Every company should have legal representation.  If you are a start-up company you want to interview several attorneys (2-3) and give them a background on your company.  You want to know how they bill and what priority you will be given at the firm.  Which attorney will be assigned to your file?  The biggest issue plaguing most attorney-client relationships is a firm’s response system if your business is in a crisis.  Are phone calls returned same day?  Who is the team in place to assist your company?   But most importantly, does your attorney have a business sense for the operations of your business?  Many attorneys can give you the mechanics of a licensing or distribution agreement but they are not savvy enough to understand the nuances of the industry that will warrant that added provision in the agreement that avoids litigation down the road.  Establish an attorney-client relationship.  Sign a retainer with the firm so when a quick question needs to be asked your attorney is in place to take your call; guide you in order to avoid litigation or prepare the needed document that memorializes the handshake agreement before either side spends money on production or discovery.  99% of the time the parties are so anxious not to lose the “deal” that motion is set into place before a written agreement can be written and approved by both sides.  When conflict arises, human nature prevails, and each side remembers only the facts of the negotiations that benefited them.  Young companies believe they “save” money by not using an attorney at the beginning stages of growing company.  In actuality, that is when you need qualified advice most of all.

Click here if you missed Part I: Laying a good foundation, Part II: More than one owner or Part III: Safe-guard your product

Every good business owner is watchful of the company’s overhead.  But the old adage of being a “penny wise and pound foolish” rings true when a Company attempts to save the cost of attorney upfront on a deal only to pay a higher cost in legal fees to resolve a dispute that was not originally or properly documented at the beginning of the deal.  To save cost Company’s will sometimes pull boilerplate agreements from the internet and fill in the blanks to serve as a temporary need.  However, when a deal goes wrong the agreement is the only document that the parties can turn to in hopes that it includes terms that cover the current dispute.  Take the time to meet with your attorney if you are entering into OEM, Licensing, distribution, private-labeling or manufacturing agreements.  Having an experienced attorney who understands your business and who can set up at the beginning the necessary terms to protect you and to provide for the risks factors that should be included in the deal.

To be continued … Next week: Part IV: Choosing your Corporate Counsel
Click here if you missed Part I: Laying a good foundation or Part II: More than one owner

If there is more than one owner of the business a buy sell agreement is always required.  Every shareholder or partnership dispute that I have been involved in always starts with my client stating, “You know, my partner and I were best friends in the beginning”.  If the business relationship goes awry a Buy Sell Agreement outlines the terms of how one shareholder or partner will buy the other out.  A buy sell agreement is always best to be negotiated while individuals are still in the best friend stage.  Having a buy sell agreement in place avoids costly litigation.  No one cares about a contract until everyone cares about a contract because there’s a problem and the frantic dissection of every sentence ensues.  We have to advise clients to address the problems before they exist, lest litigation bring the whole machine to a grinding halt.

To be continued … Next week: Part III: Safe-guard your product
Followed by: Part IV: Choosing your Corporate Counsel
Click here if you missed Part I: Laying a good foundation

Starting a business from scratch is difficult.  There is usually not enough money to start it with all the bells and whistles you would like.  You are very careful to allocate wisely which dollars will be spent where and maximizing your return for those allocations.  Hiring an attorney is usually the last thing on your list.  The internet allows us all to have just enough information to be dangerous.  The online legal services beckon us with their low cost fees.  What people forget is that you are laying a foundation for your business.  And your business is only as good as the foundation.

Our view when starting a business is to raise the funds that will be required in the first year for a good attorney and a CPA.  An attorney or CPA will be able to advise you as to what type of corporate structure should be chosen for your entity depending on the type of business (manufacturing, distribution, real estate development, investment properties, etc…) you are going into or the industry your business will be in that my cause higher risk and thus the need for more protection from the entity that you form.

A good business attorney will also advise you to search the name and logo of your company.  Before you put money into a logo, business cards, letterhead, website, and production of product make sure that another company does not have a similar name or logo that is already registered as a trademark that will force you to cease the use of your name or logo.

To be continued … Next week: Part II: More than one owner
Followed by: Part III: Safe-guard your product and Part IV: Choosing your Corporate Counsel

Questions to Consider before the LOI is Signed

The issues posed may be based on the perspective of a buyer in the examples, but the concerns are the same for sellers.  Some big picture questions that need to be answered before an LOI is executed:

Will the deal be structured as an “asset purchase” agreement or a stock sale?  There are significant differences in the structure, particularly when it comes to the liabilities that will be sold and those that will be retained by the seller.

Does Seller plan on extracting all the cash from the business at the close of the sale?

What’s happening with the accounts receivable?

Does the Seller have much work in progress and, if so, what are his or her expectations for the revenue post-close?

Does the business rely on one or only a handful of key customers?  How much of their revenue is derived from the top customers and how are those relationships?

How much of the inventory is slow-moving or obsolete and therefore of little value?

What’s the track record for warranty repairs and will the seller assume covering any existing warrantied products or services for a period of time?

Will (or should?) Seller commit to staying on as a consultant or employee for a period of time while the transition of management takes place?  Either way, will they execute a non-compete agreement?

How will the purchase price be paid?  All cash? Will Buyer have an opportunity to apportion a certain amount of the purchase price in an “earn-out” provision?  Is there a note and, if so, can it be secured?  Are there other creditors that will make the security pointless?

How will the purchase price be allocated?  Goodwill, inventory, customer list, etc.

Will Seller refrain from entertaining other inquiries from other Buyers during the time period that you are conducting your own due diligence? Negotiating with a second buyer in the background may be counterproductive to your current negotiations.

Both parties need to be represented by an attorney at these early stages.  We often encounter clients that didn’t want to retain us at an early stage to help reduce costs and prior to confirming the transaction can go through after their diligence is complete.  That error can cost much more than our services, as the material terms in an LOI will be written in stone.  Parties can be forced to honor the terms of the “harmless” LOI when those same terms are the non-negotiable substance of the purchase agreement itself.  This effectively removes the room for much negotiation as the terms of the LOI will govern.

It’s never too early to involve counsel on your side, especially when you could unknowingly be locked into some less than favorable terms at such an early stage.  The LOI, despite whatever soft language regarding the intent is drafted, is a legally binding document.  Don’t let the descriptive title fool you – it’s a contract that creates rights and obligations.

Click here if you missed Part I of Lets Talk Letters of Intent: What is an LOI and Why a Attorney Should Review it Before Signing

What is an LOI and Why your Attorney Should Review it Before Signing

Interested in buying a business?  Does the Seller want you to sign a Letter of Intent (LOI)?  Often we hear the same story: ‘The Seller says the LOI is merely a formality that will allow me to review books and records of the company and get the process started.’ Sounds simple enough, but should you have an attorney review the LOI before you sign? Absolutely. And here’s why:

The LOI can be the most important document during an acquisition. It will outline the parameters of the deal, sometimes in substantive (although ostensibly “non-binding” in parts) detail.  It is a rather simple and short document but it manages to encompass all of the material terms of the deal that will later be expounded in a lengthier Purchase Agreement.  The LOI sets up the expectations for the deal.  Seller has probably already met with his/her attorney (in fact, his/her/their attorney drafted the LOI!) and determined the most advantageous structure for the transaction.  The LOI will dictate the material terms of the sale, which will have significant consequences to both buyer and seller.

To be continued … look for Part II: Questions to Consider before the LOI is Signed. Coming soon!

At least once a month, we encounter a new client that formed an LLC because that’s what they heard they should do.  It’s usually unclear from where or who they heard that this was the right choice for their endeavors.  Chalk it up to the flavor of the day, perhaps.  Maybe it’s due to the explanation some of the online formation services offer.  This general statement is true – “An LLC offers the same level of insulation from liability as a corporation, without the requirements of corporate formalities.”  It’s an easy sell.  I don’t want the “formalities” of a corporation, so the LLC is obviously the right choice.  But, is it?

Another true statement – “An LLC allows for income to flow through to the individual and avoids ‘double taxation’ which occurs at the corporate level.”  AND….   Another true statement – “An S-Corporation allows for income to flow through to the individual and avoids ‘double taxation which occurs at the corporate level.”  Well, both statements are sort of true, at least in California.  California was a late adopter in the line of states recognizing the LLC as a legal entity and took an approach taken by some other states regarding a “bonus payment” due to the state, otherwise known as the Gross Receipts Tax.  That sounds awful, doesn’t it?  The LLC must pay an additional tax based on its gross receipts.  Luckily, that number is capped at just under $12k depending on the income bracket which the company falls into.  It’s usually a matter of doing the math in each situation to determine which might work out better in terms of tax liability.  There are disadvantages to having all income flow-through to the individual.  You’re going to pay tax whether you see the money or not.  CPAs are encouraged to play along at this juncture.

Ok, I’ve heard way too much of the corp-this and the LLC-that, but what’s right for me?  There are dramatic differences in the operation, management, and tax treatment of the different business entities and it’s not something to be chosen hastily.  Formality can be good and, to be honest, there isn’t a great deal of “formality” involved in running a small corporation. The shareholders and directors of the corporation must have annual meetings and those meetings should be documented and kept in the records of the company.  Certain officers have to be in place.  There are duties imposed on the directors to act in the best interests of the shareholders and the company.  Members of an LLC don’t ever have to meet.  Shareholders of a corporation don’t owe each other any duty or responsibility.  Members of an LLC owe each other a fiduciary duty, a high form of trust under the law.  The LLC offers greater flexibility in allocation of profit and loss, or discretionary distributions that aren’t tied to the percentage of ownership as in a corporation’s distribution of dividends.  Asset protection can differ dramatically between the two as well.  A judgment creditor can effectively take ownership of someone’s shares in a corporation to satisfy an obligation.  Conversely, they cannot take over the membership interests of an LLC because the law is generally unwilling to impose the fiduciary duty on someone (unless it’s a single member LLC, in which case the duty is to yourself and can pragmatically be imposed on a new single member).  And that’s just a few!

The fast-food version of the choice of legal entity has done some damage.  We constantly see operating agreements (similar to the bylaws of a corporation, the document that governs the rights of the LLC members) that, due to their “universal” application, don’t provide for many of the concerns that business owners have.  We don’t see a shareholder agreement when there clearly should have been one.  You can spend more money on reinventing the wheel than buying a better wheel to begin with.  There’s an old saying among attorneys -  “No one cares what a contract says until everyone cares what a contract says.”  It’s true, when problems arise, attorneys earn a lot of fees by dissecting documents like an operating agreement and finding an angle.  We like to define the angles according to the wishes and needs of the client from the very beginning.