Michigan Business Lawyer Blog

Starting a new business is exciting. In addition to the fun of being involved with a business start-up, there are important and often difficult decisions to be made. These initial decisions can have a significant impact on the future success and growth of a new business.

There are a number of important considerations that a lawyer can help you focus on:

1. Choosing the correct business entity for your business (i.e., corporation, LLC, etc.).

2. Analyzing important tax issues.

3. Obtaining the proper registrations, licenses, and permits.

4. Proper negotiation and execution of important contracts and agreements.

5. Helping you comply with the appropriate procedures to raise capital to fund your business.

6. Helping you comply with laws and regulations that may govern your particular business.

7. Establishing beneficial and appropriate employment policies and agreements.

8. Protecting you from personal liability for your business's debts and obligations.

Many entrepreneurs don't realize the importance of getting good legal counsel in the initial stages of their business formation to help them with these initial decisions. Hiring a lawyer in the beginning stages of a business will be money well spent.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Formations

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One of the main reasons businesses are conducted through corporations is to protect owners from personal liability for company obligations. Preserving limited liability is one of the most important aspects of operating a corporation because protection from liability can be lost unless certain formalities are observed.

There are three main ways liability protection can be lost:

1. Invalid incorporation.

2. Improper execution of documents.

3. Piercing of the corporate veil.

Invalid Incorporation
To form a corporation in Michigan, articles of incorporation must be completed, signed and filed with the Michigan Department of Labor and Economic Growth. In addition, certain internal corporate documents must be prepared and signed by the appropriate parties. If a corporation is not properly incorporated, stockholders may not have limited liability if a legal proceeding is brought against the corporation and may be required to personally pay if a judgment is obtained against the corporation.

How to Properly Sign a Document on Behalf of a Corporation
When signing a document on behalf of a corporation, it is important to remember that a corporation is treated as a separate individual under the law. As such, it is imperative that documents are properly signed or the person signing may find himself or herself on the hook for that obligation. Specifically, when documents are signed on behalf of a corporation, both the name of the corporation, the name of the person signing, and that person's title must be stated.

For example:

THE MICHAEL J. HAMBLIN CORPORATION
By: /s/ Michael J. Hamblin
Name: Michael J. Hamblin
Title: President

Piercing the Corporation Veil
A court may pierce a corporation's protective liability veil if the corporation is undercapitalized, or if it can be proved that the corporation is nothing more than a sham set up to defraud. If corporate stockholders and representatives do not follow the required formalities, a court could rule that the corporation is not really functioning as a corporation, but rather as what is known as the "alter ego" of the stockholders. To keep the corporate veil from being pierced, it imperative to keep proper minutes of corporate board and stockholder meetings. It is also imperative that corporate and non-corporate monies are not co-mingled.

The measures discussed in this post, among others, can help to ensure that a corporation will be treated as a separate entity under the law and protect its stockholders from personal liability for corporate obligations. To achieve the greatest level of protection when operating a corporation, it is important that an experienced Michigan business lawyer be consulted before incorporation and at regular intervals thereafter.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Formations , Corporations

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Although no one starts up a business with plans to fail or lose money, the success rate statistics for new businesses can be daunting. That's why Section 1244 stock should be on the mind of every new business owner who organizes their business as a C corporation.

Section 1244 stock is possible thanks to Section 1244 of the Internal Revenue Code. This is known as the small business stock provision, and was enacted to allow stockholders of domestic small business corporations to deduct losses incurred when they dispose of their small business stock as ordinary losses instead of capital losses.

The general rule is that any loss suffered by a stockholder upon liquidation of the company will be considered a capital loss. But, if the stock is Section 1244 stock, a part of the loss ($100,000 for husband and wife filing jointly, otherwise $50,000) will be treated as an ordinary loss. Since the loss is treated as ordinary, it can be used directly to offset the stockholder's investment income, passive income, wages, and self-employment income. In addition, because the use of the loss is accelerated, the tax advantage is much greater than if the loss is treated as capital.

Whether stock is Section 1244 stock depends on whether the requirements of IRC 1244 are met at the time the stock is originally issued. These requirements relate to (1) the corporation issuing the stock; (2) the stock itself; and (3) the stockholders of the corporation.

Being able to issue Section 1244 stock is one of the great tax benefits of organizing a business as a C corporation. Of course, you should consult with a knowledgeable Michigan business lawyer when setting up your corporation so that he or she can advise you on the requirements for issuing valid Section 1244 stock.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Formations , Corporations , Financing , General Topics , Tax Issues

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One of the main reasons people form Michigan corporations and limited liability companies (LLCs) is to protect themselves against personal liability for the obligations of their businesses. Under Michigan law, the risk of an owner of either a corporation or LLC is limited to their investment in the business. See Michigan Compiled Laws 450.1317 (for corporate rules) and Michigan Compiled Laws 450.4501 (for LLC rules). This is in total contrast to the rules for partnerships, which is one reason why no one in their right mind should be conducting business in Michigan as a partnership.

As with all rules, the rules of limited personal liability for owners of Michgian corporations and LLCs have exceptions.

First, an owner of these entities remains personally liable for their own personal negligence. This is true even if they are acting on behalf of their business entity. Thus, depending on the type of business one is conducting, a corporation or LLC may not provide very much protection from personal liability as a practical matter.

Second, an owner of a corporation or LLC is liable for any debts or obligations that they personally guarantee. Unfortunately, owners of small businesses are often required to personally guarantee the business's obligations as a condition of getting bank credit, desirable leases, supplier contracts, etc. This is a reality of life that further chips away at the limited liability protection that Michigan law provides to those who conduct their businesses through corporations or LLCs.

Third, there are certain situations that can result in the protective limited liability veil of a corporation or LLC being "pierced" so that the owner has personal liability for entity debts or obligations. These circumstances include (1) failing to follow the required formalities in company administration; (2) undercapitalizing the company; (3) using the business to achieve fraud; (4) failing to properly document transactions between the company and its owner(s); and failing to keep separate financial records for the company and its owner(s).

It is important that people conducting business through a Michigan corporation or LLC consult with a knowledgeable Michigan business lawyer to ensure they are following all of the requirements for obtaining and maintaining the limited liability protections these entities offer their owners.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Formations , Corporations , Entity Selection , Limited Liability Companies

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One advantage Michigan C corporations have over S corporations is the ability to reinvest profits in the corporation at a lower tax cost than S corporations. This is because the current lowest corporate income tax bracket is 15% for profits up to $50,000. The individual income tax bracket of a company's owner is often higher than 15%. So if that owner wanted to reinvest S corporation profits back into the S corporation, he or she could do so only after paying personal income tax on those profits at their personal income tax rate (because of the "flow through" tax treatment of S corporations). Since a C corporation is not a "flow through" tax entity, any profits not distributed to the shareholders (such as those reinvested back into the corporation) are taxed at the corporate level only.

So, let's say a start-up corporation decides to operate as a C corporation to take advantage of the lower tax cost of reinvesting profits back into the company. At some point, the company may exhaust its desire for reinvesting its profits, and decide that it wants to start distributing its profits to its shareholders. At this point, double taxation becomes an issue because in a C corporation, profits will first be taxed at the corporation level when they are booked, then again at the shareholder level when they are distributed to the shareholders.

The answer may be to convert the C corporation to an S corporation so that profits will only be taxed one time. The mechanics of switching from a C corporation to an S corporation are simple enough. Becoming an S corporation is simply a tax election that is made by filing the appropriate paperwork with the IRS. A corporation's shareholders can make this election any time during the corporation's existence. If the shareholders elect S corporation status, all future earnings will be taxed at their individual income tax rates, without being taxed at the corporate level.

But, corporations contemplating this move must be very careful. This is because any of the corporation's earnings before the S election will forever be marked and given special tax treatment under rules governing S corporations. If those earnings are ever distributed to the corporation's shareholders, they will be taxed as dividends and, even worse, will be subject to the double tax regime imposed on C corporations.

Corporations or stockholders who are contemplating changing their C corporation to an S corporation should consult with a Michigan business lawyer who can help them work through the possible tax pitfalls of making this move.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Formations , Corporations , Entity Selection , Tax Issues

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In my last post, I discussed the basics of buy sell agreements. In this post, I will explain some of the specific advantages to having a buy sell agreement between the owners of a closely held Michigan business.

1. Creating a Market for Selling Partner's Interest. When a buy sell triggering event does happen such as the death or disability of an owner, there is an automatic market for selling that owner's interest in the business. The importance of this cannot be overstated since it can be difficult to locate buyers for interests in closely held companies. Without a buy sell agreement, it might be possible to sell the interest of a deceased or disabled partner only at a bargain basement price.

2. Establishing a Transition Plan. Having a buy sell agreement allows the owners to plan in advance for a smooth transfer of the business when an unexpected triggering event occurs. This allows the business to continue operating and growing in an organized fashion while at the same time limiting disruptions to customers in what will likely be a very hectic and difficult time.

3. Generating Funds for the Selling Partner and/or His or Her Family. The proceeds from the sale of a business interest under a buy sell agreement can be a life saver for the deceased or disabled owner's family. In the event of the business owner's death, buy sell proceeds can be used to defray certain estate-settlement expenses such as death taxes and administration costs. Also, part of the proceeds can be allocated to help pay living expenses of the deceased partner's family. If the partner is disabled, the proceeds can be used to pay the living expenses for the entire family.

4. Establishing Value for Estate Tax Purposes. The price set in the buy sell agreement may be used to establish a valuation of a deceased partner's business interest for estate tax purposes. There are certain requirements that buy sell agreements must meet in order for the values set therein to be respected by the IRS, so for this reason alone (although there are many others) it is imperative to have a competent Michigan business lawyer prepare these agreements.

A buy sell agreement is a tremendous tool that allows partners in closely held businesses to do advanced planning for their business and personal affairs in a way that can benefit all involved. But, preparing these kinds of agreements should not be a "do it yourself" project. Contact a good business lawyer to assist you.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Formations , Corporations , General Topics , Limited Liability Companies

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Most entrepreneurs have their hands full actually running their businesses. It's not uncommon for entrepreneurs to leave planning for contingencies for later. But, it is important to make plans to protect your family should the unthinkable happen. One way to do this is to have a buy sell agreement with your business partners that will protect your family's interests if you become disabled or die. Not only will a properly drafted buy sell agreement protect your family, it can also help to protect your partners and the business you have worked so hard to grow.

In a nutshell, a buy sell agreement is a legally binding contract that provides for the orderly disposition of a business interest when a specified event happens. Typically, a buy sell agreement is prepared so that the triggering event is the death of one of the business owners. But, a triggering event can also be a disability, retirement, or some other kind of major event in the lives of the owners. When the triggering event happens, the disabled or retired owner or the deceased owner's family will sell their interest to either the business itself or the remaining business owners. A properly prepared buy sell agreement is a win-win situation for all involved. A market is created for the business interest of the selling owner or their family, the remaining owners are able to keep control of the business as agreed on by everyone before a major event occurs, and the business can continue to operate and grow in an orderly and organized fashion.

The exact details of how this transition happens depends on the kind of buy sell agreement that is used. There are three basic kinds of buy sell agreements:

1. Cross-purchase agreement.
2. Redemption agreement.
3. Hybrid agreement.

A cross-purchase agreement is used when the remaining or surviving owners basically agree to buy each other out. For example, if a business has three partners, under a cross-purchase agreement, if one of the partners dies, the other two partners would purchase the deceased partner's interest in the business from his or her estate.

When a redemption agreement is used, the business itself buys the interest of the deceased or departing partner.

A hybrid agreement is often used and typically provides the remaining business owners the first option to buy the deceased or departing partner's interest, with the business itself obligated to purchase that interest if the remaining partners do not exercise their option.

Buy sell agreements are often funded with life insurance policies taken out on the lives of each of the business's partners. This provides for ready capital to purchase a deceased partner's interest without burdening the finances of the business or surviving partners. It is imperative that an experienced business lawyer be consulted regarding the preparation of a buy sell agreement. There are many legal, tax, and practical issues that must be accounted for when using these types of agreements and an improperly prepared buy sell agreement can be worse than not having one at all.

In my next post, I'll discuss some of the specific advantages to having a buy sell agreement.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Formations , Corporations , General Topics , Limited Liability Companies

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Occasionally I am asked by clients if it might be advisable for them to incorporate their new business in some exotic locale such as Delaware or Nevada. Some of these clients have heard that many large Fortune 500 type businesses were incorporated in Delaware, even though their headquarters and principal places of business are located elsewhere. Others have heard radio ads touting the tax and other advantages of incorporating in Nevada or some other remote state. Generally speaking, my advice to those starting small Michigan businesses is to incorporate them right here in the Great Lakes State.

While a business can theoretically incorporate in any one of the 50 states (including Delaware and Nevada), incorporating in another state such as Delaware or Nevada will have the effect of adding additional costs to the incorporation process, while providing almost no benefits to the small business corporation.

What about the supposed tax advantages to incorporating in Delaware or Nevada? While it is true that these states do not require corporations to pay income tax, you will still have to pay income and franchise taxes in Michigan if you do business in Michigan regardless of your place of incorporation.

Another reason clients think about incorporating in Delaware in particular is that so many large companies do so. However, just because large companies incorporate in Delaware doesn't mean that is the best move for a small company. Most large companies incorporate in Delaware because of its sophisticated and business friendly court system. However, a small business corporation doing business in Michigan is unlikely to encounter situations where the differences in Michigan's law or legal system and Delaware law or legal system are really that significant. Plus, the cost for a Michigan small business to litigate a dispute in a Delaware court is sure to be much more expensive than having that same dispute resolved by a Michigan court.

If you believe that there may be an advantage for your small Michigan business to incorporate in a location other than Michigan, be sure to consult with a competent Michigan business lawyer before you do so. He or she will be able to advise you on where it makes the most sense to form your business.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Formations

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