What are Preemptive Rights?

 A corporation generally retains the right to issue new shares of stock to existing shareholders or new investors so the corporation can raise additional capital for future expansion, new projects or working capital.  The issuance of such new shares could dilute the ownership percentage of existing shareholders.  For example, if existing shareholders A and B each own 50 of the 100 outstanding shares (50%) of stock of a corporation, and the corporation sells 10 new shares of stock to shareholder B, then shareholder A would own less than 50 percent of the outstanding shares (50/110) if he or she did not also purchase 10 new shares.  If the corporation instead sold 10 new shares of stock to a brand-new investor, both shareholder A and shareholder B would be diluted and own a smaller percentage than they owned before the sale. 

The dilution problem may be exacerbated if the price paid by the new investor is lower than the price paid by the existing shareholders.  For example, if the existing shareholders each paid $100 per share, and the new investor pays $50 per share for the new shares, the existing shareholders not only have a smaller ownership percentage, but the net book value per share of their shares has also been decreased.  Of course, if the real value per share of the corporation has declined to $50 at the time the new investor buys-in, and this is not a short-term temporary slump, the existing shareholders may not be economically disadvantaged by such buy-in.

To avoid these potential dilution problems, existing shareholders are sometimes given preemptive rights.  If granted, preemptive rights allow the shareholders to purchase new shares of stock before such new shares are made available to the public.  If a shareholder exercises preemptive rights, he or she may purchase as many new shares as necessary to retain his or her current ownership percentage. 

In Ohio, under ORC 1701.15, shareholders do NOT have preemptive rights unless granted in the corporation's Articles of Incorporation.  The lack of preemptive rights is not generally a concern for the majority shareholder.  But this can be a huge issue for minority shareholders.  So if you are a minority shareholder, or are considering investing in a business and becoming a minority shareholder, you should seriously explore adding a preemptive rights provision to the corporation’s Articles of Incorporation.  If you would like assistance drafting or amending Articles of Incorporation, give me a call.  Jsenney@pselaw.com or 937-223-1130.

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AND ONE MORE THING.   Shareholders of an “S” corporation are generally permitted to receive tax-free distributions and recognize losses from the corporation to the extent of their basis. A shareholder’s basis is increased by capital contributions and profit allocations, and decreased by distributions and loss allocations.  Losses may not be used in excess of basis (and are carried over).  To increase basis so that losses can be used, shareholders can personally loan money to the corporation.  But merely guaranteeing a corporate debt will not work to increase a shareholder’s basis.  Call if you any help understanding taxation of an “S” corporation and its shareholders.  Jsenney@pselaw.com or 937-223-1130.

Serving Dayton, Serving You

Pickrel, Schaeffer & Ebeling Co., LPA, 2700 Kettering Tower, Dayton OH 45423

www.pselaw.com

Tax, Business, ERISA, Employee Benefits, Real Estate, Construction Law, Private Placement Security Law, Employment Law, Workers Compensation, Probate, Estate Planning, Succession Planning, Immigration Law, Litigation, Arbitration, Mediation

What Rights Do Shareholders Have?

Under most state statutes, the rights of shareholders generally depend on provisions in the corporation's Articles of Incorporation, Code of Regulations, By-laws, Close Corporation Agreement or other Shareholder Agreement.  Accordingly, these documents should be checked first when a shareholder is trying to determine his or her rights.  Shareholders of a corporation often have the following rights:

(1) Voting rights to elect directors, adopt the corporation’s Code of Regulations or amend the Corporation’s Articles of Incorporation;

(2) Voting rights on significant or extraordinary events that affect the corporation such as sale of all assets, merger, consolidation, liquidation, or dissolution of the corporation;

(3) Rights related to the sale, exchange or transfer of stock such as preemptive rights, put rights and call rights;

(4) Rights to receive dividends declared by the board of directors;

(5) Rights to inspect the books and records of the corporation;

(6) Rights to sue the corporation for wrongful acts by the directors and officers; and

(7) Rights to share in the proceeds when the corporation liquidates its assets.

If you have any questions about shareholder rights, or would like assistance preparing Articles of Incorporation, or other corporate governance documents, give me a call.  Jsenney@pselaw.com or 937-223-1130.

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AND ONE MORE THING.   H.B. 153 signed into law by Ohio Governor John Kasich on June 30, 2011 established a non-refundable income tax credit for small businesses which employ at least 50 fulltime employees in Ohio and have assets less than $50 million or sales less than $10 million.  Want to know more about the new Ohio income tax credits?   Give me a call or email at Jsenney@pselaw.com or 937-223-1130.

Serving Dayton, Serving You

Pickrel, Schaeffer & Ebeling Co., LPA, 2700 Kettering Tower, Dayton OH 45423

www.pselaw.com

Tax, Business, ERISA, Employee Benefits, Real Estate, Construction Law, Private Placement Security Law, Employment Law, Workers Compensation, Probate, Estate Planning, Succession Planning, Immigration Law, Litigation, Arbitration, Mediation

What is Cumulative Voting?

Shareholders of a corporation vote their shares of stock to elect members of the Board of Directors using either the statutory voting method or the cumulative voting method.  The method of voting, either statutory or cumulative, is set forth in the corporation’s Articles of Incorporation or state law.  In Ohio, unless the Articles of Incorporation prohibit cumulative voting, the shareholders are permitted to vote cumulatively when electing directors. 

Under the statutory voting method, each shareholder votes all of his shares for each director position to be filled.  Under the cumulative voting method, each shareholder may accumulate his votes for director and vote all or any part of such accumulated votes for one or more director positions. 

Under the statutory voting method, a minority shareholder can never appoint a director without the approval of the majority shareholder.  For example, if one shareholder owns 40 shares and the other owns 60 shares, and the shareholders are electing two directors, the minority shareholder votes 40 shares for each of the two director positions, and the majority shareholder votes 60 shares for each of the two director positions, and the majority shareholder always wins (60 is more than 40) and appoints both directors. 

A different result can occur however with the cumulative voting method.  Under cumulative voting, the minority shareholder has 80 accumulated votes (40 shares X 2 director positions), while the majority shareholder has 120 accumulated votes.  So if the minority shareholder casts all 80 votes (or any number more than 60) for himself for one of the two director positions, there is no way for the majority shareholder to divvy up his or her votes in such a way that both of the majority shareholder’s director candidates have more than 80 votes.

So if you are a minority shareholder, you want cumulative voting so you can get yourself or a representative on the Board of Directors.  If you are a majority shareholder, you probably want to prohibit cumulative voting so you can maintain control of the Board of Directors.   If you would like assistance drafting incorporating or preparing Articles of Incorporation, give me a call.  Jsenney@pselaw.com or 937-223-1130.

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AND ONE MORE THING.  The IRS believes it has discovered a pattern of taxpayers failing to file gift tax returns for real estate transfers between non-spouse related parties. As a result, the IRS has launched a compliance initiative to capture data from states and counties regarding real estate transfers taking place between non-spouse family members for little or no consideration during the period 2005 through 2010. While the IRS has faced hurdles getting some states to release the data, a number of states have voluntarily done so. These states include Connecticut, Florida, Hawaii, Nebraska, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Tennessee, Texas, Virginia, Washington, and Wisconsin. Thus, individuals who transferred real estate to non-spouse family members should make sure that the required gift tax returns were filed.  Call if we can help.  Jsenney@pselaw.com or 937-223-1130.

Serving Dayton, Serving You

Pickrel, Schaeffer & Ebeling Co., LPA, 2700 Kettering Tower, Dayton OH 45423

www.pselaw.com

Tax, Business, ERISA, Employee Benefits, Real Estate, Construction Law, Private Placement Security Law, Employment Law, Workers Compensation, Probate, Estate Planning, Succession Planning, Immigration Law, Litigation, Arbitration, Mediation

How Do We Handle Deadlocks in a 50/50 Partnership?

 If you didn’t have the foresight to include tie-breaking mechanisms in your organizational documents, there are not a lot of options.   If both partners are reasonable, an accommodation acceptable to both can often be worked out.  Perhaps the partners can agree to appoint an impartial arbitrator or panel, and to be bound by the decision of the arbitrator or panel.  Or perhaps one partner agrees to buy out the other partner.  But on those occasions when a compromise or method of resolution cannot be worked out, a judicial dissolution may be necessary.  In a judicial dissolution, one of the partners petitions the court to divide the assets and business between the partners in some equitable manner.  Unless the business has multiple independent divisions that can be easily separated, such dissolution can have a disastrous effect on the business.   

It is inevitable that 50/50 partners will eventually disagree on the direction, the scope or the details of operating their business.  It is not possible to avoid every dispute.  But it is possible with carefully drafted organizational documents to make resolution of such disputes less costly and time-consuming.  There are many different types of tie-breaking mechanisms that can be adopted.  The partnership agreement might provide for: (a) a third person to break ties; (b) a board with an odd number of directors to decide disputes; (c) arbitration to be handled by one or more arbitrators; (d) one of the partners to be the managing partner and have final say; (e) flipping a coin to make the final decision; or (f) whatever else the partners can agree on.

Deadlocks also arise between Shareholders of corporations, or between Members of limited liability companies.  In a corporation, tie-breaking mechanisms could be included in the Code of Regulations, shareholder agreement, buy-sell agreement or close corporation agreement.  In a limited liability company, tie-breaking mechanisms could be included in the Operating Agreement or other membership agreement.  The important thing is to adopt tie-breaking mechanisms before a deadlock occurs.   

If you would like assistance drafting tie-breaking mechanisms for a partnership, LLC or corporation, let me know.  Jsenney@pselaw.com or 937-223-1130.

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AND ONE MORE THING.  The definition of “accredited investor” was recently changed by the Frank-Dodd Act.  If you are trying to raise capital by selling shares to investors, you can avoid a lot of risk and make security law compliance easier, if you only sell to accredited investors.  One of the factors used to determine accredited investor status is net worth.  For this purpose, net worth now excludes the value of the investor’s personal residence.  If you want to discuss raising capital by doing a private offering, please give me a call.  Jsenney@pselaw.com or 937-223-1130.

Serving Dayton, Serving You

Pickrel, Schaeffer & Ebeling Co., LPA, 2700 Kettering Tower, Dayton OH 45423

www.pselaw.com

Tax, Business, ERISA, Employee Benefits, Real Estate, Construction Law, Private Placement Security Law, Employment Law, Workers Compensation, Probate, Estate Planning, Succession Planning, Immigration Law, Litigation, Arbitration, Mediation

Can an “S” Corporation Have Different Kinds of Stock?

Yes and No.  The Internal Revenue Code sets forth the requirements that a corporation must meet in order to qualify as an “S” corporation.  One of these requirements is that the corporation may have only one class of stock.  Voting and non-voting common stock are treated as part of a single class of stock.  But common stock and preferred stock are treated as separate classes of stock.  Likewise, debt convertible into stock is treated as a separate class of stock.  In making the determination whether different securities are part of the same or different classes, the IRS focuses on whether the securities have different rights to share in distributions and liquidation proceeds.  If the IRS finds that a corporation has more than a single class of stock, the corporation will lose its status as an “S” corporation, and the corporation will be treated as a regular “C” corporation. 

If you would like to know more about how to set-up an “S” corporation, or how “S” corporations and “C” corporations are treated for tax purposes, let me know.  Jsenney@pselaw.com or 937-223-1130.

If you like what you read, let me know.  And pass it on to a friend.  Tell them to check it out by clicking on the SenneySays logo.   

AND ONE MORE THING.  A friend sent me a link to an online site offering discount legal services from “top professionals.”  I checked it out.  Don’t waste your time.  It is one thing to buy a shirt or golf clubs online.  It is quite another to try to get advice on how to deal with real legal issues.   It is a safe bet that F. Lee Bailey is not answering the phone or the email at these sites.  In any event, whoever answers your inquiry doesn’t know you or your family or your business, and simply can’t give you the kind of personal care, understanding, assistance and advice you need and deserve.  If you want to speak to someone who cares, give me a call.  Jsenney@pselaw.com or 937-223-1130.

Serving Dayton, Serving You

Pickrel, Schaeffer & Ebeling Co., LPA, 2700 Kettering Tower, Dayton OH 45423

www.pselaw.com

Tax, Business, ERISA, Employee Benefits, Real Estate, Construction Law, Private Placement Security Law, Employment Law, Workers Compensation, Probate, Estate Planning, Succession Planning, Immigration Law, Litigation, Arbitration, Mediation

What is the Difference Between Common Stock and Preferred Stock?

When a corporation is incorporated, the Articles of Incorporation describe the type of stock that the corporation is authorized to issue.  At a minimum, the Articles will authorize the issuance of voting common stock.  The Articles may also authorize the issuance of non-voting common stock and/or preferred stock. 

The rights and obligations of the holders of the preferred stock are set forth in the Articles, the Code of Regulations and/or in a separate shareholder agreement.  Generally the holders of preferred stock are promised an annual rate of return, and given a priority over the common stockholders as to distributions and liquidation proceeds.  The preferred distributions are cumulative in nature, so if the corporation cannot afford to pay the preferred distribution in one year, the corporation must pay the accrued distribution from past years plus the current year preferred distribution before the corporation can make any distributions to common stockholders.  The holders of preferred stock generally do not vote, but the preferred stockholders may be given voting rights if there is a payment default.

When a corporation is seeking to raise investment monies, the corporation may offer the investors preferred stock.   Preferred stock is often the security of choice in this situation because it puts the investors (as preferred stockholders) ahead of the common stockholders in terms of rights to distributions, yet does not give them voting rights absent payment default. Preferred stock is also often used in situations where the older generation wants to turn voting control of the corporation, and future appreciation in value of the corporation, over to the younger generation. 

An important point is that “S” corporations may only have a single class and therefore are not able to issue preferred stock.  More about the single class of stock rule for “S” corporations will be found in a future blog.

If you would like to know more about preferred stock or how you can use preferred stock as part of an investment offering or an estate freeze, give me a call.  Jsenney@pselaw.com or 937-223-1130.

If you like what you read, let me know.  And pass it on to a friend.  Tell them to check it out by clicking on the SenneySays logo.   

AND ONE MORE THING.  Know anyone with state or local tax issues?  Ohio has a legion of private collection attorneys working to collect income, sales and other taxes.  Ohio has no collection statute, and I am aware that Ohio collection attorneys are trying to collect tax assessments that are more than 20 years old.  If you want to talk about state or local taxes, give me a call or email.  Jsenney@pselaw.com or 937-223-1130.

Serving Dayton, Serving You

Pickrel, Schaeffer & Ebeling Co., LPA, 2700 Kettering Tower, Dayton OH 45423

www.pselaw.com

Tax, Business, ERISA, Employee Benefits, Real Estate, Construction Law, Private Placement Security Law, Employment Law, Workers Compensation, Probate, Estate Planning, Succession Planning, Immigration Law, Litigation, Arbitration, Mediation

What is an Employee Stock Ownership Plan (ESOP)?

An ESOP is a qualified defined contribution plan that invests primarily in employer securities.  An ESOP can be an important part of a corporation’s employee benefit/incentive program.  An ESOP permits employees of a corporation to share in the growth and dividend income of the corporation.  But an ESOP can also provide important benefits for the business owner including: (1) creating a market for the stock of a privately-held corporation; (2) establishing a value for the stock; (3) permitting the owner to convert part or all of his or her stock into cash by selling it to the ESOP; (4) permitting the owner to defer tax on the gain realized upon sale of stock to the ESOP so long as the sales proceeds are reinvested in replacement securities; (5) permitting the  owner to borrow money thru the ESOP to buy the owner’s stock; (6) permitting the corporation to deduct (in the form of deductible retirement plan contributions) 100% of the amount used to pay principal and interest on the ESOP loan; and (7) if the corporation is an “S” corporation, exempting all of the corporation’s income allocable to the ESOP from federal and state income taxation.

An ESOP can be a very useful tool.  But setting up and operating an ESOP can be somewhat complex.  If you would like to know more about the pros and cons of setting up an ESOP let me know.  Jsenney@pselaw.com or 937-223-1130.

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AND ONE MORE THING.  H.B. 153 signed into law by Ohio Governor John Kasich on June 30, 2011 established a non-refundable income tax credit for small businesses which employ at least 50 full-time employees in Ohio, and have assets less than $50 million or annual sales less than $10 million.   Want to know more about the new Ohio income tax credits?   Give me a call or email at Jsenney@pselaw.com or 937-223-1130.

Can I Get My Employees Thinking Like Owners Without Giving up Stock?

Employee incentive plans can be established to reward management employees based on increases in stock value without actually giving the employees stock.  These plans are generally set-up as non-qualified deferred compensation arrangements and are often called stock appreciation right (“SAR”) plans or phantom stock plans.    

Under the typical SAR or phantom stock plan, one or more employee is awarded an SAR.  Under the SAR, a stock value baseline is established (normally fair market value on the date the award is issued), and the employee is given the right to receive cash (not stock) at some time in the future if the stock value increases over the baseline.  The employee holds only a right to receive cash in the future if the stock value increases (not the stock itself), hence the name “phantom stock.”  Yet the employee is rewarded only if there is improvement in the value of the employer’s stock.  So the employee has every incentive to work hard, and go above and beyond the call of duty, to make the employer more profitable and successful. 

Where employees are in a position to affect only part of the employer’s operations, some employer’s like to determine and measure the employee’s incentive compensation based on those specific factors the employee directly affects.  For example, a VP of Sales might receive an incentive award based only on increases in sales.  Or a controller or treasurer might receive an incentive award based on decreases in expenses or improvement in profit margins. 

SAR and other employee incentive plans may be subject to ERISA, but generally are exempt.  If I can help you set up an employee incentive plan for your management employees, let me know.  Jsenney@pselaw.com or 937-223-1130.

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AND ONE MORE THING.    Governor John Kasich recently signed HB 153 which contains language eliminating the Ohio Estate Tax for decedents dying on or after January 1, 2013.  Under the new law, the Ohio Estate Tax will still apply to decedents dying before January 1, 2013.   Want to know more about reducing or eliminating federal or state estate tax?  Give me a call or email and ask me how at Jsenney@pselaw.com or 937-223-1130.