Residential Transaction Tips
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Published: February 1, 2015
Representations and Warranties
A seller’s representations and warranties can be a hotly negotiated topic in any document. Whether it’s an asset purchase, stock purchase, real estate sale, etc., what the seller discloses is generally central to the due diligence process of the purchaser.
Three primary issues arise in the negotiation of reps and warranties, what, how much, and who.
Obviously, the first issue is specifically what “circumstances” will the seller represent and warrant to the purchaser. A purchaser may ask for the seller to represent that there is no pending or threatened litigation nor are there any circumstances that could lead to litigation, but the seller may only want to represent that no litigation is pending or threatened. From the seller’s perspective the “any circumstances that could lead to litigation” is too broad. That is a “what” issue.
Other examples of “what” issues could be environmental matters related to real property or whether the seller or the asset is in violation of any law or regulation. Environmental reps and warranties, because of their costly nature, are always at the forefront of the discussion. Sellers generally want no representations related to environmental issues and, in fact, many times will expressly disclaim liability for anything related to environmental problems. Purchasers, on the other hand are adamant about the seller disclosing any inkling they may have about anything remotely environmental.
Sometimes purchaser’s will take the approach to negotiating reps and warranties, that it will push hard for matters that it will have no or little ability to determine fully through its own due diligence and compromise on those matters it can more easily get to the bottom of itself with independent investigation.
Here come the lawyers and language police. The issue of “how much” or to what extent will the seller make a specific representation, most of the time comes down to just a few specific words inserted or deleted from this section of a contract. Those infamous words center around knowledge and range from one end of the spectrum of “to the best of seller’s knowledge” to the opposite end of “to the seller’s current actual knowledge” and includes all gradations in between.
“To the best of seller’s knowledge” may give the seller heartburn because it can mean that it is representing that certain facts are true based upon its constructive knowledge or what it should have known and not simply what it actually knows.
“To the seller’s current actual knowledge” will limit the seller’s reps to only those things that it is actually aware of without any investigation and without any constructive knowledge being imputed to it. Somewhere in the middle lies the elusive “seller’s reasonable knowledge.”
The purchaser clearly wants the insurance policy of including problems or defects that the seller does not actually know about but that it should have been aware of, however, many believe this issue is a more important to the seller than it is for the purchaser. In the final analysis though, most of the time the purchaser’s real goal is to create a situation where there is less room for argument as to whether something should have been disclosed and not so much that the purchaser is trying to hold the seller’s feet to the fire for something it was not aware of.
Lastly, when dealing with a selling entity such as a corporation, LLC or partnership, the issue of whom, exactly, is making the representations to the purchaser. A purchaser wants to see a broad statement that simply the seller is making the reps, which would include, arguably, any person of influence or involvement inside the entity, including its partners, shareholders, directors, officers, managers, employees, etc.
The seller, particularly where the owners of the entity are not directly involved with the day-to-day management of the business, will attempt to limit “who’s knowledge” is being represented. The seller may accomplish this by limiting the representations to a specific group such as only the officers of the company or it may go as far as to limit the reps to a specific person who is named explicitly in the document. As you can imagine, that is usually not very palatable to the purchaser because so many people in the organization who have information valuable to the purchaser may be absolved from disclosing it.
As with any contract negotiation at the end of the day the negotiation of reps and warranties comes down to bargaining power and risk tolerance. There are many factors that impact these negotiations, but motivation and power generally end the discussion.
Published: September 21, 2013
Introducing the Series Limited Liability Company – Now Playing in Texas, Delaware, Nevada, et al
Do you have a business that owns or leases equipment? Or, are you in the business of owning real estate? Maybe your company owns of lot of intellectual property (i.e. patents, copyrights, trademarks). What each of these has in common is ownership of valuable assets. Traditionally, businesses have protected their assets from liability by placing them in separate limited liability entities such as corporations or limited liability companies (LLC). But having to create a new LLC or corporation every time you buy a new piece of equipment can be burdensome and time consuming. That is why states are starting to create legislation for something called a “Series Limited Liability Company.”
What is a Series LLC?
A series LLC is nothing more than a special type of limited liability company that allows for unlimited segregation of assets into separate “series” or “cells.” Each separate series has the power and authority to operate like an independent entity and is shielded from liability from the other series. A series can sue and be sued, enter into contracts, hold title to assets in the series and grant liens and security interests. This type of entity is a creation of the legislature and can only be formed in states where it has been authorized by statute. The states (and territories) that have authorized the creation of series LLC include Delaware, Nevada, Texas, Illinois, Iowa, Oklahoma, Tennessee, Utah and Puerto Rico.
How does the Series LLC work?
Once you’ve created a series LLC you can transfer business assets into the separate “cells” or series. Each series will have its own series name, managers and membership, assets and records. It will operate as if it were a subsidiary of the main series LLC. It keeps it own records, books and equity ownership. Each series can have its own operation structure, capital structure and management.
EXAMPLE: Warren Buffett owns Berkshire Hathaway which in turn owns about fifty other subsidiaries such as Geico, NetJets, See’s Candies, Dairy Queen, Fruit of the Loom and Wesco Financial. Hypothetically, Berkshire Hathaway could be the Series LLC and Geico could be “Series 1″, etc. If a creditor were to sue Geico it would not be able to go after the assets of Berkshire Hathaway or any of the other entities.
Advantages of the Series LLC
The real advantage of the series LLC is that there are added costs and administrative burdens to setting up separate legal entities. With the series LLC you only set up one legal entity. The series are created internally without additionally state filings. This greatly simplifies the corporate governance of entities while maintaining the crucial liability protections.
Some additional advantages include:
- Employee equity interests incentives
- Business asset protection and segregation
- Simplified corporate governance
- Reduced administrative costs
- Diversification of capital
It is important to keep in mind that the series LLC has not been tested and tried in our courts. Although some states have approved these entities through legislation, court may challenge the integrity of the statutes. Of course, if you understand the risks and are willing to lead the way, a series LLC appears to be a very promising business vehicle.
Published: March 10, 2011
Raising Money for your Business: Private Placement
Millions of dollars are raised every year by highly motivated small business entrepreneurs. Most of that money doesn’t come from the bank. Banks are very conservative and risk averse when it comes to lending money to small businesses. Bank wants to see your business generating money before they will make a loan. As we all know, it takes money to make money. Many small business entrepreneurs turn to family, friends, savings accounts, retirement accounts or private angel investors for funding. Whenever you raise money from friends, family or other private investors you need to be give them a document called a private placement memorandum. A private placement memorandum, commonly called a PPM, is a disclosure document given to investors. Usually when a company wants to raise money they will offer to sell a piece of the company to private investors rather than to the public at-large. Investing in a company always involves a certain element of risk. Investment risks, business objectives, management and capital structure are commonly disclosed in a PPM. For entrepreneurs, the PPM is a critical piece of documentation because it provides a safety back-drop against potential claims by investors. By way of simplistic illustration, imagine you started a lemonade stand and your neighbor gave you $100,000 in exchange for 50% of the profits (notice this isn’t a loan). After years of buying lemons and making lemonade you still haven’t been able to sell any lemonade. Your neighbor might get anxious and ask for his money back. Unfortunately, the money has all been spent on lemons. Now what do you do? Hopefully, you gave your neighbor a PPM so he was aware of the risks. It is a simple fact that businesses fail. When businesses fail, investors usually lose money. On the flip side, when businesses succeed investors usually reap enormous windfalls.
BORING (but important) LEGAL STUFF ABOUT FEDERAL SECURITIES REGULATIONS
When you sell a piece of your company typically you sell shares of stock in your corporation. This intangible is also referred to as equity in a company. It basically means you are an owner of the company. This intangible ownership interest is called a security. When you offer to sell securities to family, friends or investors it is called a securities offering. The offering is subject to regulation under the Securities Act of 1933, which are designed to prevent fraud by requiring complex and extensive disclosure and registration of offerings. Complying with the registration requirements of the Act can be time consuming and quite expensive. However, there are exemptions to the registration requirements for some private offerings. Rules 504, 505, and 506 of Regulation D allow for an exemption from registration if certain conditions are met. In addition to federal laws, state laws also regulate the sale of securities by companies. These laws are typically referred to as “Blue Sky” laws. Compliance with these laws in your offering is a necessary part of raising capital for your company. The private placement memorandum gives a company the chance to make some of the same disclosures that are required in a public offering.
DISCLOSE, DISCLOSE, DISCLOSE
Sales people everywhere live and die by the phrase “under sell and over deliver.” The same concept applies when you are raising money. Appropriate disclosures in a PPM are a way of “under selling” your business and setting the right expectation with investors. Equally important is providing investors with the right type of information. Most PPMs will have the following sections:
- Summary of the Investment
- Risk Factors
- Use of Proceeds
- Business Plan
- Description of the Securities
- Terms of the Offering
- Legal and Tax Matters