1 Minimizing Risk Through Company Restructuring Garth D. Stevens, Snell & Wilmer L.L.P. Joshua P. Hayes, Eide Bailly LLP

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Minimizing Risk Through Company Restructuring Garth D. Stevens, Snell & Wilmer L.L.P.

Joshua P. Hayes, Eide Bailly LLP

2©2010 Snell & Wilmer L.L.P.

Objectives of Reorganization

1. Protect specific classes of assets (e.g., real estate, IP)

2. Create firewalls between different businesses

3. Insulate higher risk business from lower risk business

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Limited Liability and Piercing the Corporate Veil


Limited Liability

• A fundamental tenet of corporation and LLC formation:

• Ordinarily, a company’s shareholders will not be liable for the company’s debts or other liabilities beyond the shareholders’ equity investment in the company.


Piercing the Corporate Veil

Potential triggers:◦ Fraud◦ Deliberate efforts to hinder creditors◦ Recklessly undercapitalizing / underinsuring the

company.◦ Failing to observe legal formalities that give the

company independent legal status.


—High risk operations—Low risk operations—IP assets—Owned real estate

Shareholders

Company

Simple Company Structure


Common Firewall Structure

Shareholders

HoldCo

OpCo. #1 OpCo. #2 IPCo.Real Estate

Co.


Three-Step Process

• First – Factual analysis and planning; preliminary steps.

• Second – Complete the Reorganization (one time event).

• Third – Observe corporate & business formalities (ongoing).


Factual Analysis & Planning; Preliminary Steps

• Determine appropriate tax structure. • Identify contractual restrictions (e.g., bank loan

documents; shareholder agreements).• Identify permit and licensing issues, including

transferability.• Identify notices/registrations that will need to be

made (e.g., IP transfers; notices to customers).• Obtain applicable shareholder/director approvals.


Tax Analysis and Considerations

• Tax considerations – e.g., preservation of NOLs and tax credits.

• Valid business purpose.• Shareholders receive stock in exchange

for stock.• Investment position is equivalent after

transaction is complete.


How Do We Get There?

1. Form new HoldCo.2. Shareholders of current OpCo

assign their shares of OpCo to new HoldCo (Code § 351)

3. In exchange, HoldCo issues shares to OpCo shareholders

4. The result – Shareholders now hold the same % ownership of HoldCo and HoldCo owns OpCo

Step One – Formation of New Parent Holding Company

Shareholders

HoldCo

OpCo.


Shareholders


1. HoldCo forms new OpCo subsidiaries.

2. Each OpCo subsidiary issues shares to HoldCo

3. S-election for new HoldCo; Q-Sub elections for subsidiaries (watch timing)

Step Two – Formation of New Subsidiaries

HoldCo.

OpCo. OpCo. IPCo.Real

Estate Co.


Shareholders


1. Original OpCo. makes a dividend/distribution of assets to HoldCo. (Code § 368)

2. HoldCo then contributes the assets to another OpCo subsidiary.

3. OpCo’s then enter into cross agreements on arm’s length terms.

Step Three – Transfer of Assets

HoldCo.

OpCo. OpCo. IPCo.Real

Estate Co.

ASSETS


The End Result

Shareholders

HoldCo

OpCo. #1 OpCo. #2 IPCo.Real

Estate Co.

Building LeaseIP Licenses

Admin Services Agreements


Subsidiaries vs. Sister Companies

Parent Co.

OpCo.

IPCo.Real Estate

Co.

HoldCo

OpCo. IPCo.Real

Estate Co.


Subsidiaries vs. Sister Companies

• Consolidated tax election?• Combined filing?

Tax Filing Considerations:


Preserving Limited Liability

TWO KEYS:

1. Maintenance of independent existence and operation.

2. REASONABLE capitalization and/or insurance for each company.


Independent Existence

• Think of (and treat) each company as if it was truly independent of each other company.

• If you don’t treat each company as a separate legal entity, there is a good chance that a court won’t either.


Maintaining The Firewalls

• Avoid co-mingling funds; each company with its own bank account.

• Document inter-company transactions with written agreements on arm’s length terms.

• Intercompany loans should be under written, interest-bearing notes or loan agreements (not just GL entry).

• Each company should follow proper corporate formalities.• Where appropriate, each company should have its own

employees.• If possible, avoid cross guaranties and cross-default terms

in contracts.• If possible, physical segregation of businesses.


Capitalization and Insurance

• The best way to avoid a creditor’s attempt to “pierce the veil” is to give the creditor no need to do so.

• Take a REASONABLE approach to capitalizing and/or insuring each company.

7 Tax Mistakes that will cost you

• Payroll Taxes◦ It’s a VERY easy and tempting loan to make◦ It isn’t the employer’s money, it is trust fund money on

behalf of employees.

• Independent Contractors◦ Employees are expensive and healthcare reform is

complicated.◦ 20 part test IRS uses to determine status of worker



• Owner compensation strategies◦ Reasonable compensation for services◦ C-corp vs. S-Corp vs. LLC

• Hire your Children?◦ Reasonable compensation for services◦ Must be real work performed or services performed◦ College planning with low tax cost and potential

credits



• Keeping Receipts◦ Must keep an accurate diary or business log in

addition to receipts◦ Documentation of Who? Why? When? Where?

• Purchasing equipment at the end of the year◦ Mid quarter convention might limit deduction◦ Uncertainty of bonus depreciation and Sec. 179



• Embezzlement◦ Separation of duties

- Ordering vs. receiving- Check writing/signing vs. A/P input

◦ Monthly oversight by owner is a must!


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Thank You

Garth StevensSnell & Wilmer

[email protected]

Joshua P. HayesEide Bailly LLP

602.264.8663 [email protected]

Documents

1 Minimizing Risk Through Company Restructuring Garth D. Stevens, Snell & Wilmer L.L.P. Joshua P. Hayes, Eide Bailly LLP