The Start Up – The Brilliant Idea

The Brilliant Idea –

We all have them and very few of us act upon them.  There are many reasons why not.  Money, time and lack of faith in ourselves are just a few.  Today, however, there is lots of help available to take you from step A to step B.  Some examples: Openinvo.com (a matching service for idea generators and idea seekers); incubator services for start-ups some examples of which include venture capital (NYCSeed.com), working space and business support (business incubator association of New York – biany.com).  A simple Google search for business start-up help will generate hundreds of millions of links.  In fact, part of the problem today is too much information.  That’s where I come in.  Over the next weeks, months and years (yes, there’s that much information) I’m going to talk about all things “legal”.  I’m going to simplify, but not dumb down, the everyday legal issues that most start-up and small business will run into.

The Start Up – The Company

The Company –

Once you become really serious about your business – meaning you choose a partner, decide to raise capital, go live to “real” customers, pretty much anything that involves putting you or your assets at risk – you should consider forming a company.  It will cost you a few dollars, but, it is the first step in protecting yourself against personal liability in connection with running your business.  So balance it out – forming a company to limit personal liability versus exposing your home, savings, relationships to personal liability if the business runs into problems.    The path seems clear so let’s focus on the first question. What form should your company take:  corporation (C Corp, S Corp); limited liability company, sole proprietorship, partnership (general or limited)?  What are the factors to consider: state law, personal liability, formation requirements/costs, administrative requirements, management, term, taxation, transferability of interest, capital raising, and ease of operation?.  Did I say I would “SIMPLIFY”?  Well, here are some thoughts.  First and foremost, consult your accountant (yes, you should choose an accountant at the very beginning of the process – one who loves you more than your Uncle Sam!).  Here are a couple of quick reference guides that compare the attributes of various corporate forms available: http://www.ailcorp.com/comparisonchart.htm or http://www.vcorpservices.com/entrepreneur/learning-center.php; and there are many more available if you Google “comparison of corporate forms”.  The company formation can be done by your accountant, lawyer, or any on-line service [see http://www.vcorpservices.com/entrepreneur/learning-center.php ], but remember: ALWAYS CONSULT AN ATTORNEY FIRST.  It is much harder and more expensive to undo what you may have done incorrectly than to just do it right the first time.

Next installment, your Shareholder or Operating Agreement (just think of it as your “Prenup”).

The Start Up – The Prenup – Introduction

Introduction

Unless you’re going it alone, one of the most important documents you will need to enter into is the agreement that defines the relationship between you and your partner(s).  Think about it, most marriages start with the couple being “in-love” and no one is really paying attention to the realities of living with another person.   But as time goes by (and the blinders come off), who doesn’t get angry about the dirty underwear on the bedroom floor, the snoring or just the daily grind of living with each other’s habits.  And remember, for most of us, we spend more “awake” time with our business associates than we do with our marriage partner.    So, what I hope is becoming clear, is that each of you will be better off if you define your roles in this new venture.  Both the on-going management and the potential “divorce”.  Just some random statistics to drive the point home — the divorce rate in the US is somewhere between 40-50%; the failure rate for a new business is about 70% over a 10 year period; and while there are no verifiable statistics on whether those businesses that are successful have the same partners they started out with, remember Mark Zuckerberg (Facebook) and Steve Jobs (Macintosh/Next/Apple) (yes, you can Google all these statistics as well).  Bottom line, spend some real time (and money) to make sure you don’t end up in very expensive and emotionally draining litigation over how to break up, exit or wind down the business. Depending on the form of organization you have chosen (see, The Company) you will need to enter into a Shareholder Agreement, Operating Agreement or Partnership Agreement.    Each of these agreement deals with some universal issues (e.g.  management of the company) and some unique issues (e.g. taxation).

Next installment, Universal Issues – Management of the Organization, and remember, ALWAYS CONSULT AN ATTORNEY FIRST.

The Start Up – The Prenup – Universal Issues – Management of the Organization

Management of the Organization.

Remember “who’s on first”, the routine that Abbott and Costello made famous (yes I know I’m dating myself – but it’s well worth the time – and here’s the link http://www.youtube.com/watch?v=sShMA85pv8M&feature=related).  Well maybe that’s a slight diversion but getting back to the point, it’s important to understand who is taking management responsibility in the company and what the limits of that person’s responsibilities are.  Who can sign contracts, write checks and are there dollars limits to these rights.  Who can make important company decisions (e.g. sale of the company, addition of a new member). Should they be decided by a simple majority of the current members or a supermajority or maybe unanimous consent.  Every business and every relationship is different and there is no one size fits all for these decisions.

Next installment, Universal Issues – Disposition of Interests, and remember, ALWAYS CONSULT AN ATTORNEY FIRST.

Start Up – The Prenup – Universal Issues – Disposition of Interests

Disposition of Interests.

So, now you want out, or maybe one of your partners wants out.  Negotiating your way out of a business relationship is best done when both parties are level headed and that means before the event that triggers the decisions to leave.  Let’s think about the reasons why a member wants to leave – other interests, bankruptcy or other need for money, disability and death are the standard reasons but not the only ones.  The underlying question is whether all dispositions should be treated the same, regardless of the reason.  While that may be the easy answer (and sometimes the right one) generally dispositions should fall into two buckets – voluntary (desire to sell) and involuntary (death/disability) and the solutions for each may vary.   Some examples of “outs”: right of first refusal (worthy of a section all its own – but generally giving the other members the right to buy you out if you find a buyer for your interest); blanket prohibition on sales (not nice, but remember, in a small or start-up business with no significant cash flow why should the remaining partners have to find “cash” to buy out the other); buy out at fair market value (a “decent” solution for death or disability – it gives the estate a value and the remaining partners have a way of continuing the business).   Remember though, there are no easy solutions.  How do you determine fair market value for a start-up business, how do you deal with a disgruntled partner if they have no right to sell.  I could go on (as most lawyers do), but I think you get the point.

Next installment, Universal Issues – Dispute Resolution, and remember, ALWAYS CONSULT AN ATTORNEY FIRST.

The Start Up – The Prenup – Universal Issues – Dispute Resolution

Dispute Resolution.

Hmmm, you can’t work it out yourselves and counseling doesn’t seem to be an appropriate alternative (Freud may have lots to say but who has the time) so what’s the next step?  There is no way to know ahead of time what the “dispute” will be about (my personal crystal ball broke ages ago and it’s been impossible to get it fixed – but you might enjoy this one  http://www.youtube.com/watch?v=2TwGZYnfO3Y).  Back to the topic at hand, the best thing to focus on is how you can resolve the dispute, whatever it may be, and keep the business moving ahead. (Remember – if you want a buy-out go to the last installment Universal Issues – Disposition of Interests).  Mediation is the most common method for resolving these types of disputes and it is best to spell out the type of mediation in your partnership agreement.  So here are a couple of choices:  Single Mediator – this involves the appointment of a single person whom both parties have agreed has the authority to resolve the dispute; Mediation Panel – this usually involves each party in the dispute appointing a individual mediator and the two mediators agreeing to a third mediator (necessary of course to make sure the mediators aren’t deadlocked).  There are, of course, lots of variables to consider here.  Mediation is not without cost (you’ll need to pay the mediators and spend the time necessary to make sure the mediators are aware of all of your issues) and you might not the like the decision of the mediator, but non-binding mediation is a waste of time.

Next installment, Issues Specific To Your Form Of Company, and remember, ALWAYS CONSULT AN ATTORNEY FIRST.

The Start Up – Issues Specific To Your Form of Company

Issues Specific To Your Form Of Company -

Taxes, taxes, form of investment and, of course, taxes.  Other than real estate is there a topic that folks like to discuss more?  Tax considerations are one of the driving forces in deciding what form your business should take (corporation, limited liability company, partnership), the jurisdiction in which you should form your company in, and how you wish to treat your income or (heaven forbid), losses.  Unfortunately, tax law is truly a specialty and I’m not a tax specialist so I’m not going to spend much time on this topic.  Some highlights, however, that you may want to focus on with your accountant or tax specialist:  Where are the principals of the company located, where will the business be located, where will sales be made or services performed, and for the purposes of your partnership agreement, how will profits and losses be treated (passed through to the owners, reinvested in the business and every mutation of these two).   Very tied into this issue are the issues of capital allocation, ownership interests and valuation.  Will the owners have equal rights, will certain classes of ownership have preferences (distributions, priorities), and how will each owner’s contributions be valued (cash, sweat equity, intellectual property contributions).    Okay, so simple simply doesn’t work in this particular space – rather decisions must be made with the advice of a tax specialist, a lawyer and of course any decision must take into account basic “fairness” principles or the parties will end up resenting each other and we’re back to Universal Issues – Disposition of Interests. Finally, let’s not forget decisions made in this particular space can have lasting implications and may not be easily undone so “saving the hard stuff for later” is not the prudent response.

Next installment, a new topic Intellectual Property – Confidentiality, and remember, ALWAYS CONSULT AN ATTORNEY FIRST.