CORPORATE FINANCE
Purpose of the Course Book:
Provides foundational knowledge for corporate finance law.
Designed as a starting point for further research and practical application.
Importance of Independent Research:
Topics in corporate finance law are constantly evolving.
Independent research is essential for staying informed and building expertise.
Focus on Corporations:
Emphasizes corporations as the primary legal entity in corporate finance.
Other business entities (LLC, GP, LP, SP) are discussed briefly for comparison.
Comparison of Business Entities:
Corporations: Separate legal entity, limited liability, transferable ownership.
LLC: Flexible management, limited liability, tax benefits.
Partnerships (GP/LP): Shared management, personal liability for GPs.
Sole Proprietorships: Simple structure, unlimited liability for the owner.
C vs. S Corporations:
C Corporations: Subject to corporate taxes, can be publicly traded, no shareholder limits.
S Corporations: Pass-through taxation, limited to 100 shareholders, U.S. individuals only.
Class 1/15: Intro & Ch 1-4
MPC Rule 1.6 v. NJMR 1.6 – distinction is that under NY/PA/ABA, if atty knows his client is committing a crime or is about to commit crime, atty MAY report client to police or authority dept; however, in NJ, atty MUST disclose
MPC Rule 1.13 – atty represents corporation; client is corporation/LLC/LP
Gets murkier for sole proprietorship, but even there, business (not individual) is client
Client is NOT CEO, board of directors, or any manager
If at each rung the authority doesn’t do anything about your concern, keep going up ladder – if at each rung, including “highest authority” (BOD) ignore you, under ABA and state rules, you MAY disclose that info to authorities (but you’re not obligated to)
Exception: Sarbanes-Oxley Law – for publicly traded companies, there is obligation to report to SEC
“For good and valuable consideration, the sufficiency and receipt of which is hereby acknowledged” should be in every contract – consideration – each party must acknowledge it has received sufficient consideration and therefore this contract is binding
Then might be followed by definitions section
Conditions preceding
Affirmative and negative covenants
Defaults – party in default is generally given cure period
Two Roles for Corporate Attorneys:
Outside Counsel: Works at a law firm and represents corporations.
In-House Counsel: Works directly for the corporation.
Key Rules of Professional Conduct:
Rule 1.6 (Confidentiality): Protects client information with exceptions for preventing financial or property harm caused by crime or fraud.
Rule 1.13 (Organization as Client): Attorney represents the organization, not individual officers or employees.
Rule 1.6 Exceptions:
Disclosure permitted to prevent:
Client from committing a crime/fraud causing substantial financial injury.
Mitigation of harm caused by client’s past crimes.
Rule 1.13 Key Provisions:
Attorney must act in the best interests of the organization, not individuals.
Obligation to escalate issues ("up the ladder") when management violates legal obligations.
State Variations:
New Jersey: Requires disclosure in some cases (e.g., preventing financial harm).
New York: Similar to ABA but focuses on preventing client crime.
Pennsylvania: Closely follows ABA Rules but includes detailed comments on practical scenarios.
Key Responsibilities:
Distinguish between representing the organization and individual constituents.
Understand state-specific variations in confidentiality and disclosure rules.
General Role of an In-House Attorney
Represents the corporation itself, not individual executives or directors.
Role is broader than an outside corporate attorney, requiring more self-training.
Expected to be proactive, provide advice, and solve problems independently.
Essential Responsibilities
Understand the corporation’s business activities.
Be knowledgeable about federal, state, and local regulations.
Ensure corporate governance compliance with state laws.
Develop a compliance program to maintain legal and regulatory adherence.
Advise the Board and CEO on their legal responsibilities.
Manage litigation and government investigations cost-effectively.
Write legal memoranda and negotiate contracts effectively.
Adapting to Specific Corporate Attributes
Responsibilities change based on whether a corporation is privately or publicly held.
Includes advising on fundraising, mergers, acquisitions, and regulatory compliance.
Involves decision-making on going public, going private, or dealing with shareholder activists.
Key Attributes of Corporate Attorneys
Ability to write clear and concise legal memoranda.
Legal memos must be “bottom-line” oriented and valuable to the business client.
Types of Legal Memoranda
Descriptive Memos – Analyze and explain a specific legal issue.
Options/Choice Memos – Explore legal alternatives and recommend the best option.
Best Practices for Writing Legal Memoranda
Avoid excessive legal analysis unless necessary.
Clearly outline advantages, disadvantages, and recommendations in Choice Memos.
Mark memoranda as "Privileged and Confidential; Attorney Work Product" when necessary.
Avoid written communication in sensitive cases that could be subject to legal discovery.
Suggested Format for Memos
Include To, From, Re, and an Executive Summary (if lengthy).
Clearly present the legal issue and recommended course of action.
Keep conclusions brief and actionable.
Importance of Contracts in Corporate Law
Contracts define business relationships with counterparties (customers, vendors, lenders, etc.).
They range from complex, negotiated agreements to standardized "take-it-or-leave-it" contracts.
Basic Elements of a Contract
Preamble – Identifies the parties and date of the agreement.
Recitals – Summarizes the background and purpose of the contract.
Definitions – Clarifies key terms (optional in simple contracts).
Business Terms – Core agreement terms, obligations, and pricing.
Representations and Warranties – Statements of fact ensuring contract validity.
Conditions Precedent – Preconditions that must be met before obligations arise.
Covenants – Promises to do or not do something.
Events of Default – Defines breaches and consequences.
Remedies – Available actions if a breach occurs.
Miscellaneous Provisions – Governing law, jurisdiction, amendments, and severability.
Signatures – Formal execution of the contract.
Common Types of Corporate Contracts
Employment agreements, consulting agreements, purchase and sales contracts, distribution agreements, software licenses, loan agreements, leases, insurance policies.
Negotiation Strategies
Prioritize key issues; identify "deal killers" vs. minor terms.
Be willing to compromise on less crucial points.
Understand your counterparty’s priorities to find mutually beneficial terms.
Balance Sheet
Snapshot of assets, liabilities, and shareholders' equity at a specific date.
Formula: Assets = Liabilities + Shareholders' Equity
Key elements:
Assets: Cash, receivables, inventory, equipment, etc.
Liabilities: Debts like accounts payable and long-term loans.
Income Statement
Measures income and expenses over a specific period.
Key components:
Income (sales, other income).
Expenses (operating costs, depreciation, taxes).
Result: Net income (profit) or net loss.
Statement of Cash Flow
Tracks changes in cash flow.
Components: Operating activities, investing activities, and financing activities.
Money in: selling securities
Money out: paying debts
Statement of Shareholders’ Equity
Tracks changes in shareholders' equity during a reporting period.
Components include retained earnings, stock changes, and comprehensive income.
Stock options increase sh’s equity; purchase of treasury bonds decreases sh’s equity
Common Types of Financial Fraud
Fictitious Revenues: Reporting income that doesn’t exist.
Overstating Assets: Inflating values for receivables or inventory.
Understating Liabilities: Hiding or minimizing debts.
Improper Asset Valuations: Misrepresenting the worth of assets.
Capitalizing vs. Expensing: Incorrectly treating costs to manipulate profit.
Indicators of Financial Fraud
Poor internal controls (e.g., inadequate segregation of duties).
Accounting books not kept up to date.
Employees are not required to take vacations, which prevents scrutiny of records.
Case Studies of Financial Fraud
FTX: Failure to disclose loans, lack of internal controls, and fraudulent reporting.
Siemens: Listed bribes as legitimate expenses, violating the Foreign Corrupt Practices Act (FCPA).
Enron: Hid debts, created fictitious income, and misrepresented cash flow.
Key Takeaways for Corporate Attorneys
Basic Understanding is Essential: Attorneys should grasp financial statement fundamentals to identify potential fraud.
Reliance on Experts: Trust accountants for detailed analysis but be vigilant about fraud indicators.
Internal Investigations:
Use the Upjohn Warning to clarify representation during employee interviews.
Consider whether to handle investigations in-house or use external counsel.
Characteristics of Privately-Held Corporations
Majority of U.S. corporations are privately held.
Shares are not publicly traded or registered with the SEC.
Examples: Cargill, Koch Industries, X (formerly Twitter), SpaceX, Deloitte.
Advantages of Privately-Held Corporations
Ownership is more concentrated, allowing for greater control.
No SEC reporting requirements; financial statements can remain private.
Can focus on long-term growth without pressure for quarterly earnings.
Freedom to express political/social views without shareholder backlash.
Disadvantages of Privately-Held Corporations
Limited access to capital compared to public companies.
Shares are illiquid; selling requires finding private buyers.
Valuation is difficult due to the lack of a public market for shares.
Characteristics of Publicly-Held Corporations
Shares are publicly traded on stock exchanges.
Ownership is more dispersed, but exceptions exist (e.g., Mark Zuckerberg at Meta).
Must register with the SEC if assets exceed $10 million and a certain shareholder threshold.
Advantages of Publicly-Held Corporations
Shares are more liquid, allowing easy buying/selling.
Easier access to funding through public stock or debt offerings.
Valuation is simpler due to public availability of financial data.
Disadvantages of Publicly-Held Corporations
Required to file periodic reports with the SEC.
Pressure to meet quarterly earnings expectations.
Vulnerable to activist shareholders who may challenge management decisions.
Reasons for Going Public
Faster and broader access to capital.
Allows early investors and employees to cash out.
Enhances public awareness and credibility.
Reasons for Staying Private
Avoids regulatory and financial disclosure requirements.
No pressure to meet short-term market expectations.
Less costly compliance and governance requirements.
Risks of Going Public
Subject to extensive SEC reporting and compliance costs.
Increased pressure on management to meet market expectations.
Greater time commitment for investor relations and governance.
Benefits of Going Public
Ability to raise capital quickly and repeatedly.
Market-driven valuation provides liquidity for shareholders.
Potential for higher valuations due to market interest.
Process of Going Public
Assess infrastructure needs (legal, financial, compliance).
Consider market timing and conditions.
Engage attorneys, accountants, and underwriters.
File registration documents with the SEC and respond to comments.
Reasons for Going Private
Reducing regulatory burdens and quarterly earnings pressure.
Regaining control of corporate decision-making.
Avoiding activist shareholders and public scrutiny.
Process of Going Private
Management buyouts, private equity acquisitions, or third-party takeovers.
Financing typically involves private investors or bank loans.
Offer shareholders a premium to acquire their shares.
Deregister with the SEC and delist from stock exchanges.
Examples of Public Companies That Went Private
Twitter (X) – Elon Musk acquisition in 2022.
Dell – Michael Dell-led buyout in 2013, later returned public.
Panera Bread – Acquired by JAB Holding in 2017.
Nordstrom – Family-led privatization deal in 2024.
Market Perception and Valuation
Publicly-traded companies have real-time stock market valuations.
Unexpected internal or external events can impact perceived value.
Investors should focus on fundamentals rather than short-term volatility.
Key Valuation Methods
Book Value
Formula: Tangible Assets – (Tangible Liabilities + Intangible Liabilities)
Does not account for earnings, growth prospects, or investor perception.
Discounted Cash Flow (DCF)
Values a company based on projected future cash flows, discounted to present value.
Formula: Future Cash Flow / Discount Rate (%) x Time Period
Relies on subjective assumptions (e.g., discount rate, time frame).
Market Capitalization
Formula: Number of Shares × Share Price
Common for public companies but ignores corporate debt.
Enterprise Value (EV)
Formula: Shareholder Equity + Debt – Idle Cash
Treats debt and equity similarly, which may distort comparisons.
EBITDA (Earnings Before Interest, Taxes, Depreciation, Amortization)
Measures earnings performance but ignores cash flow and financial obligations.
Often used in ratios (e.g., EV/EBITDA) to compare companies.
Price-to-Earnings (P/E) Ratio
Formula: Stock Price / Earnings per Share
High P/E ratios suggest growth expectations, while low P/E ratios indicate stability.
Used for both individual stocks and market indices.
Intangible Factors in Valuation
Confidence in management significantly affects stock value.
Example: Microsoft’s stock underperformed under Steve Ballmer but surged under Satya Nadella.
Mergers and acquisitions often involve premiums over current stock price.
Capital Infusion: Shareholders inject additional funds in exchange for debt or equity to avoid dilution.
Reinvesting Profits: Profitable corporations can reinvest earnings instead of distributing dividends (e.g., Berkshire Hathaway).
Debt Financing:
Borrowing from banks, investors, or issuing bonds.
Loans may be bilateral (one bank) or syndicated (multiple banks).
Bonds require a formal indenture agreement and are typically less flexible.
Equity Financing:
Issuing new shares to raise funds, diluting ownership.
Can be private (venture capital, private equity) or public (stock markets).
Preferred stock offers a hybrid between debt and equity.
Debt vs. Equity:
Debt requires repayment with interest but retains ownership.
Equity does not require repayment but dilutes ownership stakes.
Debt Financing Options:
Shareholder Loans: No third-party involvement, but requires personal funds.
Family & Friends: Risk of strained relationships and possible personal guarantees.
Angel Investors: Typically prefer equity over debt financing.
Credit Cards & Home Equity Lines: High-interest rates and personal asset risk.
Non-Profit & Government Loans: Focus on minority-owned businesses, small enterprises, or special social causes (e.g., SBA loans).
Bank Loans:
Advantages: Large funding potential, legitimacy, long-term relationships, flexibility.
Disadvantages: Lengthy approval, collateral/security requirements, strict compliance obligations.
Loan Agreement Components:
Definitions, terms, financial covenants, affirmative/negative covenants, default conditions.
Nonbank Finance Companies:
More flexible than banks but with higher interest rates and stricter enforcement
Corporate Bonds:
Available mostly for large corporations with credit ratings.
Structurally different from bank loans (bonds use indentures, banks use agreements)
Loans vs. Bonds:
Loans involve active lender oversight; bonds are more passive.
Loans may be installment-based; bonds mature fully at a set date.
Loans often require collateral; bonds are sometimes unsecured.
Key Elements:
Representations & Warranties: Borrower confirms legal standing, compliance, and financial accuracy.
Affirmative Covenants: Borrower must maintain operations, insurance, financial statements, tax compliance.
Negative Covenants: Borrower must avoid excessive debt, mergers, asset sales, unauthorized dividends, or financial ratio breaches.
Events of Default:
Non-payment of principal/interest, financial covenant violations, material litigation, bankruptcy.
Lender Remedies:
Accelerating repayment, seizing collateral, offsetting funds, or legal action.