Bottom Line Business Insights : Maryland Business Lawyer & Attorney : Wagonheim & Associates Law Firm : Mergers & Acquisitions & Contractual Negotiation

I’m of the opinion that the best way to finance a new business is via the “3 F’s”: Friends, Family, and, for lack of a better term, Fools. Of course, the risk and headache you undertake when you accept money from relatives and close friends is often more aggravating and gut-wrenching than simply taking money from a faceless third party, like a bank or a venture capital firm. Unfortunately, however, because bank and venture capital financing is usually not viable for startups (and I’ll discuss why next week), new businesses are often left with no other alternative than to hit up the 3 F’s.

So, do you like your friends, family members and relatives? Want to continue to have a warm, fuzzy relationship with them? (I’m perhaps assuming too much here, but stay with me.) If the answer is yes (or even if it’s no), and if they’re considering providing funds for you to get your business off the ground, or to keep it running through a rough patch, then take heed of the advice I’m going to discuss here: come to an agreement with them in writing. BEFORE they give you the money.

Perhaps the best way to explain why you need to arrive at an agreement in writing with your family members or friends before they stroke you a check is by discussing what the agreement should, at minimum, include. Here are just a few of the issues you’ll want to focus on while you’re putting together some sort of document to memorialize the arrangements: 

• Did you discuss whether the money was going to be classified as debt (a loan) or as equity (an investment) in the company?

Debt and equity are treated very differently for tax and legal purposes, and they have very different characteristics with respect to repayment and expected returns. Lenders won’t (or shouldn’t) expect much more than 6% - 12% annual interest, plus return or amortization of principal on some agreed-upon schedule. Equity investors, however, often have visions of buying a Greek island with the triple digit returns they expect to make via an investment in your company. Which would certainly help out the Greek economy, these days.

If the money is a loan, you’ll want to deliver a Note to your lender (yes, even if that lender is a relative or friend) which includes, at minimum, the principal amount, interest rate, maturity date, default provisions, repayment/amortization schedule and terms, possible collateral (in which case you’ll also need a security agreement and a UCC filing or a deed of trust), and dispute resolution terms. If the money is an investment (equity rather than debt), you’ll want to include the family member or relative as a shareholder or member of your corporation or LLC, and the rights and obligations of both the company and the equity investor must be spelled out in detail in the company’s constituent documents.  If you want to avoid problems both legal and personal, that is

• Did you provide anything in writing describing your business and the expected return on an investment in your business (e.g., a business plan or a more sophisticated document, such as a Private Placement Memorandum)?

Bear in mind that even the smallest startup is bound by the antifraud provisions of federal and State securities laws with respect to the raising of equity capital, as opposed to debt financing. There are filings to make (such as a federal Form D and state Blue Sky filings), documents to deliver (such as subscription agreements, accredited investor questionnaires, and shareholder or operating agreements), and regulations to follow. Each investor must receive exactly the same information as each other investor, so if you delivered a business plan or PPM to any investor, you’ll need to deliver the exact same document to ALL potential investors. Running afoul of any of these requirements could result in serious problems for your business if you ever find yourself in the middle of a dispute with your investors.

It would also be very useful to prepare a set of pro forma financial projections demonstrating the expected return on an equity investment. This is not only useful for managing expectations, but it’s also important, from a legal perspective, that you disclose any and all material facts about your company and its prospects to your potential investors.

• If the company goes belly-up (and lots of startups do), what are the rights of your lenders or investors? Remember, we’re talking about your friends and relatives here. Will they expect you to personally make good on their losses? Will they silently seethe and exclude you from all future family functions while badmouthing you within the business community? Are you sure you’ve discussed these issues with them and that your documents accurately reflect both your intentions and your investors’ or lenders’ expectations?
  
• Suppose the company needs additional cash. Do you have a right to subordinate the loans of your family members to subsequent lenders (such as other family members)? Can you subordinate their Notes to a bank? (It would be a very good idea to retain this flexibility in case it’s ever necessary to utilize it.) Or, in the case of equity, do you have the ability to dilute the shares or equity interests you issued to your family members or friends by issuing additional equity to third parties?
  

These are just a few of the many issues you’ll need to consider as you raise money at the startup phase or for ongoing operating expenses. Which is why it bears repeating: if you’re going to be raising money from third parties (even if, or especially if, they’re relatives or friends), be sure you put the terms in writing. A very detailed writing. When all parties understand up front what their rights and obligations are, it’s much less likely that you’ll end up estranged from your family members down the road. Remember that you’re going to be married to your relatives and friends for an extended period of time via your mutual business interests in the company. There are rarely any divorces, and courts are not sympathetic to family issues in corporate disputes.

So, before you take money from the 3 F’s, ask yourself: Are you ready to get married? And is the necessity of financing the business worth the potential family issues that could arise down the road? If the answers are yes and yes, be sure you put the arrangements in writing at the outset, and be sure all parties sign that agreement before any money changes hands.

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The first response I usually get from most businesspeople when I mention “corporate formalities” is a puzzled look. Which is not surprising, since the term is rarely used except by lawyers.  The second response is invariably a request by my clients for another cup of my famous high-octane coffee, since the mere mention of “corporate formalities” usually results in the realization that the meeting isn’t over yet (the end of a meeting with me being the highlight of most of my clients’ days). Fortunately, high-octane coffee is plentiful around my office. In extreme cases, I can even produce a finger or two of single-malt scotch if I notice my client snoring and slumped over in their chair mid-discussion.

But I digress. “Corporate formalities” is a term with which you ought to become familiar if you intend to run, or are already responsible for running, a business.

The reason I even bring this arcane term of art up is because of an admonition I included in my last blog (which you can access by clicking here. In that blog, I suggested that even if you make proper filings with the appropriate State agencies to set up your company, you would still not be adequately protected from company liabilities if you failed to also adhere to “corporate formalities” and maintain proper corporate records. So, what did I mean by that?

Let’s discuss a major misconception about “incorporating” (which is a term I use to mean forming any corporate entity, whether an LLC, corporation, partnership, or something else).  The misconception is that all one need do to obtain the “magic bullet” of limited liability is to file a document with the proper State agency, and voila! -- instant “teflon” for the company’s owners.  But the reality is quite different.

You see, incorporating involves a trade-off between you and the State (you didn’t really think that the State was going to give you a freebie, did you?). In exchange for limited liability for the owners of a company, the State insists that the company adhere to certain laws, keep certain records, and adhere to certain procedures.  Those laws, records, and procedures include the following:

• The company must keep a separate bank account, and cannot commingle its funds with its owners’ funds and bank accounts. (Note that this is more straightforward in theory than in practice. I’ve seen numerous businesses get tangled up in banking and segregation of funds issues that could potentially lead to loss of the owners’ limited liability).
• The company must make certain information public, such as the identity of the owners, the address of its corporate headquarters, and the identity of its agent for service of process.
• The company must carefully authorize and document all actions taken by the company, usually in the form of signed resolutions (this is one of the most frequently overlooked corporate formalities, and potentially one of the most serious if the company is ever sued by a shareholder, employee, or customer).
• The company must not engage in activities that are extraneous to its corporate purpose, or that properly belong to the owner or owners (e.g., don’t have your company pay for your tickets to Tahiti, or take on any tasks related to your spouse’s widget factory).

The bottom line is that the failure of your company to adhere to corporate formalities can result in a “disregard” of the corporate form by a court if your company is ever sued. Legally, this is known as “piercing the corporate veil,” and it’s a disaster by any measure. How? Well, if the court awards damages to the person suing your company, it means that YOU, as an owner of the company, are personally liable for those damages. It could also result in fraud and shareholder actions being upheld against you, and the literal unraveling of your company. 

Finally, let’s take the example of a corporate acquisition: your company has been approached by a competitor with a buyout offer, or you decide that, after 15 years in business, you want out and you want to sell your company. As a mergers and acquisitions attorney, I can tell you that the first thing the lawyers on the other side are going to ask for are your corporate books and records. Because the acquirer wants to know what they’re acquiring, and they want to ensure that they’re not inheriting any potential liabilities that they don’t want to inherit. Inadequate books and records can quickly scuttle a potential deal.

Again, I would urge you to ask yourself the following question: Is the modest cost of keeping adequate corporate books and records worth the potential personal liability, or the risk of scuttling a potentially lucrative sale of the company? Only you, as the business owner, can answer this question.

Has your company properly adhered to corporate formalities? Need help getting your corporate house in order? Give me a call. 

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I have this recurring nightmare. I don’t have it every day, or even every month, and to be truthful it usually doesn’t even happen when I’m sleeping. It’s more of a daytime occurrence, but in substance and fear factor, it’s every bit a nightmare. And I have it often enough that it merits writing about here.

If you read my blog last week, you know that I’ve turned my attention to the legal issues surrounding the startup of a business. My nightmare relates to the scenario that occurs when a new client comes to me for the first time and tells me that he’s been running his business for a few months, things are going well, and he needs some sort of legal help with a new line of credit, or with a contract he’s about to sign with a new vendor or joint venturer, or something similar.

When I ask this hypothetical client what kind of company he’s formed, and whether I can see his formation documents, he gives me a blank stare. That’s when the nightmare begins. Both for me and, often enough, for my client as well.

When you form a new venture, it’s not enough to go to some online company or to OfficeMax, fill out a few forms, and file them with the designated state office. Sure, technically, you can do it that way. But there are too many issues (legal and accounting being only two) that need thoughtful consideration out of the gate, and a do-it-yourself kit isn’t going to adequately prepare you to think through those issues.

Instead, you need legal help.

Here are just a few of the issues that I’d ask a new client to consider and discuss with me before he opens his doors for business:

• What type of business are you going into?

• Did you sign any documents or commence any business operations before coming to me to discuss forming your company?

• Are you raising money from third parties (i.e., investors or lenders), or just from the “three F’s” (i.e., family, friends, and fools)?

• Do you have investors? Are they people or companies? Did they lend you the money, or invest it? Is there anything in writing evidencing their investments or loans to you?

• Are you minority or woman owned? How do you make that determination if you have several owners? Can you take advantage of contracting and funding programs related to your ownership status?

• Did you prepare a business plan? If you raised (or intend to raise) outside money, did you prepare an offering document? Did/does your investment offering comply with Securities and Exchange Commission regulations?

• In what state will you conduct the bulk of your business?

• Did you speak with your accountant about tax issues related to operations and the various corporate forms?

• Have you signed any documents in the name of the company?

• Do you have office space? Did you sign a lease, or do you intend to sign one?

• Did you open a bank account? Who has signatory authority on checks?

• What happens if one of the business partners decides to leave the business, or dies? Or one of your partners just decides to stop working on the business but continues to collect profit distributions? Can he do that?

It only took me about 45 seconds to think of the issues above, and I’m just getting started. My point is that when you start a business, there’s a lot to think about. Startup issues will affect the remainder of your business’s life, and your personal life (and mental health) as well. Your lawyer and your accountant need to be part of the process from the very beginning.

There’s an old saying: “Junk in, junk out” (the saying is actually a bit more, uh, “colorful” than this, but I think we all get the gist of it). In other words, it’s best to put high quality legal and accounting work into the startup phase of your business so as to avoid a lot of “junk” (in the form of liability, headache, tax, and other issues) later on down the road when you’re up and running.

I’m going to explore a number of the bulleted issues above in my next several blogs. In the meantime, feel free to call me if you’ve got any questions about any of these issues, or other legal issues affecting your business.

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One of my favorite lawyer jokes goes like this:

Q:  What’s the definition of a corporate lawyer?

A:  Someone who prevents exciting things from happening.

Unfortunately, and all too often, the joke is true.  Many corporate lawyers fail to see the forest for the trees.  They get so wrapped up in focusing on every possible thing that could go wrong in your business or transaction that they “overdraft” your corporate documents and contracts and scare off the other party to your transaction.  Moreover, they often adopt an adversarial stance vis a vis your business partners, customers, and contracting counterparties, which ends up souring what is supposed to be a positive business experience for the companies involved.  All this extra time and extra analysis ends up costing you time, unnecessary anxiety, and more money in legal fees.

 In short, corporate lawyers too often act like overly wordy litigators.  And that’s not what we’re supposed to be.  We’re supposed to help you build, not to tear down.  We’re supposed to help you perform cost-benefit analyses with respect to your contract language, not throw in everything but the kitchen sink.  And building and benefiting should always be a cooperative and forward-looking endeavor, not an adversarial and retrospective one.  It’s not about your lawyer’s ego.  It’s about your business.

However, there’s at least one time during the life of your company when letting your lawyer get analytical and obsessive is actually more beneficial than detrimental, and when there’s a quantifiable benefit to the money you’re paying him for his services.  And that time is when you decide to start a new business.

You’ve got to get your ducks in a row, make sure the language in your formation documents is tight, and keep your gaze steely.  You don’t want your lawyer to stop this exciting thing from happening, but you DO want him to slow it down enough for you to make some serious decisions that will affect the financial and operational future of your new enterprise.  Decisions such as choice of corporate form, tax considerations, investor rights and obligations, corporate governance, banking relationships, and a host of other issues.  Some can be put off until a few months after you’re up and running.  Most cannot.  This is one time when preventing an exciting thing from happening too quickly is actually desirable.

 Are you going to part with some money in legal fees, as the title of this blog states rather forcefully?  Probably.  You might be able to spend a bit less, but you might end up spending more.  It depends on the type of business you’re starting, your financing, your facilities, your investors, your choice of corporate entity, certain tax considerations, and your appetite for risk, among other things.  It won’t cost you an arm and a leg, but it’s going to cost you something.  And it’s going to be some of the best money your business ever spends. 

 I’m going to explain why over the course of the next several weeks of blogging.  Stay tuned . . . .

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Recently I was asked some pointed questions about my inspiration and motivation for writing The Business Owner’s Pocket Guide and I thought I’d share those thoughts here:

What was the motivation behind writing The Business Owner’s Pocket Guide?

The purpose of The Business Owner’s Pocket Guide was to help owners of small to medium sized businesses build stronger companies. As a small business owner myself, I know that these companies are the lifeblood of our economy…and I wanted to help make them better. Through The Business Owner’s Pocket Guide, I wanted to provide business owners with answers before it was too late by focusing on areas of critical importance throughout the life of their companies. I wrote the Guide to address bottom line concerns – even legal issues – in an easily relatable way in the hope that it may not only help business owners avoid unnecessary risks, but also travel well down their chosen path.

How was the content selected for The Business Owner’s Pocket Guide and what makes this guide different?

Having counseled businesses of nearly every size and description for over 20 years, I've gained an understanding of what’s important to business owners. Many of the major concerns cut across industry lines:

• What do I need in my contracts to ensure that I’m going to get paid?
• Should I ask my salespeople to sign a non-compete agreement?
• What should I do if I want to bring on a new investor?
• What happens if the owners of the company can’t agree on critical issues, and how can we prevent the problem before it arises?
• How do I position my company for sale when I’m ready to retire?

I drafted the Guide based on the questions and concerns I saw over and over again. Then I sent the rough copy out to a group of business owners to get their feedback. I think that’s what makes it different – it’s not a textbook and it’s not written to sound “like a lawyer.” It addresses real world issues in an easily accessible way…and it’s free!

Who can and will use The Business Owner’s Pocket Guide? 

In the few days since it has been out, it’s been downloaded by business owners in industries ranging from landscaping to catering, professional service firms, and even some folks in local government. Basically, I see the Guide as a valuable tool for business owners and managers, regardless of industry, and whether the business has 5 people or 500. 

I wrote it to address issues across the board…and it seems from the enthusiastic early reception as though it is doing just that.

Visit www.wagonheim.com to download The Business Owner’s Pocket Guide and come back here to leave your thoughts and comments.

The Business Owner’s Pocket Guide is the third in a series including The Contractor’s Pocket Guide and The Banker’s Pocket Guide, which were released over the past several years by Wagonheim & Associates.

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It’s not hard to find a relative or friend willing to offer a personal opinion on a professional problem. There is really no cheaper advice than that coming from your neighbor. But with the discounted price, one risks listening to uninformed advice from a possibly sophomoric source.

Every month, I consult with business owners who have received wrong, incomplete and sometimes catastrophic advice from friends or relatives who happen to be professionals, albeit with the wrong kind of experience. Often, such advice is simply unfit for the specific business or situation at hand. Advice that is irrelevant to you and your business, although well intended, is more harmful to you than harmless. 

For example, let’s say that you had a good fiscal year and need some additional accounting assistance. Your Uncle Joe has volunteered his services since he used to own his own small business and had to file tax forms for years. What your retired Uncle doesn’t know is that tax laws have changed drastically since he was last in business 20 years ago and filing these principle forms wrongly would result in damaging consequences. 

One of the great truths I have learned in my 20 years of experience counseling businesses is that paying for quality advice is never a mistake. Professional consultants are experts in their fields and have built their businesses and reputations on giving solid, experienced guidance in their areas of expertise. The time and expense it can potentially cost to correct any problems caused by misguided advice is an unnecessary one. Consulting with the right person from the beginning will save you time and money.

When you are sick, don’t you go to a doctor? When you have a toothache, don’t you go to a dentist? Reputable specialists are so for a reason. If you have a legal matter, consult a respectable attorney as you would consult a brain surgeon, if needed be. Your business is important and the counsel you seek to nurture it should reflect that worth. Consult with the right people: professionals with experience directly relating to your business.

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I may be a bit younger in years, but I can still recall when a “handshake and a promise” deal actually meant something. Perhaps some of my confidence in another’s word stems from my small-town Mississippi roots. Nonetheless, in today’s economy, your business will need a lot more than a handshake if you want to get paid. Luckily, only a few hours spent with a reputable attorney can present you with a sound contract based on solid terms and conditions, which will save you time, stress and money, should a client try and stiff you on down the line.

Without a mutually agreed upon legal contract in place, any terms agreed upon with a handshake are moot. Entering into a handshake agreement could put a business at risk for losing money not only in the original agreement but also in court fees for legal action against a deceitful client (unjust enrichment, quantum meruit, and the like).

Since we’re not in 1950’s southern Mississippi, and few millennials even know the meaning of such hospitality in business transactions, a good rule of thumb for any business is to ditch the handshake and ask for a signature acknowledging an ironclad contract, complete with terms and conditions. Those terms and conditions should include the most basic items such as:

• Compensation and payment terms
• Changes/ additional services
• Emergency services
• Reimbursable expenses
• Provisions of default
• Dispute resolution
• Governing law

Legal considerations, as stated above, are extremely important to help ensure appropriate compensation for hard work. Some businesses believe that something in writing, though not in legal contract form, is just as dependable. The reality of the situation is a lack of clearly stated legal terms and conditions could leave a business with a higher level of risk for a transaction.

While developing long-standing relationships with clients is important, don’t forget to protect yourself and your business in the process. Shake your client’s hand and exchange the promise to fulfill the contract, but also take a couple of hours with your attorney to put a “gentleman’s agreement” into writing. For the most part, your company’s terms and conditions can and should be standard with every contract, so this will not be an ongoing legal expense. Rather, it will ensure you peace of mind in knowing that should an agreement not go as planned, you have a contract to protect your business. 

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We all know the resolution drill. The new year marks the welcome of new beginnings and a commitment to resolutions focused toward adopting healthier lifestyles. Come the new year, gyms and fitness clubs across the country will be filled with people sweating off the holiday pounds.  Yet, by spring many of those same people are on the way to the office without a workout in sight. With one bite of a calorie-filled blueberry muffin, the resolution once made with dedication is no longer a priority.

Marketing your business can easily be compared to this all-too-common scenario. As soon as a new product is rolled out or new service offered, a business quickly plans a strategy to get the word out to consumers to increase sales and visibility to target audiences. Spending merely a few weeks working to get your business or product noticed, building your brand, and expanding your network will most likely not offer you the same results as making a constant, consistent effort.  

Think about the results you get from exercising. A few weeks of dedication at the gym may result in a pair of pants one size smaller, but months later they aren’t going to fit if you haven’t maintained a consistent workout regimen.   The same can be said for your business. You may feel good when business is busy and profits are up, but you must put yourself and your business at the forefront and keep marketing to consumers to stay visible.  It takes commitment.  It takes a plan.
 

An easy way to commit to marketing your business year-round is by creating a marketing plan. If this is your businesses’ first attempt, consider consulting a professional or start small by creating a short-term marketing plan with smaller, attainable goals that can be reached in shorter time.  Near the end of the short-term marketing plan, evaluate your goals and consider expanding to a long-term marketing plan with annual goals.
 

As daunting and time-consuming as a marketing plan may seem, the following are a few simple activities that can be done every week to help increase your brand awareness in the community: 

• Attend industry networking events
• Volunteer to lecture or speak at appropriate professional associations or community organization meetings
• Write editorial pieces based on recent news affecting your industry for your local newspaper
• Sponsor local events or charities

While a plethora of practices can be considered for use, the invariable ingredient to a successful marketing formula is consistency and rhythm.  Allotting the time for habitual marketing will help to steadily build a company’s brand visibility. Additionally, the regularity in practices will help to avoid making resolutions to get a business back in shape. Let’s face it…resolutions are tricky to keep, especially if they involve going to a gym, but if it’s better marketing you want, take the time and make the commitment to a solid marketing plan and adopt a proactive mentality. It could be as simple as turning on your computer once a week and researching opportunities online, blueberry muffin in hand.

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