This article articulates some but not all of the risk factors to investing in a small business acquisition.
Capitalized terms not defined herein, shall have the meanings ascribed to them in the Company's LLC Operating Agreement (the "LLC Agreement").
General Risks
Difficulty in Valuing TargetCo. The objective of the Company is to invest its investible assets and acquire TargetCo, as that term is defined in the LLC Agreement. Generally, there will be no readily available market for TargetCo and such investment will be difficult to value. Despite the Manager’s efforts to acquire sufficient information to assess TargetCo’s operations and make well-informed valuation and pricing determinations, the Manager may only be able to obtain limited information at certain times. Although the Manager has or will evaluate all information and data available to it with respect to TargetCo, the Manager is not in a position to confirm the completeness, genuineness or accuracy of such information and data. It is possible that the Manager may not be aware on a timely basis of material adverse changes that have occurred with respect to TargetCo, and therefore may have to make valuation determinations without the benefit of an adequate amount of relevant information. Potential investors should be aware that as a result of these difficulties, as well as other uncertainties, any valuation made by the Manager may not represent the fair market value of TargetCo.
General Economic Conditions. The success of the Company will be affected by general economic and market conditions, such as interest rates, availability of credit, inflation rates, economic uncertainty, changes in laws, tax considerations and tax treatment, trade barriers, currency exchange controls and national and international political circumstances (including wars, terrorist acts and security operations). There can be no assurance that the Company will not suffer material losses and other adverse effects from broad and rapid changes in market conditions in the future.
Litigation Risk. Small businesses such as the Company may be subject to litigation, including civil litigation, bankruptcy litigation, shareholder derivative suits, and creditor suits. The adverse impact of such litigation may reduce the profitability of the Company and, as a result, may reduce returns to investors.
No Assurance of Investment Return. There is no guarantee that the Class A Units will earn any positive return in the short term or long term. A holding of Class A Units is speculative and involves a high degree of risk and should be undertaken only by holders whose financial resources are sufficient to enable them to assume such risks and who have no need for immediate liquidity in their investment. A holding of Class A Units is appropriate only for holders who have the capacity to absorb a loss of some or all of their holdings.
Illiquidity of Interests. The Class A Units in the Company have not been registered under the Securities Act or any other applicable securities laws. There is no public market for Class A Units in the Company and none is expected to develop. In addition, the Class A Units in the Company are not transferable except with the consent of the Manager, which may be withheld in its sole and absolute discretion. Class A Members may not withdraw capital from the Company without the approval of the Manager.
Risks Inherent in Small Businesses. As a small business, the Company may have limited financial resources and capital compared to larger competitors. This could affect the Company’s ability to invest in essential infrastructure, marketing activities, or research and development, which may adversely affect the Company’s growth and competitiveness. Additionally, small businesses are generally more susceptible to market fluctuations and economic uncertainties, which may cause the Company and the Manager difficulties in forecasting demand and cash flow. Small businesses are also subject to fierce competition from not only other small business, but also larger enterprises with greater financial and operational resources, as well as longer operational history. Such competitive pressure could affect the Company’s ability to generate revenue, affect market share, and overall profitability. Small businesses may also face challenges in securing adequate credit or financing, which may limit the Company’s ability to expand or manage unforeseen financial difficulties. Small businesses often have limited options for suppliers and vendors due to the relatively small volume of business compared to larger competitors, which may subject the Company to vulnerabilities such as supply chain disruptions, price fluctuations, or quality issues from suppliers.
Geographic Concentration. The Company anticipates operating in a concentrated geographic location. As a result, the Company may be subject to state and local economic conditions. The Company’s reliance on a specific geographic region exposes it to increased economic vulnerability. Adverse economic conditions or regional economic downturns could disproportionately affect the Company’s revenue, profitability, and overall financial stability. Additionally, the Company may be exposed to risks specific to the geographic region it operates in, including increased exposure to natural disasters, severe weather events, or climate-related risks such as floods, earthquakes, hurricanes, or wildfires, which could disrupt the Company’s operations.
Lack of Diversification. The Company will own and operate TargetCo and does not intend to make any other substantial or material investment. This lack of diversification increases risk to the Company’s performance because the Company’s performance will solely be measured by the performance and/or value of TargetCo. If TargetCo does not perform as expected, an investment in the Company may be materially affected.
Risks Related to the Company
Management Experience. The success of any business venture heavily relies on the competency and experience of its management team. Inadequate leadership, lack of industry expertise, or insufficient managerial skills could significantly impact the company’s ability to execute its business plan effectively. Investors should be aware of the Manager’s track record, qualifications, and ability to navigate unforeseen challenges are crucial factors in mitigating risks. Any shortcomings in the Manager or management’'s experience and capability may adversely affect the company's performance and, consequently, the return on investment for investors."
No Operating History. The Company is a newly formed, early-stage company. Accordingly, the Company has limited operating history with which prospective investors can evaluate the Company’s business and prospects. The market in which the Company competes and/or anticipates competing in is highly competitive and the percentage of companies that survive and prosper is small. Although the principal and key members of the Manager’s management team may be experienced in the industry in which the Company is engaged in, the Company has no operating history on which prospective investors can base an evaluation of its performance.
Dependence on Key Personnel. The Company will be entirely dependent upon the Manager and the other individuals employed and/or engaged by the Company. No assurance can be made that any or all of such persons will remain employed by the Company. Furthermore, the Manager will hold Class B Units which may create an incentive for the Manager to make more speculative investment decisions than it would otherwise make in the absence of such performance-based compensation.
No Right to Control Company Operations. Class A Members will have no opportunity to control the day-to-day operations, including decisions related to the Business or any other asset owned by the Company, subject to limited exceptions. In order to safeguard their limited liability for the liabilities and obligations of the Company, Class A Members must rely entirely on the Manager to conduct and manage the affairs of the Company.
Lack of Sufficient Capital. There is a risk that the amount raised in this Offering will be insufficient to meet the Company’s investment objective or ability to successfully operate TargetCo. If there is a lack of capital, the Manager intends to use its best efforts to obtain funds from a third-party for the benefit of the Company and TargetCo. Obtaining funds from a third-party may require an increase in the amount of financing costs and interest expense the Company will be obligated to pay. In addition, there is no guarantee that the Company will be successful in obtaining sufficient capital at a reasonable cost. In the event the Offering proceeds prove to be insufficient, certain business activities planned by the Manager may be delayed until sufficient cash flow is generated from operation of the Operating Company, if at all.
Indemnification of the Manager. The Manager, as a fiduciary, has a responsibility to the Class A Members to exercise good faith and fairness in all dealings affecting the Company. However, the Company will indemnify and exculpate the Manager and its members from and against any liability for losses, damages or expenses resulting from their status as Manager, their acts or omissions, the Company’s business, or the management of the Company’s affairs, except in certain circumstances. Accordingly, a Class A Member may be entitled to a more limited right of action against the Manager or its members in certain circumstances than it would otherwise have absent such limitation.
Illiquidity of Class A Units. The Class A Units in the Company have not been registered under the Securities Act or any other applicable securities laws. There is no public market for the Class A Units in the Company and one may never develop. In addition, subject to certain limited exceptions, the Class A Units in the Company are not transferable except with the consent of the Manager, which may be withheld in its sole discretion. In addition, Class A Members may not withdraw as Members of the Company without the approval of the Manager. Consequently, Class A Members may not be able to liquidate their investments prior to the end of the Company’s term.
Estimates and Projections may not be Accurate. The Manager has made estimates and projections relating to the performance of the Company. There can be no assurance that the estimations, projections, and assumptions made by the Manager will accurately reflect the actual economic performance of the Company. Some estimates, projections, and assumptions inevitably will not materialize and unanticipated factors subsequent to when these estimates were made may occur. Accordingly, any estimates, projections, and assumptions should not be given undue emphasis in making a decision to invest in the Company.
Risk of No Distributable Proceeds. Distributions to Members will be made only in the event there are funds are available for distribution, which will be dependent on cash flow from operations, refinancing, or the sale of the Company. Even if there is positive cash flow during operations, the Manager of the Company is required to cause the Company to retain funds for working capital purposes. Therefore, there can be no assurance as to when and whether there will be any distributions from the Company to the Members. It is possible that the Company will not make any distributions at all.
Investors Not Represented by Independent Counsel. Prospective investors, as a group, have not been represented by independent counsel in connection with the formation of the Company, the preparation of the LLC Agreement, the Subscription Agreement, or any other document in connection with the offering of the Class A Units (collectively, “Offering Documents”). The Offering Documents, and any amendments, exhibits or other attachments thereto, have been prepared by and for the Company and the Company owes no duties to any prospective investor.
Tax Risks
Possible Adverse Tax Consequences. The following discussion summarizes certain aspects of United States federal income taxation of the Company and its Members that are taxable “United States persons” for U.S. federal income tax purposes. This summary does not purport to deal with all tax considerations applicable to any particular investor. As the U.S. federal income tax rules are technical and complex, no representation or warranty of any kind is made with respect to the tax consequences of an investment in the Company. Potential investors are advised to consult their own tax advisors with respect to the tax consequences to them of an investment in the Company.
The Company expects to be classified as a partnership for U.S. federal income tax purposes, and not as an association or a publicly traded partnership taxable as a corporation. However, if the Company were to be treated as a corporation for U.S. federal income tax purposes, its income would be subject to U.S. federal corporate income tax. In addition, distributions made by the Company would be taxed as dividends or otherwise treated as corporate distributions, and there would be no flow-through of items of income, gain, loss, and deduction.
Since the Company generally does not separately pay taxes, each Member is required to report its ratable share of the taxable income and losses of the Company and to pay any taxes resulting therefrom. Accordingly, a Member may be required to pay taxes on its share of the Company’ taxable income even though the Member has not received any cash from the Company to cover such liability. In addition, there can be no assurance that the particular methodology of the allocation of income or loss, as provided in the LLC Agreement, will be accepted by the Internal Revenue Service. Moreover, the recognition of income, gains, and losses in any year for tax purposes may not match the economic performance of the Company.
It is possible that the Company will be unable to provide final Schedules K-1 to the investors for any given fiscal year until significantly after the initial due date for tax filings of the investors or their owners of the following year (currently April 15 or the following business day for individuals). The investors and any of their owners, as applicable, should be prepared to obtain extensions of time to file their tax returns at the federal, state, local, and/or non-U.S. level.
A Member’s ability to take deductions of its share of the Company’ losses, interests, and expenses may be limited or restricted, subject to various rules, including “at-risk” rules, passive activity rules under Section 469 of the Internal Revenue Code of 1986, as amended (the “Code”), limitations on deductibility of interest under Sections 163(d) and 163(j) of the Code, and limitation on deduction of expenses for production of income under Section 212 of the Code.
The Company may withhold taxes attributable to any Member to the extent required under the Code or Treasury Regulations promulgated thereunder, or under any state, local or other tax law (including non-U.S. tax law). Any taxes so withheld by the Company shall be deemed to be a distribution or payment to such Member and shall reduce the amount otherwise distributable to each Member.
Subject to certain exceptions, no gain or loss is intended to be recognized by a Member upon the acquisition of the Units for cash, or receipt of a distribution from the Company that does not exceed the tax basis in those Units. If a Member were to sell its Units, with certain exceptions (e.g., such Member’s allocable share of the Company’s “inventory items” or “unrealized receivables” were to exceed its basis in such items), any resulting gain or loss would be treated as capital gain or loss.
Partnership Audit Rules. Generally, entities treated as partnerships are subject to a centralized audit regime (the “Partnership Audit Rules”). The Partnership Audit Rules generally provide that adjustments to tax items of entities taxable as partnerships, such as the Company, or to the partners’ relative allocable shares of such tax items, unless the partnership elects into an alternative procedure, will be determined at the partnership level, with all partners generally being bound by that determination. This imposition of tax at the partnership level can adversely affect net asset value and has the potential to significantly affect economic returns to the partners, especially if there have been interim changes in ownership. Prospective investors are encouraged to discuss the potential impact of the Partnership Audit Rules with their own tax advisors.
State and Local Taxation. In addition to the U.S. federal income tax consequences described above, prospective investors should consider potential state and local tax consequences of an investment in the Company.
THE FOREGOING LIST OF RISK FACTORS DOES NOT PURPORT TO BE A COMPLETE ENUMERATION OR EXPLANATION OF THE RISKS INVOLVED IN OR ASSOCIATED WITH THIS OFFERING. SUBSTANTIAL ADDITIONAL RISKS MAY BE PRESENT IN CONNECTION WITH AN INVESTMENT IN THE COMPANY. AN INVESTMENT IN THE COMPANY COULD RESULT IN A COMPLETE AND TOTAL LOSS. PROSPECTIVE INVESTORS SHOULD READ THE ENTIRE LLC AGREEMENT AND CONSULT WITH THEIR OWN ADVISORS BEFORE DECIDING WHETHER TO INVEST IN THE COMPANY.