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BUILDING AND MAINTAINING A FIRM
FOUNDATION FOR YOUR BUSINESS
About 10 years ago, I had an office
on the 15th floor of the old Key Bank Tower in Salt Lake City (now
demolished as part of a downtown redevelopment project). It overlooked Temple
Square – the historic and beautiful center location for the Mormon church – as
well as all points north. Between the flower gardens in the spring and summer,
and the holiday lights in the winter, I had a dazzling view of one of the most
beautifully striking places in town.
From my vantage point, I could also
see the construction of a planned LDS (Latter-day Saint, as Mormons are often
called) conference center, which began in 1997. The building, projections of
which were impressive, promised to be the largest indoor religious center of its
type (it was to seat nearly 22,000 people). It was to be stunning both in its
architectural soundness and in its outward appearance. More impressive was the
ambitious construction timetable projected for the building – a little over
three years. Daily, between phone calls and client visits, I would look out the
window to watch the progress on the undertaking. I prepared to be amazed. I
wasn’t – at least not for a long time.
The problem, as I saw it, was that
nothing of any real value appeared to be happening on the construction site. It
was true that there seemed to be quite a lot of digging, since the bulk of the
building’s indoor capacity would actually be below ground level, but other than
what looked to me to be a lot of busy work with earth movers and a couple of
cranes (one of which almost toppled over in a freak downtown tornado), it didn’t
look to me like much progress was going forward. Almost two years passed in
which I didn’t see a single wall go up, nor did I see any of the local granite
(from the same site that had supplied the stone for the impressive Salt Lake
Temple more than 100 years before) make an appearance on the scene. It was all
a rather unimpressive hole in the ground, as far as I could see.
I mentioned this to a friend of mine
in the construction trade.
“Just you wait,” he replied.
“They’re putting in the most solid base you ever saw. The rest of the building
is going to look like it went up overnight, compared to the foundation they’re
building for this thing.”
“But why is it taking so long for any
progress to be made?” I asked.
“There’s an incredible amount of
progress here,” he replied. “You just can’t see it – in fact, you’ll never see
it – but it will be the structure on which everything else will rest. This
building is going to last for a thousand years.”
And he was right. It seemed that
once the walls started to go up, the rest of the conference center was finished
in a matter of just a couple of months, complete with over three acres of grass
and gardens on the roof, and a waterfall on the side of the building. The
building’s interior is equally impressive. Every seat in the place has a
straight view of the stage, and I swear you could land a couple of 747s in
there.
I’ve been in the building a number of
times, and it never fails to impress me. The architecture is attractive, the
artwork is awe-inspiring, and the layout of the building is fantastic. But my
contractor friend is right. I can’t see the foundation of the building – the
concrete, the steel trusses or the rebar. I don’t look at the wiring or the
plumbing. I don’t see the incredible air pump that powers the amazing pipe
organ. I usually just stand inside the structure with my mouth open, staring at
the ceiling and wondering how they did it all so fast. All of the nitty-gritty
details are hidden, and would probably be lost on me anyway.
I was thinking about this during the
last couple of weeks, when a client came to me with “just a few questions” about
his latest start-up venture. It seemed that he was the brains behind a new
invention and his partner was the money guy. They’d started a company that
seemed to have a bright future, had made quite a bit of money in a short time
domestically and now wanted to expand into some international markets. They had
built, for lack of a better analogy, a pretty impressive-looking building. It
was only when I started asking the inventor partner a few probing questions that
it became clear that they didn’t have much of a foundation, however.
I started out with some easy ones.
“Where is your company established?”
“Uh, I’m not sure. I didn’t really
handle that part of it. I think, maybe Nevada … or California.”
“Is the company a corporation, a
limited liability company, a partnership? How is it structured?”
“I’m not sure, but I think it might
be a partnership, or maybe a corporation. I know that I have a half-interest in
it, though.”
“How do you know? Do you have a copy
of the partnership agreement, if it’s a partnership, or a copy of the operating
agreement if it’s a LLC, or a copy of the bylaws if it’s a corporation.”
“Uh, I’ve never seen that stuff.”
“Who owns the patent to your
invention? You or the company?”
“Well, I think it’s probably in my
name, but I know that my partner said that he might apply in the company’s
name.”
Things only got worse as my questions
got harder. The client didn’t know who had registered the website for the
company, wasn’t sure if an international patent had been secured, wasn’t sure
who the international distributors were (or if they had written contracts),
couldn’t tell me if there what the company’s total assets and liabilities were,
and didn’t know if the people doing the company’s work were employees or
independent contractors. He couldn’t tell me if the money he’d been taking from
the company was salary or considered a loan (he had neither loan documents nor
W-2 forms). He did know of a possible legal claim against the company, stemming
from some promises that had been made to some third-party outsiders, but didn’t
know if there was anything in writing anywhere that might give the company
problems. The more I asked, the more frustrated and, ultimately, angry, he got.
“I’m not sure all of that is all that
important, is it?” He finally blustered. “After all, we’re making a ton of
sales.”
“What, exactly, is your title in the
company?” I finally asked, figuring that since he was the inventor partner (at
least I thought he was probably a partner, although he wasn’t sure), he had an
excuse for not knowing all of the business details of the company.
“I’m the CEO/President,” he announced
proudly. “I’m the guy who’s been making all of the decisions.”
I swallowed hard, and tried, as
diplomatically as I could, to tell him that his company could well be heading
off a cliff. Unless I could figure out what the company’s legal and financial
foundation was, I wouldn’t be able to tell him whether he was sitting in a
mansion or precariously perched atop a house of cards. The fact that he didn’t
know was alarming.
As egregious as my new client’s
situation was, I wish I could say that it was atypical. Unfortunately, in my 26
years of practice, I’ve run into an awful lot of folks just like him – guys who
want to start building their business castle from the roof down, without ever
having taken the time or expended the money to put in a rock-solid legal and
financial foundation. Unfortunately, most of those clients came to a sudden and
bad end, either ripped off by unscrupulous business partners (or third parties),
drowned in a torrent of legal claims, or crushed under a load of bureaucratic
requirements from state and federal agencies, often involving the IRS or state
tax authorities. Often, it isn’t just the client’s business that goes under.
Instead, because of a failure to have adequately protected themselves from the
consequences of their bad business judgment, they’ve lost their houses, their
cars, their livelihoods and their marriages. Usually, by the time they get to
my office, they’ve started to circle the drain, and it’s up to me to assess
their situation and tell them whether they might have enough momentum to swim
away from trouble or whether they’d better just hang on as best they can while
they’re sucked into the undertow.
So, how does a new entrepreneur or
small businessman lay an adequate business foundation – one with real structural
integrity? Here are five suggestions (with a bonus thrown in for good measure):
First, decide what you want.
How big do you expect your business to be? How many participants are you going
to have in this business? Who is going to be in charge? Do you have partners?
Do you trust them? Where do you think this business is going to be in five
years? In one year? In three months? It’s important to have a vision of what
the business is going to be, set some very specific goals, and then measure your
business’s progress against those goals. In deciding what you want, it’s
important that you understand all of the nuances and specifics relating to your
business’s needs. You can’t afford to leave anything to chance. Decide early
what the ultimate destination of this business should be, and then lay out a
detailed roadmap for reaching that destination. Include every contingency,
every risk, every potential problem, every strength and every weakness. Good,
successful businesses don’t simply happen by accident. They are well-planned
and well-executed entities.
Second, get professional help.
If you can’t afford to get a good lawyer and a good accountant to help you put
together and carry out your business, you probably can’t afford to be in
business for yourself. A few hours and a few hundred dollars with a
professional who can advise you as to how to put together your corporate
articles (or operating agreement); your contracts with suppliers, distributors
or representatives; how to do your tax filings (and when), how to comply with
your state’s worker’s compensation laws; and how to structure your loan and debt
documents, will save you an immense amount of time, expense and hassle. Don’t
make the mistake of thinking that you can organize your life’s entrepreneurial
dream on the cheap, with a bunch of forms you downloaded from the Internet, some
advice from a friend who thinks they know how to do it, and a book you picked up
at the local thrift store on starting your own business. You should no more try
to put together and undertake your business by yourself than you should do your
own brain surgery.
Third, ask questions.
Hard questions. What will happen if things begin to fall apart? Who’ll be on
the hook? What if my partner decides to split? Is my intellectual property
protected in Romania? What if my competition rips off my idea? My suppliers?
My workers? What if I get sued? Do I have enough insurance? Should I be
pre-paying my taxes? Do I know what I’m doing? One of the most common folks I
run into is a “pie in the sky” entrepreneur who’s got a “killer idea,” a lot of
optimism and a blind faith that everything will somehow work itself out with
enough enthusiasm. There’s no idea about what could go wrong, or what will
happen if it does. When things do go wrong, (and inevitably something goes
wrong), this intrepid dreamer is clueless as to what to do and where to turn.
And they often flame out in a dazzling crash. The time to deal with problems is
before they happen. The time to ask the tough questions is before you’re stuck
with a massive headache at three in the morning, when things have started to
turn bad.
In this regard, I’ve been accused of
being the guy who, after the battle is over, walks around and shoots the
wounded. To some degree, it’s true. I believe that there is a point where
every client needs to face the possibility – in fact, I insist that they
consider it a probability – that everything will fall apart … the business will
find itself on the rocks, the owners will be sued, the business’s secrets will
be compromised, and there will be no one to turn to for help. I ask them to
consider whether, in such circumstances, they would know what to do, what their
rights are, and who to turn to. They don’t usually like those kind of
questions. It’s a lot like sitting down with a couple that’s about to get
married and then asking whether they have considered whether their prenuptial
agreement is in place, and what will happen when their marriage ends in a
bitter, ugly divorce. Nonetheless, it is exactly those kinds of questions that
will keep the client out of trouble. Businesses aren’t like marriages, of
course … at least, not exactly (although I’ve seen some partnerships that broke
up in a far more brutal and emotionally devastating way than any marriage ever
could). A good, clear-eyed look at what might happen in the event the business
falls into trouble can only help make the business a success … and avoid massive
problems if it isn’t.
Fourth, know what your
documents say. Understand what your corporate bylaws (or your limited
liability company’s operating agreement – or your partnership agreement) says
about how your business is to be done – how, for example, ownership interests
are transferred, or what prerequisites must be met before a partner or owner can
be ousted from the company. Know who can write checks on the company’s account,
what your contractual rights are with your company’s representatives, and what
your debt obligations are (including personal guarantees). Understand, for
example, whether it’s you or the corporation that owns the intellectual property
utilized by the corporation. Know whether and where you can go to court in the
event of a legal issue (as opposed to arbitration), and know whether you can
recover attorney’s fees if you prevail in a lawsuit. Read your contracts;
review your insurance policies; look at every paragraph. Know where your
documents are located. Keep them close and keep them safe. There’s no detail
that you shouldn’t know. Remember, when it comes to the documents that will
define your business (and, by extension, your life), there’s no such thing as
“boilerplate,” “legalese” or “fine print.” It’s all important, and it’s all
something that you should know and understand. No one should know or care more
about your legal rights and responsibilities than you do. Don’t figure that
someone else knows and understands all of that “legal stuff,” so you don’t need
to. Someone else often does – someone who’s on the other side of a bitter legal
battle. Knowledge is power in business. Don’t give that power away to someone
else because you were either too lazy or too busy to read your documents.
Fifth, follow the rules.
In order for you to take advantage of the corporate (or limited liability
company) protections afforded by the law, you need to make sure that you comply
with the legal requisites that pertain to that company. You need to actually
have your shareholder meetings, (complete with appropriate minutes), vote on and
record corporate resolutions for important business decisions (such as
purchasing a large piece of equipment), keep track of the company’s debt
obligations, and make sure you “paper” all of the company’s business with
appropriate documentation. It is of enormous importance to avoid commingling
your corporate funds with your personal funds. Have a separate checking account
– and separate credit cards – for your business. There’s no quicker way for
somebody who’s suing your company to jump through the corporate veil and into
your personal pockets than to be able to show that you didn’t follow the rules –
thus rendering your company an “alter ego” of yourself, which means you can’t
avail yourself of the “corporate veil” protection afforded under statutes and
case law. You can no more afford to ignore your ongoing obligations to comply
with your business’s legal requisites than you can afford to drive your car
without changing the oil. There are specific rules you must follow if you are
going to be able to protect yourself. Learn those rules and apply them, every
day.
Finally, if your foundation is
weak, fix it now. If, in looking over the above suggestions, you’ve
discovered that perhaps your company’s legal foundation isn’t quite as strong as
it should be, fix it now – before trouble comes. If, for example, you haven’t
had a corporate meeting in years, today is the day to schedule that meeting. It
will be far too late to try to try to repair that problem and wrap yourself in
the corporate veil after you’ve been sued. If you’ve been buying your groceries
with your company’s credit card, today is the time to stop. It will be too late
to convince a court that commingling didn’t really matter from the witness
stand. Talk to your lawyer and your accountant today. Fix it now.
As I said at the outset of this
article, there’s nothing particularly interesting or engaging about digging,
pouring and reinforcing the foundation to any building. In fact, it’s boring,
and it’s certainly not showy. Without a firm foundation, though, it really
won’t matter how pretty the rest of the building may be. When things start to
go bad, it will come tumbling down. The same is true of your business. Without
a strong legal and financial base, there’s a good chance of collapse.
Randall K. Edwards practices law in
Nevada, Utah, California and Arizona, with his primary office located in Salt
Lake City. |
