The $20,000,000 Non-Compete.

If you were a kid in the 70’s, you’ll remember a TV show called The Six Million Dollar Man. It was about a man with bionic technology implants that let him achieve incredible feats and protect the United States.

Recently, we learned the story of the Twenty Million Dollar Non-Compete. It’s about how a non-compete can achieve incredible feats and protect your business from rogue employees.

You may recall that in an article called Four Agreements That Can Make or Break Your Business, I suggested having an employment agreement with all key employees that included, among other provisions “restrictive covenants.”

Restrictive covenants include non-compete agreements that prohibit employees from competing against your business, as well as other restrictions that prohibit employees from stealing your customers, employees, vendors and confidential information (e.g., customer list).

These protections are all critically important when your business is based on customer relationships, on information about customers and on specialized industry expertise.

One business that is built on customer relationships and industry expertise is the insurance business.

Brown & Brown (B&B) is a large insurance agency with 180 offices throughout the U.S., including Daytona Beach and Orlando. To protect its relationship with customers, it has its producers enter employment agreements that contain restrictive covenants. And those covenants extend two years after employment.

AssuredPartners (AP) is a competing insurance agency formed by former B&B executives. According to B&B, in 2016, AP began picking off key producers in the B&B Daytona Beach and Orlando offices who had nursing home and habitational insurance expertise, as well as relationships with B&B customers, and AP knew these employees were subject to non-compete agreements.

B&B claimed that within weeks of the employees moving to AP, these former B&B employees began soliciting B&B customers and B&B began receiving notices to transfer customer accounts to AP.

B&B filed suit for injunctions and damages, against the former employees based on their employment agreements, and against AP for ‘tortious interference’ with those employment agreements.

In March, in what I believe was properly characterized as a record non-compete settlement payment, AP agreed to pay B&B $20,000,000 and agreed to an injunction preventing it from hiring B&B employees.

It is important to emphasize that $20MM was a settlement, not a judgment. AP voluntarily agreed to pay that amount rather than face the outcome of a trial. So, not only is $20MM an extremely large sum in a non-compete case, it is a shockingly large sum for a settlement payment in a non-compete case.

Plus, had there been no valid non-compete agreement, B&B would have little or no likelihood of stopping the raid of its employees.

The key points for your business are:

1.) To be enforceable in Florida, non-competes and other restrictive covenants must comply with the Florida statute. If they are property prepared, restrictive covenant agreements are fully enforceable and a valid means to protect the investment you’ve made in customer relationships, employee training and confidential information.

2.) Each key employee should have an employment agreement that contains properly written restrictive covenants.

3.) If a competitor poaches an employee who is subject to restrictive covenants, you must promptly notify the new employer of the covenants to protect your customer relationships and business confidential information.

4.) If you must enforce a restrictive covenant, you have to act diligently. Failing to do so could result in being unable to enforce the agreement.

5.) The restrictive covenant agreement should also contain a provision where the employee states that he or she is not subject to a non-compete with a former employer. This
will help protect your business from claims for tortious interference when you had no idea about the newly hired employee’s prior agreement.

Though it is unlikely an employee non-compete will get you millions of dollars, it will protect your business from rogue employees stealing valuable relationships and information that you’ve invested money to create.

Let me know if you have any questions about employment agreements. I’d be happy to talk with you about them.

Four Agreements that Can Make or Break Business Value – Part III

In the first and second articles of this series, we discussed how your business lease and employment agreements can have a dramatic effect on the value of your business. In this article, we’ll discuss the arrangements between your business and its customers.

Customers are the sine qua non of business – without customers it’s all an academic exercise. Customers bring revenue and, hopefully, profit.

Business value is tied to both profit and the likelihood of that profit continuing into the future. The more likely the profit will continue and grow, the higher the business value. The less likely that it will continue or grow, the less value the business will have.

In short, profitable relationships with high quality customers is an essential component for a valuable business.

There are two factors to creating profitable relationships with high quality customers:

(1) Marketing and Sales – to bring in new customers; and

(2) Customer Retention – getting existing customers to buy again and to buy more.

At this point you might be thinking: ‘this sounds more like a marketing, sales and service problem, rather than a legal issue.’ And you would be mostly correct.

But, legal issues play an important role here as well. You should keep in mind:

  • You don’t want every customer that comes your way – you only want those:

1.) for whom you can provide great value; and

2.) who recognize that value and are willing to pay for it; and

  • Repeat customers are better than one-time customers.

Some customers have completely unrealistic expectations or expectations that don’t match what your business can provide. Some just don’t understand how your business provides value or are solely focused on price and nothing else. Some might also not intend to live up to their end of the bargain by paying. Taking the time and spending the money to acquire these types of customers and to service them will reduce profitability and business value.

Also, because the marketing and sales expenses can be spread over greater revenue, repeat customers are almost always more profitable and have a greater and positive effect on business value than one-time customers.

Both circumstances can benefit from a good written customer agreement.

A good written customer agreement is a business tool that will:

  • Educate customers and sets expectations about what your business provides and how it works;
  • Delineate what the business will do for the customer and what the customer must do to achieve the result;
  • Act as defensive shield, should a customer seek to abuse your business, want more than you’ve promised or make a claim;
  • Weed out customers that aren’t appropriate for your business;
  • Make buying from you an easy process with little effort that can be repeated over and over; and
  • Help ensure you get paid.

The difference between a good customer agreement and one that isn’t are detail and readability. There must be a level of granularity to what, when and how things are to happen that covers the process from beginning to end. The agreement must also be readable without a law degree, otherwise the customer won’t read it or will send it to legal counsel and defeat the business purpose.

All the important aspects of the relationship must be spelled out in the agreement and in detail, including:

  • What your business will do and when and how it will do it - setting specific and detailed expectations to avoid misunderstandings.
  • The specification against which the results of the services or the operation of the products will be judged. Again, the more detail the better to avoid changing customer requirements as services are being rendered or products are being manufactured.
  • What the customer must do (above and beyond paying) for your business to render the service or provide the product (e.g., meetings, materials, documentation, etc.).
  • A set period during which the customer will inspect the results of the services or the products. This is important to avoid extended inspection periods and, possibly, delayed payment.
  • Warranty rights and conditions (e.g., who pays to ship the product back for warranty repair).
  • Payment terms, including exact costs, timing for payments and interest and late fees in the event of untimely payment.

The process should also be streamlined with a set of “standard terms” that are used for the life of the customer relationship and with variables that are modified to reflect the special circumstances of each purchase. Standard terms ease the process of buying multiple time by eliminating the need to agree on new contracts for each purchase.

A well prepared, detailed and readable “standard” customer agreement can lead to consistent and greater sales from quality repeat customers and increased business value.

Four Agreements that Can Make or Break Business Value – Part 2

In the first article of this series, I discussed the first of four key agreements that can increase or harm business value – the lease.

In this article we’ll discuss the second - employment agreements and practices.

Having an in-place capable, happy and high performing team represents a significant portion of business goodwill. In some startup company sales – such as when Google pays millions of dollars for a startup technology company with little or no revenue – the team represents all of the value of the company (commonly referred to as an “acqui-hire”).

However, even outside of the technology space, employees will (or should) be making the sales, providing the services or making the product, paying the bills, collecting the money and keeping your customers happy. They are a critical party of the machine that is your business and generate your profits and cash flow.

The key elements of the employment relationship – agreement and policies - are all centered around making sure that what your company owns or has paid to develop, remains the property of the company after the employment relationship ends.

The primary purpose of the employment agreement is to protect the company’s value by preventing the employee from siphoning off your company’s assets or value to benefit his startup or new employer.

Your ‘key employee’ employment agreements should have the following provisions:

Intellectual Property. Florida law provides that what an employee creates during his work hours that is related to his employer’s business is the property of the employer. This also known as work-for-hire.

Often, the work-for-hire provisions of the law are not broad enough to take into account all of the things that an employee might create that apply to your business. Therefore, all employment agreements should contain a provision that assigns to the employer all work product created by an employee, whether on or off the job, that is even remotely related to the employer’s business.

That provision should also require the employee to fully disclose and assist the employer with securing intellectual property protection such as, for example, signing documents to be filed with governmental agencies.

Confidentiality. Again, an employee is bound to keep his employer’s secrets confidential by Florida law. However, rather than rely on the bounds of judge decided policy in the event of a dispute, each employment agreement should

  • Define confidential information in a way that is meaningful to the employer’s business;
  • Prohibit use as well as disclosure;
  • Require return of tangible property that describes confidential information;
  • Require the employee to adhere to the employer’s requirements for storing confidential information (e.g., employer permitted online platforms, encryption requirements, and password policies); and
  • Require the employee to notify the employer if the employee is compelled to make a disclosure.

Return of Company Property. This type of clause should, in addition to delivery of tangible property at the request of the employer, require the employee to ‘deliver’ access to accounts used by the employee in his conduct of the employer’s business. Many times employees will use their own devices, telephone numbers or e-mail or social media accounts, or change passwords on company provided accounts. This clause would give your company the right to all of these.

Restrictive Covenants. Agreements with key employees should also contain one, two or three types of restrictive covenants, including:

  • Non-piracy. A non-piracy clause prohibits your employee from

· Hiring the best of your team for himself or his new employer; and

· Causing vendors to change their relationship with your company.

  • Non-Solicitation. A non-solicitation clause prohibits your employee from soliciting your customers and, with the addition of certain language, from accepting business from your customers (all in an area that competes with your business).
  • Non-Compete. A non-compete clause prohibits your employee from competing with your business, whether for himself or through an employer, within a geographical area. This is the most controversial of the restrictive covenants with many believing it prohibits the employee from working ‘in his field.’

A common question I hear from business owners is: Aren’t non-compete agreements unenforceable because Florida is a right-to-work state?

First, right to work has nothing to do with non-compete agreements or any other type of restrictive covenant. It is a union / non-union issue. In fact, non-compete agreements and other types of restrictive covenants are enforceable in Florida IF they comply with Florida Statutes Section 542.335.

That statute requires:

  • The restriction is necessary to protect a legitimate business interest of the employer;
  • There is a reasonable geographic scope;
  • There is a limited time period (typically two years or less for employment relationships); and
  • The agreement is signed by the employee.

Restrictive covenants are often necessary to enforce the confidentiality provision. In order to enforce a confidentiality agreement, the employer must show disclosure or use or intent to disclose or use the confidential information. That can be difficult.

Consider an employee that goes to work for a competitor. Unless the competitor begins picking off customers at a few points below your pricing or suddenly produces
products using your trade secret based process, you might not be able to show a direct use of your company’s confidential information.

With a non-compete, the mere fact that the employee went to work for a competitor is all you need to seek enforcement.

Employment Processes and Procedures. In addition to the employment agreement, company value will be enhanced by:

  • A well drafted employee manual that actually reflects the practices of your business (i.e., don’t download a sample and use it without substantial modification).
  • Annual reviews that ACCURATELY reflect each employee’s performance and checklists for preparing and conducting those reviews. It is a problem when an employee is terminated ‘for cause,’ but their file contains only glowing reviews.
  • A termination process that includes written notice to an under-performing employee specifying the under-performance, the requirements (time and outcome) to correct the problem, and the result if the employee fails to correct it.
  • Detailed job descriptions and qualifications requirements.
  • A hiring system.

Four Agreements that Can Make or Break Business Value – Part II

In the first article of this series, I discussed the first of four key agreements that can increase or harm business value – the lease.

In this article we’ll discuss the second - employment agreements and practices.

Having an in-place capable, happy and high performing team represents a significant portion of business goodwill. In some startup company sales – such as when Google pays millions of dollars for a startup technology company with little or no revenue – the team represents all of the value of the company (commonly referred to as an “acqui-hire”).

However, even outside of the technology space, employees will (or should) be making the sales, providing the services or making the product, paying the bills, collecting the money and keeping your customers happy. They are a critical party of the machine that is your business and generate your profits and cash flow.

The key elements of the employment relationship – agreement and policies - are all centered around making sure that what your company owns or has paid to develop, remains the property of the company after the employment relationship ends.

The primary purpose of the employment agreement is to protect the company’s value by preventing the employee from siphoning off your company’s assets or value to benefit his startup or new employer.

Your ‘key employee’ employment agreements should have the following provisions:

Intellectual Property. Florida law provides that what an employee creates during his work hours that is related to his employer’s business is the property of the employer. This also known as work-for-hire.

Often, the work-for-hire provisions of the law are not broad enough to take into account all of the things that an employee might create that apply to your business. Therefore, all employment agreements should contain a provision that assigns to the employer all work product created by an employee, whether on or off the job, that is even remotely related to the employer’s business.

That provision should also require the employee to fully disclose and assist the employer with securing intellectual property protection such as, for example, signing documents to be filed with governmental agencies.

Confidentiality. Again, an employee is bound to keep his employer’s secrets confidential by Florida law. However, rather than rely on the bounds of judge decided policy in the event of a dispute, each employment agreement should

  • Define confidential information in a way that is meaningful to the employer’s business;
  • Prohibit use as well as disclosure;
  • Require return of tangible property that describes confidential information;
  • Require the employee to adhere to the employer’s requirements for storing confidential information (e.g., employer permitted online platforms, encryption requirements, and password policies); and
  • Require the employee to notify the employer if the employee is compelled to make a disclosure.

Return of Company Property. This type of clause should, in addition to delivery of tangible property at the request of the employer, require the employee to ‘deliver’ access to accounts used by the employee in his conduct of the employer’s business. Many times employees will use their own devices, telephone numbers or e-mail or social media accounts, or change passwords on company provided accounts. This clause would give your company the right to all of these.

Restrictive Covenants. Agreements with key employees should also contain one, two or three types of restrictive covenants, including:

  • Non-piracy. A non-piracy clause prohibits your employee from

· Hiring the best of your team for himself or his new employer; and

· Causing vendors to change their relationship with your company.

  • Non-Solicitation. A non-solicitation clause prohibits your employee from soliciting your customers and, with the addition of certain language, from accepting business from your customers (all in an area that competes with your business).
  • Non-Compete. A non-compete clause prohibits your employee from competing with your business, whether for himself or through an employer, within a geographical area. This is the most controversial of the restrictive covenants with many believing it prohibits the employee from working ‘in his field.’

A common question I hear from business owners is: Aren’t non-compete agreements unenforceable because Florida is a right-to-work state?

First, right to work has nothing to do with non-compete agreements or any other type of restrictive covenant. It is a union / non-union issue. In fact, non-compete agreements and other types of restrictive covenants are enforceable in Florida IF they comply with Florida Statutes Section 542.335. That statute requires:

  • The restriction is necessary to protect a legitimate business interest of the employer;
  • There is a reasonable geographic scope;
  • There is a limited time period (typically two years or less for employment relationships); and
  • The agreement is signed by the employee.

Restrictive covenants are often necessary to enforce the confidentiality provision. In order to enforce a confidentiality agreement, the employer must show disclosure or use or intent to disclose or use the confidential information. That can be difficult.

Consider an employee that goes to work for a competitor. Unless the competitor begins picking off customers at a few points below your pricing or suddenly produces
products using your trade secret based process, you might not be able to show a direct use of your company’s confidential information.

With a non-compete, the mere fact that the employee went to work for a competitor is all you need to seek enforcement.

Employment Processes and Procedures. In addition to the employment agreement, company value will be enhanced by:

  • A well drafted employee manual that actually reflects the practices of your business (i.e., don’t download a sample and use it without substantial modification).
  • Annual reviews that ACCURATELY reflect each employee’s performance and checklists for preparing and conducting those reviews. It is a problem when an employee is terminated ‘for cause,’ but their file contains only glowing reviews.
  • A termination process that includes written notice to an underperforming employee specifying the underperformance, the requirements (time and outcome) to correct the problem, and the result if the employee fails to correct it.
  • Detailed job descriptions and qualifications requirements.
  • A hiring system.

Four Agreements that Can Make or Break Your Business

Four Agreements that Can Make or Break Business Value

Business owners understand that having good agreements can reduce the likelihood of being sued and having to pay lawyers to defend the company.

What is less understood is how good agreements can enhance business value, and how bad agreements – or no written agreements at all – can harm business value even if there isn’t a lawsuit.

As I described in detail in the last newsletter, “Your Biggest Business Pay Day,” for well performing businesses, business value is a function of cash flow and a number called ‘the multiplier.’ This multiplier is determined from a number of factors, including prior market sales, total revenues, overall business performance, and soft factors.

The multiplier is in reality an expression of the likelihood of the cash flow continuing into the future. The lower the risk, the higher the multiple. However, as risk increases, the multiplier (and therefore the value) decreases.

Therefore, to grow business value, the owner must, in addition to growing revenue and cash flow, also reduce or eliminate other risk factors.

Risks that can be controlled come in different ‘flavors.’ One of them are the terms and conditions of four key agreements that almost every business should have.

These key agreements are:

· Lease

· Employment Agreements

· Sales and Service Agreements

· Partnership Agreement

Though these are complicated documents, there are a few major considerations for each that significantly reduce or increase risk for the business.

The Lease.

I was recently a speaker at a ‘Selling Your Business’ seminar with a business intermediary who told the audience that he reviews the lease of each business before he lists it.
He’s discovered too many times after putting a sale together that the wrong lease kills the deal. He won’t accept a listing from a business with a lease he believes will ultimate hinder a sale.

In other words, this broker’s experience is that a lease can make a business unsalable. I agree completely.

And this is the case even if you don’t have a retail business. In order to sell, the lease must be transferrable. Otherwise you won’t be able to sell until the end of the lease. Plus, the cost of moving the business will reduce the business value.

Overall.

The biggest problem with leases in general is a lack of specificity. You want the mechanics of the relationship between tenant and landlord to be as detailed as possible, and
to limit the ability of the landlord to exercise its complete discretion or to change the arrangement over time or as a result of a business sale.

For example, leases will typically provide for landlord approval of signage and construction plans. To make the lease more specific you would want the requirements for
approval of signage and construction plans described in detail in documents attached to the lease at the time it is signed. This enables you to understand how to comply and prevents the landlord from changing requirements after the deal has been inked.

Lease clauses that can have a significant negative impact on business value include:

Rent Adjustment Upon a Transfer. This provision allows the landlord to change the rent to the higher of the current rent or a market rate when the lease is
assigned to a buyer. Because business value is tied to cash flow, increasing the rent reduces cash flow and, therefore, reduces business value. In short, the
landlord gets part of the value of your business through the increased rent.

Right to Terminate Lease Upon Request for Assignment. A variant to the rent adjustment provision, this gives the landlord the right to terminate the lease if an assignment is request. Unfortunately the negative effect on the business is dramatic, usually resulting in the loss of the deal at hand, and often all or most of the business value.
In the best case scenario, the owner relocates the business and builds it back for several years before being able to sell.

Fee for the Assignment. With a fee for assignment provision, the landlord either gets a specific fee – usually expressed as an amount of rent – or a portion of the business price for granting the right to make the assignment. This differs from a rent adjustment clause because the fee is in addition to rent for the location.

While it is not unreasonable for the landlord to want its expenses paid in the event of an assignment, the fee should be reasonable and based on the work that has to be done.
So, where the landlord is going to have the buyer’s financial statements reviewed by an accountant, or the consent to assignment and assumption agreement prepared by an attorney, those expenses should be paid by the tenant.

However, the sale of the business should not be a reason for the landlord to get a windfall.

Rent Adjustment for Optional Terms. Leases often provide the tenant with the option to renew the lease for additional time after the initial term. Once the tenant builds out a space and moves in, it wants to utilize the space for a significant period of time.

However, the landlord doesn’t want the space to be rented below market rate after the initial lease term. Therefore, the rent is often subject to an adjustment for that additional time that is more than the typical 3% or 3.5% per year increase.

These arrangements work for both tenant and landlord, but can be a problem in two situations:

1. Where there is no objective standard for determining the rent during the additional periods (e.g., the landlord sets it to the “market rent”); and

2. Where the tenant doesn’t get notice of the new rent until after the date to make the election passes.

Moreover, without these issues resolved, a buyer won’t know the rent after the initial term, increasing risk and reducing the business
value.

The first can be resolved by establishing an objective process utilizing third party data to determine market rent. The rent should never be determined by the landlord without reference to actual area market rents. Rather, there should be an objective process to compare rents for similar properties in the area.

The second is a timing problem. The new rental rate must be established so the tenant: (1) knows the amount before having to commit to the additional term; and (2) has enough time to consider alternatives if the rent is not acceptable. Of course, other options may not be as big a concern if there is an adequate process to establish a true
market rental rate.

Conditions for Approval of Assignment. Leases almost always give the landlord the right to approve an assignee tenant. This is certainly appropriate.

What is, however, problematic is where the assignment provision gives the landlord complete and absolute discretion whether or not to accept an assignee.

Rather than be at the risk of the whims of the landlord, the lease should provide certain minimum standards that the assignee should meet in order for an assignment to be approved, and the landlord should be obligated to provide the approval in a reasonable time and without unreasonable conditions added to the approval.

Because a lease is a key agreement for almost every business, it should be thoroughly and professionally reviewed and, where appropriate, negotiated. It represents both a significant liability and a significant opportunity for the business, directly impacting business value.

I’ll review the other key agreements in the next newsletters.

Unlocking Your Biggest Business Pay Day

Businesses pay their owners in three ways:

  • Salary for labor performed for the business;
  • Profits for risk capital invested in the business; and
  • Equity Appreciation for creating or growing the business.

Equity appreciation typically provides the biggest pay day for business owners. Unlike real estate or publicly traded stock, a business owner can create substantial equity appreciation by building and growing a high performing profitable business.

Goodwill and Equity Appreciation.

As a general rule, a business is worth the greater of:

  • A multiple of the cash flow it produces in excess of costs (including owner labor); or
  • The liquidation value of the business assets.

If a business generates enough cash through operations, it is worth more than the sum of the assets used in the business. This ‘extra’ value is called goodwill. Goodwill is created as the owner builds business revenue and profitability. For high performing businesses, goodwill value far exceeds asset value.

All things being equal, business value and owner equity value increase as goodwill increases. Maximizing business goodwill maximizes equity appreciation.

But, realizing maximum equity appreciation requires a well implemented business succession plan designed to preserve or enhance goodwill.

What is a Business Succession Plan?

A business succession plan is what the business owner plans to do with the business when she will no longer be the owner. For most owners, it is the process to convert the business equity into cash.

There are basically four business succession planning options:

  1. Die at Your Desk;
  2. Liquidate;
  3. Internal Transfer; or
  4. External Transfer.

Let’s take a look at each option and its impact on the ability for the owner to realize maximum equity appreciation.

Die at Your Desk. With this option the owner operates the business until he dies. This is the default method when the owner doesn’t do any business succession planning.

The advantages of this option are that no planning is required and the profit and, potentially labor income from the business may continue until the owner dies.

The disadvantages are many, however. First, the owner never actually benefits from any equity appreciation. Because the work of the business stops suddenly, it is likely to result in the loss of most or all of the business goodwill. Employees are out of work, and customers are left with partially completed work. And, because all or part of the goodwill is lost, the owner’s heirs don’t realize the value of the owner’s work. The capital asset appreciation from the business essentially vanishes.

This option is also problematic because a business owner never truly can be sure if she can work until the end. It is possible (and perhaps maybe even likely) that physical or mental limitations could cause the owner to stop work long before her death. If the owner’s decline occurs over time, the value of the business could slowly evaporate. In that case the owner will have neither the equity appreciation or the income from the business.

What About Hiring a Manager?

I’ve heard business owners suggest that hiring a manager to run the business after the owner pulls back from day-to-day involvement is a good option. They posit that, given the return on investment likely to be achieved from the investment of the realized value of equity appreciation, there’s no benefit to succession.

While I agree that return on cash invested in public markets is low, my experience suggests that very few owners are able to make a small business into a passive investment. A manager employee will simply not have the experience or drive of the owner.

And if the manager does not work out and causes the business performance to suffer, moving to an alternative succession plan may be difficult or impossible. At a minimum, it will destroy some of the goodwill and business value.

This view also falls to take into account the time and cost of transferring small business equity compared with that of transferring publicly traded investments. Cashing out equity appreciation takes months and has a significant cost.

In short, Die at Your Desk does not maximize the equity appreciation, destroys goodwill, causes problems for customers, employees and heirs, and should generally be avoided.

Liquidation. With this option the owner picks an end date, closes the doors, liquidates the assets and pays the creditors. If there’s anything left over once creditors are paid – most often there isn’t – it goes to the owner.

The advantage of this method is its simplicity. Though some planning is required to ensure lease terminations are coordinated with the liquidation, shutting down a business and selling the assets can usually be done in a fairly short period of time. After that the owner is free from the business.

The disadvantages are similar to the Die at Your Desk option. The major disadvantage is the loss of business goodwill resulting in the loss of most of the equity appreciation for the owner. And while Employees have to secure new work, they can be notified well in advance, and customer work can be completed prior to liquidating.

The way I see it, liquidating a well performing business because the owner is retiring, is similar to burning down your home after the kids move out. You’re taking a valuable asset and destroying it for no good reason

Unfortunately, some business owners are actually forced into liquidation because they haven’t implemented a business succession plan before they decided to retire. A business owner on the eve of retirement may try to sell only to find out they haven’t created a salable business.

In fact, only 10% to 15% of all businesses listed for sale actually sell.

While there are many reasons for this, with sufficient advance planning it is possible to make almost any business into a salable business.

As was the case with Die at Your Desk, Liquidation causes a great loss of value and should, generally, be avoided.

Internal Transfer. With the internal transfer option for succession, the owner sells his equity to a partner or an employee.

This can work well for the owner and the transferee. Because of the existing relationship, the owner can better evaluate the transferee to determine the likelihood of a successful transfer. And with the experience with the business, the transferee may have a better ability to secure outside financing to complete the purchase, and to complete a smooth transition of ownership. An internal transfer can also be completed more quickly, with the use of a business lawyer and the current accountant for the business, and less cost payable to an intermediary to market the business.

Most importantly, though, from the owner’s financial perspective, the owner will likely be paid fair market value for the equity and thereby realize the value he created in the business.

The downside is that this is an all eggs in one basket strategy. If the transaction does not work, the owner is faced with additional time before retiring to restore the business and find another buyer. And the negative effect of a failed transfer on business performance and employees can’t be understated.

Other disadvantages include:

  • The transferee may not have the assets to make a down payment or credit to secure a loan. Without cash or financing, or both, an internal transfer simply makes no sense and is too risky for most owners. Would you be willing to sell your business to a buyer with no skin in the game?
  • The transferee may not be qualified to run the business. Training an employee to be an owner is a long and involved process that could take years to complete. And some transferees may never make the leap, resulting in the ultimate failure of the internal transfer years down the road.
  • A limited pool of transferees may result in a lower price (i.e., not achieving all of the equity appreciation). If there’s only one deal to be had, it won’t be favorable to the party who wants or needs the deal the most.
  • The transferee may not have the same view of the value of the business as the owner.

The Next Generation Transfer.

Even a brief discussion about internal transfers wouldn’t be complete without a mention about inter-family transfers. According to the Family Business Institute, 88% of business owners believe that their children are an option as a transferee of the business. However, only 30% of businesses are actually transferred to the next generation. And only 12% of those are transferred to the third generation.

These statistics show that forcing a transfer on your children or grandchildren can be a disaster for you, for them and for the business and its stakeholders.

You should consider long and hard whether an internal transfer to children is likely to result in the best outcome for each of the interested parties. The statistics suggest that the majority don’t.

External Transfer. With the external transfer option, the business is sold to an unrelated third party.

This option usually results in the owner realizing maximum equity appreciation. Though the owner will typically be expected to stay on with the business for a few months or a year, the owner will have a known end date and be able to cleanly move into retirement or the next venture.

Another advantage are the professional advisors. Because the owner has advisors working on his behalf, he can focus on keeping the business growing. This benefit cannot be understated. If the owner loses focus and the revenues or profitability falter, equity value will be lost. Keeping the business on the track it’s been on will lead to greater business purchase price and maximum equity appreciation.

There are disadvantages to an external transfer too.

  • Riding the Wave. Owners notoriously ride the growth of the business up and wait until things plateau or begin to decline before thinking of selling. Once revenue plateaus, it’s too late to get maximum value. Buyers want increasing revenue. If a decline happens, it can require two or three additional years to show the decrease was only an anomaly.
  • Costs of Transfer. The cost incurred by the seller in making an external transfer will, on the surface, be the higher than the other options. They will include the broker-intermediary commission, and fees paid to a business lawyer and an accountant.

But, actual costs (being benefit minus expense) may be lower. The International Business Brokers Association (IBBA) reports that owners realize approximately 20% more for a business when an IBBA Certified Business Intermediary (CBI) is involved in a transaction. If the owner receives twenty percent more, the benefit of the increased purchase price would far exceed the costs of transfer.

  • Time. The typical time to sell a business through external transfer is 9 to 12 months. If the business needs to be improved to maximize equity appreciation, then additional time will be needed. An external transfer is not an overnight process and requires upfront planning.
  • Negotiation and Stress. Negotiations associated with a sale can be extremely stressful. Sale transactions can run the gamut from simple straight forward purchases to intricate transactions filled with hours and hours of negotiation. Using an experienced CBI and lawyer will minimize the stress through experiential knowledge and strategy, but it cannot be eliminated.

The bottom line is that, with an external transfer, the owner typically realizes the maximum equity appreciation.

Unlocking the equity appreciation payday requires preserving goodwill through business succession planning to transfer the owner’s business interest in the most efficient manner. For owners interested in maximizing the value of their business, business succession planning leads to a transfer, whether internal or external.

As always, if you have a question on this article, business succession planning in general, or any other matter related to business law, give us a call. We’d be glad to help you however we can.

What’s Happening.

We’re Growing.

Suzan Abramson, a securities and corporate lawyer with 33 years’ experience, recently joined the firm as a partner. Suzan and I have known each other since 1994 (I actually replaced her when she left a firm in the early 90’s). We previously practiced together at two firms in town. She brings a wealth of knowledge and experience and I am looking forward to working with her on many transactions.

We also recently welcomed Kim Tupper to the firm as a legal assistant and “designated hitter.” Kim comes to us with many years of experience working in law firms, is very organized and great with clients. We are very happy to have her as part of the team.

And last, but not least, Brittany Alexander also joined the firm as a paralegal / law clerk. Brittany clerked for Judge Blackwell in the spring, is in the top 5% of her class, and is on law review. She will finish law school in December.

Fun Stuff.

With summer winding down we recently held the first (annual?) Entrepreneurship Law Firm Bioluminescence Kayak Tour. Bioluminescence is a natural phenomenon created by the dinoflagellate in the coastal waters near Central Florida that causes the water to glow when disturbed.

Our tour was on the Banana River in Brevard County near Cape Canaveral. Whether it’s the paddle churning the water during a stroke, the bow wave from the kayak or a fish shooting through the water, each disturbance leads to a glowing light that looks like a natural fireworks show. Of course, the effect is most noticeable when it is darkest around you.

At one point our group came through a school of mullet. When disturbed mullet will jump out of the water. With the bioluminescence effect you could see the trails from each fish, where it left the water and when it returned to the water.

While kayaking at night is quite different – I’d never done it before and was surprised how big waves look in the dark compared with the light – it was an absolute blast and I’m looking to go again.

If you’re interested in giving it a try, let me know.

Thanks for reading,
Ed

The Startup NDA Conundrum

Founders often face a conundrum when seeking investment for their startup:

Should a startup require prospective investors to sign a non-disclosure agreement (NDA) before receiving the pitch?

An article in the New York Times on July 2, Why More Start-Ups Are Sharing Ideas Without Legal Protection, discussed this conundrum.

Understanding the custom of investors concerning NDAs and knowing how to deal with that customer (and protect the startup) is essential for the startup founder seeking investment.

Unfortunately, though the overall point of the article – that prospective investors will not sign NDAs to hear a pitch – is correct, many of the points it discusses are not completely accurate.

First, the article claims that this is new development in the past 10 years. It is not. For at least the past 20 years (since I’ve been practicing in this area) investors have refused to sign NDAs before hearing pitches or looking at investment opportunities.

Why?

The investor’s refusal to enter an NDA makes complete sense.

As one investor points out in the article, investors will see hundreds of opportunities a year. Most of these come in batches – the startup genre of the day (e.g., social media platforms). And those same-genre-opportunities often overlap in technology or market or both. In many cases, different startups are going after the same opportunity with very similar technology or approaches.

An investor who signs NDAs with one startup puts himself in harms way for a lawsuit if he invests in another similar startup (or eliminates his opportunity to invest in the genre at all).

Though the article advises “Do Not Ask Unless You Have Something to Protect”, the reality is that you should never ask an investor to sign an NDA to hear your pitch.

This should be a non-issue for startups.

Of course, the best method for protecting confidential information is not to disclose it (the article correctly advises to proceed gradually). There’s simply no need to show up and throw, spewing all of the secret sauce up during a pitch.

Instead, founders should be able to state the “what” of the business, without giving away the secret sauce (i.e., the “how”). For example, the operation of software can be displayed without describing the trade secrets in the source code. Likewise, the results of the use of a product can be discussed rather than the method of making the product.

Where there is a secret sauce – an often there isn’t any - it can be disclosed after the pitch when (if) the investor shows interest and the relationship is further developed.

I’ve found that technical founders especially fall victim to show up and throw up because they focus on the technology rather than the business aspect of the startup.

What If the Business Idea IS the Secret Sauce?

The inability to separate the business idea from the secret sauce actually indicates a fundamental problem with the startup’s business model.

If there is no difference between them, then there’s no secret sauce and nothing to protect. A business cannot protect a secret sauce like that after launch. Once such a business becomes operational, all will know the alleged secret sauce merely by seeing the business in action.

Such a business isn’t one in which rational investors will invest in any event.

What About the Value of the Idea?

Perhaps most importantly, ideas are worth nothing (one of the interviewed investors says one percent).

Why? Because ideas don’t create great companies. Execution does. Investors invest in teams who can execute to create a business.

Plus the original idea almost never pans out. Most startups change their business from the original idea (often many times) before hitting on a winner. This is the basis for lean startup methodology, and the concept of the pivot.

Therefore, ideas by their very nature aren’t secret sauce. Rather, it’s the behind-the-scenes details of method of implementing and executing the idea to create the outcome for customers that is the secret sauce.

And by keeping the idea secret, the startup loses the opportunity to test it on the intended market, to secure advise and to develop relationships with possible investors.

Pitching an Idea v. Pitching an Early Stage Business with Traction.

While a startup in California might be able to pitch investors at the idea stage with the intent to secure funding, here in Florida there must be something more.

By the time a founder is pitching prospective investors in Florida for funding, the startup must have had some success (though not necessarily be profitable) with its business model and be able to show a product-market fit. In other words, it must be an early stage company and have a bit of traction.

This adds a measure of protection for the startup – a head start with the customers and experience of what works and doesn’t work with the business model. This market relationship and experience is invaluable. And the details need not be disclosed to make a valid pitch.

It is extremely difficult (if not impossible) for someone to hear the pitch and be able quickly create a duplicate that relationship and experience. As anyone who’s done it can attest, there’s a lot of trial and error to get from idea to operating business – experience that can’t simply be duplicated.

An NDA Provides a False Sense of Security.

As noted in the article, an NDA leads to a false sense of security. Startups can’t afford to enforce an NDA because they don’t have the resources to hire attorneys or to devote time to a litigation.

More than just a waste of time, having an NDA can lead to disclosures that shouldn’t be made in any event.

Instead, the startup should use measures that will actually be effective to protect the secret sauce – don’t disclose until it makes sense to do so.

Is a Provisional Patent a Substitute for an NDA?

In a word, No.

A provisional patent application is not enforceable. It is merely a placeholder for a filing date to secure (hopefully) first-in-line status for the startup’s patent application. To get to an enforceable right, the startup must devote resources. And the filing starts a twelve month clock when the full application must be filed.

I’m often amazed at the irrational focus of startups on patents. Patents for most startups are a Siren Song. Chasing them drains startup assets for fees and costs and takes time of the founders away from developing the business. And they don’t offer the barrier to entry startups crave.

Patents are the polar opposite of an NDA. Securing a patent requires a full disclosure to enable a skilled person to practice the invention. In other words, the secret sauce is laid bare for all to see.

After making the secret sauce public, patent law leaves it to the startup to protect those rights. The startup must use its resources to prosecute infringers through legal actions. Infringement actions typically cost $2MM to $10MM in attorneys fees and take two to three years to complete; money and founder focus diverted from growing the business.

This is why it is imperative for a startup to have a cogent intellectual property strategy.

Isn’t This Strange to Hear From an Entrepreneurship Lawyer?

Part of advising clients properly as a lawyer is to understand the customs and norms of the practice area. This is simply the reality for startups in Florida.

That said, this discussion certainly doesn’t mean startups should forego NDAs.

Rather, outside of prospective investor pitches and outside of the discussion of the startup idea, all disclosures of confidential information should only be done when necessary and only pursuant to a non-disclosure agreement drafted for the specific purpose of the disclosure.

Please comment on this post if you have any questions or a contrary view.

Ed

The Importance of Due Diligence In the Context of Purchasing a Business

You have decided to purchase a business. Congratulations. It takes a lot of courage to arrive at such a major life decision. More than likely your business lawyer, assuming you’ve made the wise decision to hire one to help guide you through the process, has possibly advised you to make anasset purchase as opposed to a stock purchase. Hopefully he or she has also explained to you the potential benefits of such a choice, including extinguishing any prior liabilities of the prior company. There are also potential tax benefits to an asset purchase deal. You may be able to reset the tax basis in the company’s assets, and furthermore may be able to depreciate those assets 100% going forward. These decisions will hopefully be made in conjunction with your certified public accountant or other qualified tax advisor. Hopefully you’ve also decided to obtain a valuation of the business from an objective professional, such as a certified valuation analyst, prior to incorporating a price term when you made the invitation to make an offer. After all, even the best businesses at an irrational price can be a bad investment.

By this point in time, the parties, you and the seller, and each of their respective counsels have passed around term sheets or letters of intent. These are generally non-binding documents, that may contain bindingconfidentiality or standstill provisions, which reduce the deal to essential terms so that the parties can have a meeting of the minds. While a term sheet is not an obligatory part of a transaction, it helps to focus the parties on the transaction, saving time and money.

As part of the term sheet, your lawyer should have included and have allocated a period of time for due diligence, which serves to help confirm that all material facts represented and/or warranted by the seller as part of the transaction are true. The importance of due diligence cannot be understated. You, the buyer of the business, should be informed as possible. When you buy a house, a car, or a condo, it is customary to have an inspection performed. A business is no different in this sense from any other asset. Imagine you are paying sixty dollars for something that is worth one-hundred dollars and likely to grow in the future. You, as the purchaser of that note would likely be enthused by such an opportunity. The only problem is that in this scenario, you the buyer failed to realize that the individual who tendered to you the hundred dollar bill is a master counterfeiter, who has been using one dollar bills and imprinted the façade of Benjamin Franklin on each note tendered to purchasers. The words of Warren Buffett seem appropriate in such context: “If you’ve been playing poker for half an hour and you still don’t know who the patsy is, you’re the patsy.”

In this widely-acclaimed quote, Mr. Buffett was speaking in the instance of an investor who buys a fractional interest through the stock of a publicly-traded company, fails to understand the underlying fundamentals, and hopes to make money in the stock market from the eponymous Mr. Market. In the private markets, a buyer has less of an excuse to be the so-called patsy at the poker table because he can look to his advisors to help make an informed decision. Imagine if a purchaser of the stock of Enron or MCI WorldCom had had a forensic accountant pour through its books, attempting to uncover earnings manipulation and understand the quality of those earnings, all while calculating the free cash flow available to the owners, the companies’ shareholders (which in the case of those aforementioned firms was negative). A purchaser in the private markets, who reserves for himself a period of time to perform due diligence from a sideline view, has a clear advantage over a securities analyst, who analyzes the fundamentals of a public company from the nosebleed section of the stadium. The key thing to remember here is the following: earnings can be manipulated, cash available to owners cannot. This is one of the many reasons due diligence is particularly critical.

Your business lawyer, when making the due diligence request memorandum, should cast a fairly wide net when requesting documents on your behalf. These items could possibly include the following, which serve to get an inventory of what the business has and where it is currently: 1) Documents, including bank and tax statements; 2) Contracts and other agreements; 3) A list of vendors and agents; 4) A review of payables and receivables; and 5) Off balance sheet items that merit review. The last item can be particularly critical as it may materially impact the value of your intended acquisition, from both the standpoint of marketability and risk management. In the event something adverse is uncovered, the purchase price can be readjusted, the whole deal can be renegotiated, or in the most egregious cases, the entire transaction can be canceled. Sometimes this can be the most favorable result for a buyer, often resulting in short-term pain as opposed to a lifetime of full-blown heartache. Like a home buyer who can lead himself to financial ruin in pursuit of his “dream home,” a buyer of a business can leave himself worse off than when he began his search.

Much like asset protection is never an impenetrable fortress, due diligence can never completely eliminate risk. However, like a seasoned poker player, a buyer of a business should know to play his hand only when the odds are in his favor. Some seasoned buyers, like their poker playing counterparts, have become a living almanac of odds and risks. As such, they have little need for due diligence. Berkshire Hathaway’s duo in Buffett and Munger are two such individuals (although stacking the deck in the form of having buyers call you, possessing a war chest of capital, and only purchasing from people you like certainly can’t hurt). A friend of the firm has relayed to me he can compute the sales of a restaurant by sitting through a week of table service, without the need for tax statements. The rest of us, however, can tremendously benefit from due diligence. If nothing else, it helps to tip the odds of winning away from the house and in your favor.

If you have any concerns or questions regarding the purchase of a business or due diligence, please call the Entrepreneurship Law Firm, P.L. at (407)-649-7777.

The Two Partnership Killers – and How to Avoid Them.

The Two Partnership Killers – and How to Avoid Them.

You’ve probably heard a business owner say “partnerships don’t work.” The statement is typically followed by a story of what a former partner did (or in many cases did not do) and the tale of a lost relationship.

I’ve found that, no matter the story, there are two primary things that lead to the death of partnerships.

Though rarely noticed early on, these two things start small and, over time, cause stress to grow into tensions, then tensions to expand into disputes, and disputes to evolve into outright conflict and destruction of the partnership business. Together these two things cause failed friendships, put people out of work and cause big financial problems.

Shockingly, these two partnership killers can be easily avoided and rendered benign and powerless. Like avoiding an infection with a simple alcohol swab, the solution for both is simple. Yet partnerships fall prey daily.

So what are these stealth partnership killers?
Unstated Expectations.

  • Unstated Expectations; and
  • Verbal Agreements.

Each of us has expectations for every situation and for every relationship. Each partner has his or her own set of expectations for the partnership relationship.

These include:
The first problem arises when the partners keep any expectations secret. It would seem contrary to one’s self interest to keep expectations secret, but they do so because they don’t want to rock the boat, or because they’re assumed.

  • The type of business to be built: lifestyle or high growth
  • Whether the business is built-to-sell (exit) or built-to-cash flow
  • The contributions of each partner (type, amount, timing and value)
  • The level of committment of each partner- part time, full time or greater than full time, and hours of work
  • The deliverables (results of work) each partner will provide
  • Whether the partners will guarantee loans and credit lines of the business, and
  • What happens if a partner wants to leave or dies.

Honeymoons aren’t only for marriages. They also exist at the start of a partnership. No partner wants to offend the other. Everyone is looking to the future and how much money will be made. Difficult decisions are not discussed because it could lead to tension. And they believe tension isn’t good.

Other expectations are assumed to be mutual so they’re not considered. Only, there’s been no confirmation that the expectations are mutual. One partner wants to grow the business to cash out in two years while the other wants to settle in for an easy life harvesting the cash flow. These two paths require different tactics that are often mutually exclusive.

Unfortunately, this plants the seeds of the partnership killer. When expectations aren’t met and the path of the business isn’t in line with all partner goals, partners become frustrated and stress starts.

This partnership killer is avoided by acknowledging that it’s alright to talk about divorce before the partnership marriage is completed. A business partnership isn’t a marriage – it’s not ’til death do us part.’

Having the conversation – and making it a detailed granular conversation – will either make the relationship stronger over the long term, or kill it now before time and money have been invested and lives changed. Either way it’s a win.

Many founder’s have decided not to move forward with a planned venture because, after having an open and honest discussion, they discovered their goals weren’t in alignment. Nonetheless they were grateful to have discovered early rather than after having spent their time, money and life energy. Often they remain friends.

Verbal Agreements.

A full discussion of expectations, though, is not enough. Even the most comprehensive discussion can be undone by a verbal agreement. In fact, a verbal agreement is effectively no agreement.

We humans have lousy memories. Everything we see and hear, then subsequently “remember” is colored by our personal biases and expectations. We remember discussions in the light most favorable to ourselves; we don’t actually remember the occurrence.

Unless there’s something staring us in the face showing that our memory is inaccurate (and sometimes not even then), our current desires cloud out (and render unreliable) the past memory.

Therefore, agreed upon expectations must be put into a written agreement that has specific remedies for a breach and is signed by all of the partners.

Avoiding the unstated expectations and verbal agreement partnership killers will remove many common partnership problems and increase the odds that your partnership will be profitable and long lasting. And, even if it isn’t long lasting, the end of the partnership won’t take down the business with it.

At Entrepreneurship Law Firm we help business partners avoid these problems by:
If you have questions about a partnership agreement, shareholders agreement, buy-sell agreement, operating agreement or founders agreement, give me a call at 407-649-7777.

  • Guiding a discussion that includes key areas where partnership expectations go awry using a three page checklist of issues developed over twenty years of working with business owners.
  • Providing advice about the consequences of the options selected andhow to improve the benefits of the partnership agreement for both partners.
  • Preparing a comprehensive written agreement that is based on the decisions of the partners, rather than a cookie cutter form.
  • Reviewing the final written agreement, paragraph by paragraph, with the partners so each understands what is being agreed upon and is sure that the agreement reflects the decisions the partners have agreed upon.

Florida Revised LLC Act Seminar:

In 2013 Florida adopted a new Limited Liability Company Act (Section 605, Florida Statutes) that took effect in January. After December 31, 2014, the new law will apply to previously formed limited liability companies.

If you have an LLC, you must determine what changes should be made to your operating agreement to make sure it complies with the new law. Some of these, if unchanged, could result in personal liability for you. And, if you don’t have an operating agreement, the new law provides a default operating agreement that you may not like.

Peggy Hoyt (of Hoyt & Bryan) and I will present a no cost seminar next month to show you the major changes and how they effect you and your business.

The seminar is scheduled for March 25 at my office in downtown Orlando. Only 8 seats are left.

Call 407-649-7777 to reserve your seat now. You don’t want to miss this information that is crucial to your business and your financial success.

If you can’t attend, give me a call at 407-649-7777 to set a time when we can talk to make sure you and your business are protected.

Thinking About Selling Your Business?

Thinking About Selling Your Business?

Be Sure to Understand These Big Issues and Risks

From 2008 until 2012, the door was closed for almost all small closely held business exits. Especially in ’08, ’09 and ’10, very few people (and no lenders) were willing to take on the risk of a business purchase.

Beginning in 2012, the market began to show signs of life. In 2013, the number of sales in Central Florida increased and the market continues to recover.

Because of the five year stoppage, there’s a lot of owners looking to sell. They hung on through the downturn and are ready to move on.

A sale transaction is a critical point in the life of a small business. Things can go wrong, resulting in loss of business value and income.

These big issues and risks have to be addressed and include:
In this and future issues of this newsletter, I’ll show you how to address these big risks and issues to help you make your sale successful so you can get the most for your business in the least amount of time.

  • What’s the ‘right’ price?
  • Who will you sell to?
  • What can you do to improve the business for a higher price?
  • Should you use a broker (and pay an 8% to 12% commission)?
  • Will your customers, vendors, employees or competitors learn the business is for sale?
  • How will the buyer pay you? What’s customary?
  • Will you be able to protect yourself and your financial future?

The first and, in my opinion, most important issue to get right is the offering price of your business.

Issue #1: Pricing Your Business.

Sally and Bob (not their real names) operated their small (literally “mom and pop”) business services company for ten years after Bob got early retirement in his 50’s from a large corporation. They decided it was time for a real retirement and contacted a broker to sell the business.

This broker came to their office and toured the business. Afterwards, they all sat down in the conference room to talk about the sale. The Broker asked what they wanted for their business.

Sally and Bob heard from a friend that businesses like theirs should sell for 1.5 to 2 times sales. So, they answered $700,000, right in the middle.

The broker scanned their tax returns and financial statements for a few minutes, then proclaimed the business worth $500,000. He listed it for $550,000 (“to have room to negotiate”) on a one year exclusive listing agreement.

Sally and Bob were excited to be just a few months away from real retirement. All that was left to be done was to find the buyer and do the paperwork.

Then, nothing happened. A few weeks went by. Then a couple of months.

After 6 months with no traffic, Sally and Bob contacted the broker. He suggested a $50,000 price decrease to get the market going. So they dropped the price to $500,000.

After 3 more months, Sally and Bob again contacted the broker. He said the market is always slow around the holidays and suggested another price decrease. So they dropped the price to $450,000.

Still nothing.

Eventually, the listing agreement expired. Shortly after they met with me on a legal issue and mentioned the situation. I put them in touch with a reputable broker.

After he’d done an opinion of value, he had some good news and some bad news.

After preparing a written analysis of the value (using a method I’ll describe in a future issue), there was no way they were going to sell the business for $500,000 or $450,000, or even $400,000. The most it was worth was $300,000.

He went over the process he used, and showed them the data and method to arrive at the opinion of value.

Though unhappy they’d wasted a year trying to sell at the higher price, Sally and Bob were actually relieved. Finally, they understood. They told us that at first they wondered what the problem was. After 7 or 8 months that wonder turned to fear that they’d never be able to sell.

It still took several months to find a buyer and complete a sale, but with the accurate price they began to get traffic and a couple of offers.

Pricing your business correctly is the most important part of selling it. You’ve got to price it right to make sure it’s not so low that you leave money on the table, and not too high that it’s unattractive to buyers.

Interestingly, of these two potential mistakes, setting the price too high is more common. It’s also a bigger problem than setting it too low.

Why?

First, with an overpriced business you’ll cut out “real” buyers.

Our culture in the United States doesn’t haggle. For the most part, we view a price as “the” price and we won’t bargain if it’s too high. We move on to the next deal.

Consider whether or not most people are comfortable buying a car? Do they like visiting the dealer to “negotiate” over price and terms? Do they feel comfortable sitting with the dealer’s finance manger? No, no and no.

In fact, Americans are so much against bargaining that some auto dealers have developed “no haggle” pricing as point of differentiation.

Second, most buyers are first time buyers and they’re terrified. Combining that fear with the cultural no-haggle mindset, means that a buyer who gets any hint that your business is overpriced will bail. They’re looking for any reason not to move forward and you’ve just supplied it.

If you set the price for your business too high, you won’t get many (if any offers). People won’t even say they’re not interested; they’ll come up with excuses or just walk off into the sunset doing nothing.

Bottom line: you’re not getting many offers.

Finally, any offer you get will probably be a low ball. These will be from the few bold buyers who aren’t afraid to make any offer. They’re looking for super deals and know you’re overpriced. So, they figure “why not try; there’s nothing to lose.” They’re playing on your psyche.

Every owner starts out excited at the prospect of selling, waiting for the offers to come in. They’re thinking of the next thing: a long vacation, financial independence, the next business or retirement. Once a business owner decides to sell, it’s sold in his mind. He mentally starts his vacation, next business or retirement. The sale is only a formality to that new life.

But, as time goes by, the owner of the overpriced business starts to feel uneasy. As weeks and weeks pile up without any real offers (and often without any showings) the owner becomes very concerned. He might even begin to panic.

To put yourself in his shoes, imagine that one day your phone stops ringing and customers stop coming in your door. This goes on for a couple of days. Then a week. Then a few weeks. Then a few months. What would go through your mind? What would you do?

The owner’s panic is amplified because she’s trying to sell her biggest financial asset.

So, when a low ball offer comes in, the desperate panicked business owner is more likely to take it. Now she’s really leaving money on the table.

Sadly, there are a lot of brokers and transaction advisors who either don’t know how to price your business or won’t take the time to do it right.

Some brokers follow the path of least resistance. Rather than educate business owners about the true value of the business, they list businesses at any price the owner requests.

Why? Because it benefits the broker to have a lot of listings.

Listings generate buyer inquiries. Brokers know that most buyers who call about one business eventually buy another business. So, they use your listing just to generate traffic for their other listings. If they can’t sell your business to the caller because it’s overpriced, they’re happy to steer the caller to another listing.

Meanwhile, you sit and become more concerned (panicked) like Sally and Bob.

So, how do you properly price your business? I’ll show you an easy method to estimate the value of your business in the next installment.

And, in future installment, I’ll discuss more of these big issues and risks:
——————————–

  • The Commission Conundrum: Selling Your Business With or Without a Broker (to avoid the broker’s commission).
  • Working with Business Brokers and Professional Advisors.
  • Don’t Let the Lawyers Kill the Deal.
  • Working with Buyers.
  • Don’t Get Pregnant with a Deal.
  • Holding Paper.
  • Due Diligence.
  • Risky Contract Terms.

New LLC Act Workshop. On Wednesday, February 19, 2014, I’ll be co-presenting a complimentary workshop on the critical changes to Florida LLC Act. The Act is a complete re-write of the existing Florida Limited Liability company statute and became effective on January 1. Join me and Peggy Hoyt, Esq., to learn how these changes will affect your business. The workshop will be held at The Law Offices of Hoyt & Bryan, 254 Plaza Drive, Oviedo, FL 32765.

For more information please call 407-977-8080 or emai lTiffany@HoytBryan.com or Jean@EntrepreneurshipLawFirm.com.


On the personal side, I hope you enjoyed the holidays. I spent a lot of time with Faith, my daughters and extended family, as well as mountain biking and hiking. I’ll be mountain biking until the weather warms, when I’ll start kayaking again.

There are some fantastic mountain bike trails in Florida, including Santos (Ocala) and Alafia State Park (southwest of Tampa). Getting better skills by riding these and other trails has been great fun (not to mention a lot of exercise).

I’ve put together a list of rivers to kayak this year and am looking forward to seeing them. You can really experience the natural beauty of Florida when you’re a few inches above the water in a kayak.

Until next time.

Ed

Is Your Company Wearing Ripped Jeans?

Is Your Company Wearing Ripped Jeans?

Hiring an employee is, at best, a crap shoot. Interviews are like first dates – everyone is on their best behavior. And people are woefully inadequate at evaluating whether a candidate will be a good employee for the long haul.

To overcome this, employers use “objective” criteria, such as:
Though none are themselves indicators of success, the criteria can help easily identify candidates who don’t meet the minimum requirements. Rather than find the best candidate, they identify the worst of the pool so they can be removed from consideration.*

  • Prior work experience;
  • Education;
  • Common relationships;
  • Communications ability; and
  • Attire.

Even though you may not get the job, if you show up in a suit, have great experience and a top level education, you’re not automatically eliminated from consideration. You’re definitely going to be rejected, however, if you show up in ripped jeans and an old T-shirt.

This same process is also used by investors considering your company.

Because they have many choices and often lack the capability to pick winners, investors and customers identify and weed out clear losers based on obvious flaws.

So what are these “ripped jeans” obvious flaws?
Your company must ditch the ripped jeans and put on the suit to be taken seriously. You still might not get the investment. But, without the suit, you may never get to the point of discussing an investment.

  • Failing to have an expertise diverse team including business and technical employees, and experienced professionals and industry advisors;
  • Founders who don’t know their numbers, their market differentiation or their value proposition (‘We don’t have any competition. Really!’);
  • A focus on technology rather than the market and the business case;
  • Founders who don’t take advice and mistake arrogance for confidence;
  • A multi-billion dollar target market, where the business plan is to ‘get’ 1% market share (i.e., ‘All we have to do is get 1% of this $50B market!’);
  • Financial statements that don’t make any business sense (which are always characterized as ‘conservative’);
  • Little or no customer interaction (sales, pilots, users);
  • Founders with an extreme idea of their company’s value;
  • A 97-1-1-1% split of equity among the founders;
  • Founders who take unreasonable risks;**
  • Off-the-Internet, fill-in-the-blank legal documents that make no sense (my personal favorite for obvious reasons); and
  • Team members with the same last name as the founder and no prior experience in their job categories.

* We all do this in our daily lives, as well. If your neighbor drives a beat up car, you won’t see him as successful, even though his car may have no bearing on his technical capabilities or financial resources.

** More on this in another newsletter.


Special thanks to Randy Ellington of SmartWealth for the metaphor.

What’s Going On?

Earlier this month I helped a technology startup complete a $1MM angel round. It was a pleasure working with the founders. I’m very impressed by their team and look forward to their future success.

On Thursday of next week I’ll be speaking on a Funding Panel with a group of successful entrepreneurs as part of the Orlando Regional Chamber of Commerce (Orlando, Inc.) Entrepreneur’s Academy. The September Academy is sold out. I’m looking forward to the session and the opportunity to talk with the group. There’s something I thoroughly enjoy about the conversations I have with other entrepreneurs and business owners. It seems the focus is on growth and opportunity, and I usually learn something in the process.

I’ll also be on the Funding panel for the October Entrepreneur’s Academy. If, like me, you enjoy interacting with other entrepreneurs, you should consider attending. Tickets are still available for the October Academy.

Finally, I’m a mentor for two of the Starter Studio startups and have been going to some of their events. They have a packed schedule, including founder’s talks, where a founder tells how he (only men have spoken so far) got where he is today, including all the failures along the way. These are eye opening because we often see founders only after they’re “overnight” successes. If you’re interested in these types of events, go to the Starter Studio website for the schedule.

As always, there’s more free information at the Entrepreneurship Law Firm website and I’m happy to answer your questions and get your feedback.

I’ll be in touch soon.
Ed

Ban on General Solicitation Lifted for Private Placement Offers to Accredited Investors

Ban on General Solicitation Lifted for Private Placement Offers to Accredited Investors

Last week the SEC voted to lift the ban on general solicitation for private placement offers to accredited investors. The ban remains in effect for non-accredited investors and the change won’t take effect for 60 days after publication in the Federal Register.

Currently, companies must rely on personal relationships and referrals to get the word out on their private placements. This, of course, limits the companies’ ability to find possible investors.

Using general solicitation – advertising, “pitch fests” and other similar techniques – runs afoul of SEC requirements and taints the private placement offering, causing problems with current investors and effectively preventing future rounds.

While lifting the ban is great news, there are limitations and additional burdens for companies using general solicitation.

First, it will be permitted only in private placement offers to accredited investors. Once general solicitation is utilized in an offering no non-accredited investors may invest.

Next, issuers will be required to file a Form D at least 15 days in advance of advertising and to update that Form D no more than 30 days after the offering is completed or abandoned.

And, finally, issuers using general solicitation will have to confirm (through documentation) that purchasers are, in fact, accredited. Currently the investors need only confirm this to the issuer in writing, without backup documentation (i.e., the honor system).

Unfortunately, there’s still no effective date for the other part of the JOBS Act beneficial to small startups – equity crowdfunding.
Personal Update

Yes, I’ve been out of touch for a while. I’ve been working on a big personal project since the holidays and took a break from writing this newsletter. Those of you who’ve read my newsletter for a while know that I enjoy outdoor activities – kayaking, mountain biking, hiking, hunting, etc. So, I took the plunge and purchased a house and a couple of acres on the Suwannee River in North Florida. It’s right in the heart of all of those activities.

Calling it a house when we first bought it was a bit of a stretch. It hadn’t been lived in for the better part of a decade. When we first went inside, it was like walking into a time warp. The interior looked like my grandmother’s house in 1970. Dark everything with red and green carpet, red curtains, and red and yellow patterned plastic covering fluorescent lights. A dishwasher that connected to the sink. Really.

We had to demolish the interior and start over. We removed more than a ton (2,000 lbs.) of debris from the house and the grounds. It’s been a lot of work. But, we can see the finish line for the interior.

So, I’ll have more time to write this newsletter on a regular basis. Though I’ve kept up with the Orlando entrepreneur scene, I’m looking forward to writing about my perspective again.

We’re looking for a family friendly name for the property. Please send me your suggestions by reply e-mail. If I pick yours (and you’re the first to submit the name), I’ll give you an honorable mention.

Talk to you in a couple of weeks.
Ed

I Fell Into the Trap: Information v. Experience

I Fell Into the Trap: Information v. Experience

Recently, I purchased a ‘fixer-upper’ house in the country. The idea was to rip out carpets and to fix other cosmetic issues, then repaint, put down new carpet and enjoy our weekends there.

As with most of these kinds of projects, though, it quickly become more than we’d expected. We found more problems and had to replace more parts of the house than originally anticipated.

Nonetheless, Faith and I pressed ahead to complete the work ourselves.

Now, before you think me insane, you should know that I’m no stranger to construction work. Although I’m a business lawyer today, when I was a teenager I helped my father double the size of our house. Many a Saturday and Sunday were spent doing carpentry, plumbing, electrical and finish work. So, I felt confident that we could take on the increased scope of the project.

While it had been a long time since I’d done that type of work, I thought I could just “look things up” and “get advice” from a contractor friend.

Did you hear the sound of the wind? That was me falling through the information-is-not-experience trap door.

Information is not a substitute for experience.

While I could read about what had to be done and watch videos of others doing it, I haven’t actually done that type work for quite some time. And, when things went wrong I had no experience to tell me what to do.

Experience only comes from repeatedly undertaking an activity. Experience can’t be compressed. It takes one year to achieve one year of experience. Plus, if you’re away long enough, you don’t keep up with the state of the art. Use it or lose it.

According to one study reported in the Harvard Business Review, the time to master an activity is approximately five years of full time work – about 10,000 hours of applied effort.

I see other people falling into this trap everyday. A smart entrepreneur buys QuickBooks to become an accountant, TurboTax to do the company’s tax return, or downloads a form contract to become a lawyer.

All is in control. Until it’s not. The financial records are a mess, the IRS conducts an audit or there’s a dispute over the contract. Sometimes it can be fixed. Sometimes it can’t.

By the time things have gotten out of control, though, the problem is usually much bigger and the cost is much higher.

In my case my contractor friend came to the rescue. He pointed out that using a contractor and handyman would be more cost effective and much less stressful.

I woke up. Realizing the mistake I’d made, we found qualified help and let them do their jobs. The work was done right and I look forward to spending time in the country.

There’s humility in learning that you inadvertently made the same mistake that you preach against.

Ed

How Written Contracts Help You Avoid Business Trouble without Going to Court

“Why bother with a written contract? They’re not worth the paper they’re written on. I do business the old-fashioned way, by handshake.”

Often, business owners tell me they don’t use written contracts because they’d never sue. They’ll say the only people who benefit from lawsuits are lawyers.

While I’d agree that, in most cases, a lawsuit is not a good response to a contract dispute, detailed, well written agreements still provide important benefits for your business.

Having seen disasters resulting from poorly written and handshake agreements, I know firsthand that good written contracts save money and strengthen business relationships.

First, a written contract helps you recognize when you don’t really have a deal. Business people want to make things happen. So, they’ll hammer out an arrangement on a couple of big issues and think they’ve put a deal together.

But the devil is in the details. Its only when they’ve had to address all elements of the proposed arrangement that they find areas of disagreement.

Recently, I prepared a contract where my client said the other party would pay within 30 days. So, I added wording requiring interest 30 days after the invoice.

The other party’s attorney told me his client didn’t pay interest. I said: fine, your client just has to pay within 30 days. He didn’t find that funny. He said it wouldn’t work. So, I suggested 45 days. Again, no. Then 60. No.

Because the interest issue was addressed in the written contract, my client discovered there was no understanding on payment. The other party would pay when it felt like paying. Important information to know before you do the deal!

When preparing a detailed contract, things such as payment terms, warranties, delivery of products, scope of services, dispute resolution (i.e., avoiding court) and other less glamorous, but nonetheless important, issues come up. The parties have to discuss these up-front, and work out the details amicably or walk away without harm.

Second, contracts help you identify people who won’t live up to their word. While contracts aren’t crystal balls, observing how the other party deals with a contract is enlightening. Red flags should fly when the other party signs the agreement without reading a word or objects to reasonable terms.

I once negotiated with a business owner who wanted his obligations painted with a broad brush. He continually refused any particulars, preferring general statements like “help to market the product” and “pay a reasonable fee.” Every time we tried to nail him down, he’d refuse the specific language. Needless to say, my client questioned where there was much behind the flowery language.

Third, people can have legitimate disagreements about their obligations. When things are going smoothly, a written contract is tucked away in the filing cabinet. But, when a problem arises, the parties can look to it for history and expectations. This helps deal with the problem and can save a valuable business relationship.

Finally, although you might never sue on a contract, someone could sue you. A written agreement can be your best defense.

If you have a poorly written agreement, you might find that Florida law gives the other party the upper hand. You might have failed to limit warranties or other rights given the other party by law.

The benefits of a complete, detailed, clear and well written agreement apply to all business relationships, including customers, vendors, employees, and between partners.

Well drafted detailed written contracts will reduce business problems, strengthen business relationships and protect your business from claims and lawsuits, even if you never intend to use them in court.

Phenomenon of the Forgetful Founder

Phenomenon of the Forgetful Founder

A honeymoon is a wonderful thing. A time when the pressures of real life don’t matter and when possibilities are endless.

In addition to marriages, honeymoons happen in startups.

A honeymoon can be a dangerous thing. Whether it’s over exuberance, believing your own propaganda or failing to ask the tough questions, a honeymoon in a startup can cause founders to bake into the company big problems that are difficult to remove.

According to Steve Blank, author of Startup Owner’s Manual, between 25% and 33% of startups fail because of problems among the founders. Noam Wasserman, professor at the Harvard Business School and author of The Founder’s Dilemmas, states that approximately two thirds of startups fail because of people problems.

In short, taking the time to deal with these issues is worth it.

Over the past 19 years representing technology startups, I’ve found the scenario typically plays out like this:

Bob, Raj and Mary, all technologists, decide to form a company. Each agrees to take on the technical aspects of the product germane to their area of expertise. They also split up the perceived business functions. Because the business can’t pay them, they continue working in their current jobs.

All is going well until Bob gets an unsolicited job offer for his dream job. He’s torn because he really wants to be a founder, but this has been his dream job forever.

Bob decides to take the job, but promises Raj and Mary that he’ll continue to work nights and weekends to finish his deliverables for their startup. And he does for a week or two.

By the third week something happens. Bob can’t do it all. And, because his new job pays the bills, he has to focus more time there and less on the startup. Deadlines slip. Deliverables become shoddy and full of problems.

The founders meet to talk about what’s going on. Bob tells of the big project at work that has to get done right away. “But as soon as that’s done, I’ll get back on track,” he says.

Only it never happens. Bob spends less and less time working on the startup. Eventually, very little is coming from Bob and the other founders have to pick up the slack.

They meet again. Bob finally admits he can’t devote the time. Raj and Mary ask him to give up some of his stock because they’re now having to do Bob’s allotted work. Bob isn’t willing to do it. He feels he’s worked hard and only didn’t complete a small portion of his work. Therefore, he believes, he shouldn’t have to give up any stock.

“We agreed to be equal partners and I’m not willing to change that,” Bob says, forgetting his agreement to do his portion of the work.

Raj and Mary are not happy and want to force Bob to give up his stock. Unfortunately, without a contract allowing them to get Bob’s stock back in this situation, they’re stuck.

The problem was baked into the startup at the beginning.

During the honeymoon of the startup, all of the founders thought each would do what they promised to do. Rather than put it in writing – with a remedy if a founder ‘forgot’ to do as promised.

Of course, that written agreement must be detailed, with objective evaluation of whether tasks are complete and timelines met.

While this is a typical scenario, it’s not the only one. Other issues that founders need to discuss and get into a written agreement include:
There are many other issues to be dealt with among founders at the honeymoon stage before problems are baked into the startup causing it to fail.
This is a big week for entrepreneurship in Central Florida.

  • Exit Strategy. What do the founders want this to look like when it’s done?
  • Financing. Will this be angel/venture backed or funded organically?
  • Management. What roles and responsibilities will the founders have vis-a-vie management and operations? Management by committee is a straight line to failure.
  • Employment. Are the founders expecting to be employed by the startup? If so, when, at what salary and under what performance standards?
  • Founder Departure. What happens if a founder wants to go on to other challenges? Can the company buy that founder’s stock? Is it required to do so? At what price?

Tomorrow is the B.I.G. Summit (Business Innovation and Growth) at Full Sail in Winter Park. The event has a great list of speakers and, as has been the case for the past couple of years, is sold out.

Starting Friday night and continuing through Sunday early evening, this weekend is Startup Weekend here in downtown Orlando. Entrepreneurship Law Firm is a sponsor and I’ll be there as a mentor throughout the weekend.

Startup Weekend participants create a startup – typically with a working prototype – in 54 hours over three days. It’s worthwhile to come by and meet other people in the Orlando startup community, if nothing else. You can still register.

I hope to see you at both events.

Ed

Raising Capital 101 Seminar

This 11 part video seminar on raising capital for startups and early stage high growth companies is based on the most common questions clients ask me during consultations about selling stock, convertible notes and other securities. Covered topics include:

  • Three Sources of Capital for Your Business.
  • Steps to Raising Equity Capital.
  • The Different Types of Investors and How to Deal with Each Type.
  • How to Value Your Company for Investors.
  • How Much Equity to Sell to An Investor.
  • Securities Laws You Must Comply With.
  • Regulation D and Rules 504 and 506.
  • How to Avoid a Claim of Securities Fraud.
  • How Investors Will View Your Business.
  • What Questions You Should Ask an Investor.
  • The Legal Issues that Must Be Addressed Before Selling Stock to an Investor.

The Three Sources of Capital For Your Business -Part 1


The Three Sources of Capital -Equity Capital -Part 2


The Steps to Raising Equity Capital

To get updates on new legal issues as well as key legal tips and information for startup and early stage ventures, be sure to add your e-mail to our signup form on the right.


The Different Types of Investors


How Much Equity to Give Up to Raise Capital - Part 1


How Much Equity to Give Up to Raise Capital Part 2

To get updates on new legal issues as well as key legal tips and information for startup and early stage ventures, be sure to add your e-mail to our signup form on the right.


Understanding the Securities Laws -Part 1


Understanding the Securities Laws Part 2


The Investor’s View of Your Business

To get updates on new legal issues as well as key legal tips and information for startup and early stage ventures, be sure to add your e-mail to our signup form on the right.


Questions for Prospective Investors


Pre-Offering and Pre-Sale Legal Issues


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