PARTNERSHIPS, CORPORATIONS AND THE VARIANTS PROF. BRUCE MCCANN LECTURE 8 PP Business Organizations Lectures

Overview of Corporate Structure Shareholders PresidentSecretaryTreasurer Directors Lec. 8, pp Corps Prof. McCann 2

Types of Equity Lec. 8, pp Corps Prof. McCann Common Stock Preferred Stock Convertible preferred stock Warrants 3

Common Stock Lec. 8, pp Corps Prof. McCann 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 4

Preferred Stock Lec. 8, pp Corps Prof. McCann Preference given as to  Dividends  Liquidation of the company’s assets  May also allow certain rights if the dividends are not paid (such as electing a number of directors) 5

Convertible Preferred Stock Lec. 8, pp Corps Prof. McCann Preferred stock that carries with it right to convert to common stock 6

The Corporation’s Foundational Documents Lec. 8, pp Corps Prof. McCann Articles (Charter) By Laws Shareholder Agreements Between Themselves  Buy-sell Agreements  Aka Cross-purchase Agreements  Survivor Purchase Agreement Corporations Agreements To Repurchase Stock  Stock purchase Agreement  Aka Redemption Agreement 7

Incorporation Process Review Lec. 7, pp Corps Prof. McCann 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 8

When You Need Shareholder Agreements Lec. 8, pp Corps Prof. McCann To maintain exemption from securities registration requirements  i.e., a restriction that shareholder cannot transfer to a citizen of another state (triggering interstate sales issue); To maintain subchapter “S” status  i.e., a restriction that you cannot sell to a partnership or corporation which would exceed limit of 75 shareholders To maintain professional corporation status  i.e., cannot sell to unlicensed person 9

When You Need Shareholder Agreements Lec. 8, pp Corps Prof. McCann To Maintain Effectiveness of a Pooling Agreement  i.e., if parties pool shares under agreement to keep X off the board, important no one conveys their shares to X. 10

Restrictions Lec. 8, pp Corps Prof. McCann May be absolute:  Prohibits transfer altogether (usually unenforceable) May require others consent  Typically requires director or shareholder approval May limit class of possible transferees  Must be family members  Must be CPA  Must be non-competitor 11

Examples of Restrictions Lec. 8, pp Corps Prof. McCann Buy-Out Agreements  Whereby anyone desiring to sell must offer to designated others on same terms, so-called “right of first refusal.”  Whereby someone who may lose control of stock in a divorce is obliged to sell to other shareholders or to the corporation  Whereby the estate of a deceased shareholder must sell to the others 12

Mandatory vs Optional Lec. 8, pp Corps Prof. McCann Provision can require corporation or other shareholders buy out the interest  Frequently where shareholder dies or is expelled or retires Provision may give others the “option” to buy the seller’s interest  e.g., right of first refusal 13

Pricing the Shares Lec. 8, pp Corps Prof. McCann Three usual approaches:  Book Value  What do the accounts show the shares are worth if you divide the number of outstanding shares into the number you get when you subtract the liabilities from the assets?  Liquidation Value  What would you get if you closed the doors, sold all the assets, paid all the debts, and divided the money up?  Cash Flow or Earnings  What would an investor be willing to pay today to own a company that generates the profits your company generates? 14

Valuation Issues Lec. 8, pp Corps Prof. McCann “Book Value” can mean different things to different people. Denkins v Zinkan “Fair Value” may not be the same as “fair market value”  Discounts for  Lack of control  Lack of marketability 15

THE PLAYERS, REVISITED Lec. 8, pp Corps Prof. McCann SHAREHOLDERS  Elect directors  Usually must ratify certain acts of directors  Resolution to dissolve  Resolution to merge with another entity  Resolution to sell principal assets  Resolution to change corporate purpose  Resolution to amend by-laws or charter 16

THE PLAYERS, REVISITED Lec. 8, pp Corps Prof. McCann DIRECTORS  Charged with day-to-day operations of entity  Hire and Fire Officers  Bear ultimate responsibility for conduct and misconduct of the corporation 17

“Closely Held” vs Statutory Close Corporation Lec. 8, pp Corps Prof. McCann Any corporation can be held by a small number of shareholders. One shareholder is not uncommon. A “closely held” corporation is a term with no particular legal significance other than to mean:  Few shareholders  Most of whom participate in management  No general market for the stock (because of limitations on control and liquidity) and  Some limitations on transfer of the stock Courts now widely allow shareholders to control management via controlling director’s powers. 18

Recording the Corporate History Lec. 8, pp Corps Prof. McCann All States Require Minutes be Maintained Calif Corps Code 314  The original or a copy in writing or in any other form capable of being converted into clearly legible tangible form of the bylaws or of the minutes of any incorporators', shareholders', directors', committee or other meeting or of any resolution adopted by the board or a committee thereof, or shareholders, certified to be a true copy by a person purporting to be the secretary or an assistant secretary of the corporation, is prima facie evidence of the adoption of such bylaws or resolution or of the due holding of such meeting and of the matters stated therein. 19

By Laws Lec. 8, pp Corps Prof. McCann Must conform to the Articles Must conform to the law  e.g., by-law prohibiting any transfer of interest would be unenforceable 20