"$100 and 100,000 hours": Launching a Startup Doesn't Have to Break the Bank

I had a meeting today where we talked about the economy and the environment for entrepreneurs, and while the uncertainty in the economy is certainly not helping, the outlook is not all bad.  During the last two recessions in the early 90s and the early part of this century, new businesses sprang up in a variety of industries.  Sometimes necessity drives these ventures, such as when people start a new company after being laid off.  The times now are no different in the sense that many new entrepreneurs are looking to replace a job they used to have. But what is different this time is that many entrepreneurs do not have access to capital in the way they did in previous downturns.  The current uncertainty in the market is forcing many banks, investors, and other sources of capital to hold back.  That certainly hampers growth in industries that require large investments in inventory, real estate, or equipment, but innovation and entrepreneurship continue to find ways to thrive.

The timely article in the Wall Street Journal today about "Startups on a Shoestring" was a good reminder of the power of using creativity to overcome these kinds of obstacles to starting a business.  As I was reading it, I noted two important take-aways for entrepreneurs looking to launch a new venture.  First, that successful businesses can be started with such small amounts of capital.  I have worked with clients who started the same way: they took an idea and nurtured it through bootstrapping and hard work.  Second, the article

First, this is a good reminder that starting a company does not always require a large, upfront investment of money.  There are many businesses that have started and thrived on much less.  I have noted before that there is nothing like bootstrapping to focus a founder on what is really critical for the development of the business, and to maintain your flexibility and control for the future.

Second, it is important to note that new businesses can come from anywhere.  Traditionally, there has been a lot of attention paid to technology-driven startups in the high tech, clean energy, and biotech spheres.  And certainly, almost all businesses today will have a Web presence of some kind; that is just a fact of life in today's economy.  But it is good to remember that a company does not need to be revolutionary to get noticed, and that "low tech" ideas like bracelets, tours, and flooring services can still turn into successful businesses.

The bottom line is that entrepreneurship and innovation can find a way to thrive is just about any economy.  While the barriers to entry may be more difficult for some industries, these stories prove that there are still ways to start a business with just an idea and some hard work.

Selling to Grow: How Selling Your Business May Help It Thrive

Startups often face a tipping point - to borrow a term from Malcolm Gladwell - where they have developed their business past the initial startup phase and now need to expand in order to remain viable. Some entrepreneurs take that opportunity to sell and move on to a new venture. Others founders will need to bring on a new management team (whether the founder recognizes that or not) that can take the company to the next level. Still other companies will require a new infusion of capital from outside investors, even though they may have to give up control of the company to do it. But another option is entering into a strategic venture. We recently represented a client that was being acquired by a larger company. This was not a situation where the founder was 'cashing out' and giving the company to someone else to manage. On the contrary, in addition to a cash payment at closing, the founder received stock in the parent company, a board seat, and the ability to control his company going forward. (Some of the details of which are very interesting and will be the subject of a future blog post.) So the company that he founded would continue to build by leveraging the resources, management, and stronger platform of the larger parent, and all under his watch. A real win-win for the founder.

After the closing, the founder told me that the day before, he was just an entrepreneur trying to build a startup, but now he was "kind of a rich guy" who would be managing a growing business with a high profile company. By using this structure, he was able to cash out some of his equity in the company and continue to enjoy the growth of his investment while maintaining control as part of the larger organization. This could be a great alternative for many startups that need outside involvement but want to maintain control as their companies continue to grow.

Leave 'Going it Alone' for Euchre and Call Your Lawyer Already

First off, for those of you who are not from the midwest, Euchre is a card game.  And contrary to the views of my (NJ-born) wife, it is a great card game.  It is played with four people on two teams.  You work with a partner to choose trump over your opponents and hope that you pick up the two bowers (okay, I can see why my wife was confused).  One of the riskiest moves in the game is to 'go alone' by having your partner drop his cards and you take on the other pair by yourself.  If you are successful, you pick up four points (trust me, that is good).  But if you are not, then you give up points to your opponents. It works the same way with businesses.  Companies who chose to go alone without counsel are taking an even bigger risk.  I recently worked on three different deals, each of which came to me after the terms had been decided and reduced to a term sheet.  In each case, the deal as envisioned by the parties did not hold up.  In one, the tax issue created was a deal killer and the entire structure had to be renegotiated.  In another, the parties were very excited to jump into a deal together, but after asking a few questions, they had to rethink their prior agreement.  The third went forward despite the risks.

The point of this is that it doesn't have to be this way.  While your company may be experiencing a financing, an acquisition, or some other transaction for the first time, lawyers, accountants, and other professionals have been there many times before and can give you the benefit of that experience.

"But we just couldn't afford to bring in a lawyer early on.  Plus, we were just negotiating the business deal."

I certainly understand the concern.  Lawyers are just speed bumps on the way to completing deals.  That is why when I went skydiving for the first time, I decided to skip the guide and the training (just an extra expense).  I grabbed a pilot and a bed sheet and jumped.  (OK, in full disclosure, I have never been skydiving.  But would definitely seek expert advice before doing so because it would just be crazy not too.)

So don't be crazy.  In each of those deals, the parties ended up spending far more money and emotional capital trying to fix their original mistakes than they would have setting up the deal properly from the start.  Don't go alone.  Use your partner.

Turning up the (Flame-Broiled) Heat: How an effective franchise organization should NOT be run

I have commented previously on the ongoing feud between Burger King management and its franchisee association, which represents most of the franchisees in the Burger King system.  It appears they have not learned their lesson and are still going at it. According to a report in the Wall Street Journal, the leaders of the franchisee association sent a blistering rebuke to BK management over $1 double cheeseburgers, soda revenue sharing, and other things. The relationship is sour enough that management retorted not to the association itself, but directly to the franchisees in the system.  In fact, it seems that the only communication that is occurring between the company and the association is through a number of law suits that are currently being traded back and forth.

Franchisee associations are designed to be powerful allies in growing a brand and strengthening the system.  They serve as the common voice of the franchisees, collaborate on national advertising funds, and help guide effective franchise policy, which overall encourages more franchisees and adds to a stronger bottom line for all of its independent owners.

But in the Burger King example, their ongoing disputes have actually had the opposite effect and are now harming the business.  The WSJ noted that Credit Suisse and Oppenheimer & Co. have both downgraded BK stock over these squabbles. And the company had better hope that prospective franchisees are not turned off by the dispute since franchisees account for 90% of the Burger King restaurants.

Clearly this is a topic that stresses the terms of a franchise contract as others have noted.

So much for havin' it your way.

What Legal Issues to Watch For When Negotiating Your Commercial Lease

As I reviewed another commercial real estate lease this week, I was reminded that negotiating a commercial lease is often a challenge for tenants because each one is so different.  And there is often a difference between negotiating business terms and legal ones.  But the differences can be important.  This is why:

Of course, tenants naturally will focus on the business terms that you would expect to find there: the amount of rent payments and whether they are "gross" or "net", the use of the property, the length of the initial term of the lease, a description of the premises (which must be clear and exact).  Each of these are laden with traps in their own right, but the parties generally expect to negotiate these with every lease.

But some other items are less negotiated but equally as important.  Without being able to address all of the lease's issues here, here is just a sampling of the complex issues involved in negotiating a commercial lease.

1. Determining the Lease Commencement Date.  Many leases will provide a rent commencement date, which may or may not be the same as the lease commencement date.  Either way, pay careful attention to how much control the tenant has in actually taking possession then.  Often, the landlord will perform some type of buildout to ready the space for the new tenant, which could involve moving some walls, finishing the space with painting or carpeting, or customizing for a particular use.  In any event, date certain for rent commencement in the lease could be problematic for a tenant that is still waiting on a landlord to finish the work.  That tenant certainly does not want to be paying for space that cannot be occupied because the landlord's contractors are still working.  It is best to put into the lease either a non-specific date (i.e. the commencement date is the date that the landlord actually delivers the premises to the tenant), or build in a trigger mechanism that either penalizes the landlord or gives an additional benefit to the tenant like moving into other space temporarily, or even gives the tenant the right to terminate the lease.  Either way, the provision will compensate the tenant and reflect the true intent of the parties - that tenant will pay rent while it occupies the space.
2. Understanding Lease Renewals.  The initial term of a commercial lease is typically measured in a period of a few years - typically three to five - but can be upwards of ten.  Locking in long terms is good for the landlord's bottom line, but can be very daunting for a tenant, especially one with a new business.  A tenant may be able to negotiate for a shorter initial term with options for extensions at the end of the term.  This gives the tenant some flexibility if it needs to break the lease after a couple of years.  But no matter how long the term lasts, a tenant must clearly understand what is required in providing notice for exercising the option to extend or for terminating the lease.  Often, the tenant must give notice to the landlord more than 90 days before the end of the term, so plan ahead.  And the tenant must understand what is required to extend: Does the landlord have to give consent?  Is renewal automatic without notice of termination?  Can the landlord object to an extension?  Finally, recognize that on an extension, the terms of the lease will generally stay the same, but there is room for the renegotiation of rent and other fees.
3. Negotiating Assignment and Subletting.  As noted before, most commercial leases last for a period of years.  A tenant who is locked into an economic responsibility for that long wants to have flexibility.  What if you are a startup with a five-year lease and you outgrow the space after three years?  Or you decide that the business is not working out and you want to transfer the lease to another business?  Landlords have an interest in keeping you in the property because they have already qualified you and worked with you for a period of time - they don't necessarily want the extra hassle and expense of qualifying another tenant.  In such cases, the tenant will typically try to negotiate for the right to assign the lease while the landlord generally prefers a sublease.  The assignment transfers all of the rights to the new tenant and now that new tenant is responsible to the landlord.  In many cases, the old tenant walks away.  A sublease on the other hand keeps the lease in tact, and the tenant merely gives away some of its rights while remaining ultimately responsible under the lease.  This is better for the landlord because it allows the space to be used efficiently while keeping the original tenant on the hook.  While the landlord may not give up full unilateral assignment rights to the tenant, landlords are generally willing to allow a reasonable standard to be included (i.e. the landlord's consent to an assignment or sublease "will not be unreasonably withheld").  Massachusetts law, as an example, does not assume a reasonableness standard here, so landlords can refuse to allow an assignment arbitrarily.  So this is a provision that should be visited by all tenants.  Also make sure that any provisions personal to the tenant (e.g. a personal guaranty) will be terminated if an assignment is granted.
4. Subordination and Nondisturbance Rights.  Much of the attention in negotiating a commercial lease is on the tenant and the ramifications if the tenant defaults or otherwise does not comply with the lease.  But what if the landlord does not comply?  Particularly these days, landlords are at risk of foreclosure just as much as tenants if the property they are leasing to you is mortgaged.  If the mortgage company forecloses on the landlord, your lease is at risk because the landlord the mortgage is superior to the lease.  You can find out if this is the case for your property with a quick search of the state's public records database, many of which are now online.  If you see that the mortgage company or another party has a superior claim to yours, you should negotiate for a "nondisturbance agreement".  This says that if the mortgage company or superior rights holder forecloses on the landlord, it will not disturb your possession and will continue to recognize the lease as long as the tenant continues to perform its responsibilities according to the lease.  That could save you both serious time and money.
5. Recording a Notice of Lease.  If you have a long-term lease, you should record a memorandum of lease in the public records or your state in order to put other creditors on notice.  Here's why.  Your lease is a claim on the property in a similar way to a mortgage.  But in addition to the mortgage situation described above where you can find the notice in the public records, there may be other creditors making claims against the landlord that you don't know about.  For example, if someone purchases the property from the landlord and you have not filed notice of your lease, the new landlord can refuse to recognize your lease and force you to vacate immediately or re-negotiate the lease on terms favorable to the new landlord.  Having your lease or a memorandum of your lease recorded puts those subsequent purchasers or lien holders on notice of your lease and helps protect your rights in it, particularly if you have negotiated some specific rights.

So what issues have you run into with your leases?  Are there any mistakes you have made that drive your negotiations now?