Sole Proprietorship – Is it right for me?

By: Serge Filatov

Many people here in San Jose and Silicon Valley have a dream of starting their own small business. Small business owners that are just starting out often come to me and ask if they can simply run their business as a sole proprietor to save on the cost of forming and maintaining an entity such as a corporation or limited liability company. Although there are some cases where it is fine to conduct business as a sole proprietor, the liability exposure to the business owner individually will likely require a business owner to look at creating a formal entity.

What is a sole proprietorship?

A sole proprietorship is a form of business in which the individual (or a married couple as community property) carries on a business as the exclusive owner and decision-maker.

Benefits of a Sole Proprietorship

There are several benefits to having a sole proprietorship.

First, sole proprietorships have low start-up costs. A sole proprietorship exists simply by an individual carrying on a for-profit business. There are no state registrations required for a sole proprietor simply because they are a sole proprietor (unlike corporations and LLCs). Of course, if a sole proprietor uses a business name other than his or her own name, he or she must register that assumed name (usually a DBA at the county level) although the sole proprietor should also consider whether that name is already in use by another business. Also, certain professions require licensing and the sole proprietor will still need to comply with all licensing requirements for him or her.

Second, sole proprietorships have no annual compliance requirements. Unlike LLCs and corporations which have numerous compliance requirements with the state, a sole proprietorship can simply conduct business without worrying about state compliance requirements.

Third, it is easy to keep track of accounting and prepare taxes for sole proprietorships. There are no accounting requirements for sole proprietorships so one must simply keep adequate records for tax purposes. Additionally, there is no need to prepare a tax return solely for the business because there is no separate entity.

Disadvantages of a Sole Proprietorship

There is one major drawback that comes with the simplicity and cost savings of a sole proprietorship. The drawback is personal liability. Unlike an owner of an LLC or a corporation, a sole proprietor is personally liable for all the debts and obligations of the business. This means that a creditor, to satisfy the debts of the sole proprietorship, can go after all of your assets, including your home. For this reason, and this reason alone, many individuals often choose to form a business entity. Without an entity, an individual leaves himself or herself vulnerable to unnecessary liability.

Another drawback for the sole proprietorship is that it is difficult for third parties to invest in the business. This is because there is no separate entity to invest in; the individual is the business. A further drawback is that since the owner and the business are basically one, it can be difficult to accurately establish financial results for the business separate from the individual owner.

Is a Sole Proprietorship Right for Me?

The answer to this question depends on your specific situation. Generally speaking, if you do not expect to grow the business or have investors, and are conducting a business that has minimal liability risk, you might consider a sole proprietorship. Even if there is some liability risk, obtaining insurance on your business could help minimize risk. However, obtaining insurance is not always easy, is not always affordable, and only provides protection up to the coverage limit and then only for items that the policy doesn’t exclude. Because the answer to this question depends so heavily on the exact circumstances of each person and his or her new business, you should contact a business attorney who can guide you through the decision-making process.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

New California Law Allows Finders To Help With Start-up Financing

By: Robert Hawn

In representing start-up companies in Silicon Valley I have found that one of the biggest challenges facing founders is raising early stage capital. Emerging growth companies often do not have the necessary relationships that can lead to investment funding. To find these relationships, the company may retain a finder. A finder is an individual who can introduce the company to funding sources, typically in exchange for a commission. Because these finders were not licensed as broker-dealers of securities (essentially, someone who helps to sell securities of a company to investors), they were frowned upon by the law. A few years ago, stricter laws were enacted that created strong disincentives to start-ups to pay commissions to finders.

On October 10, 2015, the Governor signed into law AB 667 , a bill sponsored by Assembly Member Wagner, which creates exemptions to the broker-dealer laws for finders and their client companies. The act, which added Section 25206.1 to the California Corporations Code, provides a balance between protecting investors while easing requirements for fund raising by small companies. Because the law was passed during regular session and not an urgency measure, it will likely become effective January 1, 2016.

So, What Does The Bill Do?

Before the new law, any finder who was not licensed by the State as a broker-dealer of securities could not introduce any company, start-up or otherwise, to potential investors. If an unlicensed broker-dealer provided an introduction, among other things, the investor could get their money back from the company and from the unlicensed broker-dealer, who would be personally liable for the investor’s money.

Under the new law, an unlicensed finder can make an introduction if certain requirements are met. Among them is the requirement that the finder can only introduce “accredited investors”. These are investors who satisfy income or wealth thresholds, have an executive position with the company, or are certain types of entities. Among other requirements, the finder can’t (i) provide an introduction where the aggregate sale price of the securities is more than fifteen million dollars, (ii) participate in negotiating any of the transaction’s terms, or (iii) provide any advice regarding the value of the securities purchased. The law sets forth the only information the finder can disclose regarding the company. The finder also is required to make a filing with the Department of Business Oversight and pay a $300 filing fee, which must be renewed each year and filed with an additional $275 filing fee. There are other requirements that have to be satisfied, including specific disclosures to be made to the potential investor.

Positive Aspects To The New Law

There are a number of positive aspects to this new law. First, start-up companies can now use finders, and finders can now get some value from the relationships they may have with high net worth individuals, or companies, which may want to invest in start-up companies. Second, lawyers like me who are asked about using finders now have a relatively clear direction of how start-up companies can use them.

As with anything in fundraising, this new law is just one part of a large and somewhat technical body of securities laws that need to be reviewed with your lawyer to make sure your company is in compliance. Failure to comply with these laws can expose anyone who runs one of these companies to personal liability for the amount of the investment. That’s why it’s really important that before you start any kind of fundraising activities, you should confer with a lawyer that works in the fundraising area.

As a former chair of the State Bar’s Business Law Section , I can’t help but note that this bill came about as the result of the hard work of many members of the Section’s Standing Committee on Corporations. They are to be congratulated on their hard work in bringing clarity and rationality to start-up fundraising activities.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

We Are Not Going There! The Limits of Waivers in Loan Guaranties

By: Jack Easterbrook

Question: if a person signs a loan guaranty and it contains a long waiver section in which the signer gives up defenses (and the guaranties all have these sections, right?), is the guaranty still enforceable if the lender breaches the loan agreement? That is, can the lender claim that the guarantor is obligated to pay under the guaranty even though the lender was a cause of the defaults in the loan? That was the question in the DelPonti* case and the court came down on the side of the guarantors. (The case citation and the pertinent facts of the case are discussed below.)

What are the takeaways?

The court in the DelPonti case described two things the lender apparently did, which affected its rights under the guaranties taken from the borrower’s principals:

First, the court said the lender failed to honor approved payment applications (requests for advances) from the borrower on a construction loan. This is a reminder that the lender needs to be very careful that its loan documents thoroughly describe the conditions borrowers must satisfy to obtain advances. Stopping an advance without proper cause under the loan documents may jeopardize the lender’s ability to enforce its guaranties.

Second, in a subsequent loan workout the lender told the guarantors they would be exonerated if they did certain things in connection with the construction project, but later changed its position and tried to enforce the guaranties. The lesson is obvious: the lender needs to be careful about its communications with the borrower and the guarantors but if there is an agreement, stick to it!

Finally, while the guarantor may waive all of its defenses under the terms of the guaranty, the DelPonti court says that the lender continues to have a duty of good faith and fair dealing under the loan documents. The lender, according to the court, cannot sidestep that duty and use the broad waiver language in the guaranty to ensure repayment of a loan. This outcome actually seems rather consistent with the long standing trend in the courts to strictly construe loan documents and demand lender good faith. The DelPonti case addresses an area that the California courts had not previously discussed but the holding likely is not a surprise to those following the issue and familiar with the history of lender liability litigation.

Details of the DelPonti Case:*

The lender in the DelPonti case (a predecessor bank taken over by California Bank & Trust) made a construction loan in the amount of $6 million to an LLC developing a townhome project and took the personal guaranties of the principals. As the first phase of the project was nearing completion, the lender failed to honor requests for advances from the borrower which resulted in the first phase not being completed and sold. This triggered loan defaults by the borrowing LLC. The DelPonti case does not elaborate on the specifics of this; it states, however, that the trial court, after reviewing the evidence, found that lender’s failure to honor the payment applications (for loan advances) was a breach of the loan agreement by the lender. Subsequently the parties entered into a workout agreement, which was spelled out in an email from the lender. The lender agreed to exonerate the guarantors if they performed certain tasks related to the construction project. The guarantors did these things but the lender nevertheless foreclosed on the real estate collateral and pursued the guarantors for the deficiency.

The lender did not dispute the factual findings of the trial court but argued on appeal that even if the guarantor had such defenses, they were waived in the guaranty. The court discussed at length California Civil Code Section 2856, which is broad in scope and provides that a guarantor may waive the rights and defenses that would otherwise be available to the guarantor, including defenses that may exist because the loan is secured by real estate collateral.

The court said that the question of whether the waivers in a guaranty can be enforced under such circumstances had not previously been addressed in California. The lender’s argument, however, did not sway the court, which held that a guarantor’s waiver of defenses is limited to legal and statutory defenses expressly set out in the agreement. The court would not extend this to include “the predefault waiver of the Bank’s own misconduct.”

A Win for Long Guaranty Forms ?

When opining on the waiver’s effectiveness, the court emphasized that “a guarantor’s waiver of defenses is limited to legal and statutory defenses expressly set out in the agreement…” This suggests one additional point of interest to those concerned about the length of commercial loan documents: those long waiver provisions in the guarantees actually serve a purpose if a dispute arises! If a defense otherwise available to a guarantor is not expressly set out in the waiver portion of the guaranty, the courts are likely to narrowly construe the matter and interpret it to the benefit of the guarantor.

*California Bank & Trust v. DelPonti , 232 Cal.App.4 th 162 (2014)

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

Loans With High Rates of Interest – Be Careful About Usury

By: Serge Filatov

As a corporate attorney here in Silicon Vall

ey and San Jose, I have numerous clients who need help documenting loan transactions and promissory notes . These clients may be taking on debt or providing a loan to a third party. One area of law that clients are not always familiar with is usury law. The California constitution protects individual borrowers from usury, which in simple terms is the lending of money at very high rates of interest. With some notable exceptions, the general rule is that loans cannot have an interest rate that exceeds 10% per year.

How is it then that your credit card company can charge over 10% interest on your

personal card? The answer to that is that there are numerous exceptions

to the general usury rule. In fact, the general rule is riddled with exceptions that are spread out between sections of the California civil, commercial, corporate, and financial code. Often, an exception concerns a specific item that the legislature was concerned with at the time so the exceptions pop up in random places of the California code.

Examples of common exceptions to the rule include California Civil Code Section 1916.1 which states that usury does not apply to loans made or arranged by a licensed California real estate broker, which are secured by liens on real property. Licensed lending institutions such as banks and credit unions are also exempt from usury laws.

Additional common exceptions, at least for the clients that I work with, are (i) loans made to a business that has $2,000,000 or more in assets at the time of the loan or (ii) loans that are for $300,000 or more. In order to qualify for these exceptions, the borrower must meet the following criteria:

  • The borrower cannot be an individual.
  • The lender must have a pre-existing relationship with the borrower.
  • The borrower must reasonably appear to be able to protect its own interests.
  • The loan must not be primarily for personal, family, or household purposes.

What is the big deal about a usurious loan? The lender could forfeit all interest on the entire loan and may have to pay the borrower 3 times the interest paid during the 12 months prior to the filing of a lawsuit. Also, a lender who willfully and maliciously receives interest in violation of usury law can be found guilty of being a loan shark which is a felony punishable by up to 5 years of jail.

Be careful if you are making a loan with a high rate of interest. If you are considering making such a loan, you should consultant with an attorney to confirm that the loan is not usurious.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.