Legal Perspective

Always Start with a Business Plan
By Mark Hanson & Todd Guerrero | May 01, 2004
Start with a business plan. It doesn't need to be elaborate, but the plan should address the basics: feedstock procurement, processing costs and product sales, and how difficult it will be to penetrate the market.

Your plan needs to identify costs to produce the products and operating costs-including equipment, land, construction permitting, labor, inputs and financing, utilities and financial projections. It is important that financial analyses contained within business plans are verified by third parties in order to ensure that assumptions reflect current market conditions. With biodiesel projects, projections should contain some contingency analysis projections that include and exclude anticipated federal and state programs.

Project developers should concentrate on financing options-both debt and equity-based upon the business plan. Depending on the financing structure, most new biodiesel production facilities are likely to require 40 percent to 60 percent investor equity. Each project will be evaluated separately by potential lenders who will indicate the amount of equity needed to support the debt financing.

Before a project can raise either equity or debt, it needs to become a legal entity. Which entity is best? Corporation? Limited liability company? A cooperative? Here are some significant aspects to consider for each entity.

Limitation of liabilities: Most owners of businesses that sell products in the stream of commerce want to protect personal assets from business debts or obligations. Limited liability companies and "C" corporations shield an entity's owners from personal liability of the debts and obligations of the entity; general partnerships do not. As a partner (owner) in a general partnership, each partner is subject to joint and several partnership liability obligations.

Number and type of owners: If the business intends to have more than 75 owners, it cannot be conducted as an S-corporation because of restrictions on S-corporations. S-corporations generally allow only individual owners, and thus aren't an option if the ownership group includes corporations, LLCs or certain trusts.

Types and classes of equity: C-corporations, LLCs and cooperatives usually can have numerous stock classifications. In C-corporations and cooperatives, however, state law generally requires that holders of the same class be treated equally with respect to allocations, voting, etc. But LLCs are treated as partnerships for tax purposes and have greater flexibility in allocating the business income and losses. Indeed, owners of LLCs can allocate income, gains, losses, deductions, credits and other items among the members by almost any method desired, if the allocation has "substantial economic effect."

Transferability of interests: A key consideration to any potential investor is the liquidity of ownership interest in the entity. In cooperatives and LLCs, transferability of interests is generally subject to greater restriction than shares in a C-corporation. In a cooperative, shares of stock or membership interests are transferable only with consent of the board of directors. LLCs intended to be taxed as partnerships usually have restrictions on the transferability of interests. State LLC laws often require member approval before ownership is transferred. Ownership interests in C-corporations, however, are generally freely transferable. While C-corporations may agree on transfer restrictions in a shareholder agreement, state corporation laws typically have no transferability restrictions.

Once an entity is organized and prepared to raise equity capital, it must also comply with federal and state security laws. With limited exceptions, the offer and sale of any equity interest will be considered the offer/sale of a "security" that must be registered with state and/or federal securities regulators, or offered and sold subject to a legal exemption from registration. The entity and its organizers are subject to liability for omitting or misstating material facts about the project in offering the security.

Competent legal advice early in the project will save time and money in entity selection, legal issues affecting the business plan, and offering securities and disclosing risks.

Mark Hanson and Todd Guerrero are members of the agribusiness and alternative energy practice group of Lindquist & Vennum PLLP, a leading provider of legal assistance on bioenergy projects throughout the country. They can be reached at (612) 371-3211.
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