Dan
Welcome to Sound Business Insights. I’m Dan Watkins. This episode is about the importance of corporate governance. This podcast is not intended to provide legal advice
Neil
In the topic of corporate governance is one that seems to just not be on the highest priority for most business people. Let’s start with just, why do we have a business entity in the first place?
Dan
Well, according to the laws for decades, business entities are like separate legal entities from yourself. They’re actually something that you can turn into a very powerful and valuable asset just by creating it as a business. The biggest example is if you are, uh, Joe’s Pizza, then you’re just Joe and you have a pizza place. But if you have an Empire of Joe’s Pizzas all over the country, then your name is branded, then your entity has value, you can borrow against it. You can go to banks, you can go to investors. It becomes a very valuable and important tool. Probably the most important and most neglected tool that a business owner or a business formation person will go into. So when you think of your business, you create an entity and you create value for yourself and you create protection for yourself.
Neil
And then in terms of that protection, can you talk a little bit about the protections of the corporate veil?
Dan
Corporate veil applies to both limited liability companies and corporations and also some other trust and things like that. But if you have a separate business entity, you have something called a corporate veil. And the thinking is if you keep everything separate and you treat it as a separate entity, you don’t co-mingle funds. You don’t fail to keep records. Then if there’s an obligation of the corporation or if there’s no statute saying it goes right to the primary owner, owners, and shareholders, then you are not personally liable for that. And that means you can take more risks in the business place. You can take out loans, you can get vendor contracts, you can get employment contracts, you can do all kinds of things, joint ventures, mergers, all kinds of things in the name of the business. And when you get home, if things go bad, you don’t have to tell the wife, yeah, I lost the house.
Neil
Great. Dan, from a just an overview perspective, what is corporate governance and why is it so important for corporations and OCS to perform and to pay attention to corporate governance?
Dan
Corporate governance is maintaining your corporation in a legal and proper fashion, such that you’re in compliance with all the laws of the state of California, so that you may be respected in your corporate form as a separate legal entity. It’s about fairness, it’s about fraud, it’s about doing business in a proper manner, which doesn’t rip off customers, doesn’t damage vendors or lenders. If you maintain your corporation in a proper fashion, keep your minutes, keep your statement of information with the Secretary of State filed, have your meetings and maintain proper records and do business separately, then you should have benefits. You should have tax benefits, you should have investor benefits. You should have benefits of when you want to sell your company. And someone comes to look at it like when we sell a company, we have to come up with something called schedules. Schedules are what we use to identify all the different elements to tell a buyer this is a proper corporation and it’s a safe bet to purchase or to merge with. So all those things. And on top of that, if you comply with corporate governance, you’ll end up doing better in business over the last 35 years. The ones I see that don’t hold their meetings, that don’t keep records, that don’t refuse to commingle, those ones don’t do as well. The ones that really stay on it and run their business the right way are usually much more successful.
Neil
So the first step might be as simple as the corporate minutes and then meetings. Can you talk a little bit about the requirements of the annual meetings and the, and the minutes?
Dan
Sure. Well, first step, you’re going to have your articles of incorporation and you’re going to decide how you want to run your company, and you’re going to make some choices. You’re going to have a C Corp, you’re going to have an S Corp, meaning it’s going to be a pass through entity, and you’re going to get status from the Secretary of State saying that you are a property filed and managed corporation. Then after you start making decisions in your corporation, instead of just saying, let’s do this, you are, even if you’re by yourself, you’re going to say, whereas this corporation has decided to take these actions, we’re going to take a loan out, we’re going to do this. And it’s all reflected in your meetings, and it is identified and decided in your status as an officer, director of shareholder of the corporation. And that just from the very get-go tells anyone who wants to buy your company or any banker who wants to maybe invest in your company, this is a proper company from the get-go.
Neil
You mentioned the corporate documents. How important is it to update and review those corporate documents, the operating agreement or the shareholders agreement and the bylaws on a regular basis?
Dan
Well, that’s a good point. Shareholder agreement and operating agreement corporations, if you have multiple parties involved, you’re going to want a shareholder’s agreement. The only time people fight is when they make money <laugh>. And when you start, if you have a shareholder agreement, then they won’t fight because all those issues have been decided. It’s very difficult when the company’s making money to get a shareholder agreement drafted. But it’s really easy when you start out.
Neil
And then things change, right? So as things, people come in, new investments are made, new partners are brought in, are equity positions, the shareholders’ agreement, operating agreement need to reflect those and what equity positions they hold, their voting status, all of those things. Correct.
Dan
The basic facts of the company, how they’re doing business, the trends, fashions, <laugh>, whatever’s happening in business that happens at the same time. The law changes. Yes. Since I’ve been practicing for the last three decades, I’ve seen the limited liability company acts change like four times.
Neil
Yes. And if you don’t keep the documents up to date, then they’re not going to be enforceable when and if the inevitable dispute arises.
Dan
And in California, those changes (in the law) can be used against you if you’re the business owner. So it’s probably important for you to keep up to speed on what the new rules and regulations are.
Neil
Risk management is a portion of corporate governance. How do you perceive risk management and how is that part of the process of good corporate governance?
Dan
Well, for most people, risk management not being sued individually is extremely important. <laugh>, you hear about so many lawsuits in this state, especially against business owners. And so when they come in, they want to make sure that they’ve got a properly formed company that’ll withstand some attacks by people that want to go around the corporation and hold the individual shareholders personally liable for everything, even if the their contracts and agreements don’t say so.
Neil
Dan, you are probably one of the strongest advocates I’ve ever met for strategic planning. Not only having a business plan from the outset, but as you go in looking ahead three, five years, is strategic planning part of that corporate governance?
Dan
Absolutely. If you have proper corporate governance, you talk to your lawyer once every year or two <laugh> and talk to your CPA and your banker, you can use a properly drafted and maintained corporation or LLC much more efficiently and what with much more profit than you would otherwise. You, you’ll be able to identify opportunities with lenders and with vendors you’ll be able to, uh, hire employees and also you’ll be able to take wealth distributions from your company to yourself at a lower tax rate and not be worried about someone going through your corporate veil and trying to get those assets.
Neil
Absolutely. Another important component of any company is its employees. And so part of good governance would be how are we working with employees? How do we maintain ethics throughout the company, top to bottom? How are we managing our team? What aspect of corporate governance applies to our employees, Dan?
Dan
Well, when you have a corporation, you’re going to comply with all of the withholding and tax rules. You’re going to, but you’re also going to comply with, with all of employment practices, including sexual harassment and wage an hour and, and making sure you report all of your, uh, employees payroll and they get the right amount of breaks. So what we recommend once you start hiring employees is an employee handbook. In fact, it’s required, but we recommend it, and we do so many of them that we have our paralegals take a lot of the heavy work so that the cost of having your employee handbook done isn’t as much as just having a, a lawyer make it by hand.
Neil
And in a conversation with Kat on that subject here in our office, we have an an office administrator who works with a lot of our clients on that. And she says a lot of the mistakes they make is to go too broad in their employee handbook and that that can actually open you up to additional liability.
Dan
Correct. The lawyers and the paralegals have, have been working on this every year. Every January we change our own employee handbook and we send out notices to all of our clients that, Hey, these changes are happening. And you want to make sure you have a strong employee handbook because if you do get a claim meeting against you, <laugh>, a lot of the times if it’s covered in the employee handbook, that’s a defense to an action against you.
Neil
A strong defense. Yes. Finally, Dan, what responsibility does the corporate management and the stakeholders have as far as overseeing the accounting and the financial reports and the disclosures and the financial statements of the business itself?
Dan
Well, in your regular business, you’re going to have your accounting programs and you’re going to have your accountant and you’re going to pay taxes, and you’re going to pay your bills. And when you make decisions about loans or about vendor contracts, whatever, you make decisions on it, you can if you want, put them in your minutes so that they’re reflected as an action of the corporation. Which means when someone, one of your vendors, you don’t want to pay because they’re not providing the services or products as promised, and they threaten you with a personal act against you individually instead of the just the company. You can point right to your minutes saying, no, this was always an action of the company and not me individually. And that’s a very good defense.
Neil
Dan, you often talk about the vision of where we’ve been, where we are and where we’re going, but lately it’s even become more important to consider the values of our company and what we stand for. How do you advise our clients on both vision and values?
Dan
Well, we have transactional attorneys (who have) been doing this for 30 and 40 years, and we’ve seen the changes in how people do business over the last 40 years. And so in addition to legal advice, when we meet with our clients and we help form their companies and we talk about what they’re doing, we also, most of the time, I’d say 99% of the time, we, we’ve also already represented a business in that field numerous times. And so we’ll be able to ask questions and provide insights about how to, let’s say, make your ophthalmology practice up to date with current employment practices and how should we be thinking and speaking to our employees when it comes to the newer cultures. And we cannot just say what we think we can reflect based on what numerous other clients have informed us that works for them. And on top of that, our, uh, team attends quite a few seminars and other events around the country, both virtually and in person to try to make sure we are up to speed on the current trends and, uh, values that are so important to our employees and our clients, vendors and customers and general business population.
Neil
Dan, you often say that it’s so important for our clients to stay in touch with us and corporate governance is a natural time for us to have a conversation with our clients. What is the substance of that conversation generally, and how does it look?
Dan
Well, we do both transactions and litigation. So when we form a company or advise a client or achieve a merger, acquire an asset, we also think about our experience in the firm from a litigation point of view. Like we know <laugh>, how many of our clients are being sued for this type of issue? When is this trend? You know, for a while, for a long time it was all sexual harassment suits. Now we see a change and it’s all, it’s not all but a lot of wage an hour mm-hmm. <affirmative> claiming that the, uh, corporate government and the records of the company are not proper and that there should be penalties paid before because of it and trying to turn it into class action lawsuits,
Neil
PAGA Actions,
Dan
PAGA. Yes. So we do deal with a lot of that. And also when a client comes in and says, I want to merge or I want to form a new company, or I want to do this and that, we also will talk to them frankly, about what we’re seeing and what they should do to avoid being a victim of one of those kind of pitfalls and lawsuits.
Neil
Would an example of that would be a management services organization from a medical and healthcare perspective that might not be something they’ve considered and something that we can suggest that they look at going forward?
Dan
When it comes to forming entities, merging entities, and dealing with regulations for professionals. Those types of discussions are key because the law in that area changes every year, or it attempts to be changed by different legislators every year. And so it’s very important to stay on top of it and it’s also very beneficial. It opens up a lot of possibilities that you might not believe were otherwise there. And we do form a lot of those every year.
Neil
Yeah. So we’re talking about corporate governance. From a business perspective, how different is corporate governance from a medical practice or healthcare business perspective?
Dan
Well, they’re professionals and professionals are restricted, same as lawyers, accountants, and especially doctors. There are lots of regulations, not just based on you’re in the healthcare field, but different levels of regulation based on what type of healthcare field you’re in and what type of professional you are. And we deal with pretty much every level and every type of healthcare professional. And so we can identify which level can own which level or which level can be invested in which level and how. And just go into a regular law firm that just does regular formations. They might not go into that much detail and you’ll invest a year or two of your life and find out that the state doesn’t like what you’re doing and you have to undo it. So we spend a lot of time making sure we get those details correct when we deal with the healthcare industry.
Neil
And Dan, as you said, there’s so many additional laws and regulatory compliance issues that must be dealt with as part of corporate governance in the medical practice and healthcare industry. Can you cover some of those things that should be addressed during corporate governance?
Dan
Sure. There are, for example, this is just a handful of regulations that I can think of off the top of my head that healthcare professionals have to deal with. A long time ago, I’m sounding like an old guy, but a long time ago in the eighties, uh, doctors, uh, orthopedic surgeons would own their own physical therapy centers. And then insurance companies started complaining because they felt that these doctors were prescribing physical therapy too much. And so they passed laws that restrict a doctor’s ability to own <laugh> a physical therapy center. And those are long and detailed as to the exceptions. You can have an ancillary service, which is a, a way which a doctor could do. So, but there’s all kinds of regulations on it. And then what happened going in the nineties and two thousands less physical therapy and more surgeries, <laugh> mm-hmm. <affirmative>. So now we’re wondering, well, is that the smart way to go when maybe you could have cured somebody or improved someone’s life with physical therapy and, and now they’re having surgeries? I mean, has that affected it? It’s not for us to say, but we do know the law on how doctors can participate in the ownership of different types of ancillary services to the healthcare field.
Neil
And that’s become an issue within management service organizations as well as there, there’s a fine line between a professional relationship and a service entity versus referring back and forth and practices like that.
Dan
We could have a separate session for four hours on MSOs. Yes. And what you can and can’t do, the hard part about describing an MSO is because the details of everyone’s business and their practice and what they want to do vary. Right. So just one hypothetical, it doesn’t work for, for very, it works for very few. If I came up with a hypothetical here and I, we talked about it, uh, there’d be exceptions and exceptions and exceptions mm-hmm. <affirmative>, then I’d be getting calls about why did I say that when it wasn’t true for their situation.
Neil
Great. So for a medical practice, we’re thinking about stark law issues. We’re thinking about billing practices, HIPAA compliance, health and safety even. Um, and then the employment practices and the licensure requirements and how all of those things come into play into protect the corporate vale and just make sure everything’s continuously upholding and fulfilling changes that come down the line
Dan
And safe harbor and anti-kickback and a much larger list than that. Yes. All those things come into play when you, when you’re dealing with a healthcare entity and organization. And on top of that, you combine which area of healthcare you’re dealing with
Neil
And in your mind, Dan, how integrated should the effort be between our clients and the Watkins firm, especially when it comes to issues of corporate compliance.
Dan
We do this with our lawyers. Obviously you want to talk to a lawyer about this, but if you have your company up and running and you’re bidding compliance, you just want to make sure that everything’s correct or you want a little bit of help, then we have our corporate paralegals do most of the work. And then you can call the, the lawyer for quick 30 minute call and you can review everything and saying, and tell you you’re right on track or, or we need to make some changes.
Neil
So not only a good advisory opportunity, but an insurance policy in effect,
Dan
It’s a lot cheaper.
Neil
<affirmative>. Mm-hmm. <affirmative>. Yes, it is.
Dan
I mean, if you have to ask a lawyer to review all your documents from, from the beginning and then talk to you about it, he’s going to charge you 3, 4, 5 hours when you can have a paralegal do it and you may spend two, 300 bucks.
Neil
Right. So, so that leads us very naturally into what I would consider the final, why should I do this? How, Dan, do you think corporate governance affects litigation?
Dan
Corporate governance affects litigation by protecting the shareholders, number one. Number two, depending in the type of litigation, it’ll be a business record that will prove that you are doing business in a certain way. Whereas in using litigation and some vendor or some customer or someone saying that you do this, you act in this way. Every lawsuit I’ve, I see in business almost always has an unfair business practices cause of action. Yes. In your corporate governance records, if you’re keeping minutes and track of what you do well, then you can prove you don’t have an unfair business practice right there. It’s in writing and it’s a business record and it’s not hearsay, it’s admissible. So those, it’s one of the things when it comes to litigation, if you’re complying with corporate governance, you’re less likely to make mistakes that’ll get you involved in a lawsuit because you’re being a little bit more formal with your company. Yes. And you’re less likely to make mistakes or appear to have made mistakes to other people,
Neil
And you’re less likely to put the corporate veil at risk.
Dan
It’s a good habit to get into.
Neil
Yes. And then from mergers and acquisitions, I don’t think most business people understand how good corporate governance and compliance affects the value of their company. Not only when they’re buying, other companies are merging, but when they’re being acquired themselves, what’s the impact of good governance on mergers and acquisitions?
Dan
Over the last several decades, we’ve sold hundreds of millions of dollars in companies. When I say sell, I mean merged, acquired, or uh, did some type of joint venture in the ones that have excellent corporate governance. Excellent records are organized, have a substantially higher value than the ones that don’t. And the ones that have transactions that don’t close are usually the ones where when you do your due diligence, you can’t confirm what the seller’s saying. You can’t, there are no documents there, there’s no paper trail, there’s a lot of disorganization. And it brings into doubt the value of the company. So if you think you’re forming a company just because you want to have an entity to make a profit from on a year to year basis, that’s true. But you’re also forming a company that has value. Yes. Your 20 year, your 10 year company that’s shown a solid profit has value and somebody out there wants to buy it. Otherwise, we wouldn’t be buying and selling hundreds of millions of dollars in companies over my career. No one would want to buy them. So if you do this right, you’ll add substantial value to your company and when you want to get out of the market or move on, and then you’ll make much more money.
Neil
My final question on the topic, Dan, is how often should they be attending to corporate governance and compliance and is there a natural time of year this occurs?
Dan
This is the time of year. We’re doing a lot of them. Now, generally speaking, most companies, most small businesses only need to reach out to their lawyer once a year,
Neil
End of the fiscal year
Dan
Or calendar year. Right. And we can go over what you did that year, determine what things should be in the minutes, what things should not. We can make sure that you’ve got records of a, you know, a shareholder meeting or informal shareholder meeting. So you can do all those things once a year. If you’re a larger company, you’re going to have in-house council or you’re can have us coming to your board of director meeting Yes. And sitting and taking notes and then presenting meeting minutes for the board to approve. So, and we do that as well.
Neil
Thank you.
Dan
You can learn more about the Watkins firm at https://watkinsfirm.com or call our office at (858) 535-1511.