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Benefit Corporation

The Benefits of a Benefit Corporation

Benefit corporations (commonly known as B-Corps) are a relatively new—around a few years now in California—way of organizing your business entity. Designed to balance the for-profit interests of a traditional C-Corporation with the corporate responsibility that all modern businesses should take part in promoting. It’s like a for-profit-non-profit hybrid! Keep in mind, though, you don’t get the tax exemption benefits from the IRS (and your state) like you do with a non-profit.

But why would you want to go with a benefit corporation over a traditional C-Corp, S-Corp, LLC, or even a non-profit?

Before we get into the benefits of B-Corps, let’s briefly discuss how to form one and how they work.

Forming a B-Corp is essentially the same process as forming a normal C-Corp. Articles of incorporation filed with the Secretary of State’s office and you’re good to go. Of course, you can still limit director liability as you can with a regular corporation, but you also have to specify the corporation’s public benefit purpose. Filing fees at the time of this writing are the same for C-Corps and B-Corps.

After formation is where running a B-Corp becomes significantly different from running a traditional business entity. First off, the California B-Corp statutes require transparency in your business. This means you’re mandatorily required to report certain corporate records, generally on your company’s website.

Another big change is that a super-majority (more than just over 50%, generally two-thirds vote) of shareholders is required to modify your B-Corp’s public benefit purpose, and to make other various corporate changes. And if you’re a dissenting minority shareholder, you may actually have the right in certain circumstances to have your shares purchased from you at fair market value.

Benefit corporations are required to provide a reports to shareholders with reports detailing the goings on of the company and how they’re meeting their requirements to further their public benefit.

Finally, because this is a benefit corporation we’re talking about, your company has to advance a general public benefit. This means that your B-Corp must make a positive impact on society and/or the environment. Along those lines, there is a third-party organization, called B Labs, that certifies benefit corporations, providing them with a variety of extra perks upon certification. And that’s the real reason why benefit corporations are great—the perks that come with being a Certified B-Corp and the fact that your company is being used (albeit forced) to do good for society as a whole.

Which leads us to the question of how you choose between a traditional corporate structure, a benefit corporation, or a non-profit.

The main question that I ask my corporate formation clients who have expressed interest in benefit corporations is what they want out of their business. Are they purely interested in making a profit? Are they interested in promoting a public purpose? Or is it a mix between the two—and how weighted to one side or another is it?

On a very basic level, here’s how the answers to those questions tends to group my clients.

If you’re purely interested in making a profit or if you’re starting a technology startup and you know you’re going to be seeking venture capital financing in the near future, stick with the C-Corp (or S-Corp in certain circumstances).

If you’re purely invested in helping society and promoting a public purpose, then form a non-profit.

If you’re somewhere in between, go for the benefit corporation—or the lesser known Flexible Purpose Corporation if you’re in California.

So which type of entity is right for you?

When it all comes down to it and you’re in the process of starting your new company, how do you choose which type of entity to base your company around? The best way is to sit down and have a chat with a business attorney to help you sort out which entity is the best based on what you’re interested in doing. While I’ve provided a few questions above, it really comes down to a lot of nuanced, individualized factors to determine whether a B-Corp is right or an S-Corp is right. And that’s really why talking to an attorney is paramount—you don’t want to find yourself spending the extra money down the road to change your corporate structure.

Norton Law Corporation Blog Etsy Business Trademarks and Corporate Formation

How to Protect Your Etsy Business

The idea for this post came from a couple of different sources. First of all, I’m getting married in just over a month, and my fiancee and I have been ordering quite a few things from the handmade capitol of the world over the last few months. Secondly, I recently read an article a couple weeks back about Urban Outfitters, H&M, and Forever21 allegedly ripping off the designs from a number of artists on Esty—I’d post the link, but I forgot to save it (and in true lawyer fashion, I also can’t really comment on whether those companies engaged in that kind of activity). So I figured, why not make a post on how shop owner on Etsy can best protect themselves not only from liability, but from other companies leaching off of their great ideas and unique designs.

Now, it should be noted that Etsy’s corporate counsel, Hissan Bajwa, wrote a post a year or so ago about the various types of business entities an Esty shop owner could own, but I feel like he may have left out a few things and wanted to go into a little more detail. Keep in mind that everything in this post is merely general advice, and none of it should be considered legal advice since (for most people reading) I’m not your attorney and I’m not basing any of this article on specific, individualized, facts but merely general observations.

The Best Legal Structure for an Etsy Shop Owner

What the best legal structure is for your business is going to be a question for your own personal business attorney. That’s right, you’ll need to evaluate what you’re selling, whether you’re working with anyone else, and what the taxes will be like depending on the type of structure you’re interested in (and that’s also a good question for a CPA, as most good business attorneys will tell you).

Let’s Talk Sole Proprietors

With that said, I’ve been shopping on Etsy for a long time, and I know that for most of the seller out there, who are working part time crafting their wares, a sole proprietorship is fine. You’re doing business as yourself (or under an assumed name, for which you’ll need a “Doing Business As” DBA recorded pursuant to your county’s rules), and as a result, if you run a shop on Etsy, you’re already a sole proprietor. From a tax perspective, you and your business are one in the same, and from a liability perspective, you’re also one in the same—which an lead to you being held personally liable for any lawsuits that may pop up against your business. Do keep in mind that you may be able to protect yourself with liability insurance, but be sure you really know what your policy says.

In short, a sole proprietorship structure is easy to run (all the money just goes to you), easy to maintain (you don’t need any specific filings or documentation except for a DBA), easy to form (automatic as soon as you start doing business), but you need to watch out for the liability problems or you could get seriously burned (you’re personally liable for everything done in the name of your business).

So, in an incredibly general way, I’m going to say that for most Esty sellers, a sole proprietorship is all you need—especially if you’re just starting out and don’t want to invest a bunch of money into a business you’re not sure is going to work—unless you’re selling items that could injure someone, including vintage items, food products, beauty and grooming products, certain types of furniture, or anything that could injure someone.

Partnerships Are Just…Meh

Now, the question when you decide to start working your business with another is whether to form a partnership or one of the more “sophisticated” business structures like a corporation or a limited liability company (LLC). This might just be personal preference talking, but I’m not a fan of the partnership structure unless it’s absolutely necessary (which does happen in very specific circumstances which are way, way outside the scope of this article). Essentially, you and another person enter into a business partnership, at which point I always recommend a partnership agreement—seriously, if you’re partnered with someone and you don’t have a partnership agreement, call an attorney and get one drafted now, this very instant, I’m not kidding—when you start operating the business together.

A partnership is kind of like a sole proprietorship, but for two people. Same as before, they’re easy to run (just split that money as stated in your partnership agreement, or equally if you don’t have a partnership agreement), easy to maintain (again, just file for a DBA and that’s all you’ll need provided you and your partner are still getting along), easy to form (just start doing business with someone else), and as with the sole proprietorship, easy to get totally screwed if someone sues the partnership. And why you may ask? Because in a partnership, both partners are on the hook for the entire amount of any liability the partnership incurs. So if your partnership is sued, and your partner can’t or won’t help pay, you’re going to be stuck holding the bag (though in all fairness, you can try and get the money from her later).

My feeling about partnerships for Etsy store owners is this: if you’re doing enough business that you’re in need of a business partner, skip the partnership, spend the money and form a corporation or an LLC.

Better Liability Protection Comes at the Price of a Corporation or LLC

We come to the last two types of businesses for Etsy shop owners: the corporation and the LLC. Now, there’s only one type of LLC (unless you count LLPs, which are like LLCs and partnerships mashed up and only used in limited circumstances), but there’s a whole slew of corporation types, from C-Corp to S-Corp to B-Corp. We’re going to talk about a few pros and cons of all of them, but a somewhat more detailed study, you may want to check out my other articles on corporations and LLCs.

For a lot of small business owners, the biggest issue I run into with corporations and LLCs is that entrepreneurs don’t like to pay for them. Most of the time, as long as you do yourself a favor and stay away from the non-lawyer legal service providers you see advertised on TV, you’re going to have to shell out around $500 to $1000 to get a corporation or an LLC formed after attorney fees and filing fees with the state you choose to incorporate in. For some business owners, especially Etsy sellers who are just getting started, that’s quite a chunk of change, and you’re probably wondering what you get for that.

What you get for that is a lot more liability protection in case something goes wrong and your business gets sued. This means that if the business is sued, you’re most likely going to be protected. It also means that you have to keep up with a lot more busywork to keep your business going. Extra documents will need to be drafted, meetings will need to be held, a separate set of taxes will need to be done, and so on. But all of that comes with the big perk that if your business is sued, you and your family aren’t going to have to pay for the damages out of pocket if you lose—your business is solely responsible. And because of that big benefit of a corporation or LLC, if you’re selling products that run a higher risk of hurting someone, do yourself a favor and talk to a business attorney (most of us are free to consult with) about whether you should go the corporation route.

On top of the liability protection, some of the corporation types also give you extra benefits. For smaller businesses, I say stay away from the C-Corp structure unless you’re interested in securing some kind of venture capital investment. However, an S-Corp can help you save money on taxes, and a B-Corp can help you save money on certain supplies and other necessaries to keep your business running since having a (Certified) B-Corp shows the world that your businesses takes social responsibility seriously.

Protect Your Handmade Items from the Prying Eyes of the Big Companies

While the first part of this post dealt with how to protect yourself in the face of liability, the second part of this article will deal with how to protect your products from “theft” by the competition. At the outset, it’s important to know that not everything can be protected and a full on, proper protection scheme will cost you a lot more than you’re probably making selling your products on Etsy, but I’ll give you a few hints and tips on how to protect your products without breaking the bank.

Also, every industry has a preferred type of protection, wether it’s copyright, patent, trademark, or trade secret, so I’ll be touching on all types of protection.

Don’t Copy Me…I Have a Copyright

Copyright protection is automatic for things that qualify for it. That’s right, you don’t need to file any paperwork, pay any fees, or anything like that if your items qualify for copyright protection. However, obtaining a copyright for many types of products is simply impossible, and if you want to go after someone for money damages who has copied your work, you’re going to have needed to register your copyrighted item with the Copyright Office arm of the Library of Congress.

So here’s how copyrights come to be. They need to meet two main requirements: originality and fixation in a tangible medium. First, something needs to be original to be copyrighted. It doesn’t have to be super original, just mostly original. Second, it needs to be fixed in a tangible medium. Say what? That just means it has to be more than just an idea, it has to be “touchable” for lack of a better word. There’s also a third requirement: the item can’t be functional.

With the requirements out of the way, let’s talk about a few items currently on Etsy’s front page that may be able to qualify for copyright protection. Jewelry, clothing and accessories, photographs, paintings, furniture, and eyewear. That’s a pretty wide range of products, all of which may be available for copyright protection provided any individual item from a group of items like that is able to meet the requirements for a copyright.

If You’re Trading Goods, You Need a Trademark

Trademark protection is another great way to keep the big companies at bay and protect your products. First things first, I’m a trademark attorney, so I always recommend that if you’re serious about your business, you really need to spend the few hundred dollars to trademark your company’s name. You don’t have to spend extra to trademark a logo or a slogan, but do yourself a favor and trademark the name of your company to give you that extra leverage to fend off competitors who may try to leach off your success. And even if you’re not worried about that, at least have a qualified attorney perform a trademark search to make sure you’re not infringing on the trademark of another. Seriously, I’ve seen it happen before, and a few hundred dollars now can save you tens of thousands later.

With that out of the way, trademarks are designed to protect brands and make sure consumers know where any given item is coming from. Most notably, business owners register trademarks for the name, logo and any slogans used by the business, along with the names they use to brand their products. However, beyond that, certain characteristics of the products themselves may be eligible for trademark protection under what’s known as trade dress. Trade dress extends trademark protection to the decorative, non-functional, non-essential portions of a product, which makes it an excellent way to protect certain types of products. Here’s a few examples of where trademark protection may be applicable: watches, clocks, clothing, jewelry, eyewear, and accessories.

Patents are Patently Expensive

Patents are the third category of intellectual property protection, and to be perfectly honest, they’re way beyond what you’ll likely need as an Etsy shop owner. They’re usually incredibly expensive and take a long time to obtain, and I really don’t recommend patents for most small businesses.

Keep Your Recipes a Secret, a Trade Secret

The final type of protection for your products is trade secret protection. Purveyors of food products, beauty products, and other consumables, its time to listen up. Trade secrets protect the recipes and formulas you use to create your products, but they can also be used to protect things like customer lists, supplier lists, and pretty much anything that makes you different from your competition. The catch? You need to keep your trade secrets a secret. Don’t tell anyone you don’t need to. Make those you do tell sign a non-disclosure agreement. And if you write any of your trade secrets down, keep them under lock and key and only let others see them on a need to know basis.

A Quick Conclusion to a Long Article

At over 2400 words, I think this is the longest article I’ve written on my site, but there was a lot of information to cover and I hope you’ve learned a thing or two about how to protect yourself and your Etsy business. A few things to keep in mind in parting.

Sole proprietorship is probably fine for many Etsy shop owners, but not all, so call an attorney if only for a quick (free chat) about business structures if you’re worried about liability or interested in taking advantage of the perks of a corporation or LLC.

Copyright and trademark protection may be available for your products, but don’t just assume. As far as trademark protection goes, take a look at the (growing) database of common trademark questions for some quick answers on whether your product may be trademarkable. And if you have a product or service to add, let me know and I’ll give you credit for it.

Whether you’re a sole proprietor using a DBA or a full-fledged corporation, trademark your business name, or at least spend the money on a professional trademark search to make sure you’re not infringing on the trademarks of another.

And that wraps it up. Good luck in your endeavor on Etsy and I hope your business continues to grow into a huge success. And if you’re already a shop owner on Etsy, feel free to share your shop in the comments below.

Norton Law Corporation Presents a Post About the Business Documents Your Company, LLC, or Corporation Needs

7 Documents You Need to Keep Your Business Legally Sound

I’m always a little surprised when savvy business owners come to me to make sure their business is operating legally, only to find they’re missing a number of key documents. To be perfectly honest, a lot of the documents only matter if you’re in the process of expanding your business, going to sell your business, looking to take on investors, or you’re going to register your company’s securities with the SEC. But, that being said, if you want to save yourself a lot of headaches (and a lot of money having attorneys fix things that are horribly, horribly broken) before you take those steps towards growth and expansion, and if you want to protect you and your family’s interests in the most comprehensive way possible, it’s always a good idea to make sure your business’s documents are in order sooner rather than later. Without further ado, the documents you’ll need:

  1. Articles or Incorporation / Certificate of Incorporation / Articles of Organization: These documents have many names depending on where they’re being filed and what they’re being filed for, but they all have pretty much the same purpose—to let the Secretary of State (or the equivalent Division of Corporations) know your business is registered as a corporation or a limited liability company (LLC).

    If you’re incorporating your business in California, for example, you’ll need to draft and file the articles of incorporation. There’s a form, but if you hire a half-decent business attorney, they’ll draft you articles that actually apply directly to your business rather than shoehorning you into what the state’s template provides.

    The Certificate of Incorporation is the document you’ll need if you want to incorporate your business in Delaware. It’s very similar to what you might file here in California, with a few tweaks (and a different name). If you’re not sure whether you want to incorporate in Delaware or your home state (not necessarily California), I wrote a nice article on that a few months ago: Why Your Home State May Be the Best Place to Incorporate Your New Business.

    As for the Articles of Organization, that’s the document you’ll file in California to organize your business as an LLC. Of course, there’s also a form for that—and you generally have to use it.

  2. Bylaws / Operating Agreement: As with the documents above, these two documents have different names, but essentially do exactly the same thing. They help you determine the ground rules for how your business is run. Bylaws are used by a corporation (no matter what kind: C-Corp, S-Corp, B-Corp, etc.) to specify such issues as how large the board will be, where the initial office will be located, what powers the officers and directors have, how shares may be transferred, and how shareholders and directors can vote.

    Now, if you’re the sole shareholder of your own private corporation, you’re probably thinking why in the world would I want to spend a few hundred dollars on a document like this when what I say goes. And that’s a fair question, but here’s a fair answer: in some states, you have to submit your bylaws to the Secretary of State/Division of Corporations/Whatever they’re called in your state at the time time you register your corporation. Even if that’s not the case, some banks will want to see your bylaws before you open an account, the professional licensing organization of your state may want to see them if you’re running a professional corporation, investors will definitely want to see them before they send any money your way, and the buyer will want to see the bylaws when it comes time to sell your business.

    Oh, and if you’re passing your corporation on to your kids when you die, the bylaws can help them easily make the transition from your ownership to that of your kids without too many struggles (provided it’s drafted properly). And best of all, if you’re a sole shareholder of your company and you want to protect your family from liability if your company is ever sued, a set of bylaws can go a long way in proving your company is it’s own entity and not just your alter ego.

    For the purpose of this post, an operating agreement is practically the same as the bylaws, except they’re used for LLCs.

  3. Minutes from Meetings: You’re holding regular shareholder/director/member meetings, right? Right? Well, don’t feel too bad if you’re not. There’s a ton of small businesses out there where regular meetings means once every five years. But while you may not think that the minutes from your regular shareholder meetings are that important, in truth, they really can be.

    Here’s the thing. Imagine your business is going along smoothly when all of a sudden someone sues you for some screw up of one of your employees. Maybe they hit someone with the company car while they were en route to the job site. That person has a valid case and sues your company and you. Normally, if the company has caused some kind of wrong, all of the liability rests on them, but there’s a theory in the law called piercing the corporate veil which basically means that if the plaintiff (the person who’s suing you) can show that your company is no more than just your alter ego, they can go after your assets too to satisfy their judgment debt if they win. And here you thought forming a corporation or an LLC totally insulated you from liability.

    But how can you protect yourself from such an attack? Holding regular meetings and keeping records of them. It doesn’t matter if they’re shareholder meetings, board meetings, or member meetings (if you’re operating an LLC), just make sure you have them and make sure they’re properly documented.

  4. Trademark Registration Certificate: Strictly speaking, this isn’t required, but you should really get one. Seriously, you’ll save a lot of money down the road, especially if there’s already someone else using your trademark and you don’t know about it.

    No matter what kind of business you own, your brand is your most valuable asset. I’ve said it before, and I’ll say it again until I’m blue in the face.

    I don’t care if you’re a cruise ship operator with vessels that cost tens or hundreds of millions of dollars—your brand may be just that valuable. After all, when someone is looking for a cruise ship, they’re not going to trust a company they’ve never heard of, they want the Disney cruise experience or the Carnival cruise experience—not the “some guys we’ve never heard of with a huge boat” experience. So spend the money now and trademark your business’s name (and it’s logo too if the logo is really nifty and a part of your brand’s image).

  5. Employment Documents: Planning to hire someone (or a few someones)? You’re going to need employment contracts, an employee handbook, and independent contractor agreements at least. And you’d better make sure you know the difference between an employee and an independent contractor, because if you misclassify someone as a contractor who’s actually an employee, you’re going to be in a world of hurt. And at the very least, make sure you know whether your employees are classified as exempt or non-exempt.

  6. Distributor / Vendor / Service Contracts: From E-Commerce sites to plumbers, everyone needs basic contracts to help them run their business. Whether you’re distributing someone else’s goods or selling your own goods or services, it’s always a good idea to have your agreements properly documented—and that means in writing. Oral agreements, while technically enforceable in court, are always an uphill battle, so put your contracts in writing.

  7. Non-Disclosure Agreements (NDAs): Sharing your business information with others can be a good idea, but having them steal that information for their own uses later can be disastrous. That’s where NDAs come into play, when you’re showing off some aspect of your business to a third party (including your employees and independent contractors), you want to make sure they’re not going to divulge the information they’ve gleaned to another, or worse, use that information to further their own business interests. Just make sure you don’t give one of these to a potential investor (from a legitimate investment firm or VC) or you’ll look like a real novice in the startup and small business world.

After all of that, you’re probably thinking there can’t possibly be any more documents that may come into play during the life of your business—but there are. Copyright licenses, trademark licenses, commercial leases, industrial leases, equipment leases, retail leases, franchise agreements, term sheets, share purchase agreements, merger and acquisition documents, and the list goes on. As you can see, this was by no means meant to be an exhaustive list of what kinds of documents you need for your business, but it should give you a better understanding as to why hiring a business attorney sooner rather than later can save you a lot of headaches down the road. These documents aren’t going to write themselves, and only an attorney (or a very, very, very skilled businessperson) should undertake drafting, revising, and negotiating them.

3 Reasons Why Your Startup Shouldn’t Be An LLC

One of the earliest legal decisions you’ll need to make as the owner of a startup is deciding what type of entity your new company is going to be. Will you choose a C-Corp? An LLC? Something a bit more eccentric, like a B-Corp? There are a number of options out there, and picking the wrong one can spell disaster for someone hoping for a high growth rate fueled by venture funding.

For most startups, there are three different corporate structures to consider: the C-Corp, the S-Corp, and the LLC. The three are primarily differentiated by their tax treatment, but that’s a story for another article, and I have posted an introduction to LLCs and a primer on Corporations before, so check them out if you want to learn more about those entities, how the differ, and what they’re best suited for. Spoiler: the C-Corp is the best entity for a startup.

Now onto the matter at hand. Why are LLCs are terrible for tech startups? There are tons of reasons, but I’ve distilled them down into three.

  1. Investors Don’t Like LLCs. Venture capitalists can be a funny bunch. On the one hand, they’re always trying to discover the next great thing that’s going to turn into a huge success. On the other hand, they’re ultra-conservative (as much as possible, anyway) with their investments. And they have good reason to be—especially those who are investing other peoples’ money. As a result, investors don’t like LLCs because they’re different than the standard C-Corps they’re used to investing in, which means more money must be spent on due diligence, including evaluating each LLC’s unique operating agreement and drafting the often complex LLC documents; the partnership style taxation of most LLCs means some tax-exempt investors can’t invest in LLCs and all investors can still be taxed on the LLC’s income even if they’re not getting a cut of it in any given year (due to reinvestment, etc.); and investors living in other states may have to declare income, and subsequently be taxed on it, in not only the state where they live, but they state where they’ve invested in the LLC. The upshot of this is that because most investors have issues with LLCs, it makes it much more difficult to find investors for your new startup.
  2. Unlike Corporations, LLCs Are Difficult to Manage the Larger They Get. With a C-Corp, where stocks are issued instead of membership interest when someone acquires an equity stake in the business, a corporation can easily manage how its stocks are being distributed. Stocks are simple and easy to manage no matter how many shares are being issued. Instead, with an LLC, the company is left trying to cut the pie into smaller and smaller parts with each new investor, leading to all kinds of tax complications. Also, LLCs are predominantly governed by their individual contracts, and as more investors get on board, the contracts will become longer and more complex, leading to higher legal fees with each new transaction (except for those lawyers who help startups for flat fees).
  3. Taxes, Taxes, Taxes. I’ve already touched on some of the major tax issues, including taxation in states where passive investors reside and where the LLC is located, but tax problems can also arise each and every time a new investor comes in, depending on how they want their preferential treatment structured (liquidation preference, etc.). The tax code also doesn’t recognize LLC membership interest for reduction in capital gains taxes under Section 1202. And to top it all off, when it comes time to sell your company, you’re going to be stuck with taxes and, unlike with a corporation where you can swap the stock of your company for that of the acquirer in certain circumstances in order to help defray those taxes, with an LLC, you’re left hanging out to dry by the tax code with no option but to pony up the cash to pay the tax bill.

So, as the founder of a new startup, what are you to do? The common solution to the problem with LLCs is to just not use them for startups. While ease of operation and need to not follow any of the traditional corporate formalities may seem like a boon for founders in the early stages, the problems with LLCs escalate as they grow. As a result, if you’re bootstrapping your company, you can freely choose any entity you like (though I recommend doing so at the suggestion of your startup attorney and your accountant). But, if you have any desire to raise funding on a large scale down the road, you’re going to want to consider an alternative structure.

For some reason, those who have navigated away from an LLC tend to be drawn towards the S-Corp. Maybe it’s because someone told them they were a great way to protect themselves from taxes and “all the rich people use them” as tax shields, or something like that. And while an S-Corp is certainly better than an LLC in terms of running a startup driven by investor financing, there are still some problems you can run into. Namely, foreign investors and corporations cannot invest in the S-Corp, and as far as growth goes, you’re stuck at a maximum of 75 investors—so much for rapid growth with lots of investors. As a result, if you’re starting out and planning to bootstrap your operation entirely, an S-Corp is a solid choice for your business structure. But if you’re hoping to build the next great startup with a shower of VC money coming your way, think again.

Which leaves us with the C-Corp. The ideal structure upon which your startup should be based. Investors (and their lawyers) are used to them, they’re easy to deal with, there’s a ton of law about how they work, and it just makes sense.

Now, which state should you incorporate in? Delaware? California? Nevada? Your home state?

10 Things to Consider Before Buying a Business

Starting your own business entity from scratch is definitely not for everyone. While running any business involves a ton of hard work and dedication, starting from square one involves even more. That’s why so many business owners choose to purchase another person’s business that’s already running strong. But before you sign that check to purchase an existing business, have you done your due diligence and made sure that everything the seller or the business broker told you is correct? We’ve complied ten of the top considerations to check in your due diligence process to ensure the business you’re buying is all its represented to be.

Current and Accurate Financial Information

You’re buying a business to make money. That much is given. But is the business you’re purchasing actually as successful as the seller’s made it out to be? For starters, you’ll want to have the financial statements for the last three to five years audited. Also, check any credit or analyst reports that may be available on the business. Read through schedules of inventory, accounts receivable and payable, and check for any additional indebtedness.

Make Sure the Business is in Good Standing

All too often, a business owner forgets to submit annual or biennial documents to the state’s Secretary of State, causing the business to be suspended. Do yourself a favor and make sure the business is still in good standing. And while you’re at it, read through the Articles of Incorporation (or Organization), the Bylaws (or Operating Agreement), and all other documents contained in the corporate binder, including minutes and additional records.

Check for Employment Law Violations

Employment law is an absolute quagmire for a lot of employers. Minute differences between exempt and non-exempt employees as well as the failure to update an employment handbook can spell disaster for an unaware employer. So be sure to check through all of the employment records for current and former employees of the business to determine their categorization, benefits paid, and any workers’ compensation or unemployment insurance claims they’ve made, among other things.

Taxes Paid

Taxes, like employment laws, can be a tricky situation for a business owner to navigate. While many businesses employ attorneys or CPAs to fulfill their accounting needs, far too many believe they can do their taxes themselves and fail to meet requirements set forth by the IRS or state or local taxing authorities. When you’re going through the company’s financials, be sure to look through all tax filings s well, and focus your attention to any tax liens or discrepancies that could spell trouble later.

Look for all Necessary Licenses or Permits

Many businesses must maintain active licenses or permits with various state and federal agencies for them to conduct business legally. Unfortunately, quite a few of those businesses—particularly the smaller ones—often neglect their licensing requirements. If you’re contemplating the purchase of a business where a license or permit is required, make sure the business has it, and it is up to date.

Examine the State of Physical Assets

There are few businesses that can get away with having little to no physical assets as a part of their business model. While a schedule of assets can take you a long way to understanding the types and status of the assets the business owns, that is only the first part of the puzzle. You’ll also need to look to any equipment leasing contracts the business has with manufacturers or dealers, any UCC filings for the equipment, and lists of all purchases and sales of capital equipment.

Intangible Assets such as Intellectual Property

While physical assets are often thought of as one of the most important factors in the purchase of a business, intangible assets, such as intellectual property, can often be more valuable than the physical assets of a business. What are intangible assets? We’re primarily talking about trademarks, patents, and copyrights the business owns. Be sure to check if the business’s name and product names are trademarked (and still actively maintained). Go over methods for protecting trade secrets with the managers. Comb over patents and licensing agreements to make sure they’re valid.

Vendor, Supplier, and Other Contracts

A business is often only as good as its supply chain. And as an integral part of that supply chain, you need to be sure that your contracts with vendors, independent contractors, or any other suppliers of materials or labor are all valid and intact. Start by getting a list of all of the third parties the business deals with on a regular basis. Check to make sure their contracts are all valid and there are no breaches between the parties. Also, while you’re checking these contracts, take a look at any real property leases or mortgages.

Environmental Issues or Other Litigation

One of the most hot-button issues currently for purchasers of new businesses is whether the previous owners have any environmental problems that may pop up later. From pollution to exposure violations, even the smallest environmental issue can spell big trouble for the business. Be sure you check out any types of hazardous materials the business uses as well as how those materials are handled and disposed of. Also, check for hazards in the form of litigation that could harm the company later on, including any current or threatened litigation by or relating to the company.

Get as Much Customer Information as Possible

A business will not have any success without a strong customer base. And any business that is worth its price will have a detailed list of customer information on hand for your perusal. If possible, read through a list of customers to find out who they are, where they live, and what products they purchase. The more you know about your customer base, the better position you will be in when it comes time for you to take the reins of the company from the seller—meaning you’ll be able to enjoy profits as quickly as possible.

Photo Courtesy: Sebastiaan ter Burg

Soon to be featured at: Directory World

A Quick Primer on Corporations (C-Corps & S-Corps)

A corporation is the business entity that most people think of when they think of a business. Seeing the Inc. or Corp. at the end of a business name conjures up images of well-known, successful businesses. Beyond that, though, corporations are seen as people in the eyes of the law. Just like an individual, a corporation can bring lawsuits, own property, and enter into contracts, among other things. Corporations have a perpetual lifespan, meaning that short of dissolution, corporations will persist indefinitely, allowing their shareholders to buy, sell, and trade shares for years to come. Speaking of shareholders, corporations, while sometimes thought to be owned by the board of directors, are actually owned by their shareholders and managed by the board of directors. Officers, such as the president, CEO, and CFO, run the corporation through its day to day activities, in turn delegating work to managers and other employees. In smaller corporations, a single person may hold several roles, as shareholder, board member, and officer.

S-Corporations, formally known as Subchapter-S Corporations after the tax code section which authorizes them, are very similar to C-Corps above. As far as similarities go, both are corporations and are inherently structured the same in the eyes of the law. However, S-Corps are designed with certain tax savings in mind—at the expense of the large amount of growth a C-Corp can experience. While all of the differences between the two are outside of the scope of this quick guide, the most important thing to keep in mind when comparing an S-Corp to a C-Corp is that with an S-Corp, you sacrifice the ability to grow to a very large size and issue a wide variety of stock for tax savings benefits.

Photo courtesy: ernestopletsch

A Quick Primer on Limited Liability Companies and Partnerships (LLCs & LLPs)

A Limited Liability Company, or LLC, is a far newer type of business entity than a corporation, though they have quickly become the most popular type of business entity around. This rapid growth in popularity is because LLCs combine liability protection afforded by a corporation with a partnership’s lack of strict administrative rules and formalities. And let’s not forget that an LLC can also provide for tax savings as well. While it would be overkill to say you can form an LLC and immediately forget about its required formalities, it is the simplicity of the LLC that has made it hugely popular among small business owners who would much rather be running their business than scheduling shareholder and board meetings.

A Limited Liability Partnership, or LLP, is very similar to the LLC discussed above. In most situations, if you’re considering an LLC versus an LLP, choosing the LLC is the way to go simply because it affords you more options for growth and provides a better business structure overall. However, some states, like California, require certain professionals to form LLPs instead of LLCs for liability purposes. Some professionals, such as attorneys, architects, and accountants, are prevented by state law from organizing as an LLC, and therefore must form an LLP instead.

Photo Courtesy: Manish Prabhune

Choosing Corporation or LLC: The Legal Side of iOS App Development Part III

At this point, you’ve read through Apple’s developer contracts and you’ve decided on an amazing name for your iOS app. But what’s the next step, aside from actually designing and coding your app, of course?

While it is definitely possible to have a single individual, also known in the business world as a sole proprietor, post an app to Apple’s App Store, you’re going to be much better off if you form some kind of business entity before you submit your app. Why? Several reasons—most of which revolve around liability and growth.

But before we get too far ahead of ourselves, we need to ask what is a business entity? It’s kind of a strange phrase, but it’s simply a general term for corporations (both C-Corps and S-Corps), limited liability companies, and partnerships. Which one is right for you is going to be a judgment call you should make after you discuss your situation with other iOS entrepreneurs and a knowledgable business lawyer.

With the general nomenclature out of the way, let’s talk about some specifics. Most small developers like to form LLCs. People talk a lot about the benefits of an LLC (liability protection, electable S-Corp taxation status, lack of corporate formalities). However, there are a number of very significant drawbacks. For example, I’ve discussed this on our site before, but if you’re forming a single-member LLC, you’d better be sure you know what you’re doing—or you could find yourself liable for the debts of your company. And that’s not a position anyone wants to be in. Further, LLCs often have a problem scaling, which is something even the smallest app developer should be concerned with since app development can sometimes be an expensive undertaking and you may want to take on extra investors in exchange for a percentage interest in the company. That said, LLCs are great for a small number of shareholders (called “Members” in the LLC context), but trying to add more members and investors down the road can lead to some major problems. After all, corporations are much better suited to taking on investors than LLCs are.

And that brings us to the corporation. Compared to LLCs, corporations are slightly more costly to set up and require more effort to keep running (in terms of required meetings, corporate minutes, resolutions, etc.). However, if you’re looking for a way to scale your business at some point, setting up your entity as a corporation is the way to go. With the ability to issue a range of stock types to investors, you’ll be in a position to grow in ways you never thought possible.

But what if you’re looking for something in between? You’ve started out and you’re developing your first app, after all. What do you do? Well, we sometimes recommend setting up the LLC first and then converting it to a corporation later. That way you don’t have to worry about all of the corporate formalities at the beginning and you can focus on what you do best—developing your app. Then, after your app is finished and selling like hotcakes on the App Store, you can convert the LLC to a corporation. And to top it all off, you’ll have saved some money to boot.

Next time we’ll discuss the legal ramifications of using third party resources and code in your app—what it means for your development now and in the future.

Photo Courtesy: Thomas Leuthard

Understanding the Difference Between Common Stock and Preferred Stock Equity Financing for Startups

Financing your startup is easily one of the most important steps in the process of developing your company—but is it also one of the most despised. When it comes to financing, you’re looking at several rounds, ranging from the very beginning when you’re just getting money from friends and family members who want to help you out from the kindness of their hearts all the way to the IPO and taking your company public. Through it all, though, there are three main ways to structure your company’s financing. Common Stock, Preferred Stork, and Convertible Notes. While this article is limited to a discussion of common stock and preferred stock, each type of equity financing has its own benefits and drawbacks, and hopefully this article will help you understand exactly what the differences are between the two stock classes and how each is used.

Common Stock for Startups

Of the three types of equity financing discussed in this article, common stock is probably the one you’re most likely familiar with. When you form a corporation at the beginning of a venture, this is most likely the stock you’re issuing to yourself and your cofounders. This type of stock is used throughout the early stages of fundraising, and is mostly given to the friends and family members who have helped you out when you’re just getting started.

From your perspective, this is the best type of equity to give to investors. It keeps everyone on the same playing field in terms of voting rights and special privileges, and you don’t have to worry (as much) about running afoul of some securities law by issuing something other than the common stock you started with. It’s the perfect way to get smaller investments from a larger number of individuals in a Kickstarter, crowdfunded kind of way. In short, if all investors are given common stock, everyone has the same rights, and that usually means the founders get to keep control over the company they built.

However, investors do not share the same perspective you do as the founder of your company. Investors are putting large amounts of their money on the line in hopes they’ll see some big profits in the future—and that’s why they hate common stock. When an investor comes calling, they want to have more control over the way the company is run, and common stock simply doesn’t grant them the ability to run the business in a way they’ve determined is the most prudent manner. Ultimately, because the investor will be negotiating with you at a time when your company needs the money, they’re going to have all of the leverage and you’re going to have to give up and accept you’re going to have to give them a class of stock better than common.

Preferred Stock for Startups

And that’s where preferred stock comes in. Preferred stock doesn’t really do much for the company itself, but means the world to the investors because of all of the additional bells and whistles that come attached to the stock to help increase investors’ reward while decreasing their risk. The main factor is that most of the preferences and rights associated with preferred stock go into effect at the time of a liquidation event—often purchase of the company, merger, public offering, or closure.

When it comes to preferred stock, all are not created equal. There are a number of different features that separate one class of preferred stock from another. It is important to keep in mind that a company’s preferred stock may have one of the following additional rights or all of the following rights—it really just depends on how well negotiations went and who the company has as its investors.

Conversion Rights: These are rights given to an investor designed to protect that investor from having her shares diluted by future financing rounds. After all, as more shares are issued, the fixed number of shares an early investor purchased becomes a lower overall percentage of the company’s equity. Generally, what happens with conversion rights is the investor is given the right to convert each share of their preferred stock into a larger number of shares of common stock.

Dividend Preference: While finding a dividend-paying startup is like discovering a dodo on your front lawn, dividend rights ensure a preferred stockholder gets their dividends before anyone else does—even if they have to wait years. The key here is some investors require dividends accrue even if they’ve not been officially declared by the board of directors. If this is the case, the dividends, which should have been paid out on a regular basis, grow in the background and are then paid to the preferred stockholder at the time of a liquidation event, thereby increasing the money made by the investor beyond just an increase in value of her stock.

Liquidation Preference: What happens with a liquidation preference is the investor gets her investment back before any of the common stockholders get a dime. These are triggered by any liquidation event (liquidity event). Something to look out for are liquidation preferences that provide a return on 1x the amount invested, though that’s a topic for another post.

Redemption Rights: The redemption right gives the preferred stockholder the right to force the company to repurchase its preferred shares. Generally, these are only activated after a specified amount of time and, for the most part, most redemption rights go completely unused—particularly in early investment rounds.

Voting Rights: Now here’s a big right for preferred stockholders that can mean a lot of different things. Voting rights can range from the ability to have the investor installed on the board of directors. They can also mean that each vote from a preferred share is worth more than that of a common share. Or, there can be protective provisions in place that give the investor the right to veto certain decisions made on the company’s behalf. Needless to say, the voting rights of a preferred stockholder are far beyond those of a common stockholder.

And those are the most common preferences and rights of preferred stock. Whenever you seek investor financing, always, and I mean always, consult with a startup lawyer to read the terms provided by the investor and help negotiate the deal.

Photo courtesy: Robert S. Donovan

3 Problems with Single-Member LLCs and How You Can Easily Solve Them

I help my clients form lots of business entities. While many of them are corporations, LLCs (Limited Liability Company) are, without a doubt, the most popular. It seems everyone these days wants to start their own LLC, and that’s not necessarily a bad thing—but there are drawbacks to having what is known as a single-member LLC.

Before we get into the reasons why a single-member LLC is not necessarily a good thing, we need to go over some of the background on LLCs in general. Time for a history lesson. The LLC was developed as an alternative form of corporate entity from the classic C-Corp, or corporation. Structured based on partnership rules, the LLC is technically just that, a fancy partnership recognized by state law and given added liability protection than what was provided by the typical general partner/limited partner model used by partnerships. If you have an understanding of the difference between partnerships and sole proprietorships, you may see where I’m going with this.

Partnerships all require more than one member. That’s why they’re partnerships, right? You can’t be a partner to yourself. If an LLC is considered to be highly similar to a partnership, then if you’re operating a single-member LLC, it’s like you’re operating a partnership with only one partner—and that’s a no-no. Traditionally, a partnership with only one partner, then, was a sole proprietorship, a type of business entity with undoubtedly the least amount of liability protection you could have. Therefore, if you’re operating an LLC as a single-member LLC, which makes you more like a sole proprietor than a partnership, that means you have less liability protection than if you have an LLC with multiple members. Which, of course, is why I, as a business attorney, always recommend including a second member when forming an LLC. People don’t always listen, but at least we can say we warned them.

OK, so back to the problems with the single-member LLC. Considering the above, we know these types of LLCs have less liability protection than if there were multiple members—but did you know that in some places they’re completely disregarded? Take the IRS, for example. When you register for an EIN (Employment Identification Number), they tell you your LLC will be taxed as a disregarded entity—just like a sole proprietorship. Not like a partnership. Not like a corporation. You have to affirmatively select one of those options. Even more amazingly, some states don’t even allow you to form a single-member LLC. California isn’t one of them, in case you were wondering. Though California will definitely disregard your single-member LLC (and hold you personally liable for damages) if your LLC is ever sued and doesn’t have enough capital to cover the damages if the other party wins.

To recap, the single-member LLC is problematic because it can be so easily disregarded. This means less liability protection, possibly less tax benefits, and the risk of personal liability if your LLC is undercapitalized.

So How Do I Solve This Problem? I Thought My LLC Was Supposed To Protect Me From Liability

The solution is easy: add another member to your LLC. We always recommend a family member, such as your spouse, partner, parent, or child. You don’t have to give them a 50% stake in the company, just a couple percent will do. You still get to make all of the important company decisions while they are just entitled to a very small share of the profits (and losses).

But I Don’t Want To Share!

There’s always those people who feel the’ve built their company by themselves, with their own hard work and capital, and they don’t want to share the membership interest in their LLC with anyone else. A completely valid point that I can definitely accept. If you’re one of those people, just keep in mind that you’re never going to insulate yourself from liability as well as you could by adding another member, but here are a few tips that may help you protect yourself slightly more.

Elect corporate tax treatment with the IRS instead of “disregarded entity” tax treatment that is default with a single-member LLC.

Keep unbelievably perfect records of all meetings and resolutions for your company. Even though you’re only one member, vote on everything. Document all major events. The more records your company keeps, the better.

Never personally sign for any LLC-related purchases or contracts. Always sign your name on behalf of your company.

Never mix money in your personal bank account with your company’s bank account. Keep them totally separate and keep excellent records regarding your LLC’s assets and liabilities.

Use your LLC’s EIN on all tax filings.

So there you have it, some reasons why a single-member LLC is not necessarily the best idea for forming your business entity, and some tips on how to get around the problems it presents.

Photo courtesy: Bob Jagendorf