CHAPTER II
Start-Up Activities
Choosing the Right Business Entity
YOU PAY BILLS EVERY month to businesses like Jack’s Garage, Tax Prep LLC, and Green Utility Corporation. Each of these businesses has a unique corporate structure. When you set up yours, you need to pick the best type of business structure to suit your great idea.*
Whether you set up your business as a sole proprietorship, partnership, limited liability company (LLC), S-Corporation, or C-Corporation, it is vital to understand not only the filing and paperwork requirements, but also the different tax implications and liability impacts that each choice entails.
Sole proprietorships: Commonly, owner-operated small businesses are set up as sole proprietorships due to the simplicity of the filings and regulation, as well as the single-layer tax impact on the revenues of the business. This type of ownership also allows you, the owner, to be your own boss. However, you should be extremely cautious if you set up either as a sole proprietor or in a general partnership. Both types of business structures allow for all of the liabilities of the business to be shared with the individual owners on a personal level. Unlimited liability can be scary. Just remember to hope for the best but plan for the worst. Don’t choose a business structure based on the ease and convenience of setting it up.
It is more common than one would think to have business situations end in lawsuits resulting in general partners and sole proprietors being sued personally and losing homes, cars and savings accounts. There are plenty of hurdles that these types of business owners have to overcome. Management can be difficult with limited participants and there is commonly an overwhelming time commitment associated with this type of business.
Partnerships: There are two types of members in a partnership—a general partner and a limited partner. General partners have unlimited liability and are typically managers of the company. Limited partners have exactly what you would think—limited liability, and they usually do not have a role managing the company. Just remember, no matter how well the individual partners get along, one of the most common issues with partnerships is the disagreements that arise among members. This sometimes leads to unfortunate fallings-out among friends.
Corporations: Most successful types of businesses are corporations—either limited liability companies (LLCs) or conventional corporations (C-Corporations). They generate approximately 80 percent of all sales in the United States and they all share two major benefits. First, they have limited liability, and second, they usually qualify for special tax advantages that other types of business ownerships do not enjoy. (An S-Corporation is actually not a business entity; it’s a tax election or choice that causes all income to be passed through to the owners, thereby eliminating the double taxation of traditional corporations. More on that in a moment.)
Incorporating a business is a great strategy. It allows for the company to grow, it has perpetual life, makes change of ownership easy, and it’s common for corporations to be able to afford talented employees. However, there are some disadvantages to incorporating a business. Corporations cost more to start than sole proprietorships or partnerships, they require more paperwork, and conflicts among owners and board members can arise. They are also affected by double taxation, which means that the business’s profits will be taxed, as well as the shareholders’ dividends.
Let’s revisit the S-Corp for a moment. It’s a tax election, not an entity per se. It offers single taxation, like in a partnership. Downsides of incorporating as an S-Corporation include ineligibility for a dividends-received deduction, and S-Corps are not subject to the 10 percent of taxable income limitation that is applicable to charitable contribution deductions.
A limited liability company (LLC) is a form of business in which owners and managers receive the limited liability and tax benefits of an S-Corporation without having to conform to the S-Corporation restrictions. For certain professions, e.g., accounting, architecture, and medical or psychological care, the LLC becomes a PLLC, a professional limited liability company.
Choosing the best type of business is a personal choice, and it’s certainly one that shouldn’t be taken lightly. This is an area where professional advice, tailored to your locality and business sector, is essential. Seriously analyze your business’s projected longevity, growth and future development before making your choice.
S.G. and M.R.M.
The Difference Between Copyrights and Trademarks
BLACKSMITHS WHO MADE swords in the Roman Empire may have been the first trademark users. In later times, copyright law applied only to the copying of books. Patents are recorded as early as 500 BC among the Greeks, giving people who invented new recipes one year’s exclusive use of the dish.
Protection of your intellectual property (IP) should be your very first step when starting a new business or project that depends on your IP. Also, just because you’ve conjured up a great concept or idea doesn’t mean that you’re the first to come up with it. Do yourself a favor before you start marketing your new idea and check with the appropriate government offices in order to ensure that you’re not accidentally taking credit for something someone else has already registered or copyrighted.
Below is a list of Fun Facts that you may not have known about copyright and trademarking. These similar, but legally different, protection practices cover different things. By all means, seek legal advice if you have any questions on these subjects.
A copyright is a set of exclusive rights granted by a state to the creator of an original work (or the creator’s assignee) for a limited period of time, upon disclosure of the work. This includes the right to copy, distribute and adapt the work.
A trademark is a distinctive sign or indicator used by an individual, business organization, or other legal entity, used to identify that the products or services to consumers with which the trademark appears originate from a unique source, and to distinguish its products or services from those of other entities.
A copyright protects works of authorship as fixed in a tangible form of expression. Examples of what a copyright covers include works of art, photos, pictures, graphic designs, drawings, songs, music and sound recordings of all kinds, books, manuscripts, publications and other written works, plays, software, movies, shows, and other performance arts. If you are interested in protecting a title, slogan, or other short word phrase, then generally, you want a trademark.
© is the copyright symbol in a copyright notice
™ is the symbol for an unregistered trademark (a mark to promote a brand or goods)
SM is the symbol for an unregistered service mark (a mark to promote or brand services)
® is the symbol for a registered trademark and a registered service mark
In the U.S., copyright is obtained through the United States Copyright Office (USCO), which is a division of the Library of Congress (see www.copyright.gov). Other countries have similar offices, which you can locate on the web.
Likewise, in the U.S., trademark is obtained through the United States Patent and Trademark Office (USPTO, at www.uspto.gov). Check the web for other countries’ offices.
Keep in mind that there may be occasions when both copyright and trademark protection are desirable for the same project. For example, a marketing campaign for a new product may introduce a new slogan for use with the product, which also appears in advertisements for the product. The advertisement’s text and graphics, as published, are covered by copyright. That will not, however, protect the slogan in your ad. The slogan may be protected by trademark law, but that law will not cover the rest of the advertisement. If you want both forms of protection, you will have to perform both types of registration with the appropriate offices.
The websites of the respective offices of control in countries around the world offer a wealth of further information, ranging from tutorials and step-by-step walk-throughs to other valuable information that can get you on your way to protecting your intellectual property. Don’t neglect to do so.
S.G.
How to Patent a New Product
ALL TOO OFTEN, we hear about peoples’ dreams of starting a business being bogged down by government paperwork. They complain that because of it, their great plans to start a new business based on a product or invention they have developed never get off the ground. The patenting process seems too overwhelming to them.
Take Europe, for example. Presently, although there exists a mechanism through the European Patent Office (EPO) for challenging and verifying a granted patent’s validity, the process is limited to a nine-month period of opposition, beginning the day the patent is granted. Beyond that, a centralized way of challenging a patent granted by the EPO does not exist. Contracting states of the EPO must each separately validate a granted patent. It then becomes the responsibility of each contracting state to enforce and challenge the granted rights. It’s truly a bureaucratic maze. (More information for obtaining a patent in Europe can be found at www.epo.org.)
For entrepreneurs in Australia, the patent process is very similar to that of the U.S. The patenting process in Australia begins at www.ipaustralia.gov.au and roughly follows the same steps as the U.S. procedure.
Here is a step-by-step guide, with the U.S. procedures serving as an example, to getting past the patent paperwork and on your way to building your new business.
1. First, you need to find out if your product has already been patented. You can accomplish this by running a simple search with the United States Patent and Trademark Office (USPTO) on their website, www.uspto.gov. If you discover that someone has already patented your idea, then sorry: Unless you think of a new way to use your product, there isn’t much you can do.
2. If your product hasn’t already been patented, your next step is to decide what type of patent you want to apply for. There are three types: (1) Design Patents (for ornamental characteristics), (2) Plant Patents (for new varieties of asexually produced plants), or the most common (3) Utility Patents (for useful processes, machines, articles of manufacture, or the composition of matter).
3. Once you decide which of the three types of patents fits your idea best, you must determine a filing strategy. Decide whether you want to file in the U.S. only, or if you want International Protection. International Protection involves international cooperation among various worldwide Intellectual Property Offices. If you foresee international business, it’s best to go with International Protection.
4. Assuming that you want to file a Utility Patent, which is the most common type, you will next need to decide if you want to file a Provisional or Non-Provisional Application. Don’t be scared by the long words. Basically, Provisional filings are informal and rather quick, while Non-Provisional filings are formal and involve a much more tedious process. While the Provisional process is easier, we recommend taking the time and effort, if possible, to protect your idea more fully by completing the Non-Provisional Application process.
5. The fifth step is optional. It is expedited examination. The USPTO offers an Accelerated Examination Program whereby, basically, if you meet certain qualifications, you can “jump the line” and get your patent processed faster.
6. Now you’re ready to make the final decision before filing: Who will actually do it? Will you file yourself (which is called pro se) or use a registered attorney or agent? While many people undertake the process of filing themselves, we recommend that you use an attorney or agent to complete the actual filing. This will ensure that your application is not returned or delayed for inadequate completion. This is a perfect example of having to spend a little money to make money, but it’s definitely worth it in the long run.
7. Next, you or your attorney or agent gather needed elements for electronic filing. Here, you determine your application processing fees and apply for a customer number and digital certificate. You can do all this directly on the USPTO website. Your customer number allows you to easily manage all of your filings and correspondence with the USPTO and your digital certificate is a security measure that will uniquely identify you and allow you secure access to your patent information and data.
8. Now it’s time to actually apply for your patent. In the U.S., we recommend that you use the USPTO’s Electronic Filing System (EFS) as a registered eFiler. Using the EFS, anyone with an Internet connection can file patent applications and documents without downloading special software or changing document preparation tools and processes.
9. The good news about the ninth step is that you don’t have to do anything! After you (or your attorney or agent) have completed the eighth step and submitted your application, the ninth step involves the USPTO’s examination of your application. You can check your application status at any point on the website, using your Customer Number and Digital Certificate from Step 7. At the end of this step, if the USPTO gives you a “thumbs up” and your application is accepted, congratulations! Jump down to Step 12!
10. If the USPTO doesn’t accept your application on the first try, it’s no big deal. Don’t get discouraged. You have several options here. You can file replies, requests for reconsideration, and appeals as necessary.
11. This step is another one in which you need not take any action. Step 11 is the USPTO’s reply to your request or appeal from Step 10. If, after your appeal or request, the USPTO decides to overturn their rejection and accepts your application, they will send you a Notice of Allowance and charge you for any fees that you may owe from their additional attention.
12. The good news, if you’ve made it to this point in the patent filing process, is that your patent has been accepted and only one small step stands in your way before your patent is granted! The bad news is that now, you have to pay the issuing and publication fees. Once the USPTO processes your payment, the patent is granted and your product is protected.
13. One final step involves the preservation of your protection. Maintenance fees are due at 3.5, 7.5, and 11.5 years after the initial patent is granted.
It must be said that the United States Patent and Trademark Office has done an exceptional job streamlining their electronic filing and informational system. In the U.S., patenting through the USPTO is the only recognized option, but they make it easy and affordable. To learn more, see their website at www.uspto.gov.
S.G.
Renting and Leasing Property for Your Business
THE MOST COMMON TRANSACTIONS regarding real estate deal with renting and leasing. However, there are many other situations that blend business interests, law and real estate. Are you thinking about leasing an office space or retail storefront? Subleasing extra space to another business? Are you a tenant in a strip shopping center or mall where an anchor tenant has moved out? Is your city considering changing the direction of traffic flow, the parking laws or the name of the street where your shop is? These issues are vitally important to your business’s success. We will get back to some of them later in this section.
Since most start-ups work on tight budgets, we won’t focus on buying property for your business here. If you need to purchase land or space right away, work with a real estate attorney, but read this section to acquaint yourself with some issues you’ll need to consider anyway. If you are among the many entrepreneurs who start out by renting or leasing space, let’s look now at some basic concepts that you will find in most landlord/tenant negotiations.
A lease is a written contract that sets up terms under which the Lessor (the owner or landlord, who can be a person or a company) and Lessee or Tenant (you) agree to let you use the owner’s property (land, building, equipment) for a defined, fairly long period of time under defined terms, which could be variable or adjustable. Those terms stay in effect for the entire term (life) of the contract. The benefit to both the Lessor and Lessee of a lease is its fixed, stable nature. If a lease feels too tightly binding for your new business in its early days, by all means consider renting, but be aware that the landlord can change terms, raise rents, evict you and so forth, short-term. However, you can also move on short notice! So not surprisingly, small businesses with simple property needs sometimes start by renting and then change to leasing once the business picture seems stable.
Commercial property leases
The first step is to understand a commercial lease, i.e., what you will be negotiating and agreeing to when leasing space. It is important to fully understand the different elements of a commercial lease and how it differs from a basic residential lease agreement. Keep in mind that you can always elect to work with a real estate professional that specializes in tenant representation for commercial real estate deals. These trained professionals known what to look for and what to avoid.
The next step is to clearly identify what you need: how much space, what location, the type of space, budget, build-out assistance or tenant allowance, signage, deferred rent, CAM (Common Area Maintenance) etc. Again, if you don’t feel comfortable determining these variables then you may want a professional to advise on pros and cons and to represent your interests.
Once you find a suitable property, you can ask the landlord for a draft of the lease. This document should outline the terms and conditions of your proposed lease agreement. It should be as specific as possible, including all necessary detail on these things, plus any special considerations you may need:
• The space in question
• The actual term of the lease in months or years
• The different ways the rent will be calculated
• Proposals for fees for space and other items
• Revenue thresholds that must be met in order for the lease to continue to exist
• Expected move-in dates
• The condition of the property at move-in time
• Percentage of revenue due the owner, if applicable
• Common Area Maintenance (CAM), if applicable
• How taxes will be addressed
• Any other costs associated with the potential lease agreement
Common types of leases
Leases come in several varieties, and can be customized as needed. Skim through the following discussion and then give some thought to what suits your business best.
Gross or Full-Service Lease This is the most basic and least common business lease; it includes everything. The agreed-upon lease fee covers the cost of the space but also insurance, tax, maintenance, utilities, trash, etc. It’s the most straightforward type of lease, and it’s easy understand the total costs and commitments involved. It will have escalation clauses to protect landlords from rising cost in maintenance, insurance and taxes. These clauses often use a prior year or current year’s total expense load as what is called a base year. These financials are used to set the base for expected expenses that will be incurred once your lease begins. Typically the lease payments include the lease fee and expense load referenced in the base year, but any additional expenses or increases in expense will be incurred by you, factored proportionally by how many square feet or meters of space you occupy.
Net Lease This type of lease can have a variable structure. It is commonly used in environments with mostly industrial tenants, where you find variability in their usage of things like utilities. In this type of lease, you are directly responsible for everything outside of the agreed-upon lease fee. So you will pay for the space, and then pay separately for insurance, maintenance, cleaning, taxes, utilities, etc.
Modified or Hybrid Lease These leases are common, and usually are a hybrid between a net and a gross lease. Often a tenant will pay for the space, insurance and proportional taxes, but there will be some kind of negotiated arrangement for how maintenance and other expenses will be handled.
Common lease terms, clauses and provisions
You will run into various technical terms in rental agreements. Each one needs careful consideration, as it can affect your bottom line or cause future problems if you don’t think long term.
Escalation Clause This very basic clause, found in full-service leases, protects the landlord from rising costs associated with taxes, insurance, maintenance, etc. The calculations commonly used for the escalation clause impacts are base year and expense stop (see those items below).
Use Clause A clause used by landlords to either specify what the use of the space and the operation of your business can be, or to specify what you can’t do with the space. They are nightmares, due to the unforeseeable changes that businesses and their products go through as they evolve. Try to avoid these at all costs.
Exclusive Clause Similar to the Use Clause. Have you ever wondered why there is rarely a bakery or a deli in the same strip shopping center as a full-service grocery store? It’s because of this clause. Often larger, more powerful tenants will ask for exclusive rights to market or sell certain products or services for an entire property. This limits competition from neighboring business in the same development. If you’re the big fish, it’s good.
Restrictive Use Clause This is the reciprocal of an exclusive clause, and it affects you if you are the small fish. If you are moving into an already established development with other tenants, you many find a restrictive clause. This clause will outline the items, services and business practices that you are prohibited from engaging in while in the space.
Permissive Use Clause Similar to a use clause, in that the language of the clause outlines what you can do in the space. Often these clauses are produced after a prospective tenant lists the activities that she plans on doing. Therefore just make sure to list everything, and I mean everything, that you many want to do in the space—now, next month, next year, or even five years down the road.
Expense Stop This is the alternative to using a Base Year calculation. When an agreement is being drafted, often a landlord will simply set a expense number (the expense stop). It is the prospective tenant’s responsibility to make sure the amount makes sense. Once the expense stop is agreed on, then any expenses that exceed this amount, either monthly, yearly, etc. depending on how the agreement is written, will be yours to pay.
Base Year As mentioned above in the Gross Lease discussion, a base year is the total expenses incurred in a year, usually the current year or prior year, that is used as a base amount in a new lease agreement. Future expense must not exceed that amount, or the increase in expense will be passed on to you.
Common Area Maintenance (CAM) This is an additional charge you must pay for things like window cleaning, elevator (lift) maintenance, and so forth—things that benefit the whole property’s function. It’s based on the proportion of the space you occupy. Unfortunately it can be a fairly large number relative to the agreed-upon rent amount, so be careful. Your monthly CAM contribution can be 20 percent of your rent or more.
Percentage of Sales This common provision requires you to pay a percentage of revenue to the landlord. It’s common in shopping malls and retail spaces and usually doesn’t kick in until your business volume reaches a certain revenue threshold.
Some typical scenarios
Now that you’ve become an expert on commercial real estate, let’s get back to those head-spinning scenarios we considered at the start of this section.
What if an anchor tenant moves out of the shopping center? Happily, most retail leases are outfitted with a clause that triggers a significant reduction in rent or even releases you from the lease agreement, allowing you to move out if an anchor tenant moves out. Before you sign a proposed agreement, make sure such events are addressed in an acceptable way.
What happens if I can’t make a lease payment? The best thing you can do in this situation is to be honest with your landlord and see if you can work something out, depending on whether your constraints are temporary or permanent. If they are permanent, it’s not the end of the world, but you may have to get permission from the landlord and/or work with her to sublet or find another tenant for your space.
What if a unit of government changes the rules affecting my leased property? Sometimes the bigger picture changes and your leased property is affected by things such as changed zoning ordinances, new parking and street plans, energy farms being planted, and so forth. It pays to keep your ears open for pre-implementation hearings and public discussions about these things, as that’s your opportunity to protest or try to modify plans that negatively impact you. Ideally, you, your landlord and fellow tenants will be on the same side of the issue. But regardless of your positions, you may want to bring in your attorney to represent you in public discussions. She can research the current rules and the context of the proposed changes and might be able to argue more persuasively (on paper or live) than you about your concerns.
We can’t possibly cover every scenario and situation that may arise when dealing with commercial real estate and negotiations. But these basics should shed some very valuable light into the world of tenant/landlord business dealings, and start you thinking about what to look for and what to avoid. Armed with your conclusions, and if necessary, a good real estate attorney, you can deal with issues and then re-focus your attention on what goes on in the space you occupy.
M.R.M.
Everybody Wants a Piece of You: Licenses, Regulations and Taxes
THE TYPICAL ENTREPRENEUR starts a business with a head full of dreams and plans and a huge store of energy to accomplish them. For some, the glowing visions are cramped by the demands of government, their professional organizations, and tax authorities. While you may find these impositions annoying, in most cases it’s a waste of your precious energy to fight or evade regulation. Plan for the requirements that apply to you and your business and move on to the goals that fired you up in the first place.
Licenses
Business or professional licenses are permits issued by government agencies or professional regulatory organizations that allow businesses or individuals to operate a business or practice a profession within a certain jurisdiction.
Getting a license usually requires three basic steps: application, registration and qualification.
• Application is the formal process of requesting the license. It can be as simple as a one-page form or could include requirements like affidavits in support, proof of financial assets or completion of prerequisites, etc. Each application is unique and should be reviewed and completed carefully.
• Registration is the ongoing requirement to notify the regulating agency of ongoing business information. This includes information like your current business addresses, the basic financial status of the business, and continued evidence of complying with all business requirements, like having insurance or a medical doctor on staff.
• Qualification is the process of meeting all initial requirements to attain a particular license. This may only be a business address within the county and a small fee, or it could be a full background check and written examinations.
The various types of licenses
Professional service licenses include doctors, lawyers, teachers, tradespeople, and service industry workers. These are individuals regulated by a governmental agency. Most will require continuing education in their profession and other ongoing professional standards, such as ethical and lawful behavior, in order to maintain the quality of the profession. Each profession will have individualized requirements for licensure, education and professional standards.
Professional business licenses include the businesses associated with the abovementioned regulated professions, such as medical clinics, law firms, schools, skilled labor enterprises and restaurants. These are business organizations regulated by a governmental agency. Most will require ongoing certification of compliance with professional standards of care related to business operation and participation by qualified professionals in the operation of the business.
Business licenses for specific industries in which the business is regulated and licensed beyond the individual members of the business. Examples include construction, cosmetology, farm labor, real estate, hotels, restaurants, cooperatives, chemicals, gambling, etc. The business must acquire licensure and meet operational standards, be subject to inspection, and meet other industry-specific requirements. Depending on the industry, there may be individual requirements related to employees for the business to maintain its license. For example, a timeshare property might have to have a qualified manager appointed through the state, a yacht broker could be required to maintain a surety bond or letter of credit, and many sectors must comply with periodic reporting requirements.
Geographic location licenses are licenses to operate a business in a particular geographic location, e.g., a city, county, region, state or country. These entities may require multiple and overlapping licenses. And a business with multiple locations could require multiple licenses for each unit. You will need to verify that the zoning for your location is appropriate for your business. This can be an important issue for some home-based businesses.
Specific action or risk licenses are licenses related to very specific actions, such as illuminated signage, display of giant inflatable balloons, dancing gorillas out front or extreme noise for a set period (e.g., a concert, contest or event). Licenses can be required for routine actions like the preparation or sale of certain foods that could require additional permits from the health department. These can also be associated with particular risks like fire, pollution or hazardous chemicals.
Sales and tax licenses are related to the sale or resale of goods. This is critical to verify, especially if you are conducting sales through the Internet and across multiple jurisdictions. There are significant differences between jurisdictions. Failure to pay or plan for proper taxes could lead to significant financial, civil and possibly even criminal consequences, not to mention sinking your business.
What do I do?
It can be bewildering to face these things, but that’s the nature of the game. If you are just starting up, this might be a good time to see if your local business community offers help for starters, specifically in this area. Talk to contacts in your sector, but be wary of their information until you verify it yourself for your own business.
However you do it, find out who regulates your business. Expect that it could be multiple entities, such as national, state and county governmental agencies. You could also be regulated by industry-specific agencies such as the Bar Association or a certification board. Pay close attention to local labor requirements as well, such as those from unions. Contact each and/or use their online resources to determine which are relevant.
Multiple jurisdictions
When operating a business across multiple jurisdictions, you must check what’s needed in each individual jurisdiction. The commerce clause of the U.S. Constitution encourages the regulatory systems not to inhibit interstate commerce through unnecessary regulatory requirements, but it can still be very complex. For example, I represented a trucking company that had business operations in 36 states. After it was all said and done, we had to deal with four business organizations, nine insurance policies and almost sixty different licenses, just for the business and corporate officers.
Regulations
Regulations are rules that trigger punishments if you break them. Punishments are civil, meaning they might be monetary fines or prohibition from taking specific actions, but violations are not criminal offenses.
Regulations are closely tied to the licensing we just discussed. Your business’s regulations will come from your industry, probably including multiple jurisdictions and multiple levels.
Your business will have regulations or rules in all its aspects: environmental, financial, tax, advertising, Internet, public policy, etc. Ignorance is never an excuse; it is not a valid defense to a violation. If you are unsure or do not know, then ask or research. Yes, there are quite a few regulations out there, but they are not hiding. The system is designed to be known about and complied with.
Why the licenses and regulations?
The two primary purposes behind licensing and regulation are public policy and economic benefits. The public policy purpose states that if your business’s goal is to make a profit, it may choose that profit over the greater good of the community. For example, consider the harmful chemicals and emissions which many manufacturing industries continue to produce and improperly dispose of. Until the government enacts regulatory standards for allowable chemical emissions and proper disposal, the manufacturers may choose practices based on savings rather than the public good.
But not all policies go against the potential profits of companies. The economic benefit purpose states that for the benefit of consumers and the overall market, the government should regulate as necessary to encourage fair marketplace competition. This policy has led to the break-up of monopolies in specific industries, creating separate competing entities, like the historic breakup of AT&T in the U.S.
Taxes
No doubt, taxes are one of the most critical aspects of business planning and operations. It’s sad but true: improper bookkeeping, record maintenance and tax planning will break many new businesses.
The process starts with implementing and reinforcing the procedures for proper and accurate bookkeeping. Money is one big reason you are in business, and it is what keeps you there. Bookkeeping is not about efficiency, it is about accuracy and forming a clear picture for future action.
All this rests on professional records maintenance: This includes the checks and balances of having information recorded in multiple locations by multiple people. Have a backup for everything offsite, scan paper copies, etc.
Most small business owners do not actually understand or utilize their financial information. When I ask, “What are your monthly fixed costs? What is your monthly breakeven point?” I usually get a dazed look. Or responses like, “Last month was a good month” or “I have no idea.” Answers like these mean that the owner is basically flying blind financially, and not just about taxes. The amount of debt, the business’s liquidity, its 90-day forecasted budget and other key measures of business health are all unknowns.
You can avoid nasty surprises if you regularly spend quality time with your accountant or bookkeeper. Get into the numbers until you understand them, until they speak to you. The time you spend will be worth its weight in gold in the end.
So as we leave the topic of licenses, regulation and taxes, we come back to the initial point. Get your ducks in a row on these matters, ensure that records and compliance are completely reliable, and then, plow back into the business you dreamed of, knowing you have not neglected these technical requirements that can sabotage your success.
M.R.M.
Insurance—A Risk-Management Tool
IN THE LAST SECTION, we looked at obligations you and your business have toward governing entities. Now let’s look at an obligation that you, as an entrepreneur and business owner, have to your own business. You need to protect it against events that could harm or even destroy it. In effect, that’s what insurance is all about.
Insurance allows you to transfer risk to your insurer, in exchange for the compensation you pay to him (your insurance premium). You buy insurance, in the form of policies, from licensed insurance companies. The insurance policy may be general or specific. There are often options, modifications and riders (amendments available for extra cost) available for policies that allow you to customize the policy for your specific business needs. The most common of these are deductible amounts and total policy amounts.
Business insurance comes in several varieties:
• General Liability—very broad coverage, a necessity for every business. It covers the costs of legal defense or repairing damages related to harmful events or claims against you, your employees and your products. Such insurance only covers accidents and negligence. It does not cover willful actions or gross negligence.
• Property—covers real and personal property owned by the business. This is specific insurance and is limited to the replacement of the property only, in the event of the destruction or loss related to a specifically covered occurrence. You must verify what types of risks are covered. For example, some policies put all damage to property on one policy, in contrast with coastal areas, where flood and/or windstorm insurance is often only covered if an additional policy is purchased. Note that property insurance does not protect from loss of income or operations related to the destruction of property.
• Casualty—general coverage related to specific occurrences. It is very similar to general liability insurance. In addition to covering for negligence, it could be used to cover events like theft, political risk, earthquakes or shipwrecks.
• Flood—a specific type of property insurance related to flood damage. Note that this coverage may not be available in all areas, and will only cover property actually damaged by floodwaters.
• Terrorism/Acts of War—covers losses related to terrorism or war risk. This type may not be necessary for the average business. Government contractors and other businesses conducting business operations in high-risk environments use it.
• Business Owners’/Income/Business Interruption—coverage related to replacing the revenues and income of a business in the event of a loss. It may be bundled with other specific coverages and customized to the business.
• Vehicle—covers events related the operation of motor vehicles. This may include company vehicles operated for business purposes and also employees’ personal vehicles operated for work purposes. This is high risk insurance, with significant variability among insurance policy options.
• Workers’ Compensation—coverage related to employee injuries on the job. The insurance will provide income replacement and medical coverage to the employee. Workers’ Compensation insurance is mandatory in most jurisdictions in the U.S. Note that this does not cover any effects on the business for decreased revenues due to the limitations of the employee.
• Professional Liability/Errors and Omissions—coverage related to the defense and damages of claims for improper professional service by a licensed professional or business. Note that this type of risk is usually excluded from all general insurance policies, so to get this protection you must purchase a separate policy.
• Product Liability—coverage related to claims for damages related to your product. Certain customers (e.g., a nation-wide chain store that buys your baby toys) sometimes will require you, their supplier, to purchase this coverage for stated minimum amounts, and even to name them as beneficiaries.
• Directors’ and Officers’ Insurance—coverage to protect the directors and officers of a business, should they suffer any loss or expenses for legal defense based on their actions within the business.
• Data Breach—coverage that protects the business in case a breach of confidential data occurs.
• Transactional—coverage related to risk on a specific transaction. Examples include insuring a shipment or title insurance on a property transfer.
• Homeowners’—general liability insurance for the business owner’s personal home. If you are a home-based business owner, you need to verify whether your business can be covered on your existing homeowners’ policy. Also ensure that the operation of your home-based business does not void your homeowners’ policy.
• Renters/Contents—coverage related to only the contents or equipment within leased or rented premises. If you store your products in a third party’s warehouse, you may be required to insure your stock against damage from fire, water, etc. while it’s there. You may want to insure it even if it’s not required; do the math to see what’s reasonable.
• Disability/Life/Key Person (or Keyman)—specific coverage related to the business’s loss of income in the event of the death or disability of a key person within the organization. This type of insurance is often integrated into a business’s buy/sell agreement or in succession planning. Note that this coverage may require key people not to travel together, to minimize risks.
• Umbrella—general coverage that supplements all other existing policies. Think of it like your safety net in case any of the other insurance policies are insufficient.
As a business owner you must effectively cover both the business and yourself to insure that claims agains one cannot impact the other. Business owners are very often the preferred targets for conmen and fraudulent claims. Also, please remember that the insurance agent and company are for-profit businesses. You need to understand what your risks are and then verify that those are insured against.
M.R.M.
“The Name’s Bond—Surety Bond”
OCCASIONALLY, a small business, especially one performing contracting services, is asked to bond its work in advance. In some places, certain types of contractors are required to be bonded.*
Simply put, a bond is a financial guarantee that you will honor a business contract. Sometimes referred to as a surety bond, a bond is a promise by a third party to pay if a vendor does not fulfill its valid obligations under a contract. There are various types of bonds, such as license bonds, performance bonds, bid bonds, indemnity bonds, and payment bonds.
• A license bond is required by some localities for certain businesses. In some cases, you pay the locality directly rather than obtaining a bond.
• A performance bond is a guarantee that you will perform work in accordance with the terms of a contract.
• A bid bond is a guarantee you will perform work if you win a bidding contest.
• An indemnity bond promises to reimburse losses incurred if you fail to perform or if you fail to pay other vendors in the fulfillment of a contact.
• A payment bond promises that you will pay all subcontractors and material providers utilized in the performance of a contract.
It is important to remember that a bond is not an insurance policy. A bond only provides assurance that the contracted work will be satisfactorily completed. For example, your bond will not pay for property damage or personal injury resulting from your work. For this, you need conventional insurance coverage.
A simple Google search will list companies that provide bonding services under surety bonds in your area. In general, bonding companies will only provide bond coverage up to an amount that you can cover with existing liquid assets.
Before you purchase a bond from any bonding company, have the bond documentation reviewed by your attorney and ensure that you understand exactly what the bond can and cannot protect against. This will benefit both you and your customer.
S.G.
How to Reorganize or Restructure Your Business
WHY WOULD YOU reorganize or restructure your business? There are many reasons. They all share the goal of making your business more profitable and better positioned for success in the future.
When you start a business, the last thing you might picture is turning it upside down and inside out. Yet a smart entrepreneur doesn’t take much for granted. You start detecting things that aren’t working well, or opportunities you’re not set up to seize… that’s when it’s time to think about change.
You are right to think that restructuring and reorganizing are management tools, not legal issues per se. But imbedded in many actions you might take here are vital legal implications. Don’t neglect to bring your attorney into your planning sessions if you are undertaking significant change. She may recognize things you need to consider or do that will save you many future headaches.
Reasons to restructure a business
• Strategic Repositioning New strategies may require changes to the core business, moving into new or developing markets and out of saturated ones, developing new product lines, etc. This reshaping reflects and supports a fundamental change in the business’s long-term goals, which renders the current business structure obsolete. Note that this may require new business leadership, so don’t put blinders on.
• Crisis Management Often this is a swift, urgent reaction. It could be as extreme as a business liquidation bankruptcy, the relocation of manufacturing related to growing instability in the area, or downsizing by laying off 50 percent of the workforce to get back to profitability.
• Negotiation with Stakeholders Topics could include buyouts, shuffling of positions or recapitalization in preparation for the future.
• New Operational Methods Changing to a new and better way to get the same work done more efficiently (running the business in three shifts instead of one); adopting a new management style or culture (implementing Six Sigma); or embracing new technology (since every sales rep now carries a tablet and can prepare estimates on site, we no longer require dedicated estimators).
• Litigation and Compliance Suppose that in relation to a lawsuit, audit or other inspection, deficiencies were discovered within the business organization that must be corrected. Compliance can be forward looking as well. There may be significant new regulatory or legislative requirements on the horizon, and you want your business to be the leader in implementing changes to comply.
• Mergers, Acquisitions and Sales of Businesses In the eat-or-be-eaten business world these things happen all the time. Merger is joining with another company, and then merging your organizations together to from a stronger business. Acquisition is the assimilation of one business into another. Sales could include all or part of a business, or just specific aspects of the business, like a data base, intellectual property, or only one division.
• Insolvency In this situation, change could include debt settlement or negotiation before a bankruptcy is filed. Public policy encourages businesses to be profitable, and therefore the insolvency process is designed to reorganize unprofitable or unstable businesses for greater long-term economic benefits.
If you have determined that you have a reason and need to restructure or reorganize, then you must determine whether the changes will be primarily internal or external. Be aware that with any reorganization, the changes will always affect the business internally and externally. Each situation will be unique, and you will need to analyze the situation and consider many factors beyond the items listed here. These are meant as simple guiding principle to get you moving in the right direction.
Internal reorganizations
These reshape the inner workings of your business: its leadership, management, operations, profit and regulation. There’s a natural process you can follow:
• Identify the purpose for the reorganization
• Develop various options to achieve that purpose and evaluate each one’s costs and benefits
• Select the best reorganization model available
• Prepare a detailed plan for the reorganization (see more on this below)
• Clearly communicate it to all members of the organization or team affected and others indirectly affected
• Assign actions, giving specific reasons for the change required and detailed descriptions of to-do’s and deadlines
• Stay on top of the change process until it’s complete, as it’s your job to maintain organizational cohesion and confidence in the business while changes are implemented
As you move through the process, remember that all members of the team have a stake in the success of the business, and put yourself in their shoes. What would motivate them? Freedom from frustration and inefficiency? Dividends? Continued work and a paycheck?
The importance of planning and tracking changes
A business reorganization is an extremely resource-intensive process, consuming time, money and labor. It is critical that you take your time and move through the process in a deliberate manner. Unless there is an impending crisis, the planning phase can seem extremely slow and detail oriented. Use any and all available outside resources to assist in the process, whether that is a professional consultant or hiring temporary labor for moving items physically. That will allow you to focus your energies on the business, where it needs to be.
The two most common mistakes I see in the planning phase sound like this:
• “That’s not what I told them to do.” Put your plans in writing and be prepared to say things many times. Your documentation does not need to be fancy, but it must be crystal clear. Place it in a centralized, accessible source for all reorganization information. That could be on your company’s server, or in the lunch room—make sure it’s kept up to date and encourage everyone to check on progress frequently. Use graphics, pictures, flow charts, maps, slides—whatever it takes. The goal is just to get the same message and a track on progress out to all organization members.
• “Well, I started it, but we never quite finished.” Most people work better with deadlines. As part of your plan, include a timeline that states when certain milestones and tasks need to be done. You owe it to the business to fully complete the plan, since the reorganization might not work as expected unless it’s finished. I’ve had clients blush and confess, “I went through all the trouble to amend my corporate structure, but never filed the documents.”
Implementation
Once the plan is complete and everyone knows what to do, go ahead and get it done. Watch out for unintended effects. Assist as necessary to ensure all deadlines are met and make changes as necessary. Ensure you are complying with all local rules or professional guidelines. For example, some unions have requirements that employees are told who their supervisor is within a certain period after hiring or after there’s a change in supervision. If layoffs are involved, emphasize that the business and remaining employees’ jobs are now more financially secure. Pay particular attention to employee interactions with clients to ensure they convey confidence in the business.
Just about every business goes through internal reorganizations. The process need only be as formal as you think necessary. But it must be thorough. The more thorough you are, the more your business will gain from the changes. Suppose you need to reassign job duties in an office. You could do that by simply saying, “Allen, you’re going to answer the phone.” Or you could explain why this change is needed and what you hope it will accomplish, then provide Allen with a job duties description, a copy of the phone greeting he should use, a summary of likely questions and responses, and a printed form to use for messages taken. Which scenario will produce the best performance from Allen?
External reorganizations
External reorganizations focus on how your business works facing the outside world: its business structure (sole proprietor? partnership?), customer and vendor relations, market interactions, sales and marketing activity, growth model, billing, accounts receivable, accounts payable, brand value, etc.
Once the business has identified the need for reorganization, the same planning process as for an internal reorganization can begin. But because external reorganization may impact many participants beyond your control, it will be more complex, and some of the players may not be influenced as easily as your employees. Planning considerations include legal and other regulations, taxes, liabilities, and a wealth of other aspects of your business. Further, you must consider the impact of changes on external relationships and responsibilities, including market and contractual relationships with clients, suppliers, debtors, creditors, etc., before selecting the appropriate process.
Debt-driven external reorganizations focus on debt, collections, liquidity and insolvency. Planning considerations are driven by the willingness of creditors to settle, restructure or reduce debts owed; the desire of the business to continue operations; and the individual liability of stakeholders for business debts. In the U.S., a Chapter 11 business reorganizational bankruptcy, or the threat of it, is an immensely powerful tool available to businesses in continuing operations. The alternative is a Chapter 7 liquidation bankruptcy, or the local jurisdiction’s statutes on cessation of business operations. These aim at a termination of the business entity.
Appropriate planning and assistance are critical for success. Your attorney very likely can help with her broader base of experience with clients who have come through similar situations, as well as representing your business’s interest if you need to renegotiate terms, develop new agreements, or wind down the business.
Pitfalls to avoid
There are some common issues that cause the most trouble in completing a business reorganization.
• First, objections by stakeholders (anybody with an interest in the change), whether a majority or minority, which can affect the process.
• Resistance by management or employees, which can be a respectful difference of opinion, general resistance to change, or malicious actions with ulterior motives. They can derail a perfectly reasonable plan.
• Financial or tax consequences to particular individuals. These can make reorganization difficult or impossible.
• Corporate documents or regulations that prevent or forbid the reorganization desired.
• Current operations or contracts that can also block reorganization.
I mention these things not to deter you from launching a well-planned reorganization, but to ensure you are aware of the magnitude of responsibilities that face you as you progress through the process. Being aware of them and handling each challenge effectively is the mark of an excellent leader.
Documentation
As with any discussion involving an attorney, I must remind you about documenting everything. Depending on how your business is set up, you will have some level of requirement to record (keep a written record of) major decisions made, who made the decision, if or why they had the power to do so and details on notifications of all necessary parties about this change. Have you updated all regulatory agencies? Have you updated all license registrations? Are there any follow-on changes required, such as amendments to previously filed documents?
In short, your business, like your baby, is going to grow and change over time. You cannot ignore this. You must plan for change, including your attorney in the change team as needed. In the long run, the more effort you put into keeping your business properly organized in support of your goals, the more rewards and profit you will see in the end.
M.R.M.
Starting at Step… Two?
FOR THOSE OF YOU who read our first book, Starting a Business, you’ll recall that we explained that fledgling entrepreneurs all pass through a basic two-part progression. Step One is creating your exciting new venture and actually getting it off the ground. Step Two, how you actually run it, will determine your success or failure. That’s particularly true when you consider your customers’ experiences in dealing with your company.
Know what you don’t know
Faced with high failure rates, a new business needs all the help it can get. Two areas, accounting and law, are typically black boxes for entrepreneurs. There’s a reason why financial and legal professionals are required to have so much education, knowledge and training. Knowing what you don’t know is the first step to succeeding, especially long-term.
Think like a customer—that tells you what to do
No matter what type of business you have (or are planning to launch), one of your first research projects will be to learn everything you can about your potential customers. What are their needs? What are their buying habits? What do they expect when problems arise? What does the competition do? How can you maintain your customer base over time? What promises and guarantees will earn customers’ trust and confidence?
With your results in hand, you need to set up policies that address your customers’ needs but that are also legal. A lawyer can support these efforts in many ways. Here are just a few examples of legal matters she can advise you about:
• Warranties, written guarantees, renewals and updates
• Help desk, post-sale service and user-support websites
• Contracts, agreements, invoices, work and purchase orders
• Packaging, product disclaimers, information and warnings
• Contests, drawings, customer loyalty programs
The last thing you want is disputes with your customers. If you’ve established correct, customer-friendly ways of doing basic business, your customers will come to trust your company and feel loyal to your brand. An up-front approach provides an “open book” feeling for both parties.
Taking the time to properly establish these legal baselines can have a positive effect on sales, marketing, and advertising initiatives too. It will even boost word-of-mouth referrals. Entrepreneurs who understand the importance of delivering on every element of a customer experience through a well-defined legal approach are usually the ones who defy most odds and beat the competition. And don’t forget that every day, your lawyer sees things that work and don’t work in other clients’ businesses. She can become your ad-hoc business advisor with insights that go beyond just legal matters.
Now, go run your biz like a pro
Empowering your employees to interact with customers in all phases of your sales process, from initial contact through negotiations to the final sale, becomes much easier with legal documentation in place for all to access. It protects both parties during each stage of the process and leaves little to the imagination on both sides. It’s also easier to train new hires, as the written policies and terms are established and in place.
Additionally, elements such as warranties and return policies, if drawn up properly, will allow you to compare yours with competitors’. Use these points in marketing and advertising campaigns to differentiate your offering as well. Showcasing your “money back guarantees” and other equivalent components can lead to more sales.
These principles have been a way of life in everything I’ve ever done as an entrepreneur. I’m convinced that attorneys can contribute at every step of your business’s existence.
M.P.