This First Thing Every Founder Should Purchase

What is the first thing a new startup company should purchase? Right, a hat rack. Wait, what?  You need one because each founder is going to be wearing several hats - organizationally speaking - and it is important to keep the various roles separate. Here is why. I was recently working with a client who is splitting off from a business he started with a partner, taking some of the assets from their company, and putting those assets into a new company in which he is the sole stockholder. As an exiting founder of the old company and the sole founder of the new one, he is taking on several different responsibilities, including as a stockholder, director, and even lender. This is legally significant, even if he does (inaccurately) refer to "my company" or "my equipment".

But when talking about roles, first understand that that I am not talking about titles. The titles that companies often hand out early on have less to do with the business than they do for establishing some sort of status hierarchy. Some state laws even necessitate designations like president, treasurer, and secretary - Massachusetts is an example - but don't get bogged down in titles. The law dictates legal distinctions between stockholders and directors, but don't try to pigeonhole your team into arbitrary titles that don't fit your organization.  Let the work dictate what roles and responsibilities to assign to management.

Why does this matter, you ask? There are several reasons:

1. Title to property. New founders often erroneously treat company property as personal property. This has ramifications both from a practical standpoint (who owns the property that he wants to take to the next venture) and legal significance (can the company collateralize the property for lenders). If the exiting founder wants to take certain property with him, it is already tied up by a security interest under the company's bank debt? Did the company pay for the equipment or was it using property belonging to its stockholders? Those questions become all the more important when a change of ownership takes place.
2. Organizational confusion. It is critical to sort out the rights and responsibilities of the organization - who has the ultimate control and authority? Often, a pair of founders will split these management roles equally (see my earlier post on why that may not be the best idea), but that effectively means that every decision requires unanimous agreement. Many important decisions have to get made on a daily basis; without proper role assignment, decision-making can get bogged down or actions may be taken without authority or notice. Even worse, an organization may not understand who is responsible for making key decisions.  Not only does this create problems within an organization, but it could also raise red flags to future investors.
3. Legal risk. there are also significant legal ramifications should the rights and responsibilities of the owners and managers get muddled. While state law protects owners from personal liability for corporate obligations, a court may sometimes "pierce the corporate veil" and assign personal liability where owners of a company did not maintain the "separateness" of the entity.  Blurring the lines between corporate and personal increases that risk, as does lax handling of roles. It may seem odd for a stockholder to elect a director who authorizes the company to take debt from a lender when each of those is the same person.  But maintaining those distinct roles will help protect you from liability and confusion.

So where does all of that leave business owners? From the start of your business, choose a structure that fits with your business and keep straight what actions you take as a stockholder versus the actions you take as a director.  Then clearly allocate management responsibilities between the founders and the rest of the team and make sure that structure is clear to the rest of the organization. Because your decisions not only have ramifications for the company, but also may directly impact your personal bottom line.

Can You Finance and Grow a Small Business Through Crowdfunding?

I have received more inquiries recently about the possibility of using crowdfunding to fund a business.  Crowdfunding is a method of using small donations from the public as a way to raise money without losing control over a project.  It has been used successfully to fund many different types of projects over the past few years including movies, music, fashion, and art.  Now that same model is starting to be applied to business ownership - but that is a much different and risky proposition. Here's why. If you have never seen crowdfunding in action, you should check out sites like Kickstarter, RocketHub, and Quirky which allow artists, designers, inventors, writers, and others to raise money to fund some creative project they are working on.  Donations are pledged online and, once a certain set amount is reached, the project gets funded by those small donations.  The key here is that backers of the project are making a donation to support the project but they receive no ownership in the project other than perhaps getting a free copy of the finished project as a gift.  But this simplicity is what makes the project-based model successful.  First, potential backers can easily wrap their heads around, say, a new short film or a book, and donating a small amount of money is a low risk proposition.  So a project gets completed, and backers may get a free copy of the project to keep.  A win-win.

But now companies are trying to expand the model beyond project financing to funding business concepts, which can be another avenue to funding without turning to angels or VCs.  The problem with taking money from a large number of people in exchange for ownership in a company is that this is exactly what the U.S. securities laws - both on a federal and state level - are guarding against.  In general, any securities sold in a company must either be publicly registered or must qualify for one of the enumerated registration exemptions.  Generally speaking, selling ownership in a company to people without a large net worth (so-called "unaccredited investors") may trigger a number of disclosure and registration obligations on the company, and specific laws of each state where investors are located will have an effect as well.  As the number of investors and states involved goes up, so do the costs.  So tackling a financing project like this should be done with the careful counsel of a securities attorney because these rules can be treacherous to navigate and could result in penalties and rescission.

Some may opt for services from companies like Profounder, which was recently launched to provide assistance with this kind of financing for a flat or small percentage fee (in addition to all of the filing fees).  Sounds like a great option for companies to raise money, but be very careful here.  The securities laws were written pre-Internet, and are certainly not optimized for the rapid changes in technology.  Just because you can do it does not mean you can get away with it.  And compliance requirements under state securities ('blue sky") laws vary and are notoriously different.  Again, seek out an experienced securities lawyer to help guide you through.

Have you tried crowdfunding?  What was your experience like?

Because It Can't Be Said Enough: Choose Your Founders Wisely

I ran into another situation this week where a business completely fell apart and is heading for dissolution solely because of a growing war between the two founders.  I will have more on the details of this in a future post because it is enlightening for startups, but in the mean time, you can find more info on the right way to choose your founders and how to structure your initial equity here in my Founders Series Parts I, II, and III. Remember that you should always set up an agreement between the founders at the beginning of the business, but structure it for the end of the business.

Just Do It: Entrepreneurs Show Why Now is a Great Time to Start a Business

I saw today another example of people using entrepreneurship to overcome the struggling economy.  In addition to the 9.6% of Americans that are officially unemployed, there are many, many more who are underemployed or stuck in a job they don't want just for the security of a paycheck.  But in reality, they don't feel very secure. This article highlights people who are taking control of their situations by starting their own businesses.  Whether it is buying an existing business, purchasing a franchise, or bootstrapping a new small business, I hear similar stories from my clients all the time, and I am constantly surprised by their resourcefulness.  There is a real buzz from the entrepreneurs out there that are creating business for themselves, many of them without quitting their day jobs. Perhaps it is your turn to give it a try.

To learn more about starting a business, franchising, or entrepreneurship in general, take a look through the categories on the right for some additional posts on these topics.

Have you already started a new business?  What has been your biggest challenge?

New Law Provides Needed Help to Small Businesses Now and For a Limited Time

After the last couple years of bailouts for financial firms and large manufacturing companies, small business is finally getting some much needed direct relief.  President Obama signed into law this week the Small Business Jobs & Credit Act of 2010, which aims to loosen up credit for small businesses and provide immediate tax breaks to help these companies.  But many of the law's provisions are short-term measures that businesses need to understand now if they are to enjoy the benefits. Here are five provisions that may be immediately useful for your business:

1. Money to Lenders:  The law authorizes $30 billion of funds to be directed to small businesses through community banks and additional funds to state lending institutions.  This is intended to get more capital flowing and allow small businesses to borrow needed capital at reduced rates.  Check with your local bank to find out more.
2. Start Up Expense Deduction:  For startup expenses of new companies, the maximum allowable business tax deduction of $5,000 is doubled to $10,000.  But this increase is only applicable in tax year 2010.
3. Qualified Small Business Stock Deduction:  If your small business has investors looking for liquidity, now is a good time to act.  A holder of qualified small business stock can exclude 100% of the gain on the sale of stock through the end of 2010.  This was increased from the 75% exclusion that was enacted as part of the stimulus in 2009 (the normal exclusion prior to 2009 was 50%).  This provisions is also only available to Subchapter C corporations (S corporations and LLCs do not qualify).
4. Capital Expenditure Limits.  Businesses that acquire capital equipment any time through 2011 can write off up to $500,000, which is double the $250,000 available under the 2009 stimulus.
5. Health Premium Deduction.  Anyone who is self-employed can deduct as a business expense the amount of health care premiums paid in 2010 from the amount of income that is subject to self-employment tax.  Again, this provision is limited to one year.

These are just a few of the provisions intended to help small businesses.  If you own a small business, which do you think will be most beneficial to you?