RE: Merger and Investors

Dear [Clients],

We plan to meet today concerning what I understand to be your plan to possibly merge with another company or allow an investor to come into your company. In anticipation of our meeting I have put down some thoughts about control of a business and merger which may be a starting point or a later resource.

An initial thought would be, if you are considering a merger, you might want to consider forming a limited liability company as an umbrella. Your present company and the investor company could each be a member (like a partner or shareholder) in the new LLC. LLCs are a relatively new form of legal entity in Kentucky which have insulation from liability (like a corporation), tax treatment (like a partnership or "S" corporation) and tremendous flexibility in terms of control, equity and management.

This concept could also be analogized to a joint venture agreement, but with a common legal entity and greater insulation from liability for debts and tort type negligence. Each member company could still pursue other ventures not related to the LLC business, if agreed. Each entity could still retain ownership of assets, including equipment and accounts receivable.

Initially, if you are pursuing a merger or capital infusion, I would suggest executing a letter of intent, subscription or merger agreement between the parties which would define, as clearly as you can at this stage, how the corporation or other legal entity would be set up, what the responsibilities of the incorporators or investors would be, etc. If you can not obtain initial consensus on the subscription agreement, then you are either forewarned of likely problems, should negotiate a new deal, or get out. Once you have become an incorporator without other agreements binding the parties (such as to duties and financing) it may be too late to get out easily or get your "product" to market without additional cost or problems which could have been avoided.

I am concerned that you could easily be in a deadlock situation out of the starting gate, if you only own 50% of the stock of any new entity. Structure of the percentages of stock ownership, number and loyalty of voting directors of the corporation and possible stock restrictions must all be dealt with before the deal goes too far.

You should consider, in a corporate situation, the need for preemptive stock rights. Preemptive rights are, basically, those right of a shareholder to acquire unissued shares in proportion to their then current interest in the already issued shares. (i.e. If you own 25% of the issued stock and the corporation will issue 100 more shares, you could acquire another 25% of the new shares.) This would give shareholders a right to maintain their percentage of ownership and control of a corporation (and prevent dilution) in the event new stock was issued.

The current law in Kentucky is that a shareholder does not have preemptive rights unless the articles of incorporation specify that they do. I enclose a copy of KRS 271B.6-300 for your review.

There are a variety of ways to exert control over a corporation at an early stage. Some of the many methods are listed below:

There are a variety of other methods of control but the above list should get you started. You should be careful of the wording of the articles of incorporation, bylaws, buy-sell agreement, employment or consulting contracts and any license agreement. Promissory notes for the subscription agreement investments should probably be obtained from them (secured if you want some real promise) and a written lease or sublease for the corporate space should be drawn up with all due formality and detail.

If a merger is to be negotiated, some of the considerations, in outline form, follow. A formal agreement between the parties would be negotiated and executed, subject to the internal formality requirements of each corporation. Typically, articles of merger are filed in the state of incorporation of each corporation. Some of the many issues are:

Please be advised that the contents of this letter are not meant to be exhaustive of your strategic options, nor are you ever totally protected in these situations. There are other steps you can take and other ways to go about this. Some of this will obviously depend upon how well you can negotiate. How well you can negotiate certainly starts with what leverage you have or the other party perceives that you have.

If I can be of any further help now or as this progresses, please let me know. I will take no further steps unless you specifically request them. Thank you for allowing me to be of service to you.

                                             Yours very truly,