/index.jsp (800) 829-4933. Receive Certificate of Registration Receive franchise tax number Complete online franchise tax questionnaire Create and sign bylaws or operating agreement If GP is a corporation, purchase or create stock certificates, and issue them.

(29) Limited Partnership Formation. (continued). Checklist: Step 2 -- Create Limited Partnership ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦ ◦. Check name availability Obtain agent for service of process File Certificate of Formation with TSOS (Form 207) Pay fee ($750 + 2.7% credit card fee) Obtain EIN Number . https://sa1.www4.irs.gov/modiein/individual/index.jsp. . (800) 829-4933. Receive Certificate of Registration Receive franchise tax number Complete online franchise tax questionnaire Create and sign partnership agreement.

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(33) Limited Partnership Governance  Annual filling with state comptroller (May 15) ◦ Public Information Report ◦ Franchise tax return (or “no tax due” statement).  Governance required for GP entity  Whatever reporting is required to be furnished to the limited partners by the partnership agreement.

(34) Assumed Named (dba)  Texas Secretary of State ◦ No proprietorships ◦ $25 filing fee.  All counties where “doing business” ◦ Separate form for “unincorporated” and “incorporated” ◦ $14 filing fee, plus $.50 for each additional owner.  10-year maximum.

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(39) Attorney Fee Schedule.

(40) Common Governance Problems  Primary goal of Bylaws/Operating Agreement should be to prevent problems among owners  “Three Ds” should be foreseen and dealt with: ◦ Disputes ◦ Disability ◦ Death.

(41) LLC Case Study #1: Problem “For purposes of this Section 7.2, the Company shall have two Managers. Members A and B shall have the authority to designate one Manager each. A shall be deemed to have appointed A, and B shall be deemed to have appointed B. The signature of one Manager shall be sufficient to bind the Company.” What are the problems with this clause?.

(42) LLC Case Study #1: Solutions ◦ Require 2 signatures for checks more than $X ◦ Require unanimous vote on matters such as :.  Long-term lease  Sale of assets of more than X% of total assets  Merger/sale/bankruptcy/dissolution of company. ◦ Deadlock solutions.  If either Manager declares deadlock, both must go to mediation  Coin toss  Appoint a “decider”  Final solution: Push-pull clause.

(43) LLC Case Study #2: Problem “Each. Manager shall serve until he or she resigns in writing.” What is the problem with this clause?.

(44) LLC Case Study #2: Solutions  Define scenarios under which a Manager position is terminated: ◦ Disability.  Lasting how long?  How is disability determined if disabled Manager opposes?. ◦ Death ◦ Bankruptcy ◦ Criminal conviction.

(45) LLC Case Study #3: Problem “No Member may transfer his or her Membership interest in the Company without the written approval of all of the other Members.” What is the problem with this clause?.

(46) LLC Case Study #3: Solutions  Define “permitted transferees”.  Beneficiaries of a Will  Trusts created for the benefit of a family member.  Define “non-permitted transferees”.  Spouse, if pursuant to divorce settlement.  Separate right to receive income from a Member share from the right to be a voting Member  Determine whether permitted transfer carries the right to appoint a Manager.

(47) Structuring a Business or Investment  1. Business: You are providing products and/or services  2. Investment: You are holding property to receive income/appreciation generated by the property and/or tax deductions (depreciation)  Securities  Rental property  Commercial real estate If 2, then you are the investor. If 1, you may want to attract an investor..

(48) Tax Deduction: Depreciation, etc.  Active vs. Passive  Always Active: ◦ Trade or business in which you materially participate ◦ O&G working interest ◦ Rental of your vacation home.  Always Passive: ◦ Rental real estate -- unless you are a real estate professional.

(49) Material Participation  More than 500 hours of participation in a year (12.5 weeks @ 40 hours/week)  Substantially ALL of the participation, even if only a single hour  More than 100 hours, if no other person (including nonowners) participated more than you  Material participation (as defined above) for any 5 of the last 10 tax years  Material participation in a personal services company (consultant, etc.) for any 3 prior tax years.

(50) Clash of Limited Liability with Material Participation  Conflicting goals ◦ Primary goal of entity formation is to limit liability ◦ Primary goal of favorable tax treatment is to materially participate.  LLC managing member: BOTH goals  Corporate shareholder/officer: BOTH goals  Limited partner: Oops Trick is to materially participate WITHOUT losing limited partner liability protection.

(51) Limited Partner Activities that Do Not Cross the Line into Liability TBOC § 153.103  Contractor/agent/employee of the Partnership  Owner/director/officer/member of GP  Consultant to GP  Provide collateral for Partnership loan  Attend meetings of the Partnership & serve on committees  Vote on major matters (but not everyday operational matters).

(52) Choice of Entity 1. Nature of business – high risk of liability? 2. Availability of high-dollar deductions, such as depreciation (buildings, equipment) 3. Nature and amount of your other personal income sources and tax deductions 4. Your exit strategy 5. Your need to attract equity capital 6. Your personal tolerance for complexity.

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(56) Practical Aspects of Entity Formation and Structure Liza Farrow-Gillespie Farrow-Gillespie & Heath LLP 1700 Pacific Avenue, Suite 3700 Dallas, TX 75201 214-361-5600. www.fghlaw.net.

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