By Abby Kotun and Ladd Hirsch

For many company founders, the business they created is far more than an investment and is closer to a baby they have nurtured and supported.  As the company achieves a significant level of success, however, the founders may not be quite as involved in day-to-day operations of the business.  In this later phase, the owners may have retained an experienced CEO along with other senior officers who are striving to maximize the company’s bottom line while the owners focus on strategic alternatives and other opportunities outside the business.

It is at this point, when things appear to be running smoothly and company is on a profitable glide path, that the owners are stunned to learn that the rock star CEO they retained or one of the members of the CEO’s hand-picked management team is accused of sexual misconduct.  This situation is becoming more common as the EEOC reported a 12% increase in the number of sexual harassment charges filed in fiscal year 2018.  EEOC Preliminary FY 2018 Sexual Harassment Data (Oct. 4, 2018), https://www.eeoc.gov/eeoc/newsroom/release/10-4-18.cfm.  What are the next steps that company owners should take when these allegations are made?  The answer is of critical importance to the business, because the company’s stakeholders are watching how this is handled, including other employees, managers and customers.  This post presents some important Dos and Don’ts for company owners to consider when faced with their #MeToo Moment.[1] Continue Reading Rejecting the Ostrich Approach: Responsibly Confronting #MeToo Allegations of Misconduct by Private Company Leaders

By LaCrecia Perkins and Ladd Hirsch

A look back at Business Divorce developments during Texas 2018 reflects a continuing negative trend for private company shareholders[1] who have claims for misconduct against the company’s control group (e.g., majority owners, officers, managers, and/or directors).  The rocky road for Texas shareholders began in 2014 with the Supreme Court’s Ritchie v. Rupe decision,[2] which eliminated the remedy previously available to minority shareholders of securing a court-ordered buyout of their ownership interest upon proof that majority owners had engaged in oppressive conduct.  The slope became even steeper in late 2018 with an appellate court decision requiring dismissal of shareholder derivative lawsuits if the shareholder cannot meet the “Continuous Ownership Rule.”  See In re LoneStar Logo & Signs, LLC.[3]

What are shareholder derivative lawsuits, how does the Continuous Ownership Rule apply to claims in these cases, and do private company shareholders continue to have the right to pursue valid claims for wrongdoing against the company’s majority owners, officers, managers, and directors?  This post answers those questions, and the upshot is that the best advice for shareholders is to file their derivative lawsuit as soon as possible.  While winning the race to the courthouse provides no guaranty that the lawsuit will be permitted to continue through trial, under the current Texas law, having a derivative lawsuit on file gives the shareholder the best possible legal and equitable arguments for maintaining the lawsuit to judgment. Continue Reading Scaling an Even Higher Bar:  Texas Law Raises the Stakes for Private Company Shareholders in Pursuing Derivative Claims

In her thoughtful column in the January edition of the Texas Bar Journal titled, “Do You Suffer From Impostor Syndrome,” lawyer coach Martha McIntire Newman, focuses on a topic that has too long flown under the radar.  Ms. Newman describes this condition as “a state of chronic self-doubt that causes lawyers to fear they will be exposed as incompetent even though the evidence of their success is obvious to their colleagues and clients.”  TBJ, Jan. 2019, p. 56. TopLawyerCoach.com   This anxiety causes even “successful lawyers to second-guess themselves no matter how well they perform.”

The Impostor Syndrome discussed in Ms. Newman’s column is not limited to the legal field.  We have encountered many business owners, executives and entrepreneurs who have struggled, at times, with crippling self-doubt.  Ms. Newman quotes former Starbucks CEO Howard Schultz: “Very few people, whether you’ve been in that [CEO] job before or not, get into the seat and believe today that they are now qualified to be the CEO.  They’re not going to tell you that, but it’s true.”  For business leaders who face doubts resulting from the Impostor Syndrome, this post offers three suggestions to consider in addition to the sage advice provided by Ms. Newman. Continue Reading Surviving The Impostor Syndrome: Staying on Course as a Successful Business Leader

Conflicts with business partners are not just a serious distraction for majority owners of private companies, these ownership disputes can be expensive, time-consuming and harmful to the long-term prospects of the business.  The start of a new year is therefore a great time for majority owners to consider whether there are steps they can take to head off disagreements with business partners. Fortunately, the answer is yes, and this post looks at New Year’s resolutions that majority owners may want to consider that will lessen or completely avoid these ownership conflicts.

The Sweat Equity Problem

The first New Year’s resolution majority owners may want to make is to decline to issue  “sweat equity” in the company.  Sweat equity refers to the grant of an ownership stake in the company to employees or outside consultants who provide services to the company, but who do not provide any financial capital for their interest in the business.  Sweat equity is granted most often by new or emerging companies that are short on cash, and they therefore issue stock rather than paying compensation for the services needed.  In other cases, owners provide sweat equity to longtime employees as part of a succession plan. Continue Reading New Year’s Resolutions for Majority Owners: Promoting Peace With Partners in 2019

When a private equity (PE) firm buys the controlling interest in a private business, the purchase often includes an earn-out provision which calls for the owner to remain active in the business for some period of time. The use of an earn-out provision can seem like a win-win for both parties, because it allows the PE firm to buy the company for a lower purchase price and provides the business owner with the opportunity to secure a substantial additional payment if the company achieves certain agreed financial performance targets after the sale.  The problem with this rosy picture is that earn-out provisions are a common cause of disputes and litigation over whether the earn-out requirements were met after the purchase and whether the owner is entitled to the additional payment.

This post focuses on conflicts that frequently arise between PE firms and owners over earn-out provisions and suggests changes for both PE Firms and owners to consider, which may reduce or eliminate these post-purchase conflicts.   Continue Reading PE Firms: The Earn-Out Conundrum—Avoiding Post-Purchase Conflicts With Private Company Sellers

In the private company world, the buck stops with the majority owners, who generally hold the reins to running the business.  In our experience, however, it is not uncommon for some majority owners to push the limits of their control by engaging in self-dealing transactions that are for their own benefit.  The self-interested transactions in which majority owners may engage can take many different forms, including paying excessive bonuses to themselves, directing the company to enter into “sweetheart” deals with their other companies, taking company opportunities for their own gain, and using company assets or personnel free of charge.

When minority investors seek legal recourse from abuse of authority by its majority owners, the controlling owners will often point to a little-known Texas statute, which they contend renders them immune from liability for their actions.  See Texas Business Organizations Code § 101.255.  As we say in Texas, that dog won’t hunt.  This post explains why the existence of Section 101.255 does not provide majority owners with a “get out of jail free” card, and why this statute does not validate their improper conduct when they engaged in self-dealing. Continue Reading The Private Company Cookie Jar: Who Decides How Many Cookies The Majority Owners Get to Eat (And Which Ones)?

By Sam Vinson and Ladd Hirsch

In his famous “To Be or Not to Be” soliloquy, Hamlet anguished over whether his future was worth living. [1] Hopefully, private company founders picture a future less bleak than Hamlet’s grim outlook. When the founders of fast-growing private companies accept new investment capital, however, they need to consider the future of the resulting ownership structure of the business, particularly when the financing involves issuing new company shares.

When a private equity investment is made in a private company, a balance must be struck between the competing interests of the company’s founders, on one hand, and the private equity or venture capital firm (the “PE investor”) on the other. From the PE investor’s perspective, an investment in a private company makes sense only if the founders maintain their continued commitment to the company’s success. Once the investment is made, founders will want to make sure they have an exit plan in place that provides them with ample rewards when they depart based on the financial success (hopefully) they helped the company to achieve.

This balancing of interests between founders and PE investors is often handled through a vesting process regarding the founders’ stock or equity ownership. This post, therefore, focuses on the use of vesting schedules by private companies when issuing stock. Ideally, the use of vesting schedules that apply to stock ownership is complimented by buy/sell exit planning, i.e., founders will want to secure some type of a buy/sell agreement that permits them to monetize their interest in the company at the time of their exit. Continue Reading “To Vest, or Not to Vest” —The Question for Company Founders Who Receive Equity/Stock In Connection with a New Private Equity Investment in the Business

By Jeff Balcombe [1]We are pleased to present this guest post from Jeff Balcombe, a highly regarded business valuation expert based in Dallas, who is a founding principal with his firm BVA Group.

In a perfect world, business partners who reach the point of parting ways would have a clear, unambiguous plan in place governing their separation.  Unfortunately, when they engage in business in the real world, many company owners who need a Business Divorce find that they never adopted any type of separation agreement or that the agreement they have is missing key elements necessary to facilitate a prompt, inexpensive separation.  This post therefore outlines a Business Divorce process designed to achieve a prompt, efficient exit plan for business partners.

The Exit Plan Should be Approved When the Investment is Made

For an exit plan to work effectively, it must be adopted in advance, because a successful Business Divorce involves far more than determining a buyout price based on an appraisal that supports the buyer’s or seller’s notion of value.  In fact, a “ready-fire-aim” approach that calls for getting an appraisal, and then starting buyout negotiations is almost certain to result in a drawn-out, expensive process that may end with the parties in dispute.  To minimize costs and reach an agreed outcome, both parties must adopt a process with a definite end-point—a successful separation. Continue Reading Avoiding Business Divorce Disaster: A Business Valuation Expert’s View

“The bad things you can see with one eye closed. But keep both eyes wide open for the little things. Little things mark the great dividing line between success and failure.”
Jacob Braude, Author and Humorist (1896-1970)

By Sean Brown[1] and Ladd Hirsch

In business, an eyes wide open approach is essential to the successful purchase of a private company. When the purchaser of a private company enters into a letter of intent (“LOI”) or reaches a handshake deal to buy a private business, the little things often have not yet been fully disclosed and it therefore remains to be seen whether the transaction will fail or succeed. This post reviews focuses on little things that a private company buyer should make sure to address to achieve an optimal outcome, including steps to be taken after the parties have signed the LOI.

Recognized by Texas Bar Today’s Top 10 Blog Posts

Little Thing No. 1: Conduct Adequate Due Diligence

Due diligence, in the context of mergers and acquisitions, is commonly referred to as the process by which the buyer gathers information about the business or the assets for sale. It is crucial for a buyer to conduct sufficient due diligence to establish the following information, a minimum, before closing on the purchase:

Confirm the seller has the authority to sell the stock or assets of the target company;

  • Identify and investigate potential liabilities or risks;
  • Identify necessary steps to integrate the target business into existing business; and
  • Identify any obstacles to closing the transaction, such as shareholder consents, third-party consents, or prohibitions on transfer.

Establishing this information requires the buyer to review the seller’s organizational documents, such as formation documents, bylaws or operating agreements, benefit plans, vendor contracts, supply contracts, and customer contracts. Some of the common issues the buyer will need to focus on are: (i) ownership of the target company, (ii) existing management of the company, and (iii) necessary consents from third-parties in connection with key contracts. Continue Reading Buyer Beware: Purchase a Private Company With Both Eyes Wide Open

By Ladd Hirsch and Trip Dyer[1]

“There is no such thing as a free lunch.”  It is a common expression with a clear meaning— don’t expect to receive something for nothing.  But there is an important corollary expressed less often: it is possible to receive something that will have value in the future, but without having to pay for it now.  Like seeds waiting to sprout, the concept of a private company profits interest fits this description of an asset with no current worth, but which may become quite valuable over time.  The profits interest therefore has an important role to play in the private company context, but what exactly is a profits interest and how does it work?

Defining a Profits Interest

In brief, a profits interest is a creative way for private company business owners to provide their employees with a significant financial incentive—an ownership stake in the company—but without saddling them with a tax burden when they receive this interest.  A profits interest can serve a purpose that is similar to a stock option by granting an equity interest in the company to the employee, but unlike some stock options, the employee does not recognize income or pay taxes on the grant of a profits interest because the profits interest has no value when it is granted.

The absence of value is because a profits interest is forward-looking; it provides the employee with a share in: (i) the company’s future profits and (ii) the appreciated value of the company.  If the company was liquidated on the day that the profits interest was granted, the employee would receive no proceeds from the liquidation.  The employee receives financial benefits only when the company’s assets are sold for a higher value than the date the profits interest was issued or when the company makes distributions with respect to future profits.  Further, the employee is not required to contribute any capital and is awarded a profits interest based on the services that the employee has provided or will provide to the company. Continue Reading The Equity Profits Interest: Giving Seeds Time to Sprout, Incentivizing Key Employees, and Keeping the Tax Collector at Bay