Friday, May 28, 2010

Use of Unpaid Workforce by For-Profit Businesses

In these difficult economic times it may be tempting for a business that is trying to cut down costs to accept help from unemployed unpaid professionals who are simply looking to get the right experience. However, business owners that are using unpaid volunteers should be careful: misclassifying employees can turn into a costly mistake that can even lead to bankruptcy.

There is no recognized legal authority that allows a “for profit” business (as opposed to a charity or government employer) to use unpaid volunteers. Also, there is a lot of inconsistency among the courts in the use of the definition of “employee” as opposed to a “volunteer”. So, beware: if the relationship sours, a volunteer can claim that employer-employee relationship existed and can ask for unpaid minimum wages and even overtime pay. Business owner may also be liable for unpaid taxes (Social Security, unemployment and workers’ compensation payroll taxes) and failure to withhold income tax.

Based on the Supreme Court decisions and DOL interpretations, it is safe to say that volunteers would be those who:

(1) work without an expectation or receipt of compensation or benefits,
(2) are not economically dependent on this position,
(3) work on a less than full-time basis,
(4) perform services of the kind typically associated with volunteer work (charitable purposes, such as help to minister to the comfort of the sick, elderly, indigent, infirm, or handicapped, and retarded or disadvantaged youth) and
(5) who would not be displacing any paid workers.

I don’t believe that any volunteers working for a for-profit business would satisfy the above criteria.

Consequences for misclassifying employees as volunteers can be grave. For example, in December 2009, AOL agreed to settle a class action suit brought against it by thousands of former volunteers (community leaders who during the 1990’s spent approximately 2-4 hours per week hosting chat rooms, reviewing bulletin board postings, etc), claiming that they were employees and not volunteers and should have been paid at least minimum wages for the work they performed for AOL. What started as a two-person lawsuit was later certified into a class action and now AOL may be paying millions of dollars to settle the litigation. In May 2010 the Court issued the final approval of the settlement.

Therefore, correctly classifying employees is very important for any business, whether it is a start-up or an established enterprise. The amount of money that may be saved by using volunteers now may pale in comparison to all the back wages, legal fees, fines and penalties that a business would have to pay later if sued by the disgruntled volunteers or investigated by the Department of Labor.

Thursday, May 20, 2010

Asset Protection 101: Protecting Your Business’s Intellectual Property

Timely asset protection has enormous benefits. Especially, if these assets are very valuable, like certain intellectual property may be. In fact, for a technology or a media company, intellectual property, such as patents, copyrights, trademarks and trade secrets (IP) may be the essence of the business, i.e., its brand, its main source of income. The easiest way to protect the IP is to simply put it in a separate limited liability company (LLC) that has been properly structured. A business structure could, for example, look like this: founders own 100% interest in a holding company, a corporation, which in turn owns 100% of the IP LLC and 100% of the Operating Company (Opco) that has contact with the public. Alternatively, the founders can forego the holding company and hold directly the shares of the Opco and the interests in the IP LLC. Then, the IP LLC can lease or license its intellectual property to the Opco (it is important that the license agreement and money exchange be real and done at arm’s length). Of course, each case is different and one should seek professional advice on the entity structure and tax implications.

In case the Opco or the holding company is sued or goes bankrupt, the assets held by IP LLC cannot be reached by creditors unless only by the charging order. A charging order is a unique asset protection feature of LLCs. If an entity or an individual wins a law suit against the LLC entitling the creditor to damages, it can only obtain a charging order against the LLC, which means that the creditor does not get title to the assets held by the LLC but instead only the right to the distributions of the LLC allocated to the members. If the LLC has allocated profits but chooses not to distribute them, then the creditor with the charging order has to pay tax on this “phantom income”.

In addition to asset protection, placing intellectual property in a separate company may help the founders maintain long-term control over their companies. If the holding company or Opco receives outside funding, there is a chance that the founders may lose control over their companies. Holding IP assets in a separate LLC may allow the founders to gain leverage in any future battles over control.

This reminds me of a recent sale of Skype and the related lawsuits. At the time of the original sale of Skype to Ebay in 2005, the founders of Skype, Niklas Zennstrom and Janus Friis, kept the underlying source code of Skype’s peer-to-peer network in a separate company called Joltid, and instead of selling the source code, licensed it to Ebay. The 2009 lawsuits span from the alleged infringement by Ebay on the founders’ copyright to the source code, and later allowed the founders to settle for a 10% stake in Skype.

A little planning early on in a business’s life can go a long way…

Friday, May 14, 2010

New York City Economic Incentives for Biotech and Other Start-ups

On May 12, 2010, Christine Quinn, the City Council Speaker, spoke to the business owners - members of the Bensonhurst Business Club, located in Brooklyn. She talked about the City’s focus on jobs and what is being done by the City Council to create/maintain them. She mentioned the biotech tax credit that was adopted in 2009 and the current proposal to eliminate double taxation for certain small S corporations (since currently New York City does not recognize the federal treatment of S corporations as “pass through” entities).

This speech inspired me to summarize the tax incentive programs available to biotech and other technology companies.

First, there are the New York State Qualified Emerging Technology Company Credits (QETCs), available to early-stage technology companies (such as new media, communications, IT, engineering, advanced materials, biotech and electronics), with annual sales under $10 million, gross revenue under $20 million, fewer than 100 full-time employees (with at least 75% based in New York) and New York-based R&D spending of at least 6% of net sales. These QETCs are comprised of (1) QETC Employment Credit, available to businesses creating jobs; (2) QETC Capital Tax Credit, available to the investors in qualified emerging technology companies of up to $300,000 for qualified investments; and (3) QETC Facilities, Operations and Training Credits, that may be applied to costs related to the purchase or lease of property to be used for R&D, equipment, production costs, expenses associated with in-house research, patent and grant applications, and training employees.

Second, there is the Empire Zone, a program that provides New York State tax credits and tax exemptions to manufacturing and biotech firms located in the Zone, including the East River Science Park and the Brooklyn Army Terminal.

Third, there is the New York City Biotech Tax Credit that Speaker Quinn mentioned at the Bensonhurst Club meeting. The credit is applied against the City’s General Corporation Tax and Unincorporated Business Tax for certain expenses by qualified companies. It is only available to emerging biotechnology companies with similar sales, revenue and employee requirements as those for QETCs and only during 2010-2012 tax years. The maximum yearly tax credit per taxpayer can be $250,000, and the aggregate amount of credits for a calendar year cannot exceed $3 million. If it does, the credits will be allocated to eligible companies on a pro rata basis. Credit can be reduced by 50% if the company does not create a certain number of new jobs. Tax credit is available for purchases of properties (18%), research (9%), employee training (max $4,000 per employee) and in certain other instances.

All together, the three tax credit systems, coupled with funding options available to start-up tech companies in New York City (ex: New York City Investment Fund and the East River Science Park Lab Space Loan Fund), may provide just enough incentives to create a booming biotech industry. It is somewhat unusual to think of New York City as a biotech haven. Typically, one would think of San Diego, Seattle or Boston as being particularly welcoming to biotechs, and New York as being the world finance center. However, given the incentives and the proximity of academic and research institutions, I cannot find good reasons why New York would not succeed as a national biotech center, other than one: once the tax credits expire, will the biotech companies that have emerged during these “incubator” year be able to survive on their own, when faced with New York City’s high tax rates and real estate prices, or will these companies flee to the other traditionally biotech-friendly locations?

Thursday, May 13, 2010

Factoring - Funding for Your Business

The following is a guest post contributed by Ella Zalkind, the founder of Action Business Solutions, Inc.

Finding and securing business funding has become increasingly difficult in this economy. Banks are hesitant to open or renew credit lines even for prosperous long-standing businesses. Even if bank financing is secured, the terms are frequently onerous and the process itself is riddled with so much red tape, document overload and bureaucracy that it can make any business owner or manager frenzied. This economic climate is forcing businesses to look for alternative means for funding as well as reexamine their credit and collection policies. In addition, cash flow management is playing an increasingly important role as businesses need to find creative ways to survive and prosper in light of these conditions. Tighter collection policies where companies are less lax about the credit terms offered to customers as well as more responsive collection practices are being forced on business owners. All this is of course distracting to an owner or manager who should be focusing on running the core business but is a necessary evil in order to survive.

One solution that companies who need financing or a boost to cash flow should consider that has many added benefits is the sale of their outstanding receivables and invoices to an accounts receivable management firm; this simple process is known as factoring and has been around for many years in select industries but is becoming more mainstream and desirable in current market conditions. In a nutshell, factoring is basically a business selling the factoring company the business' invoices for the goods or services that the business delivers for a nominal discount. The business receives a significant percentage of the invoice amount up front while the factoring company waits for the business' customers to pay. This allows the business to use the funds right away for business needs such as payroll, purchase of inventory, expansion, business expenses, etc. Essentially, this is accounts receivables management that can put an end to a company’s cash flow deficits and frees owners and managers to handle more important matters. The factoring company handles the accounts receivable management issues such as collections and often billing.

This service can be very valuable for a small and growing business in that it would have money much sooner which can be put to use in growing and building the business. Factoring is a very personalized and individualized process in that typically the factoring company endeavors to learn about the business, the company's history, customers, present day activities and concerns as well as projected growth so that the most beneficial factoring relationship can be recommended. The factoring company looks at various materials which may include budgets, projections as well as the company’s cash flow and working capital requirements, among other things. By thoroughly understanding the business, a factoring company often becomes a strategic partner of the business with a vested interest in the business' success and is ready to respond quickly to the business' needs, whether or not foreseen.

Working with a small factoring company that takes the time to understand and meet the business' needs is important in order to ensure a mutually beneficial relationship. In addition, factoring with a small company that understands the business and its needs offers many additional benefits that should not be overlooked when considering this highly desirable and effective form of financing. For example, the factoring company pre-screens the company's customers to ensure that the company works only with stellar, legitimate and paying customers; the factoring company frequently provides additional business consulting on collection practices, credit policies, cash flow management, and business strategy, to name a few services, and all without additional cost. Additional advantages of factoring include the fact that factoring is a straight sale of an asset (the receivable) so there is no debt or loan involved; the process is streamlined and much more friendly and efficient than traditional bank financing (with cash available within days rather than months as would be the case in a typical bank loan); frequently there is no long term commitment and the business can choose which invoices to place with the factor depending on the business needs at a given time; and not less important, cash concerns and cash flow management issues are alleviated.

In summary, factoring with a legitimate factor whose staff takes the time to provide individualized and personalized attention is a very effective and powerful way for a business that offers credit to its customers to obtain funding. Factoring can enable a business to succeed and thrive in this very difficult credit market where bank credit is tight or non-existent and cash flow management is a primary concern.

To learn more about factoring and to see if factoring makes sense for your business, we welcome you and your staff to contact the professionals at Action Business Solutions, Inc. at (888) 777-0689 or send us an email at or visit our website at We are locally based New York and New Jersey small factoring company that caters to small and growing businesses. We will be happy to chat with you to give you a better understanding of what would be involved with factoring and whether factoring makes sense for your business.

Tuesday, May 11, 2010

Federal Exemptions Available for Private Placement of Securities – Part II

In this Part II I will focus on the “small offering” exemptions, - private offering exemptions under Sections 4(6) and 3(b) of the Securities Act. Please consult securities lawyers for advice regarding which exemption is most appropriate for your company and your offering.

Section 4(6)

Section 4(6) exemption is available only to companies offering securities to the accredited investors and only for the amount not exceeding $5 million. There may be no general solicitation or advertising. The securities so issued are restricted. The issuer must file Form D with the SEC at the completion of the offering.

Section 3(b)

There are two rules (both, like Rule 506, are part of Regulation D) that may be used by the companies for small-sized private placements.

First, Rule 504, the “seed capital” exemption, allows certain companies (typically small start-ups) to sell up to $1 million worth of securities during any 12-month period. Such companies cannot be subject to reporting requirements of the Exchange Act (which generally means that they are not public) and cannot exist solely for investment purposes. In order for general solicitation and advertisement to be permitted and securities issued in the offering to be freely tradable, the offering must be either (1) registered under state law requiring public filing and delivery of a disclosure document to investors before sale (for sales in states which do not have such requirement, offers must be registered in another state which has such requirement and the disclosure document must be delivered to all purchasers prior to sale in both states) or (2) be exempted under state law permitting general solicitation and advertising so long as sales are made only to accredited investors. For all other transactions not qualifying under (1) or (2) above, general solicitation and advertising will not be permitted and the securities will be restricted.

Second, Rule 505 allows companies (other than investment companies) to sell up to $5 million worth of securities during any 12-month period. There are additional requirements:

1. There may be unlimited number of accredited investors
2. There may be only up to 35 non-accredited investors.
3. Non-accredited investors must receive a disclosure document, which is similar to the requirements of Rule 506, discussed in Part I.
4. The issuer does not have to make a determination whether or not a non-accredited investor is sophisticated, and unsophisticated investors do not need to have a purchaser representative.
5. General solicitation or advertising is prohibited.
6. “Bad boy” disqualifiers make this exemption unavailable to certain issuers.
7. Securities issued in a Rule 505 offering are restricted.
8. States can regulate Rule 505 offerings, which makes this a less popular choice as compared to Rule 506 offerings, where state regulation is preempted.

In both cases, the company must file Form D with the SEC within 15 days of the first sale of securities.

This posting will continue in Part III.

Thursday, May 6, 2010

LLC Publication Requirement - present and future

Since 1994 New York has required LLCs (as well as LPs) to publish a notice of formation in two newspapers. New York is one of several states which imposes this extra step upon small companies who are already sensitive to startup costs (the publication costs can range widely from county to county from around $300 to over $1,600 in Manhattan). LLCs cannot avoid this requirement by forming their LLC in a foreign state; as soon as the LLC does business in New York, the publication requirement will be triggered. All publication filing fees go to the newspapers.

How does a company satisfy this requirement? The LLC must contact the county clerk of the county where the LLC has its principal office. The county clerk will give the LLC the names of two newspapers in which the LLC must publish their notification within 120 days of formation.

What happens if the LLC fails to publish within 120 days? The company will lose its authority to do business in New York State, which means that the LLC cannot sue anyone in New York courts and the Department of State will not issue a “good standing certificate” for the entity. Another serious consequence is the potential loss of limited liability protection. However, the LLC can still defend itself in the New York courts and its contracts are enforceable. There is no penalty for failing to publish or publishing late. Even if delayed, the publication will allow LLC to regain good standing.

What is the purpose of this requirement? Theoretically, the publication aims to notify members of the general public who they are doing business with. However, in practice, it is hard to imagine that members of the general public regularly go through all the newspaper ads (especially in this Internet age when information about all companies registered in New York is freely available on the Department of Corporations website). Also, if forming an LLC in New York County, the New York Law Journal will likely be designated as one of the papers. The readers of the NYLJ are mainly lawyers, which displays the “irrationality” of the publication requirement being necessary to inform the general public who they are doing business with. Interestingly, the law does not require publications about a change in ownership or dissolution, even if such events happen shortly after the publication.

What is the future of this publication requirement? The constitutionality of the law was unsuccessfully challenged in 2003 (See Barklee Realty v. Pataki, 309 A.D.2d 310 (2003), holding that (1) the statute did not violate plaintiffs' limited right of access to New York courts, and that (2) the statute was rationally related to legitimate state interest in ensuring that limited liability companies actually made required disclosure, and thus, did not violate plaintiffs' equal protection rights). The court noted that it was not their job to consider the wisdom or efficacy of that law or whether it is superior to other alternatives; rather, it is for the legislature alone to determine whether the statute was necessary.

Recently, an interesting development has occurred in the legislature: Senator Lanza has introduced Bill S1101 eliminating publication requirements for LLC and LPs. On January 6, 2010, the Bill has been referred to the Committee on Corporations, Authorities and Commissions. It is unclear if and when the NY legislature will act on the proposal. Perhaps now is the good time for all the future LLC owners and members of the general public to let the legislators know their opinion about the publication requirement.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.