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Demonstrating value is about adding value but also showing how you do it.

Delaware

Formation of business entities in the United States is largely at a state level and the most popular jurisdiction is Delaware. It has the most flexible, up-to-date and pro-business corporate laws. With a corporation, for example:

• the identity of shareholders does not need to be disclosed;
• shareholders do not need to be US citizens or even US resident (NOTE: even so, for certain classes of industries in the US there are foreign ownership restrictions);
• you can have sole director corporations;
• meetings and records can be held anywhere;
• directors can amend the by-laws (i.e. constitution) of the corporation without shareholder consent; and
• there are no minimum capital requirements.

The Delaware Court of Chancery is a specialist court for corporate law, with great expertise and precedents. There is also an efficient state administration of business entities, and there is no corporate income tax for corporations that do not transact business in the state.

Because it’s the most popular jurisdiction, I’ll focus on the Delaware laws in this summary.

Main types of business entities

The main types of business entities are shown in the diagram.

Offshore entities are sometimes also used as part of a structure to do business in the US.

Distinguishing features

The key differences between the different kinds of business organisation fall broadly into three categories:

• Taxation – how they’re taxed
• Liability – the liability of owners for liabilities and obligations of the entity
• Flexibility – the extent to which you can structure the entity to suit your own requirements

Let’s look at each of these a little further. Taxation

• Corporations generally have ‘double taxation’ – i.e., corporate income tax on earnings and then income tax on dividends in the hands of the recipient. Small business or ‘Subchapter S’ corporations are different. They have pass-through treatment of income (i.e., no double taxation), but there are restrictions: these corporations can only have a maximum of 75 shareholders, the shareholders must not be an LP, LLC, a corporation or non-resident alien, and there can only be one class of stock. Because of the foreign ownership restriction, the Subchapter S corporation usually won’t work for a foreign investor.
• LLCs are subject to ‘check the box’ regulations, under which you can choose pass-through or double taxation. If you fail to choose, the default option is pass-through.
• Partnerships (LPs, LLPs, LLLPs and general partnerships) are pass-through entities and are not separately liable for income tax.
• Statutory trusts can be set up to be taxed like a corporation or pass-through like a partnership (or taxed as a grantor trust).
• Offshore enities formed in low-tax or no-tax jurisdictions are sometimes used by businesses operating in the US (and elsewhere), mainly for tax reasons, but there can be many complications in obtaining those tax advantages.

Liability

• Corporations have limited liability of shareholders for the obligations and liabilities of the corporation. There are exceptions of course: what is known as ‘piercing of the corporate veil’.
• LLCs also have limited liability, like corporations: the members are not liable for the obligations and liabilities of the LLC. So they offer the advantages of pass-through income for tax purposes, unlike a corporation, while maintaining the benefits of limited liability.
• With an LLP, the partners are not personally liable for obligations and liabilities of the LLP. A general partnership can be converted to an LLP to achieve this result.
• LPs have limited partners and general partners. The limited partners are not personally liable for obligations and liabilities of the LP beyond their contribution (but can be if they participate in the control of the business); the general partners will be personally liable for the obligations and liabilities of the LP. In some states (including Delaware), an LP can convert to an LLLP, under which the general partner’s liability is also limited.
• General partnerships have unlimited liability of partners, who are each jointly and severally liable for the debts and obligations of the partnership.
• The beneficiaries of a statutory trust have the same limitation of personal liability as a shareholder of a corporation, and the property of the trust is not available to creditors of a beneficiary. The trust is a separate legal entity and can have perpetual existence, except as otherwise provided by the governing instrument of the trust (usually called the trust agreement). The liability of the trustee is determined by the governing instrument, so it can be more restricted than would otherwise apply at common law. The statutory trust can also indemnify the trustee, beneficial owner or anyone else from liability, where permitted by the governing instrument.
• A joint venture is a similar type of arrangement to a partnership, but the general concept of a JV is to avoid the joint and several liability of a partnership. The rights and liabilities of the joint venture parties are determined by the joint venture agreement, and so the joint venture agreement will normally allocate and limit respective liabilities.
• Sole proprietors, of course, have unlimited liability.

Flexibility

• The corporation is probably the least flexible form of business entity. There are a lot of statutory provisions about structure. For that reason it is the preferred form for public offerings of securities. The corporation must have a certificate of incorporation and by-laws, and be governed by a board unless it is classified as a ‘close corporation.’
• An LLC is more like a partnership in terms of its flexibility. But it can have a sole member, which is something a partnership can’t (by definition). Unlike a corporation, it doesn’t need to have a board (although some do), and profits don’t have to be distributed in proportion to ownership as occurs with a corporation. The governing document of an LLC is usually called its operating agreement or limited liability company agreement.
• A partnership will have a partnership agreement as its governing document. If it is an LP, LLP or LLLP, the agreement can limit the liability of partners. And a joint venture will have a joint venture agreement, which can limit the respective liabilities of the joint venturers.
• Statutory trusts are also very flexible. There are the basic concepts of trustee and beneficiary, but their respective rights and liabilities have a potentially wide range of variation, as set out in the trust agreement.

Multi-entity structures The best form for a business may involve multiple entities, and there is an endless variety of combinations. Often businesses are structured with separate entities for separate lines of business. Another common structure is to have a holding company at the top with the corporate group consolidated for tax purposes. Sometimes entities in the chain are located offshore. Delaware business entity laws online For more details, you can access the Delaware laws on business entities online.

• Corporations - Delaware General Corporation Law
• LLCs – Delaware Limited Liability Company Act
• LPs and LLLPs – Delaware Revised Uniform Limited Partnership Act
• LLPs and general partnerships – Delaware Revised Uniform Partnership Act
• Statutory trusts – Delaware Statutory Trust Act

This week saw Akio Toyoda, the President of Toyota, apologise to a US House Committee for the recall of 8.5million cars due to safety fears.

This is a truly revealing insight into a company’s culture.

See the video and story at BBC News.

Also at BBC news is Gordon Brown’s apology to the child migrants sent by the UK to former colonies.

And this note can’t end without a link to Tiger Woods’ apology.

I learned these from experiences, both good and bad. (Somehow the bad experiences are always more memorable than the good ones. Maybe as a client you take good service for granted, and only notice when things go wrong.) I’d like to think these lessons will help me in private practice to better understand the client’s perspective.

So here is my list of the lessons I learned – my note to self.

1. Say less, listen more

The most common problem I encountered with outside counsel was misunderstanding. I noticed several kinds:

• Not understanding the facts: providing advice without a proper understanding of the facts to which the advice relates.
• Not understanding what advice is needed: providing advice that is not the type of advice the client is seeking. For example, giving a detailed exposition of the law when the client wants a ‘yes or no’ short answer.
• Not understanding the client’s expectations: for example, not appreciating the importance of the matter for the client, or not picking up on the client’s expectations for service delivery.

Better communication between lawyer and client is the remedy. Both lawyer and client need to work on this, but as the professional adviser, the external lawyer should take responsibility for making it happen. To improve communication, one of the main skills is to be a better listener. Getting all the facts from your client takes time. You need to ask a lot of questions, in a patient and non-intrusive manner. You need to clear your head as much as possible of your own assumptions and listen to what the client is saying. Ask clarifying questions to confirm your understanding.

2. Don’t build a bridge when a rope will do

My second gripe is the tendency of external legal advisers to over-engineer solutions – building a bridge when a rope will do. In part this relates back to misunderstanding – proposing solutions that don’t fit the client’s needs or expectations. Part of it also is imposing your perspective, rather than seeing things from the client’s standpoint. Another cause is a lack of commercial practicality with some external counsel. Beautifully engineered legal solutions sometimes are not operationally efficient. The in-house lawyer is more attuned to the commercial requirements of the client, and external counsel should take their cues from the guidance of internal counsel on these matters. Seek out the simple, cost effective solution, if that will suffice.

3. Advice is not just analysis

An excess of caution can often lead to advice that is not advice at all: the lawyer’s letter that manages to say very little, despite the use of many words. Advice is not just analysis. An adviser should take a position, to the extent that it is possible; a position that is a recommendation or a conclusion, not a decision, because the decision should always rest with the client. So often we are served up legal advice that does not really make any recommendation or conclusion. I expect that is because lawyers are concerned that they do not have all the facts or context, and fear that the client could come back at them if they make a recommendation that turns out not to be the best way forward. But the absence of any position in an advice makes it worthless. It should be possible to appropriately qualify one’s advice to minimise unforeseeable risks from error or misjudgement.

4. Get to the point

Winston Churchill said “jargon can be used to destroy any kind of human contact or even thought itself.” There is a common practice in legal writing to bury the advice under lengthy extracts from legislation or cases and mountains of wordy legal jargon. The more legal writing I read, the more I think that the complexity of the law unfortunately owes as much to the poor expression of lawyers as it owes to the concepts of the law. Some people think form and substance in legal writing are separate matters, where substance is important and form is merely cosmetic. According to this view, as lawyers we are legal technicians, and style is a matter for the marketing department. I reject that distinction between form and substance, as will any reader of an advice. Written advice is a communication – the communication of a recommendation or conclusion. As such, it should be coherent, concise and comprehensible. There is an art to writing legal advice. You should think as much about the way the advice is expressed as you do about its technical content.

5. Don’t ambush on the bill

External lawyers are not always as upfront as they should be about costs: how much a matter is likely to cost, and how much costs have been run up. Even if a good job has been done, as a client there is nothing more unwelcome than getting a nasty surprise on the bill for the work. If you agree on the price, stick to it. That’s the deal. If you provide an estimate that proves too low, alert the client at the earliest opportunity, then discuss and resolve. And please be realistic with estimates. A good understanding between lawyer and client should help in that regard.

AVCAL defines ‘private equity’ as investment typically in unquoted companies that are considered to have strong cashflows from operations and/or high growth potential. Used in this broad sense, it includes venture capital as well as later stage investments. Investments are normally made through funds formed specifically for the investment.

 The fund is usually structured as a limited partnership. The managers of the fund are general partners of the limited partnership and liable for its debts and obligations. The investors are limited partners, with their liability for debts and obligations of the fund limited to the amount of their investment. To protect their limited liability they are passive investors only, prohibited by the constitution of the fund from being involved in investment activities.

Investors are usually super funds, governments and sovereign wealth funds, financial institutions and other sophisticated investors: Australian super funds were the source of 55% of funds in Australian private equity in the 2008 financial year. The ten largest Australian private equity firms manage about 70% of the private equity funds invested in Australia.

Foreign investors make up slightly more than half of their funds under management. Foreign participation is usually lower in smaller funds. About 92% of foreign limited partners are from countries with existing tax treaties with Australia, mostly OECD countries. International funds often channel their funding commitments through feeder collective investment vehicles or ‘fund-of-funds’ in offshore financial centres.

The Cayman Islands is the most popular jurisdiction, and has become one of the main geographical hubs for accessing private equity funds.

Funds are set up this way so that investors avoid double taxation on their gains as the funds flow up the chain from Australia back to the home jurisdiction of the limited partner. AVCAL’s paper was issued in response to draft tax determinations from the Australian Taxation Office (TD 2009/D17 and TD 2009/D18), which if made final may make these kinds of structures less tax effective for foreign investors.