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

Yesterday at 5:00, I found myself sitting in our conference room across from a very interesting gentleman. He was in his upper fifties, maybe 60, and carried himself as a professional. He explained that he had been in business for upwards of 40 years – that he had made some big mistakes, learned from them, moved on, and built a fairly successful business. 

He told me that the business that he had started had run its course and he wanted to start a new one, having learned from the mistakes of the old. In order to start the company, he decided to bring in 3 additional people. These people were friends of his, experienced in his industry, and possessed of the skill sets necessary to make the new venture run. My visitor had decided to divide 40% of the stock among them, retaining 60% for himself – enough, he felt, to keep control of the company.

He was convinced that giving out shares of the company was the only way to keep the group motivated, absent money to pay each person’s going rate. My visitor was wrong.

Recently, I wrote a piece in our e-mail series discussing the mistake of offering partnership at the outset of a business relationship. And whether the discussion concerns true partnership or co-ownership of a corporation or LLC, the fact of the matter is that co-ownership is a business marriage. And make no mistake, just like the real thing, a business divorce can be expensive and emotionally draining. 

For his part, my prospective client was asking his friends to invest their time and skill in a new business for little or no compensation. What he wanted was a way to show his friends that they would reap the benefits of their investment.   We explored a number of possible solutions, but what we decided upon was offering stock options.

People, you see, are unpredictable. Some may be highly skilled and great friends, but start working together and it’s a trainwreck. Different business philosophies, work ethic, or personalities can destroy a team that could not possibly look better on paper.   Stock options and a vesting schedule are two ways to put together an arrangement now which takes effect later. 

In this case, we could commit to an option to purchase stock in the company beginning in 3 years, discounted for each year the person had been with the company. Moreover, as incentives, other discounts to the purchase price could also apply, provided we took care not to trigger any unwanted tax consequences.

In other words, my prospective client could date before he got married. And in my experience, that’s a pretty good plan.

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“There is a difference,” I was taught, “between ten years of experience and one year of experience repeated ten times.”   I thought about this the other day as I contemplated the calendar change to 2011 and the fact that next year will mark my 25th year in practice. 

Everyday it seems like I see too many examples of companies celebrating survival, rather than progress. We regularly receive letters adorned with “our 10^th anniversary” ribbon stickers and see businesses using the phrase “since 1956” or some such instead of an actual message.   When I was a young attorney (maybe for ego’s sake I should say “younger” attorney), I was hoping to be made partner when the management committee told me instead “we’ve decided that you have to wait 3 more years before we extend an offer of partnership.” 

Now, granted I was young – younger than any of the partners by a long shot – but I had just as many clients and generated more revenue than most.   “Why,” I asked, “does it matter how many more sunrises I see between now and an offer of partnership?” I urged them to give me something different such as a revenue, performance, or even billable hour target to hit. But no, to them it was time. To me, this made no sense.

One of the real values of seeing another sunrise is the ability to leave behind the mistakes and absurdities that had, no doubt, been a part of your yesterday. But equally as important, with the sunrise comes the opportunity to build on yesterday’s lessons. Sometimes that’s painful in business.

Print out your customer list. Not a list of your most active or largest. Print out a list of all of them. Don’t just read the names, ponder them. As to each, are they enthusiastic about your work or did you make a cringe inducing mistake? Were you late? Were you, perhaps, a bit less responsive than you should have been? Are they loyal to you or are they casting a wandering eye across the business landscape wondering if they can do better? 

I have yet to find a business owner who, in his heart of hearts, can honestly say that he did right by 100% of his customers 100% of the time. 

So here are the questions: What are you going to do about the failures? Are you committed to learning? Have you created a company culture open to improvement? Can you begin a lasting and productive dialogue about your failures? Have you ever conducted a bloodless autopsy – one with a mission of education rather than the identification of a scapegoat?

In other words, in 2011, what will you have learned by the sunrise?

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My wife is a product of Oregon.   So is her favorite beer, Bridgeport Coho Pacific Extra Pale Ale. Years ago, when she first made the move to join me in Maryland, I tried to surprise her with a case of Oregon’s finest. Unfortunately, the brewery did not ship product farther east than Colorado. It was not willing to make an exception in my case. 

Maryland law required that I first obtain a distributor’s license to facilitate the transaction. I did not qualify for one. I tried to get a few of our retail stores interested in serving as my proxy, but no one would bite. And as much as I revere Baltimore’s Natty Boh roots and tradition, the two products were hardly interchangeable. 

My memory of this failed gift came flooding back to me yesterday when I read Scott Calvert’s article in the Baltimore Sun reporting on the possible loosening of Maryland’s prohibition against direct shipment of alcoholic beverages. The Sun cited Maryland’s wine industry lobbyists as basing their opposition to direct-shipping on two arguments: (1) that direct shipment to consumers would make it easier for minors to obtain wine; and (2) aggressive out-of-state competition would imperil Maryland’s own wine retailing industry. 

We’ll leave the first argument by the wayside, saying only that on its face it makes no sense, given that how alcohol gets into the dining room liquor cabinet is much less significant an issue than the parentally-imposed controls over how it gets out.

It’s the second argument that attracted my attention.  According to the Sun, the Maryland wine industry lobby favors the existing statutory environment because it limits competition.   Now, I completely understand why an industry lobbying group would want to insulate its members from competition. In fact, I’m certain that there are very few businesses in the country that wouldn’t benefit from a little statutorily-imposed exclusivity.  

But that’s hardly the point.

The point is that a business in our economic system should be constructed to beat the competition, rather than rely on the law to do it for them. If a company is not able to articulate to its prospective customers at least one (and ideally three) clear benefits to doing business with it as opposed to its competition, then it deserves to lose those potential customers. Price, service, selection, trust, relationships, knowledgeable sales staff, value-added services, an expanded product line…something. These are the elements of successful competition – regardless of industry.

Friend of the firm, Mitch Pressman of Chesapeake Wine Company was exactly on point when he was quoted in the Sun article as saying that he welcomed the competition. He welcomed anything that would bring about an increased interest in his product. And it is precisely his confidence in his business, staff, selection, knowledge, etc., rather than a reliance on antiquated statutory protections, that positions him to overcome the competition. 

And that’s the way it should be.

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Newton’s First Law of Motion, though revolutionary in its day, is simple enough: An object in motion will stay in motion and an object at rest will stay at rest, unless acted on by an outside force. 

This Law has helped legions of students understand physics and has shaped the world view of generations of scientists. And it works, too, until one gets down to the subatomic world where quarks, fermions and baryons dwell. There, as Daniel Pink says in his revolutionary book Drive about employee motivation, “things get freaky.” In other words, things don’t work the way logic and history teach us they should.

Surprisingly, the same can be said for employee motivation. 

The quest for employee motivation is about control and the application of external force. Speaking as an employer myself, I am constantly thinking about what I can do to control the outcome I desire. I think: “What can I do to raise our revenue by increasing the rate at which files are opened or the efficiency with which work is performed.“  

My mindset, in other words, tends to reflect conventional wisdom of “pay more, get more.”  If you want more widgets produced, hours billed, or projects completed, create a bonus structure that rewards production.   When I took Introductory Economics at Duke in 1982, our textbook instructed us that in a world of perfect information, the parties will work toward a wealth-maximizing result. In other words, wealth was the determinative factor in human motivation. And if wealth is the determinative factor, business owners like me could manipulate wealth, thereby increasing motivation.

The problem is that it just doesn’t seem to work that way with anything but repetitive piecework. Where creative, problem-solving work is concerned, things tend to get freaky.

Time and time again, people leave lucrative positions to take lower paying jobs doing what they truly like. They’ll forgo a W-2 environment for the much riskier (and more work-intensive) entrepreneurial undertaking. They’ll spend hundreds of hours playing clarinet when they don’t have a hope of getting to the stage. They’ll spend hours on Sudoku or puzzles without any kind of incentive or reward. 

My brother-in-law has spent his career as a long-haul truck driver, now working for UPS. From his observation of several large, nationally known companies, he concluded that most people wanted to do a good job. But when companies began installing incentive programs, long-term productivity plummeted. In the short run, of course, the drivers worked to attain the bonuses. Then, as the company began raising the targets and installing more incentives to hit, people began to tie their motivation to the bonus(es) they hoped to achieve. Once they determined that an incentive was out of reach or unimportant, their productivity dropped off to a point far below pre-incentive levels. 

Pink comes to this same conclusion by traveling a different path. Pink refutes the historical incentive laden bonus structure by pointing out such seeming anomalies as the rise of open source products such as Firefox and Linux, the triumph of all-volunteer Wikipedia over the heavily funded Microsoft Encarta, and the pervasive presence of non-compensated, open resources offering everything from car repair advice to recipes. 

In 1999, thirty years after his groundbreaking work as a psychology graduate student at Carnegie Mellon University, Edward Deci, reviewed 128 separate sociological experiments and came to the conclusion that tangible rewards tend to have a substantially negative effect on intrinsic motivation.    Why? Because the creativity and sense of accomplishment that people once enjoyed had, when presented with productivity bonuses, suddenly become “work.” As Pink stated, “over and over again, they discovered that extrinsic rewards – in particular contingent, expected “if-then” rewards – snuffed out the third drive [of internal motivation].”

The challenge, therefore, is a daunting one. It is easy, after all, to figure out the results we want and provide a monetary reward based upon achievement. The challenge, however, is to create an environment that sparks each producer’s internal drive to succeed. 

As we approach the New Year and contemplate, as business people, what we can do to make our own enterprises better in 2011, nothing merits consideration more than the question of employee motivation. We have to determine:

1. What outcomes do we want to inspire; and
2. What can we do as managers to incentivize the outcome without snuffing out that all-important self-motivation?

I’ll write more on this subject in upcoming blogs. Please feel free to weigh in with your comments.

Questions? Comments? Concerns? Raise it for discussion on Facebook, Twitter, or LinkedIn.

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I have to admit that I’m a sucker for a good, old fashioned sarcastic remark. I’m the type of guy who’ll actually compliment someone who directs a sarcastic remark my way, as long as the sarcasm is sufficiently artful. I admit that this is a little weird, but I think I can trace its origins back to one of the most sarcastic guys ever to put pen to paper, and someone who intimately understood the absurdities of life: British mathematician and novelist Lewis Carroll. Carroll, you may recall, wrote Alice’s Adventures in Wonderland (but to everyone except English professors, it’s just plain old Alice in Wonderland). One of my favorite passages from the book also happens to involve my favorite character, the Cheshire Cat. It goes something like this:

Alice:   “Would you tell me, please, which way I ought to go from here?”

Cheshire Cat: “That depends a good deal on where you want to get to.”

Alice:   “I don’t much care where . . .”

Cheshire Cat (grinning, no doubt):     “Then it doesn’t much matter which way you go.”

Alice:   “ . . . so long as I get somewhere.”

Cheshire Cat: “Oh, you’re sure to do that, if only you walk long enough.”

I can hear the wagering in the room now: “$50 bucks says there’s no way he connects Alice in Wonderland to anything remotely resembling a legal issue.” Oh, Grasshopper! Watch this:          

Anyway, where was I? Oh, right. The Cheshire Cat. I like this passage as much for the Cat’s lethargic, disdainful sarcasm as much as for what the Cat teaches us about knowing where we’re going – and where we’ll end up if we don’t know: “somewhere.” Well, if “somewhere” isn’t good enough, then planning is required. This applies not only to a trip to the supermarket, but to careers, family life, business plans, and “succession planning” – which, conveniently enough, is what I want to focus on in this week’s blog. 

So, what’s succession planning? Fundamentally, it’s deciding early on in the life of your company what happens to the ownership interests – the equity -- if something happens to you or your fellow partners or stockholders. What could that something be? How about a decision by one of your partners to just stop working, for whatever reason (such as an illness, retirement, a lifelong desire to move to Bangkok, or just plain boredom). Would this leave your company in the lurch? Would the company be obligated to continue to pay distributions or dividends to a partner who just stops working? In the absence of a well-drafted succession plan, the answer is highly likely to be “yes.”

Or, let’s take another example. One that most people would prefer not to think about: the death of one of your partners, or your own passing. It’s not pleasant to contemplate, but the reality is that the deceased partner’s equity in the company lives on. Something has to happen to it. Succession planning will determine what that something is. Unless you would prefer for a probate court or your deceased partner’s last will and testament to determine who succeeds to her equity in the company. In which case it’s as likely to end up in the hands of her husband as her crazy sister who lives in an Ashram in Kathmandu. How would that affect your company’s operations and its cash flow? Better to avoid these possibilities altogether and come up with a written succession plan or agreement.

A well thought-out succession plan will determine what happens to each stockholder’s or partner’s ownership interests and rights in, as well as obligations to, the company in the event something happens. In the case of a corporation, the succession plan is usually made part and parcel of the Shareholders’ Agreement (which would make a good topic for another blog – making mental note to self). In an LLC or partnership, the succession planning language is generally included in the operating agreement or partnership agreement. In any case, it can also be a separate, stand-alone agreement if not included in either of these documents.

Most succession plans give the company itself, or the other partners or shareholders, the right (but usually not the obligation) to buy the departing (or departed) shareholder’s equity. It will also determine whether the company or the other partners have a right to buy out a seriously ill partner, or to oust a non-performing partner. The succession plan will also determine who else has a right to buy or inherit the equity in the event the company or the remaining partners decide not to buy it. And, perhaps most important, the plan will provide for a methodology for valuing the equity. Different types of businesses lend themselves to differing valuation techniques, which your financial advisor, accountant, and attorney (me, remember?) will discuss in order to select the proper valuation method.  Because the absolute worst time to attempt to value equity is when a partner dies or leaves. (By way of example, what do you suppose the odds are of arriving at an amicable agreement with your recently deceased partner’s sister with respect to the value of her equity interest? Which the sister now owns, incidentally.)     

There’s much more to succession plans that I’ve touched on here, of course. But I think I’ve covered the major issues with a broad brush. A good succession plan will let you sleep easier at night. And the sooner you implement the plan, the more comfort it provides.

So, now that we’re all comfortable with succession planning and grinning like Cheshire Cats, let’s get down to business and make a succession plan. Before you end up “somewhere,” rather than where you want to be.

If you enjoy reading our blog, please vote for us for the Baltimore Sun's 2010 Mobbie Awards under the category of "Business & Technology" blogs.  Voting starts at 8:00 a.m. Nov. 2 and ends at 5:00 p.m. Nov. 12.  Thank you to all who nominated us!

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My client was a car guy…and he was terrific. A gifted mechanic, to say he loved what he did was an understatement. He was passionate about it. He reveled in the mystery of that unknown knocking sound and prided himself on being able to fix problems that defied even description. People kept telling him to open his own shop. “You’ll have them lined up around the block,” they told him.  

After 15 years, he did.

And there was a bank to find, a line of credit to work out, employees to hire and shifts to create, policies to form, a lease to sign, equipment to install, and marketing to do. Months went by and the only car my car guy saw was the one he drove him home at night exhausted.

You see, my mechanic had promoted himself to the level of his own incompetence – running a company. And in doing so, he took himself away from his highest and best use which was fixing cars.

So if you know someone in this situation, or think it even sounds a little like you (maybe sometimes?), what do you do?  

I don’t have a quick, ten word answer to this. But after 23 years practicing business law, here’s what I do know: Every business owner should have someone – may a few someones – outside the company to whom she can pour out her soul – all the angst of running a company, together with the stress and doubt that goes with it. Ideas come from give and take. And when they promote themselves to CEO, the give and take is the one thing most entrepreneurs seem to accept has been lost. 

My advice: Don’t lose that give and take without a fight. Keep it. Make it a priority by putting sessions on the calendar.   After all…love takes work.

If you enjoy reading our blog, please nominate us for the Baltimore Sun's "Mobbie" awards under the category of "Business & Technology" blogs. The nominations start Oct. 20 at 8 a.m. and will end Oct. 29 at 5 p.m.

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Those of you who’ve been following my blog over the past 10 weeks or so (or at least the 3 of you who are still awake and haven’t yet slit your wrists) know that I’ve been discussing how to finance a new or existing business. I’ve been spending a lot of time on this topic for 3 reasons:

1. it’s one of the most important issues business owners face,
   
2. it’s a topic about which I receive a significant number of questions, and
   
3. it’s worth understanding the legal and business ramifications of the various methods of financing a business.
   

Alas, every journey must eventually come to an end, as must this one. With that in mind, let me briefly discuss 3 additional financing sources that I haven’t yet talked about to tie up our financing miniseries: using credit cards, funds from your IRA, or home equity loans.

• HOME EQUITY LOANS:  The advantage of taking out a Home Equity Loan is that you’ll pay a relatively low rate of interest and get a long term loan. Disadvantages? The obvious one is deciding whether you believe in your business enough to risk your house (have you done a business plan and some basic financial projections?). The less obvious one (but perhaps more problematic one) is that your spouse will have to co-sign the loan (I’m assuming that if you’re married, you hold title to your house jointly with your spouse). Is your spouse willing to be liable for the debts of your business if things don’t work out? More important, what happens if the two of you get divorced? In the absence of an up-front written agreement with your spouse dealing with this issue, it’s not going to be pretty. If you go this route, talk to me first.
  

• CREDIT CARDS: Again, are you confident enough in your business plan to risk your personal credit and the inevitable lawsuits and collection efforts should the business fail? If so, there are a number of advantages to using credit cards, including the lack of a need to put up security, the lack of spousal involvement, and the possibility of very low “teaser” rates (which are worth shopping around for). Once the teaser expires, it’s possible to roll the balance over to another card with another low “teaser” rate. 
  

Disadvantages? The risk, of course. Also, credit card financing is and should be short term due to the inevitable interest rate hikes once the teaser period expires. Plus, you will almost certainly have to personally guarantee the card.

Finally, remember all the ink I spilled a couple of months ago blogging about the limited liability gained via incorporating, and the various transgressions that could give rise to a loss of that limited liability? Funding a business using your personal credit cards implicates some of those issues (specifically, segregation of funds issues). Call me so we can discuss if you’re thinking of going this route.

• IRAs: This is the financing technique that I find to be simultaneously both the most appealing and the most terrifying.   So here’s your question: Should you take money out of your IRA to finance your new business?
  

For me, the 2 most important threshold issues related to IRA financing are these: (1) how much of your IRA you’ll be tapping, and (2) your age. Here’s a long but important sentence: If the remaining funds in your IRA (after you pull out whatever you’re going to pull out to fund your company) would be sufficiently small such that living on those funds would have a significant adverse effect on your quality of life at retirement, AND you’re over the age of, say, 45 or so, I’d have a serious heart to heart with both your spouse and your accountant (not necessarily in that order) before pulling the money out. I also personally believe (and you can take this for whatever you think it’s worth) that it’s best to be ultraconservative and assume that the funds remaining (if any) in your IRA after you tap it to finance your business will be all that you’ll have left for retirement. In other words, assume that the remaining funds will NOT grow significantly between now and your retirement (and could possibly decrease), and that you WON’T be able to contribute any additional funds to your IRA between now and retirement.

However, once you decide to take the plunge, you’ve actually got several advantages over virtually any of the other financing techniques I’ve been discussing in my financing miniseries. Debt financing (banks, SBA, home equity, credit cards, etc.) can put a serious strain on your business’s cash flow – not to mention your personal financial situation, since you’re likely giving personal guarantees or security for the loans. Venture capital financing can result in the loss of control over your own company and your eventual personal obsolescence. And financing using the 3Fs can result in family discord, estrangement, disappointment, and broken relationships. But utilizing IRA financing eliminates all of these pitfalls. And, you can avoid early withdrawal penalties and taxes if you employ an IRS approved financing plan.

So, how does it all work? First, you’ll form your new company (and, of course, you’ll form the right kind of entity because you’ve read my blogs on corporate formation). Second, your new company will set up a “qualified retirement plan” in accordance with IRS regulations. (You’ll need an experienced and reputable benefits firm to do this for you. I can help with recommendations, if necessary). Third, you’ll roll over the desired amount of your personal IRA funds into the company’s new “qualified retirement plan.” Last, your company’s newly-established “qualified retirement plan,” fresh with funds from your personal IRA, will use those funds to buy stock in your new company. Your company is now funded with equity from the stock sale (rather than cash flow -draining debt), and the “qualified retirement plan” owns all (or some) of your new company.

The following goes without saying (but since I’m anal retentive AND a lawyer, I’ll say it anyway):  I strongly recommend that you work with an experienced corporate attorney when setting up the new company and when consummating the stock purchase by the qualified retirement plan. Someone like me, perhaps. These are sophisticated corporate transactions and need to be treated as such.

Next up: ever think about what would happen to your company if your business partner died? What if he decided to sell his interest in the company to a third party?  Or suppose she decides to just stop working (can she do that)? If you haven’t thought through these issues, you should. Succession Planning is on deck.

Questions? Comments? Concerns? Raise it for discussion on Facebook, Twitter, or LinkedIn.

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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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