Good Cap Table Hygiene: How to Avoid Dooming Your Startup Before It Ever Gets Off the Ground

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You’re a startup company founder with a great idea or product. After bootstrapping through the early days, and perhaps early funding from friends and family, you’re ready for more significant investment. Before you even get to discuss term sheets with your potential investors, the investors ask for the company’s capitalization (or cap) table—and after getting it, the investors suddenly lose interest. Discussion doesn’t even get to negotiation, and the investors move on. What just happened? Well, maybe your company’s cap table was the problem—was it in good shape and did it make sense? There are some common mistakes founders make with respect to cap tables. Here’s how to avoid them with good cap table hygiene.

A cap table is a record providing details on who has what ownership in a company, including the number and types of securities. At the most basic level, the cap table shows how much equity has been issued, how much is still available and who owns what portion of the company. At a more strategic level, the cap table can and should reflect who the company owners are, how the owners relate to one another and the business of the company, how control by the owners is achieved, maintained or protected, how value of the company is now and in the future shared by the owners, how much room for additional owners there is, and more. In short, while a cap table is just a record of company ownership, it is much more than just an exercise in paperwork and administration: it is a framework for the story of what company ownership means now and in the future. Founders would do well to pay attention to what story their company’s cap table communicates.

A cap table may be simple to begin with when a company has a single owner holding all of the securities of the company. But a cap table can become complicated quickly as a company grows and securities are used more broadly for different purposes – like securing talent, incentivizing performance, and raising capital. While this complexity is easily identifiable when investors come on board, even so-called simple cap tables present unappreciated nuances. The cost of not thoughtfully managing your company’s cap table is not just confusion about your ownership or the value of your investment. It may also include scaring off potential investors who translate a confused, muddled, or incomplete cap table as a “risky” or, worse yet, “bad” investment opportunity. Without a purposeful understanding of the strategy underlying your cap table and a clear and accurate presentation of that, your potential investor may just decide to move along to the next promising company.

Here are three common mistakes company founders sometimes make with regard to cap tables:

1. Failure to document and track your company’s capitalization.

Founders are busy people on whom falls most if not all of the tasks of owning and operating a startup company. In the midst of all the competition for a founder’s attention, creating and maintaining the cap table can easily be dismissed as a mere administrative task that can be done later. Even those who appreciate the importance of tracking issuances or promises to issue securities may not be doing so in a format that helps them substantively understand the current and future value or strategic future of the company. If you don’t track it, especially in a form where you can see the big picture, you might give away more securities than you should, or to the wrong people, or for the wrong reasons.

2. Commitments for securities without documenting.

A cap table provides detail on company ownership, but company ownership is not created by a cap table. The issuance of securities to owners reflected on a cap table should be based on documentation of the issued securities. Have you been promising someone options or shares, maybe even included them on your cap table? You better have the paperwork evidencing the actual issuance of those options or shares. If there is no evidence as to what securities have actually been issued, it’s a red flag for investors who can’t trust what the cap table says about who else owns part of the company—and what that means for their prospective investment.

3. Not appropriately valuing the equity.

This is a common and costly mistake. A new startup company doesn’t have any cash flow, so the founders pay with what they have readily and “freely” available: securities of the company. It can be very easy to give away 100 shares (the value of which is speculative) rather than give someone $1,000 in cash. It is a simple matter of paperwork to generate 100 shares—just print it out a piece of paper with some fancy doilies! But $1,000 in cash? If you fail to maintain a clear understanding of what the value of those shares is, not just now but in the future, you could be betting against your own company. Those recipients could end up owning a disproportionate share of the company, a problem which may prevent future investment.

Even though these and other cap table problems are often fixable, you can end up wasting valuable time (and money) getting your cap table back on track. Why not avoid them instead? Your company doesn’t need to be doomed from the start. Get serious about your company’s cap table—create it, maintain it, track it, and thoughtfully and critically use it.

Legal Rights When EGLE Requests Removal of Sandbags on the Great Lakes Shorelines

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Just a few years ago, property owners on the shorelines of the Great Lakes took measures to protect their property from high water levels. Many people installed sandbags, usually at significant cost. The sandbags were often permitted under Part 353, Sand Dunes Protection and Management, or Part 325, Great Lakes Submerged Lands, of Michigan’s Natural Resources and Environmental Protection Act. The Michigan Department of Environment, Great Lakes, and Energy (EGLE) is now requiring the removal of those sandbags, including sending some property owners a compliance communication if they have not yet removed the sandbags.

EGLE’s actions in requiring the removal of sandbags has drawn criticism from many property owners. One obvious concern is that the removal of the sandbags may cause more damage to dunes and the environment than simply leaving them in place. Some property owners question the feasibility of removing sandbags, especially those that have been buried by sand or that have sunk below the surface. In some situations, structures (such as steps) have been built over sandbags. Others have concerns that water levels may rise again or that the sandbags are still actively protecting their property from eroding due to the unique geographic features of their property.  

What makes the situation particularly ironic (and bothersome) for some property owners is that they did not want the sandbags in the first place. Some property owners sought permits for structures such as sea walls that would have permanently protected their property, even though such structures are far more expensive than sandbags. But EGLE denied some of those requests and instead told the property owners to install the purportedly less intrusive sandbags. Now EGLE is requiring the removal of the very solution it preferred, even though removal will certainly require disruption to the dunes while property owners with sea walls are allowed to keep their structures.

Throughout the years, Varnum has represented many property owners to help them protect their property on the shoreline of the Great Lakes and to assist them in navigating their legal rights with EGLE. If you need guidance navigating your legal rights when EGLE sends you a compliance communication, requests removal of your sandbags or issues you a Notice of Violation (NOV), please contact one of our environmental attorneys and we would be glad to help.

Is Collaborative Divorce Right for You?

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Divorce is often associated with feelings of animosity, bitterness and lengthy, expensive courtroom battles. However, there is an alternative, less adversarial approach to ending a marriage – collaborative divorce. In collaborative divorces couples work together with their professionals to reach a settlement in a team approach. Unlike traditional divorce proceedings, collaborative divorce encourages a problem-solving mindset rather than an adversarial one.

The key features of a collaborative divorce include the following:

A Collaborative Team

Each spouse hires a collaborative attorney, who is specially trained in this approach, and assembles a team that may include financial experts, child specialists and/or therapists. This multidisciplinary team provides guidance and support throughout the process.

The Collaborative Agreement

At the start of the process, all team members sign a Collaborative Agreement in which both sides commit that neither will file anything in court until a final agreement is reached. If at any time the negotiations break down or either party abandons the process, all members of the team must withdraw from the case. This can be a harsh consequence, which often motivates people to stay committed to the collaborative process.

Transparent Communication and Disclosure of Assets

In collaborative divorce, all parties commit to open and honest communication along with efficient and full disclosure of financial information. This fosters an environment of trust, where concerns and interests can be expressed freely without fear of judgment or retaliation.

Interest-Based Negotiation

Instead of focusing on positional bargaining, where each party advocates for their demands, collaborative divorce focuses on identifying and addressing the underlying interests and needs of both spouses. This approach allows for creative solutions that may not be possible in a courtroom setting.

Out-of-Court Settlement

Through a series of negotiation sessions, the collaborative team helps the couple work towards a comprehensive and mutually satisfactory settlement agreement. This agreement covers all aspects of the divorce, such as property division, child custody and parenting time, child support, spousal support and other relevant issues.

Preservation of Relationships

Collaborative divorce prioritizes maintaining a respectful relationship between divorcing spouses, which is particularly crucial when co-parenting children. By fostering cooperation this process reduces the likelihood of long-lasting animosity and allows for healthier future interactions.

Privacy and Confidentiality

Unlike traditional divorce proceedings that take place in a public courtroom, collaborative divorce proceedings are private and confidential. This confidentiality provides a safe space for open communication and reduces the potential for public exposure of sensitive information. Though couples going through a traditional divorce may also get the benefits of privacy and confidentiality in a mediation, they will likely not have the transparency and interest-based negotiations utilized in a collaborative divorce. The mediation process in a traditional divorce may be less effective as well, if it is scheduled within the constraints of a court’s scheduling order before all financial disclosures are complete or conducted with shuttle-style diplomacy rather than a facilitative approach.

Emotional Support

Collaborative divorce recognizes that the emotional well-being of the parties involved is as important as the legal aspects of the process. All divorces involve some emotional trauma – whether or not there are diagnosable mental health issues. With the help of therapists or divorce coaches, individuals receive the emotional support needed to navigate the challenging emotions associated with divorce.

Cost-Effective

By avoiding lengthy and contentious court battles, collaborative divorce can often be a more cost-effective option. The process typically requires fewer hours of legal representation, resulting in lower attorney fees and overall expenses. In addition, couples learn problem-solving skills which often helps reduce post-judgment legal interactions.

Collaborative divorce offers a peaceful and constructive path to ending a marriage, allowing couples to move forward with their lives while minimizing conflict and stress. This approach can be beneficial to divorcing spouses, their children and extended families. However, not all cases may be suited for the collaborative process and may require court intervention.

Varnum’s Family Law Team can help guide you through the various options to help determine what may be best for your particular circumstances.

NLRB Sets the Stage for Increased Scrutiny of Work Rules and Employee Handbooks

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In a troubling decision released yesterday, the National Labor Relations Board (the Board) issued a new standard for reviewing workplace rules that do not expressly prohibit activity protected under the National Labor Relations Act (the Act) and reversed the frameworks set forth in the 2017 Boeing case. The new standard evaluates whether a reasonable worker who is “economically dependent on the employer” would interpret the rule to prohibit organizing or engaging in concerted activities. This new standard applies to all work rules and employee handbooks in both unionized and non-unionized workplaces.

A work rule is unlawful under the Act when the rule has a reasonable tendency to chill employees’ exercise of their rights under the Act. Under the new Stericycle standard, an administrative law judge (ALJ) or the Board will interpret the rule from the perspective of an employee who is economically dependent on the employer. Any ambiguity in the rule will be construed against the employer. If an economically dependent employee could reasonably interpret the rule to restrict or prohibit concerted activity under Section 7 of the Act—even if a different, reasonable and lawful interpretation is possible—the rule is presumptively unlawful and invalid. The employer’s business reason for adopting the rule, for example, safety or protection of confidential information, does not matter. If the rule is found to be presumptively unlawful, the employer’s only defense would be to establish that that the its “legitimate and substantial business interest” could not be accomplished by a more narrowly tailored rule.

In light of the decision in Stericycle, employers should review their employee handbooks, policies, procedures, employment agreements and other workplace rules to ensure that such documents are narrowly tailored to effectuate the purpose of the intended rules without creating an opportunity for argument that the rule has a chilling effect on concerted activity. 

Please contact your Varnum attorney if you have any questions or for assistance with reviewing employee handbooks, policies, procedures, employment agreements and other workplace rules.

H-1B Cap Second Random Selection, Revised Form I-9 and ETIAS Implementation

H-1B Lottery

U.S. Citizenship and Immigration Services (USCIS) announced it will conduct a second lottery to reach FY 2024 numerical cap for H-1B registrations filed in March. We will notify clients of selection results as soon as they are completed.

Revised Form I-9

On August 1, 2023, USCIS will publish revised Form I-9 and end COVID-19 flexibilities. E-Verify employers qualify for new DHS procedure to remotely examine employees’ identity documents. All employers must utilize new Form I-9 starting November 1, 2023, that has the following updates:

  • Shorter in length
  • May be completed on tablets and mobile devices
  • Separates Preparer/Translator Certification into standalone supplement
  • Revises list of acceptable documents
  • Includes new checkbox for employers examining documents remotely

ETIAS Implementation

Expected implementation of European Travel Information and Authorization System (ETIAS) online visa waiver system is early 2024. ETIAS will require individuals from certain visa-exempt countries, including US citizens, to register online before visiting more than 25 countries in Europe. Once ETIAS is granted, US citizens will receive visa-free entry for a maximum of 90 days within any 180-day period. ETIAS registrations are valid for three years or until registered passport expires.

Please contact your Varnum immigration attorney with questions.

SECURE 2.0: Important Changes to Roth Accounts

SECURE 2.0 has changed dozens of benefits plan rules. Among these are changes to when and how Roth accounts are used. Roth account are retirement accounts, in a 401(k) plan or an IRA, to which after-tax money is contributed and no income tax is paid on distributions, including earnings (as opposed to “traditional” 401(k) or IRA accounts, which accept pre-tax contributions, but for which distributions, including earnings, are taxed when received). These changes have increased the required and permitted uses of Roth contributions.

Matching Contributions

Plan sponsors may decide whether to offer participants the option to designate employer matching contributions as Roth contributions, rather than only as a traditional (pre-tax) match. This option also applies to matching qualified student loan payments (if the employer elects to do so) and matching contributions to a 457(b) plan. This is an optional provision. If a plan sponsor decides to offer Roth matching contributions, it will need to amend its plan. If implemented, matching contributions must be fully vested at all times, so employers should carefully consider whether to elect this option. Plan sponsors may elect to implement this provision effective any time on or after December 29, 2022.

Catch Up Contributions

Catch up contributions are 401(k) deferrals in excess of the regular elective deferral limits that may be made by participants who are over age 50. Plans must now require participants who made at least $145,000 (adjusted annually after 2024) in the previous year to designate catch up contributions, if any, as Roth contributions. Plan sponsors may also elect to require participants who made less than $145,000 (as adjusted) make catch up contributions as Roth contributions. Before SECURE 2.0, catch up contributions could be made as traditional (pre-tax) contributions or Roth contributions, depending on the plan. This change is effective for plan years beginning on or after January 1, 2024. Plan sponsors will need to coordinate with legal counsel and plan administrators to ensure this change is implemented properly.

Pre-Death Distributions

SECURE 2.0 makes several changes to required minimum distributions (RMDs). Effective January 1, 2024, plans are no longer required to make RMDs for Roth 401(k) accounts before the participant’s death.

Conclusion

For plans that do not currently permit Roth contributions, now may be a good time to reassess whether broad inclusion of Roth contributions should be added to the plan. Roth contributions are essentially required for any plan that offers catch-up contributions, and may be desirable for other plans as well. Employers should also monitor changes in this area, as there are industry groups requesting guidance, relief during the transition and delayed effective dates for implementing the required changes.

Varnum will continue to provide updates throughout the year highlighting other provisions. Employers are encouraged to contact their Varnum Employee Benefits Attorney with any questions.

Michigan Supreme Court Expands Parental Rights of Same-Sex Parents

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On July 24, 2023, the Michigan Supreme Court (“the Court”) issued a 5-2 ruling resulting in the expansion of parental rights for LGBTQ+ parents in the state. In Pueblo v Haas, the Court considered whether an unmarried, same-sex parent can seek custody and parenting time over a non-biological child conceived during a decades-long domestic partnership prior to the 2015 decision in Obergefell v. Hodges which legalized same-sex marriage at a federal level.

The central legal argument before the Court concerned Michigan’s “equitable parent doctrine,” which allows non-biological parents the ability to petition the courts for custody and parenting time over their children if they were previously married. Plaintiff Pueblo argued that the Court should narrowly extend the doctrine to include same-sex couples who were prohibited from marrying by now-overturned state law; the Court agreed. “The children of same-sex partners bear no lesser rights to the enjoyment and support of two parents than children born to married opposite-sex parents,” Justice Megan Cavanagh wrote in the decision. “Justice does not depend on family composition; all who petition for recognition of their parental rights are entitled to equal treatment under the law,” Cavanagh wrote.

The Court’s two conservative justices, David Viviano and Brian Zahra, dissented. Justice Zahra cited “far-reaching ramifications,” claiming that the Court’s decision would be used by unmarried same-sex couples pre-Obergefell to petition the courts for “property division, spousal support and any other traditional areas of domestic-relations law that accompany a divorce.”

As a result of the ruling, an unmarried same-sex parent may now petition courts for custody and parenting time under the equitable parent doctrine provided proof is established that marriage would have occurred had it been legal prior to Obergefell. Therefore, plaintiff Pueblo can now petition a lower court for custody and parenting time.

Varnum’s full-service Family Law Team represents parties in all manner of sensitive disputes and parenting matters; please contact any member of our team to learn more.

Primer on Fines and Suspension in Covenant Enforcement

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Enforcing violations in a community association can be cumbersome, contentious and unneighborly. Depending on the nature and severity of the violation, the association may be able to exercise self-help and cure a violation such as overgrown grass. Alternatively, in severe situations, the association may be forced to pursue an emergency injunction.

The most common enforcement mechanism is the use of fines and suspensions. Although the idea is to provide a simple “in-house” remedy to avoid clogging the court dockets with disputes over minor violations, the reality is that the process to levy a fine or suspension can seem daunting. This advisory is intended to provide a basic understanding of the fining process and recommendations to utilize this remedy effectively and properly.

1. The Violation Must Be “Ripe” 

Despite the severity or frequency of a violation, community associations may be required to provide warnings or cure opportunities before imposing fines and suspensions. Although the Florida Statutes do not require a community association to provide one or more warning letters, many covenants or internal enforcement policies self-impose a requirement to provide a warning. Many communities adopt enforcement policies or amend their governing documents to provide owners with one or two warning letters before the association will impose fines or suspensions.

Although this is good intentioned, the association may be precluded from pursuing a fine for a serious violation. For example, if an owner drives 60 mph through the community, it may not be enforceable if the association’s internal policy requires 10 days to cure a violation. When the car eventually slowed down, the violation was arguably cured. Likewise, if a tenant hosts loud parties late into the night every two weeks, the violation may be cured every night when the party ends.

Thus, the first recommendation is to review any internal policies and procedures to make sure the violation is ripe. If the community has self-imposed restrictions such as providing a warning or cure opportunity, it is recommended that the Board either remove these requirements or add a provision to allow the Board to skip the warning and cure requirements when there is a severe or egregious violation requiring immediate action.

2. The Board Must Vote

After the violation is ripe, the Board must vote to accomplish three tasks. First, the Board must vote to determine that a violation occurred. Second, the Board must vote to determine the number of dollars per day of the violation. Third, the Board must vote to determine the number of days to be fined at the daily rate determined above. Likewise, for a suspension, the Board must vote to determine the number of days of a suspension. The Board is not required to provide any special notice to the offending owner other than its normal Board meeting and agenda requirements.

It seems arduous to have a Board meeting to levy fines of $20 every time, for example, a neighbor leaves out their trash cans. As a result, many communities adopt a policy which delegates authority to a specific person or group to carry out the three tasks listed above. The resolution could delegate authority to the property manager or an office to make these initial determinations. In addition, the Board could adopt a pre-determined schedule of fines for the most common violations. Together, this would avoid lengthy Board meetings to impose penalties for routine violations and still require a Board vote for unique or rare violations that would normally justify a discussion at the Board level.

3. An Impartial Hearing 

After the Board (or its authorized designee) determines the amount of the fine or suspension, the association must conduct a hearing with an impartial committee of community members. The hearing committee may not be connected to current directors or officers and is intended to act as a neutral and impartial jury of peers. The committee’s role is to vote to approve or disapprove the fine or suspension approved by the Board. The committee will often ask questions, review photos, e-mails and incident reports relative to the act giving rise to the hearing and allow the owner to present a defense.

Confusingly, both the homeowners association and condominium statutes have historically provided that an association is required to provide “an opportunity for a hearing.” This can be interpreted to mean that the association must provide a hearing whether it is requested by the owner or not, but this was not a settled issue, as some communities would only provide a hearing if the owner requested a hearing. 

Effective October 1, 2023, the Florida legislature amended Section 720.305 for homeowners associations to clarify that a hearing must occur before a fine is due and payable. Unfortunately, the same clarification was not adopted for Section 718.305 applicable to condominium associations. Nevertheless, it has always been my recommendation to schedule and conduct a hearing in all situations and irrespective of whether the owner requests a hearing.

4. Collection 

If the hearing committee approves the fine, it is due and payable five days after the association provides notice to the owner of the approved fine. If the owner refuses to pay the fine, the association’s collection efforts will depend on the amount of the fine and the language in the association’s governing documents.

Chapter 720 governing homeowners associations provides that a fine of $1,000 or more may become a lien against a home. This means fines less than $1,000 must be collected as specified in the association’s governing documents or through small claims court. It is also recommended that the Board review the governing documents because some older covenants will expressly state that fines may never become a lien against a home. Chapter 718 governing condominium associations does not authorize fines of any amounts to become a lien against the condominium unit.

Generally, the association should work with its legal counsel to ensure that the Board’s goals and procedures align with the statutes and the association’s governing documents. If the Board desires to use fines and suspensions as a means of enforcement, the association should also be cognizant whether the Board pursued similar violations in the past and whether the Board is currently pursuing all known and similar violations to avoid a defense of selective enforcement. 

Please contact your Varnum attorney with any questions.