Making It Legal:

Why open yourself up to personal liability when you don’t need to?  Today’s query comes from someone wanting to know that fundamental first question: “What form of business should I be?”

Q.:  I’m wondering what kind of company you would recommend for me to register under for a clothing company. I was thinking going Limited Liability because I would not be personally responsible if companies came after me for some reasons and couldn’t take my personal assets. Which one would you recommend because I don’t really know how much money I’m going to make in the first year.

A.:  For all but a v-e-r-y few situations, I recommend that entrepreneurs form either a corporation or a limited liability company.  There are simply too many variables and pitfalls in starting and running a business . . . so why leave your personal assets exposed? 

Which form of limited liability entity you choose, though, depends on a number of factors:

• Where the business will be located
•  How many people will own the business
• The nationality of the business owners
• Whether you will involve passive investors in the company, or want to take the business public
• The federal, state, and local taxes that may be levied against the entity
• The costs of formation
• Your exit strategy and what you want to get out of the business

Before you take the step of forming the business, make sure you’ve taken the time to calculate the kind of financial investment you’ll have to make in startup and ongoing costs.  While 1st year’s revenue will be guesswork, you can have a more solid sense of what’s involved with the right financial planning.  It will also help you decide whether the venture will be worth the risk and financial investment.

From the “No good deed goes unpunished” department:

Q: I deposited more than $20,000 into my business partner’s account under the impression that he would add my name to the new company and to the house I had paid off for him and that he would put my name on the new car title,  too. But none of the above has happened and he refuses to discuss it since I am not going hungry or without a place to stay.

He now says he cannot trust ANY woman to do the right thing in money matters that involve him (But he sure took my money without any qualms).  How can this be resolved?

A: You have a thorny situation on your hands, and I don’t envy you.  Unfortunately, without having anything in writing (which I assume you don’t; otherwise your business partner wouldn’t be as cavalier with your money), your only option right now is to sue him.

You may get lucky in that the threat of bringing a lawsuit (and the costs he’ll incur) may make him reconsider his actions,  either by making you a rightful business partner in writing or by refunding your money.  The catch is that you’d need (and want) to have your own counsel begin this process for you.  If you try to handle this yourself, he may not take you seriously (especially as he doesn’t seem to do doing so now).  Contact your local bar association, as it may be able to give you referrals to attorneys in your area who are familiar with these legal issues.

Investors can be a real boon to your business, but no question–they’ll want a piece of the action.  What’s involved in issuing shares to them?

Q: We currently have a market cap of $200,000 (2,000 shares X $100 per share). We were wondering how to authorize new shares to new investors.

A: It’s not unusual for companies to issue new shares at some stage in their existence. This can happen when:

• You want to provide bonuses to employees or directors
• You’re issuing additional equity as part of a takeover of another company
• As in your case, you want to provide equity to new investors.

However, before you run to the secretary of state and fill out the forms to issue more shares (and to change your certificate of incorporation to reflect the increased number of authorized shares), you need to look carefully at a couple of matters. First, is there a shareholders’ agreement among the current owners?  You need to be sure that you properly document the shareholders’ approval of this transaction and follow the procedures in the agreement for admitting new shareholders.  If this transaction will dilute the profit percentages (and it likely will), the current shareholders may need to be specifically apprised of this effect that the transaction will have. Make sure your legal counsel helps you through this process. 

In addition, you’ll want to speak with your accountant to determine both the value of the shares and whether they will fall within the same class of shares as those already issued. If not, that, too, will need to be documented and squared away with the secretary of state of the state you’re incorporated in.

When you’re in business by yourself, the math is easy.  But when you have multiple owners, how should you share the spoils?  That’s the nature of this week’s basic training post.

Q: How should I divide profits in an LLC?

A: Especially in an LLC, you have many options for how to divide your profits. There’s no hard-and-fast rule. The formula you choose can depend on a number of factors, including:

• The number of people actively involved in the day-to-day operations of the business
• Whether there are any passive investors who have contributed capital
• The extent to which the active owners are actively involved (e.g., are some full-time with the company, whereas others are only part-time?)
• The non-cash contributions the owners have contributed to the company (e.g., inventions, client lists or other intellectual property) and the value placed on that contribution
• The time commitment each owner is prepared to make to the business (are some in it for the long haul, whereas others want a quick ROI and to move on?)

It’s not something you want to take lightly, because it will guide the amount you’re required to pay someone to buy him or her out, should the time come. Best to speak to an attorney and an accountant in your area who can specifically guide you to the result that’s right for your company.

This is a perennial favorite:  “I have no money, but have an idea that’s going to be great.  How can I take steps to launch it on a shoestring?”

Q: I have a great diaper idea for the ”on the go mom” that I think is unique. I don’t have money for any startup to manufacture this product, but I have started creating a presentation explaining how the product works. If this product goes to market, I’m sure it would be profitable for myself and others involved. In addition, there would be a possible partnership with diaper manufacturers such as Luvs, Pampers and Huggies. If possible, would you be able to point me in the right direction on how to get started with getting a patent or trademark, potential investors and anything else I would need to possibly get this product to market?

A: One of the dangers of getting started on a shoestring with great ideas alone is that ideas are very easy to steal. In fact, unless you have been able to translate them into some form of intellectual property (like a patent, trademark or copyright), it’s very hard to protect ideas themselves.  You could try to have your potential manufacturers, corporate partners and investors sign confidentiality and nondisclosure agreements, but often, major corporations won’t do that, as they may simultaneously be working on their own prototype in their R&D department and will not want to jeopardize their own efforts. 

The Patent and Trademark Office has a lot of educational information on its website (http://www.uspto.gov/). That said, actually filing for a patent (or provisional patent) is not something you should attempt without the benefit of legal counsel. Doing it improperly or inaccurately could create long-term problems for protecting your prototype, which would make the product less attractive to investors. Where you may want to start is by consulting with an intellectual property attorney who knows this area and getting some ballpark figures on the costs for getting started on the right foot legally. You’ll also want to do some market research to get a clear handle on the potential market and costs for product manufacture to put into a business plan. Then you can make a more educated determination of whether you really do have the finances (or access to credit) to give your idea the solid footing it will need to move it forward.

Like cheating on taxes, playing fast and loose with Fair Labor Standards Act employee classifications can land you in a world of hot water. Do you know the distinction/difference between “exempt” and “non-exempt” employees as it relates to their duties and the paying of overtime?

Q: I want to lessen my payroll by finding ways to lower the amount of overtime I pay people. The question has come up about converting someone from an hourly employee to a yearly salaried one. It’s my understanding that there are strict limits on who can be a salaried/exempt employee vs. someone who works on an hourly basis. I’d prefer to pay someone more via a salary, but less than it would cost me to pay overtime. 

A: The exempt/non-exempt distinction is not one you want to play around with.  Violations of wage and hour laws are one of the top reasons employers get sued–and the penalties can be stiff. 

The issue is not whether the employee will be paid a salary (instead of hourly) for work done–it’s the nature of the work the employee is doing that affects the pay structure. The U.S. Department of Labor specifically designates certain classes of workers as exempt, including executives, administrative personnel, outside salespeople, highly skilled computer-related employees and licensed professionals, such as doctors, lawyers, architects, engineers and certified public accountants, among others. In addition, managers who hire and fire employees and who spend less than half their time performing the same duties as their employees are typically also exempt employees. In general, the more responsibility and independence or discretion an employee has, the more likely the employee is to be considered exempt.

If the concern is slashing payroll/overtime costs, you may be better served by looking into outsourcing certain functions (e.g., for janitorial services) by hiring a separate company, rather than trying to reclassify an employee and run the risk of violating the Fair Labor Standards Act.

It’s said that more than 40 percent of all marriages in this country end in divorce.  So there’s a not-insubstantial likelihood that your business could be affected by divorce . . . even if you’re not the one divorcing.  Here’s today’s query:

Q:  My partner’s ex-wife is suing him for a large amount. Can it affect our business if my partner doesn’t pay on the due date? Also, I am thinking of buying the business from my partner. What are things I need to ask and sign?

A:   There is a possibility that your partner’s ex-wife’s lawsuit could cause a problem for your business. Among other ways, if she gets a judgment against your partner, she may be able to collect against your partner’s assets . . . and his ownership of the business is one of his assets. Make sure to review your partnership agreement (if you have one)–many of them provide that if the stock (or ownership interest) of one of the owners becomes subject to a lien or judgment, it triggers a buyout by the corporation (or other owners).

If you choose to buy out your partner at this time, you’ll want to consult with an accountant to get a fair value of the business, determine the price you’ll pay and how much time you’ll have to pay it. You’ll also want to speak to an attorney to make sure that your purchase/sale transaction doesn’t somehow get embroiled in your partner’s litigation. Look for certain safeguards in your purchase and sale documents (often referred to as “indemnification”) where the partner will protect you and the company in the event that the wife widens her litigation net to include you.

Above all, get it in writing and be aboveboard in handling the transaction. The last thing you need is the wife poking around in your transaction (and possibly voiding it) with the allegation that you didn’t offer fair value or that it was a “sham” you and your partner cooked up to stiff her out of her rightful due.

Q:  I have invented something that could almost be considered reinventing the wheel.  Here is my question.  If I built and used my own invention (not just a prototype), would I still have protection if I only have a provisional patent on it? I don’t want to manufacture it myself; I want to sell the idea to a manufacturer in the industry that it was targeted for. I also want to retain licensing rights to the invention.

A:  The short answer is this:  If you file a provisional patent but don’t follow up with a full application within one year, someone else could come along and grab the patent rights, and you could lose any opportunity to later file for the patent rights–regardless of whether you’re already using or selling the invention.

Selling or licensing the idea to a manufacturer could be a lucrative approach, but chances are that a manufacturer paying for those rights would want to know that they could be protected.  If your time clock is running to file the full patent, I’d strongly suggested that you consult with a patent attorney to get clear guidance on your next steps and ways to structure a sale or license of your invention.

Today’s post deals with the conundrum, how to account for business expenses without a company bank account, and how to set up a company without business funds?

Q.:  “I recently formed an LLC to create an online store. Because I saved diligently I had enough money in my personal savings account to cover all setup costs for the company (ex: LLC formation, website development, logo creation, etc.). I have initially paid for all business-related expenses with my personal AMEX because I did not yet have a business bank account set up.

A lawyer told me that I would be able to account for the use of my personal AMEX/savings by issuing promissory notes from my business to my personal self. I wanted to know how you would suggest using my personal funds to fuel my startup and how I should properly account for this in my business books in order to keep my personal and business separate.”

A.: The attorney you spoke to had a good point: If you are treating the money you put into the company for startup as a loan and not as a capital contribution, a promissory note would be in order. Make sure you also provide for a reasonable interest rate–the IRS doesn’t look kindly upon no-interest loans. Somewhere between 4 percent and 6 percent is common–and state when the company will start making payments. In addition, you may want to have the LLC issue “minutes” (a brief write-up) acknowledging your contribution and confirming that the funds will be repaid.

However, as to setting up your books and deciding how much should be deemed a capital contribution and how much should be a loan (if any), it’s best to speak to your accountant. Definitely set up a separate bank account for the LLC.  Once that decision has been made, a bookkeeper can help you keep track of it.

Once again, I’m asked whether you can take what someone else has made and simply sell it to a new market . . . even (and especially) if the original manufacturer hasn’t had the wisdom to move into the new area.  Just think of the money they’re leaving on the table!

Unfortunately, in many cases, it’s their money to leave on the table.

Q.:  “I have developed several ideas of new markets for an existing product that the manufacturer is not currently selling into. They hold the patent on their product; the markets I see do not require any changes to the current product, so I cannot develop a new patent. Is there a simple way, perhaps a common contract that we both could agree to where I would be compensated for my ideas if they like them, and do end up selling into these new markets ?”

A.:  You may be able to work out a license agreement with the patent holder, but it would require your doing the legwork to sell the product in the new market. However, it’s not likely that they would pay for the idea to sell to the new market (”hey–why not sell your baby carriages to dog owners?”) unless you could back it up with a sound marketing plan, contacts and meaningful projected revenue. You’d also need to carefully screen whether the manufacturer has thought of the idea previously–it’s entirely possible that the manufacturer has already considered it and chosen not to move into the market you identified for lack of staffing/infrastructure or other reasons.

License agreements are not something you want to treat as an off-the-shelf item. Their terms can vary widely concerning how you get paid. Make sure you speak to an attorney in your state who understands product licensing so that you’re getting the counsel you need.

OK, so there aren’t many usable “Z” words in this context.    Today’s Basic Training post revisits that old, old lesson that you can’t just escape or quit your business by walking away.

Q.:   What are the ramifications if I walk away from my small business–just turn the keys over to the landlord and walk away? I paid the business loan off with a personal loan.  I have equipment at the site but no longer live in the state.

A.:  Walking away from your business is like walking away from a dead relative without having a funeral.  Someone has to dispose of the body–or, in your case, the equipment you’ve left at the site.  Someone has to wrap up estate matters–just as a business should be formally dissolved.  Someone has to take the time to handle outstanding debts–just as you now have this loan on your personal books that has to be paid.

There may be outstanding taxes, outstanding invoices, filing fees. If you walk away from the business, depending on your state’s laws, you may still be held personally responsible for these matters, regardless of whether you’re now living in another state. Do you have employees? Any recurring contracts (website hosting, other service providers)?  Any other regulations or notifications in connection with your particular industry? You may want to turn the keys over to the landlord, but the landlord may not accept that deal, in which case you’re still on the hook. Also, by not making sure you’ve tied up any possible loose ends, you run the risk of finding yourself embroiled in litigation you didn’t expect–especially if you personally have been hard to reach because you’re out of state.

Closing out a business needn’t be an onerous process–especially if there are few debts or assets involved.  But it does take at least some planning and forethought . . . to make sure you don’t get “zapped” by legal surprises.

Here’s the lowdown on taxes when it comes to home-based businesses. If you earn money on it, no matter how little, plan on paying taxes. Doesn’t matter that it’s for a little “walking around” pocket change, for the baby’s diaper fund or to help Grandma get her heart medications.

Q.: I was thinking about doing something from home–gift baskets or cookies–because I am a stay-at-home mom. I was wondering if I would have to pay taxes if I made these items and sold them to make a little extra money. Also how would I go about checking to see if the business name I want has been taken? Is there a specific website for that? And can I advertise on one of those free websites?

A.: Let’s leave aside for now the morass of food licensing issues that arise if you use your home kitchen for a food-based business. The IRS takes the position that whatever income you generate through a business activity, no matter how small and no matter whether it’s a home-based business or otherwise, is taxable . . . so yes, you’d generally have to pay taxes on what you earned. An exception is if your legitimate business expenses outweigh your income but, in that case, you’d be losing money on your products (which brings up other headaches).

In terms of checking the business name, if you plan to form a corporation or LLC, your state’s secretary of state may have a website where you can check business names. Or if you just plan to file a fictitious name (or DBA), you’ll want to go to the offices of your local county clerk (usually you have to go there in person; not that many have business name records online).

From there, however you want to advertise your products is up to you. However, I’d strongly recommend that you put together some form of business plan so you can be crystal clear about your product expenses, advertising budget and competition for your target market. I’ve encountered a lot of people who have run headlong into business ideas that they thought would make them easy money, then ran out of cash before they could really get them off the ground. I’d hate for that to provide an extra strain on your family. Consult with your local Small Business Development Center. You can find a list of centers near you at http://www.sba.gov/aboutsba/sbaprograms/sbdc/sbdclocator/SBDC_LOCATOR.html.  They should be able to give you all of the basic information you need to get started and have many programs available for free.