If corporations are people and the formal business structure is a marriage, then the business world’s version of shacking up is the Ad Hoc company.
Essentially, professionals and small companies come together for the sole purpose of winning and completing a single project. Then they split when the project is done, sans messy divorce agreements and child custody disputes. Such a business arrangement is appropriately named since Ad Hoc is a Latin phrase meaning for this. “For this” project we so solemnly get it on and split when the fun and money are gone.
But like sex, Ad Hoc companies are nothing new. It may feel exciting and breathtaking to the parties involved in any new deal pairing but meh! folks have done it before – most notably in Hollywood and in defense contracting.
“Ad hoc companies – centered on discrete projects, where individuals or other entities come together to pursue specific goals or projects and then disband at completion – have a long history,” explains Richard Santalesa, senior counsel in Information Law Groups’ east coast office. “Indeed, until the rise of corporations this was in fact the norm.”
What’s new now is that the practice is widely appealing to a new business audience. Solo professionals and small companies want to take on projects too large to do alone but also want to return to their independence as soon as the job is done.
“It's increasingly common and does raise various legal issues,” says Santalesa, who is also a newly minted Certified Information Privacy Professional (CIPP/US) having recently passed the IAPP exams.
For Profit or Bail Money?
The shiny part of forming an ad hoc company is obvious if not blindingly so. Ad hoc companies are agile and freeing. The arrangement slices, dices, minces, and juliennes, and you can skip the dishwashing duty.
But, yeah, Santalesa is right. There are lots of sticky thorns on the legal end of things. It’s best to check everything out before you agree to live together for awhile. The arrangement, most commonly dressed up and called a joint venture (JV) to look more presentable to the nouveau-corporate types, may be temporary. But the punishment for doing it wrong could be far more lasting.
“Setting up a JV or Team as a front to get a contract is a plan for disaster, and it's illegal too,” warns Ken Marks, president of Anacapa Micro, a provider of comprehensive IT and AV solutions which sometimes teams up with larger companies to go after government contracts.
“Small businesses do form teams and joint ventures in the name of a new company to take on government contracts,” he says. “But those who venture off to do this must be very careful on the structure of the team or JV. The federal government is very concerned about who's taking on the risk, who is doing 51% or more of the work, and the representations and certifications of the JV.”
Indeed, if you are looking to secure a government contract with a newly made ad hoc company, look to this handy, stay-out-of-jail card, i.e. instructions on what and what not to do with a JV for government contracting produced by an SBA Procurement Center representative for the Army. Different arms of the military and government may have different requirements, so carefully check with whichever one you are targeting before you proceed.
If, however, you are targeting a project in the private sector, the deal gets a whole lot less tricky. “This is much simpler to do in the commercial world because Government Federal Acquisition Regulations (FARS) do not apply,” says Marks.
In either case, you need to sit down with a good accountant before proceeding. Tax concerns can eat your profits otherwise.
“For ad hoc entities, tax consideration may very well have a significant impact in big dollar contracts especially if various parties are spread out over many states,” says Santalesa.
The Legal Steps
Once you and the other parties have decided it makes monetary sense to form an ad hoc company, you need an attorney to walk you through your options. Most frequently, the choice is to form a joint venture, although your attorney may suggest another option. Of course, you need the attorney to legally execute the deal, too.
If you go the joint venture route, Santalesa advises you start by reviewing the Small Business Administration’s (SBA) handy guide to joint venture basics, which provides a helpful and concise review of the high level issues.
Beyond those, on the legal side, “The type of the contract and the other contracting party, i.e., private company, public agency, whether on the local, state or federal level, determine many of the hoops those considering a joint venture need to jump through and the legal considerations as well,” Santalesa says.
Once all that is considered and done, Santalesa advises, consider and implement the following to make the deal and the JV legal:
- A Joint Venture Agreement, often preceded by a Memorandum of Understanding, specifies the parties’ respective responsibilities, expected benefits, contributions, and conflict resolution mechanisms. Most importantly, it details when and how the end of the JV occurs and what each party receives thereafter.
- A Confidentiality and Non-Solicitation Agreement. The parties each likely bring their own proprietary technologies, trade secrets, intellectual property, know-how, and skills to the table in accomplishing the goals of the JV. These must be adequately safeguarded by all involved. In addition, JV members no doubt want to prevent the other members from hiring employees away.
- Intellectual Property and allocation of deliverables and developments. If the project and contract creates unique intellectual property and inventions, not otherwise transferred to the client, the parties must determine how each member of the JV will benefit. Will the JV entity continue on and “own” the IP that is then licensed to its members? Will the IP be assigned, in whole or in part, to the members of the JV or sold? Regardless of the end determination, the considerations need to be reviewed and determined up front, including the possibility that some new and unanticipated technology, invention, or other valuable product may stem from the JV either during the JV or afterwards.
- JV as an entity. Depending on the contract size, parties, length, and other variables, those entering the JV may want to, or need to, form a separate corporate entity for the JV. The benefits include the ability to cabin potential liability and insulate the JV members and member entities from liability, among other items. The downside is that a newly minted corporate entity may have more difficulty obtaining insurance coverage or financing beyond what the parties may supply themselves. Typically, JVs are formed as limited liability companies, due to the formation speed and ease of creation for LLC’s in most states. But if the members are spread across many states, give additional thought as to the state of formation and the designated forms and other formalities needed.
Insure Now or Cry Later
As with any business venture, risk is involved. Arguably there is more risk in an ad hoc company because if one member fails to perform, becomes disabled or drawn into a lawsuit, or <gulp> dies, the entire project could fail.
“Insurance is paramount due to the many parties that are involved,” says Christine Marciano, president of Cyber Data Risk Managers, an independent insurance agency. “Depending on the project, some of the types of coverages to be explored and obtained include commercial general liability, property, cyber liability, errors and omissions, directors and officers, intellectual property, and workers compensation insurance.”
To determine precisely which insurance your new venture needs, and to avoid either over- or under-buying insurance, Marciano recommends you consider the following:
- What are the risks and open exposures of the project? Can insurance help the company mitigate them?
- Property insurance may need to be obtained, in which the company could schedule and insure all of the tangible assets that pertain to the contract.
- What happens if the company defaults on its obligation to fulfill the project? Depending on the industry or project, can a bond be obtained for default of obligations?
- What if the company fails to perform and financial loss is caused by an error or omission? Professional liability insurance, a.k.a. “Errors and Omissions” insurance can help protect the company if they are sued for negligence, such as an error or omission.
- What happens if the network goes down or is hacked? Depending on the project, business interruption insurance may be needed.
- Who’s responsible for securing and protecting data, and responding in the case of a data breach? If these are concerns, explore the purchase of a cyber liability insurance policy.
- If applicable, the company may want to make sure they purchase “Directors and Officers” insurance, otherwise the board may be personally liable.
- Workers compensation should be explored, and be sure to list all of the states in which the company will operate and conduct business.
- Intellectual Property insurance coverage can help protect the company for copyright, trademark, or patent infringement claims.
“When the formed company ultimately purchases their insurance, if possible, all of the companies that have joined in to form the company should be named as insureds on the policy,” advises Marciano.
But even after you’ve gone through this entire exercise, you may find it difficult to get any insurance at all. This is not a problem unique to ad hoc companies as it can afflict any new company regardless of how it is legally organized.
“While it sometimes can be difficult for a newly formed company without a proven track record and claims history to obtain insurance, that’s not to say it’s impossible,” says Marciano. “The nature and industry of the company and the experience of all the parties involved will be an important factor of how easy or difficult obtaining insurance may turn out to be.”
Even so, ad hoc companies are in vogue again and providing an excellent vehicle for independent-minded professionals and companies to complete a profitable project and move on.