From Idea to Exit: Structure - For Cause Repurchase Rights

Blog Layout

You know how hard it is to build a successful business. Our business lawyers want to make sure that entrepreneurs and small business owners have every advantage possible in making that happen.

A solid and secure legal foundation is a crucial component to doing so, and that is why your operating agreement or your bylaws are so critical to your business. In previous posts, we discussed methods of ensuring that your business can control your company’s equity in a way that allows the company to grow, develop, and reach its potential.

Considering this theme, a provision that we as business attorneys advise our clients to include in their operating agreements or bylaws is a for-cause repurchase right.

https://youtu.be/ZBX-UOqy1Qs

Protection from Bad Actions

For-cause repurchase rights protect the business when owners make actions that are not in the company’s company’s best interest. The for-cause repurchase rights allow the company to distance itself from that owner and purchase that owner’s equity back.

An example of an action that is not in the company’s best interest is if an owner of the business is convicted or engages in an activity that could lead to a conviction of a misdemeanor or felony-level criminal offense involving fraud, embezzlement, or dishonesty. By having this provision, the company can elect the right to repurchase that owner’s equity.

Another common trigger in a for-case repurchase clause is if there's a material breach that goes uncured of the operating or shareholder agreement or other agreement between an owner and the company. The threat of losing your equity creates an additional incentive for owners to comply with their contracts and obligations to the company.

Ability to Rebuy Equity

The idea is that if someone does something that materially hurts the company, then the company needs to be able to repurchase that bad actor’s equity. There is no room on the cap table for deadweight, and there is no reason that they should ever benefit further from you building your business.

We even regularly add a provision that allows for the company to buy the equity at a reduced rate, typically at about 50% of the fair market value of that owner’s equity. The percentage discount can change depending on how big of a disincentive they want to set for bad-actors. As a result, we regularly see the discount spanning between 20% and 80%.

As these are common aspects that go into a for-cause repurchase right, it's something that each company should carefully evaluate having in their operating agreement or bylaws.

The business attorneys at Freeman Lovell love assisting entrepreneurs and small-business owners understand, mitigate, and take the right legal risks in their operating agreements and bylaws.

Call or text us at (385) 217-5611 or send us a message through our , Contact Form .

You can also access all of our presentations on this section to learn more about how you can build your business and how we will clear the way for your success from idea to exit at this LINK .

< Older Post Newer Post >

Beneficial Ownership Rules

28 Dec, 2023

In a couple of months, a new rule will take effect, requiring all registered legal entities to report their beneficial owners to the Financial Crimes Enforcement Network (FinCEN). We wanted to give you a heads up about the rule and give you as much information about what it means to you. What is the rule? The rule, which is called the Beneficial Ownership Information Reporting Requirements (BOI Rule), comes from the Corporate Transparency Act, which was passed by Congress in 2021. This law created the BOI Rule with FinCEN as part of the U.S. government’s efforts to make it harder for bad actors to hide or benefit from their ill-gotten gains through shell companies or other deceitful ownership structures. Under this new law, FinCEN will permit Federal, State, and local officials to obtain ownership information for authorized activities related to national security, law enforcement, and intelligence. When does the rule take effect? And when do I have to submit a report? The BOI Rule takes effect on January 1, 2024 . If your company existed before January 1, 2024, you must file its initial beneficial ownership information report by January 1, 2025. If your company is formed or registered after January 1, 2024, you must file its initial beneficial ownership information report within 30 days after receiving actual or public notice that its creation or registration is effective. If any beneficial ownership information changes, you will have 30 days from the day of the change to file an updated or corrected report with FinCEN. What do I need to include in the report? The BOI Rule requires that all entities report information about the company, each individual with substantial control over the entity, and each beneficial owner. What information is required to report about the entity? Full legal name of your company and any DBAs names; Complete current street address for your company's principal place of business (P.O. boxes will not be accepted); The jurisdiction of formation or registration; and Tax identification: IRS tax identification number (TIN) and employer identification number (EIN). What information is required to report about the controlling individuals and beneficial owners? The individual's legal name; Individual's date of birth; Individual's residential address; and A unique identifying number from an acceptable identification document (such as an unexpired driver's license, passport, identification document issued by a State or local government or Indian tribe.) and the name of the issuing state or jurisdiction. Who is considered to have substantial control of the entity? Examples of an individual that exercises substantial control over the entity are: An individual is a senior officer (President, CEO, CFO, COO, Manager, or other office who performs a similar function); An individual has the authority to appoint or remove certain officers or a majority of directors of the reporting company; An individual is an important decision-maker for the company; or An individual has any other form of substantial control over the company. Who is considered a beneficial owner? A beneficial owner is an individual that owns or controls at least 25% of the entity’s ownership interests. This includes individuals that indirectly own or control 25% of the ownership interest. For example, if Joe is a 50% owner of Parent LLC, which in turn owns 50% of Subsidiary Corp, then Joe beneficially owns 25% of Subsidiary Corp (50% of 50% = 25%). What type of entities will be required to file a report with FinCEN? All domestically formed entities and foreign registered entities in the USA are required to file a report. Types of entities include corporations, limited liability companies, limited partnerships, general partnerships, and any other entity registered with a state Secretary of State or Division of Corporations or other similar office. There are some types of companies that are exempt from the reporting rule, and in general they are companies that already have to report beneficial ownership to another federal agency. The 23 exemptions listed by FinCEN are: Securities reporting issuer, Governmental authority, Bank, Credit union, Depository institution holding company, Money services business, Broker or dealer in securities, Securities exchange or clearing agency, Securities exchange or clearing agency, Other Exchange Act registered entity, Investment company or investment adviser, Venture capital fund adviser, Insurance company, State-licensed insurance producer, Commodity Exchange Act registered entity, Accounting firm, Public utility, Financial market utility, Pooled investment vehicle, Tax-exempt entity, Entity assisting a tax-exempt entity, Large operating company, Subsidiary of certain exempt entities, and Inactive entity. Now what do I do to comply with the BOI Rule? While you are not able to submit the beneficial ownership information report until January 1, 2024, you should use this time to gather information about your company, owners, and other entities now, so you can timely file your report. We added a small BOI Rule cheat sheet for you to keep and reference. Also, you can read FinCEN’s FAQ page about the BOI Rule https://www.fincen.gov/boi-faqs . Can you help me with my company’s report? Yes! We are happy to help prepare and file your company’s BOI Rule report with FinCEN. We can begin to gather and prepare the information for your filing right away and be ready once the BOI Rule takes effect January 1, 2024. To get started, please reach out to us. We also know that some situations can be complicated, so please feel free to ask us any questions regarding compliance with the beneficial ownership interest reporting requirements for your company.