Partnerships,

1
Business Organizations2009-2010 Lectures

• Partnerships,
• Corporations
• And the variants
• PROF. BRUCE MCCANN
• [phone]
• Lecture 7
• capitalization
• pp. 239-286

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Incorporation Process Review
3
Incorporation Process Review

• Articles filed
• By laws prepared
• First meeting held of shareholders
• Elect Directors
• Make subchapter S election
• Directors meeting
• Adopt pre-existing agreements
• Appoint officers
• Authorize issuance of stock
• Authorize banking relationships

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Cal Corp Code 25608(c)

• (c) The fee for filing a notice pursuant to
  paragraph (5) of subdivision (h) of Section 25102
  and the fee for filing a notice pursuant to
  paragraph (4) of subdivision (f) of Section
  25102, in addition to the fee prescribed in those
  paragraphs, if applicable, shall be determined
  based on the value of the securities proposed to
  be sold in the transaction for which the notice
  is filed and in accordance with subdivision (g),
  and shall be as follows Value of Securities
  Proposed to be Sold Filing Fee
• 25,000 or less 25
• 25,001 to 100,000 35
• 100,001 to 500,000 50
• 500,001 to 1,000,000 150
• Over 1,000,000 300

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Where Does a Corporation Get the Money to Get
Started?

• They borrow it (debt)
• They sell stock (equity)

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The Debt-Equity Relationship
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Why Capitalize with Debt?

• You can keep (i.e., leverage) the cash you have.
• You retain ownership (control) of the business
• Interest payments are tax-deductible
• Generally easier to sell debt because you dont
  have to convince someone that the company will
  grow, only have to convince them that theyll get
  paid back (and they get paid first).
• Lender is first in line to get paid if must
  liquidate assets
• Have a good return on investment (ROI)

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Other Peoples Money

• The Beauty of Leverage
• Step One Put, say, 25,000 into your business
• Step Two Put 10 down on a building (or any
  depreciable asset)
• Step Three Say building increase 3 per year in
  value
• Ka-ching your net worth increases 7,500 each
  year
• Step Four The building is depreciated for tax
  purposes over 20 years (depending on asset)
• Ka- chingyou write off 1/20 X 250,000 each
  year, or 12,500.
• (At a 30 tax rate, you saved 3,750 on taxes
  alone, meaning you made 15 on your 25,000
  investment on tax savings alone)

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Typical Types of Debt Contracts

• BONDS
• Long term obligation secured by the assets of the
  corporation
• DEBENTURE
• Long term unsecured obligation
• NOTE
• Short term obligation

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The Indenture

• A contract underlying the bond/note/debenture
• Governs actions corporation may take while debt
  remains unpaid such as
• Limit other borrowings
• Limit payment of dividends
• Limit use or disposition of security
• May give corporation right to call the
  bond/note

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Typical Terms

• COVENANTS
• (a) Use of Proceeds. Proceeds received from the
  Payee pursuant to this Note will be used by the
  Borrower for working capital and general company
  purposes.
• (b) Affirmative Covenants. Until the conversion
  or repayment (or prepayment) of this Note in
  accordance with the terms and conditions set
  forth herein, each Borrower shall perform all
  covenants in this Section 4(b).

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Typical Terms

• (vii) Compliance with Laws. The Borrower will
  comply with the requirements of all applicable
  laws, rules, regulations and orders of any
  governmental authority, noncompliance with which
  could reasonably be expected to have,
  individually or in the aggregate, a Material
  Adverse Effect. As used herein, Material Adverse
  Effect means a material adverse effect on and/or
  material adverse developments with respect to (i)
  the business, operations, properties, assets,
  condition (financial or otherwise) or prospects
  of the Borrower (taken as a whole) (ii) the
  ability of the Borrower to fully and timely
  perform its obligations hereunder (iii) the
  legality, validity, binding effect or
  enforceability against the Borrower of a Loan
  Document or (iv) the rights, remedies and
  benefits available to, or conferred upon, Payee
  under any Loan Document.

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Typical Terms

• (c) Negative Covenants. Until the conversion,
  repayment (or prepayment) of this Note in
  accordance with the terms and conditions set
  forth herein, the Borrower will not, without the
  prior written consent of the Payee, undertake to
  do any of the following (i) create, issue, sell
  or transfer any debt securities of the Borrower
  or enter into or incur other indebtedness other
  than indebtedness which, together with this Note,
  does not exceed 200,000 in principal amount (for
  purposes hereof, Indebtedness shall mean any
  indebtedness of the Borrower for borrowed money
  from banks, other financial institutions, (except
  indebtedness consisting of drawing down on
  existing lines of credit) and any Person (defined
  as natural persons, corporations, limited
  liability companies, limited partnerships,
  general partnerships, limited liability
  partnerships, joint ventures, trusts, land
  trusts, business trusts, or other organizations,
  irrespective of whether they are legal
  entities))

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Negative Covenants Continued

• (ii) (A) redeem, repurchase or otherwise acquire
  for consideration any outstanding equity
  securities of the Borrower (or securities
  convertible or exercisable into or exchangeable
  for equity securities of such entity) or permit
  any Borrower to take such action or (B) declare
  or pay any cash or property dividend or
  distribution of any kind on any class of stock or
  membership interest (except with respect to
  ordinary course inter-company transfers and
  accounts of the Borrower) (iii) make any
  material change in its ownership or organization
  or the manner in which its business is conducted
  outside of the ordinary course of its business
  (iv) transfer, sell, lease, or in any other
  manner convey any equitable, beneficial or legal
  interest in any assets of the Borrower except
  inventory sold in the normal course of business,
  or allow to exist on its assets any mortgage
  interest, pledge or security interest , title
  retention device, or other encumbrance, junior or
  senior to Payee, other than as set forth herein.

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Advantages of Selling Equity

• Motivate buyer to pull for the success of the
  company
• Doesnt use precious cash
• No obligation to re-pay
• Can print more when needed

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Disadvantages of Selling Equity

• Usually requires giving up at least some control
• Allows camels nose under the tent
• Dividends are not deductible from corporate tax

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Types of Equity

• Common Stock
• Preferred Stock
• Convertible preferred stock
• Warrants

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Common Stock

• Required to be issued
• Usually carries voting power
• May or may not have par value
• First in line in terms of control, last in line
  in terms of getting paid on liquidation

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Preferred Stock

• Preference given as to
• Dividends
• Liquidation of the companys assets
• May also allow certain rights if the dividends
  are not paid (such as electing a number of
  directors)

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Convertible Preferred Stock

• Preferred stock that carries with it right to
  convert to common stock

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Warrants

• Are issued by the corporation
• Give the owner the right to acquire common stock
  in the future for a specified price
• Usually added as an enticement to lenders but may
  be sold independently