Corporate Transparency Act: Beneficial Ownership Challenges for Business Startups

Corporate Transparency Act: Disclosure and Reporting Requirements for Startups
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For newly formed businesses (startups), the first few years of operations are integral to the company’s success. Founders are concerned with hiring the right employees, developing intellectual property and products or service offerings, fundraising, investor relations, and now, they will also need to be concerned with the compliance requirements of the Corporate Transparency Act (CTA).

Congress passed the CTA in January 2021 to provide law enforcement agencies with further tools to combat financial crime and fraud. The CTA requires certain legal entities (each, a reporting company) to report, if no exemption is available, specific information about themselves, certain of their individual owners and managers (beneficial owners), and certain individuals involved in their formation to the Financial Crimes Enforcement Network (FinCEN) of the U.S. Department of Treasury. The beneficial ownership information (BOI) reporting requirements of the CTA took effect on January 1, 2024. Those who disregard the CTA may be subject to civil and criminal penalties.

As explained in a prior advisory, a startup formed on or after January 1, 2024 is unlikely to fall into one of the CTA’s twenty-three (23) exemptions from the reporting requirements, so such startups will need to file a BOI report with FinCEN within ninety (90) days of its formation (or, if formed on or after January 1, 2025, within thirty (30) days of its formation), with updated BOI reports due within thirty (30) days of any change in the startup’s BOI as reported to FinCEN.

With complex capitalization tables, demanding investors and bespoke management structures, CTA compliance will present some unique challenges to startups, founders and officers.

Challenges in Disclosure

  1. 25% Owners: Nonexempt startups must disclose information about each individual that (directly or indirectly) holds 25% or more of the fully diluted equity of the startup. In order to calculate the fully diluted equity of the startup, a reporting company must consider the total number of shares that would be outstanding if all derivative instruments were exercised. This would include instruments such as stock options, simple agreements for future equity (SAFEs), convertible debt, and warrants. But the initial BOI report is just the beginning, as the set of persons whose details must be disclosed may change each time a derivative security expires, equity interests are sold, additional funds are raised, or the ownership structure of a corporate investor changes. Any such change may trigger an obligation to file an updated BOI report within thirty (30) days.
  2. Substantial Control: Nonexempt startups must also disclose information about any individual that (directly or indirectly) exercises substantial control over the startup. This includes:

    1. Senior officers of the reporting company;
    2. Persons who have the authority to appoint or remove certain officers or a majority of the board of directors of the reporting company;
    3. Persons who direct, determine or have “substantial influence” over important decisions of the reporting company, including decisions about its business, finances or structure; and
    4. Persons who otherwise exercise substantial control over the reporting company.

In the case of startups, this may require the disclosure of information about all members of the board of directors, as the relatively small size of most startup boards and the broad authority held by their members could bring those individuals within the definition above.

In addition, certain investors (including investors owning less than 25%) may get captured by the “substantial control” definition based upon their voting rights as owners of preferred stock, their negotiated veto rights over important decisions or actions, or other forms of influence over key appointments and decisions of the startup. The list of individuals who need to be included in the report will vary based upon the governance structure designed and negotiated by investors in the process of formation and fundraising, and each further round of investment or change in management will need to be scrutinized as a potential trigger for an updated report.

Challenges in Reporting

Each beneficial owner (including those who exercise “substantial control”) will need to provide his or her name, date of birth, current address, and photocopy of an acceptable identification document.  While this seems like information that would be easy to obtain, startups will face challenges.

    1. Structural Challenges: If the direct “beneficial owner” is an entity instead of an individual, the startup will need to conduct multiple levels of due diligence to determine the ownership structure and exercise of control at the level of that entity-owner. This may involve collecting detailed information about the ownership and management of complex investment funds and ownership vehicles, many of whom may be reluctant to provide details to founders.
    2. Reluctant Investors: Some investors may be hesitant or refuse to provide their details for personal or data privacy reasons. Others may take the position that the startup’s legal analysis that they qualify as beneficial owners is unsound. There is no good faith exemption for attempting to comply with the BOI reporting requirements. If the startup fails to comply with the CTA for any reason (including the acts or omissions of an uncooperative investor, director or officer), the startup will be out of compliance. Those that willfully fail to comply may face civil and criminal penalties.

Tools for Compliance

    1. Monitoring Triggers for Updates: As startups continuously raise funds, the ownership structure of the startup is constantly subject to change, and the resulting update requirements under the CTA are likely to be time-consuming and tedious for founders and investors. To meet this challenge, the startup will need to have protocols in place to monitor events likely to trigger an update requirement.
    2. Data Protection and Confidentiality: startups should consider how they will comply with data protection obligations and confidentiality requirements associated with the collection of personally identifiable information gathered pursuant to the CTA. It may be beneficial to designate a third-party provider to collect and store this information or direct persons to obtain a FinCEN identifier to mitigate risks associated with data protection, which can be costly.
    3. Ability to Gather Information for Disclosure: startups should include language in their formation and governance documents that requires investors, directors and officers to provide information necessary to facilitate CTA compliance as a condition to investing in or serving the startup. startups should also disclose the repercussions for investors and senior officers if an investor, director or officer fails to provide required BOI. Existing and potential investors, directors and officers may resist disclosing the necessary information, and the startup should be prepared to take action to compel such disclosure, where possible, to avoid liability to the company and personal liability to senior officers.

Varnum’s Corporate Transparency Act Taskforce of attorneys and other professionals can assist you. Contact Mallory Field of our Venture Capital and Emerging Companies team, any member of Varnum’s CTA Taskforce, or your Varnum attorney to learn more.

What Are Your Rights if EGLE or EPA Suspects Contamination at Your Property?

Understanding your rights if EGLE or EPA Suspects Contamination

We see it a lot: a client buys a piece of property and completes the necessary documents (i.e., a baseline environmental assessment) to ensure they are not liable under Michigan law for preexisting contamination. But then they are contacted by government regulators, looking for contamination and environmental risks and raising a multitude of questions: Do you have to respond? What is EGLE (Michigan’s Department of Environment, Great Lakes, and Energy) or EPA looking for? Are you going to have to pay a bunch of money to clean up the property? Do you have to do the testing that is being requested?

Michigan’s clean-up laws are largely government-regulated by Part 201, Environmental Remediation, of Michigan Natural Resources and Environmental Protection Act. Under Part 201, property owners and operators have various obligations, even if they completed a baseline environmental assessment (BEA) when the property was purchased. For example, a property owner or operator has certain “due care” obligations with respect to the property, such as not exacerbating environmental conditions. The property owner or operator must also ensure that the property is protective of the health and safety of persons using the property.

Similarly, the federal EPA has broad authority as well. Usually, the EPA does not get involved when EGLE does because a memorandum of understanding exists between the EPA and EGLE, which essentially says that EGLE will regulate properties that are suspected of containing hazardous substances. However, exceptions exist, such as Superfund sites. Under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), the EPA has broad information gathering authority. Thus, as one client recently experienced, do not be surprised if EPA sends you a 104(e) request for information if you own or operate a Superfund site, even if it is a site in which EGLE is actively involved.

Michigan and federal environmental clean-up laws are complex. Thus, to no surprise, when clients get a notice of violation or compliance communication from government regulators, we often get a call. We can navigate you through the many complicated legal issues and we often involve environmental consultants as well.

Varnum’s environmental team is well versed in helping property owners and operators navigate the many issues that need to be addressed when government regulators start requesting information from you. If you have questions about environmental regulatory issues, contact a member of Varnum’s Environmental Team.

Beware of Corporate Transparency Act Scams and Fraud

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The Corporate Transparency Act’s (CTA) Beneficial Ownership Information reporting requirements are set to take effect on January 1, and bad actors are already using the CTA’s requirements to solicit unauthorized access to Personally Identifiable Information. To that end, the U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) recently issued a warning regarding such scams. FinCEN describes these efforts as follows:

“The fraudulent correspondence may be titled “Important Compliance Notice” and asks the recipient to click on a URL or to scan a QR code. Those e-mails or letters are fraudulent. FinCEN does not send unsolicited requests (emphasis added). Please do not respond to these fraudulent messages, or click on any links or scan any QR codes within them.”

Be on guard against such fraud and stay abreast of key developments involving this new law by visiting Varnum’s CTA Resource Center.

It’s That Time of Year: Keep Deferred Compensation in Mind

Navigating Year-End Deferred Compensation

At year end it is common to provide bonuses and additional compensation. A growing part of that compensation is deferred – promised in one year and paid in a later year. The Tax Code provides strict rules for when and how to award deferred compensation. In time for year-end awards and vesting, we are providing four reminders to help with compliance.

When do the deferred compensation rules apply?

Whenever a business promises compensation in one year that could be paid in another year, the deferred compensation rules (known as 409A rules after the Code Section where they are located) might apply. There are limited exceptions, such as for 401(k) as well as other qualified retirement plans, health and welfare benefits, and compensation paid by March 15th of the year after the award vests.

Follow Your Plan Documents

One of the biggest risks is failing to follow the documentation around deferred compensation. The Tax Code requires there to be a written record of deferred compensation that includes the key features, including, without limitation, who receives an award, the amount of the award, when the award will vest, and how payment occurs. The documentation will also provide important definitions from the Tax Code that control how those same terms would otherwise be used. For example, the Tax Code has definitions that must be used for separation of service, termination of employment, disability and change of control. Beyond definitions and documentation generally, it is important to remember that once a deferred compensation award is made, it should be modified or amended only after talking to legal counsel, as changing existing awards is an easy way to create problems which are best avoided.

Avoid Accelerating Payment

The Tax Code has strict prohibitions against speeding up a deferred compensation payment. However, waiving or accelerating vesting is not normally a problem. For example, if deferred compensation vests 20% for each of five years and then pays out at the end of the fifth year, it is normally permitted to accelerate vesting, so long as the award will still be paid at the end of the fifth year. One important exception is when vesting triggers payment. For example, it would be a compliance concern if vesting was accelerated in an award that paid when it vested on the earlier of five years, death or disability. The prudent approach is not to accelerate an award unless it is expressly permitted by the award or if experienced legal counsel has reviewed the circumstances.

Carefully Consider New Deferred Compensation

Even though deferred compensation does not get paid out right away, there are real costs and expectation that come with it. Deferred cash needs to be paid out over time and even synthetic equity, which is based on the value of the company is paid out, normally in cash. This cost is one of the many reasons why it is important, when granting new awards, to consider what type and how much compensation is appropriate for the position and goals. Another important factor is whether awards will be made on a one-time basis or annually. If awards will be made every year, it is worth considering smaller annual awards that when collected over several years, remain at an appropriate or reasonable level of compensation.

Value the Awards Properly

One technical and important aspect of the deferred compensation rules is the proper determination of fair market value for equity-based awards. A valuation that complies with the Tax Code is often required when an award is made or paid out. For publicly traded companies, the trading price is the value. If a company is not publicly traded, the Tax Code establishes guidelines for valuation. These guidelines are technical. Getting help from a valuation expert is important, even if an executive or accounting team has established a valuation for other purposes.

If you have questions about your existing deferred compensation awards or are considering new awards, you can contact a member of the employee benefits team for additional information.

NCAA President Proposes Rule Permitting Division I Schools to Pay Athletes

NCAA President Proposes Rule Permitting Division I Schools to Pay Athletes

On December 5, 2023, NCAA President Charlie Baker sent a letter to over 350 member schools, which proposed rules that would permit Division I member schools to pay their athletes for the first time, in ways not tied to educational resources.

The letter outlined a broad “forward-looking” framework needed to sustain the best elements of the student-athlete experience, build on the investments that have changed the trajectory of women’s sports, and enhance the athletic and academic experience for student-athletes.

In order to “deliver this framework” Baker proposed three fundamental changes:

  • First: permit all Division I colleges and universities to offer student-athletes “any level of enhanced educational benefits they deem appropriate.”
  • Second: rules should be changed to permit any Division I school to enter into name, image, likeness (NIL) licensing opportunities with their student athletes.
  • Third: proposed the creation of a subdivision comprised of institutions that would invest in their student-athletes. The institutions in this subdivision would be required to:
    • (1) (within the framework of Title IX) invest at least $30,000 annually into an enhanced educational trust fund for at least half of the institution’s eligible student-athletes, and
    • (2) commit to work collaboratively with peer institutions in this subdivision in order to create rules that may differ from the rules in place for the rest of Division I. These rules may include, but are not limited to, scholarship commitment and roster size, recruitment, transfers or NIL.

Baker noted that the first two changes seek to enhance the financial opportunities available to all Division I student-athletes. Additionally, the first two changes will help to level the playing field between men and women student-athletes, as schools must abide by existing gender equity regulations in their athletic program investment decisions. As it pertains to the third fundamental change, as it stands now, the NCAA would permit schools to choose who, when, and how their student-athletes receive the trust fund money. Importantly, the NCAA does not intend to require that an athlete finish their degree before they have access to the trust fund.

In short, for the schools that choose to adopt these rules, these fundamental changes have the effect of permitting Division I schools to pay their student athletes in ways not tied to educational resources. Baker’s letter is seen by the NCAA as a model that Congress may use should it choose to enact federal laws governing college sports. While there is no timeline as to when these proposed rules may be enacted, members and student-athletes are encouraged to provide the NCAA with feedback as the NCAA works to further develop this proposal. In order to adopt this proposal, NCAA schools must vote to adopt the changes.

Corporate Transparency Act: Implications for Business Startups

Corporate Transparency Act: Implications for Business Startups
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Congress passed the Corporate Transparency Act (CTA) in January 2021 to provide law enforcement agencies with further tools to combat financial crime and fraud. The CTA requires certain legal entities (each, a “reporting company”) to report, if no exemption is available, specific information about themselves, certain of their individual owners and managers, and certain individuals involved in their formation to the Financial Crimes Enforcement Network (FinCEN) of the U.S. Department of Treasury. The beneficial ownership information (BOI) reporting requirements of the CTA are set to take effect on January 1, 2024. Those who disregard the CTA may be subject to civil and criminal penalties.

A recent advisory explaining the CTA reporting requirements in further detail may be found here.

While the CTA includes 23 enumerated exemptions for reporting companies, newly formed businesses (Startups) may not qualify for an exemption before the date on which an initial BOI report is due to FinCEN. As a result, Startups (particularly those created on or after January 1, 2024) and their founders and investors, must be prepared to comply promptly with the CTA’s reporting requirements.

As an example, businesses may want to pursue the large operating company exemption under the CTA. However, among other conditions, a company must have filed a federal income tax or information return for the previous year demonstrating more than $5 million in gross receipts or sales. By definition, a newly formed business will not have filed a federal income tax or information return for the previous year. If no other exemption is readily available, such a Startup will need to file an initial BOI report, subject to ongoing monitoring as to whether it subsequently qualifies for an exemption or any reported BOI changes or needs to be corrected, in either case triggering an obligation to file an updated BOI report within 30 days of the applicable event.

Startups also should be mindful that the large operating company exemption requires the entity to (i) directly employ more than 20 full time employees in the U.S. and (ii) have an operating presence at a physical office within the U.S. that is distinct from the place of business of any other unaffiliated entity. Importantly, this means that a mere “holding company” (an entity that issues ownership interests and holds one or more operating subsidiaries but does not itself satisfy the other conditions of this exemption) will not qualify. Startups may want to consider these aspects of the large operating company exemption during the pre-formation phase of their business.

Fundraising often requires Startups to satisfy competing demands among groups of investors, which can lead to relatively complex capitalization tables and unique arrangements regarding management and control. These features may cause BOI reporting for Startups to be more complicated than reporting for other small and closely held businesses. Founders, investors, and potential investors should familiarize themselves with the CTA’s reporting requirements and formulate a plan to facilitate compliance, including with respect to the collection, storage and updating of BOI.

By ensuring all stakeholders understand the BOI reporting requirements and are prepared to comply, your Startup can avoid conflicts with current and potential investors and ensure that it collects the information that it needs to provide a complete and timely BOI report.

Varnum’s Corporate Transparency Act Taskforce of attorneys and other professionals can assist you. Contact your Varnum attorney or any member of Varnum’s CTA Taskforce to learn more.

Michigan Adopts the Uniform Power of Attorney Act

Michigan Adopts the Uniform Power of Attorney Act

If you have executed a Power of Attorney (POA) to give a trusted individual the ability to access your financial accounts or sign documents on your behalf, whether in case of emergency or simply for convenience, or if you are thinking about doing so, a new law in Michigan impacts the way surrogate authority is granted. 

By executing a POA, you grant someone else important powers to act on your behalf. The person you appoint is called your “Agent.” A POA can be “Durable” or “Non-Durable.” A Durable POA can be particularly useful because, unlike a Non-Durable POA, your Agent’s authority to act on your behalf will not be terminated even if you are incapacitated. A new law in Michigan is designed to provide for increased accessibility, effectiveness, and standardization for POAs. 

The Uniform Power of Attorney Act (UPOAA) was signed into law by Governor Gretchen Whitmer on November 7, 2023, and will take effect on July 1, 2024. Given the increased mobility of the population and modernization of technology, the UPOAA codifies state legislative trends across the United States and creates a cohesive set of best practices for drafting and utilizing POAs. To date, a version of the UPOAA has been enacted in 31 states.

The UPOAA accomplishes several important objectives:

  • It promotes uniform acceptance of notarized POAs. No longer will third parties be permitted to refuse to accept a validly executed POA simply because the document didn’t clear the entity’s legal department. The UPOAA provides sanctions for persons or entities who refuse to accept an acknowledged POA. “Acknowledged” means verified before a notary public (or other individual authorized to take acknowledgements).
  • It provides protection for third parties who rely on notarized POAs. The UPOAA is designed to protect third parties who accept a notarized POA in good faith, and also provides clear circumstances where acceptance of a POA can and should be denied. If there is any doubt, the third party can request a certification or opinion of counsel as to the validity of the POA within a seven-day window of the presentment of the document. 
  • It provides a series of default rules for POAs. If the POA is executed in compliance with certain requirements, the POA will automatically be durable under the UPOAA. This is a change from current Michigan law which mandates that there be an affirmative statement as to durability in the POA. There are other helpful default rules in the UPOAA including provisions regarding the determination of incapacity, and the coordination of co-agents’ authority, successor agents, and court-appointed guardians and conservators.
  • It promotes accessibility and frees up judicial resources. Michigan has had a statutory form Will and statutory form Designation of Patient Advocate for some time. Now, there will be a statutory form Power of Attorney. The purpose of the form is to give the public easy access to creating POAs, which will decrease the necessity of guardianships and conservatorships. However, as clearly stated on the form, because of the important authority granted in POAs, individuals should use caution in preparing these important forms without the assistance of counsel.

Given these sweeping changes promulgated by the UPOAA, it’s a good time to revisit your POA. The UPOAA applies to all POAs, even those executed prior to July 1, 2024. As long as your POA was validly executed at the time it was signed, your POA will remain valid – but you may want to confirm that your POA is notarized. Many individuals executed legal documents during the pandemic when it may have been difficult to obtain a notary. If your POA is not notarized, you may want to re-execute the document before a notary to garner the additional protections that the UPOAA provides to acknowledged POAs.

Corporate Transparency Act’s Reporting Requirements: Impact on the Private Client

Cooperate Transparency Act: Impact on the Private Client
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Private clients and family offices commonly create legal entities, such as limited liability companies, limited partnerships and corporations, to facilitate investment, asset management, tax planning, business succession planning, privacy, liability protection and many other purposes.  Such planning will be impacted by disclosures required by the Corporate Transparency Act (CTA), set to take effect January 1, 2024. The CTA, enacted to combat illicit financial activities, brings significant regulatory changes and effectively creates a national registry for law enforcement and certain other entities of the beneficial ownership information (BOI) for many legal entities formed or registered in the U.S. (Reporting Companies).

A recent advisory explaining the CTA reporting requirements in further detail may be found here.

Under the CTA, Reporting Companies include limited liability companies, corporations, and any other entities created by the filing of a document with a secretary of state or other similar office, whether or not the legal entity engages in any business or other commercial activity. If a legal entity meets the definition of a Reporting Company and does not qualify for an exemption, the Reporting Company will be obligated to disclose to the U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) specific information about itself and the BOI of its beneficial owners and company applicants, including their full name, date of birth, complete address, and other identifying information. The CTA defines “beneficial owner” as an individual who either, directly or indirectly, exercises substantial control over the Reporting Company or owns or controls at least 25% of the ownership interests of the Reporting Company.

A trust itself is not a Reporting Company if it is not created by the filing of a document with a secretary of state or other similar office (which is often the case). Regardless, if a trust exercises substantial control over the Reporting Company or holds an ownership interest in a Reporting Company and the other requirements are met, at least one individual associated with the trust will be a beneficial owner. The CTA contains specific rules under which an ownership interest held by a trust or similar arrangement is attributed for determining the individual(s) subject to the BOI disclosure requirement. The Reporting Company should attribute such ownership as follows:

  • To any individual trustee that has “the authority to dispose of trust assets.”

  • To any individual beneficiary who “(i) is the sole permissible recipient of income and principal, or (ii) has the right to demand a distribution of or withdrawal substantially all the assets from the trust.”

  • To any individual grantor or settlor who “has the right to revoke the trust or otherwise withdraw the assets of the trust.”  

For many trusts, more than one individual will meet these criteria, and, in such cases, each individual’s BOI must be reported. Even if a trust owns or controls less than 25% of the ownership interests of the Reporting Company, the Reporting Company must assess whether the trustee exercises substantial control over the Reporting Company, such as through board representation.

As noted above, certain Reporting Companies are exempt from the CTA, including certain tax-exempt entities, certain entities subject to other federal reporting, and certain large operating companies. Additionally, certain individuals who may otherwise qualify as a beneficial owner will not be required to disclose BOI if an exception applies, including minor children (if applicable, the Reporting Company may instead report information about the parent or legal guardian of the minor child). The failure to timely comply with the reporting requirements could result in civil and criminal penalties.    

The disclosure of BOI for private clients and family offices may be counter-productive to privacy and other goals and may in some circumstances necessitate further analysis and planning. Each private client, family office, and small business owner should prepare now.  Varnum’s Corporate Transparency Act Taskforce of attorneys and other professionals can assist you. Contact your Varnum attorney or any member of Varnum’s CTA Taskforce to learn more.