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Avoiding Five Common Mistakes Entrepreneurs Make PDF Print E-mail

Over the years, I have seen many clients come to me after having repeatedly made the same errors.  My basic general advice is always the same.  While I appreciate that many of these mistakes arise from frugality, it is still important for entrepreneurs to recognize the risks and problems that may arise.

1.  The cocktail napkin business plan (a/k/a think it through and pencil it out).

While a formal business plan is wonderful, you really need something more than chicken scratches on a bar napkin.  Undercapitalizing a company not only can cause that business to untimely fail, but it is one of the biggest reasons creditors are able to pierce through the corporate/LLC veil and attach the shareholders/members assets.

Sit down on your computer and put your realistically anticipated revenues and expenses in a spreadsheet.  Be honest and try to account for all expenses you will incur.  You also really need to have some cash reserves in place to take care of the unforeseen expenses.

2.  The Do-It-Yourself Entity (a/k/a you get what you pay for).

First, a confession, I love Nolo press, legalzoom and those other Internet do-it-yourself corporate formation mills because in my 11 years of practice, I have yet to see a corporation or LLC that was formed 100% correctly.  After I point out the various errors (some minor – some serious) to a prospective client, that client sees the true value of a lawyer.

These mills have some great websites, suck you in with introductory prices that no lawyer can afford to touch and then convince you that you are getting the “complete” “Platinum” package.  Unfortunately, what they don’t (can’t do) is give you the correct advice to make sure your entity is not only just formed, but legally and correctly formed to meet your goals and ensure all the appropriate filings have been made.

In fact, in really, really, small, lightly colored print, at the bottom of their page, the purported leader in the industry made this very honest disclaimer:

Disclaimer: The information provided in this site is not legal advice, but general information on legal issues commonly encountered.   LegalZoom's Legal Document Service is not a law firm and is not a substitute for an attorney or law firm. LegalZoom cannot provide legal advice and can only provide self-help services at your specific direction. (source legalzoom.com - on August 3, 2008)

Basically, what they are saying is, do not rely on anything we say, because all we do is fill in the blanks where you tell us too, and you are the expert as to how your entity needs to be formed.  It begs the question, if you are such an expert why don’t you just avoid the Internet Mill and file your articles directly with the Secretary of State for $70-$100, and buy a set of fill-in-the-blank documents (Bylaws, Organizational Minutes and Investor Representation Letters) from the stationary store.

The basic problem, is unless you are a business law attorney, you are not the expert.  You probably have no idea whether:

  • you should make/can make a Qualified Small Business Stock & 1244 Election;
  • a Section 351 exchange is warranted and to what extent you need a reorganization plan and related documents;
  • the issuance of securities in your entity (corporation, LLC or limited partnership) requires a Federal or State exemption and under what code section the exemption is claimed;
  • the investment representation letter is compliant with state and federal securities law?

There are a number of other important considerations such as tax treatment (s-corp v. c-corp) that your accountant should advise you on, and an assortment of other issues, especially if you will have additional shareholders involved in the company now or in the future.

3.  Using the “Intergooglepedia” for your Accounting/Banking/Legal Advice (a/k/a why you need a good accountant, banker and lawyer).

If it is on the Internet, it must be true.  As a lawyer I can’t tell you how many times I’ve visited a website, which contained legal advice that was really close to being accurate … but wasn’t.

When it comes to your business, you need a core group of three professionals: an accountant, banker and business lawyer.  Here is why:

Accountant/CPA – Most people are in business to make money, most people also want to “avoid” paying more taxes than is necessary.  In the beginning, your accountant will help advise you how you should set up your financial books (accrual, cash, modified cash), and will suggest whether you should make an s-election if you incorporate or elect to be taxed like a corporation if you form an LLC.

Your accountant will also help you set up your books and records properly, which will save you a ton of money come tax time because he/she won’t be trying to unravel the mess you made earlier in the year.

Moreover, by working closely with a good accountant (and following their advice) you will stay out of trouble and likely, pay no more taxes than you are legally required.

Banker – It is said that it takes money to make money.  The Banker is sitting on lots and lots and money and wants to “lend” it to you, provided he has strong likelihood of getting it back (with a little interest).  Having a relationship with a good banker is vital to putting in place financing vehicles that can help a small business grow.  Find a smallish bank (but not too small) and establish a relationship with a Banker that will be in a position to help “bend the rules” when it comes to financing your business.

Business Attorney – While it sounds self-serving, working with a business lawyer (like Michael W. Newcomb, Attorney at Law) that understands your needs is essential.  You must be able to connect and communicate with your lawyer.  Communication is essential.  The more your lawyer knows about your business plans/needs/challenges, the better and more cost effective the advice from that lawyer will be.

You also want a lawyer that understands your business, if you involved in the technology field, then having a lawyer that appreciates the intricacies of technology licensing and protection can be invaluable.  Above all, you need to genuinely trust your attorney to help you navigate the obstacles and avoid the pitfalls that your business will face.

4.  The “contract” of the Sierra Madre (a/k/a get it in writing).

For whatever reason, many otherwise intelligent business people suffer from a form of temporary insanity when it comes to documenting their relationships.  It is as if they just watched that old Humphrey Bogart movie The Treasure of the Sierra Madre, where the Mexican bandit leader (Gold Hat played by Alfonso Bedoya) is trying to convince Fred C Dobbs (played by Bogart) and company that they are the Federales:

Dobbs: 'If you're the police where are your badges?'

Gold Hat: 'Badges? We ain't got no badges. We don't need no badges! I don't have to show you any stinkin' badges!'

Every time a client comes to me with a contractual dispute based on an oral promise this little vignette plays in my head (but, I just substitute the word “badges” for “contracts,” and “the police” for “a successful business”).

Get it in writing.  If you cannot afford to have a lawyer draw up a good contract, at a minimum, memorialize your agreement in writing, after the fact and before any of the parties have breached the agreement.  A simple letter or email to the other party that outlines the deal is better than nothing and will give your lawyer a legitimate argument if a dispute arises.  For example:

Dear [Cain (i.e. Able’s brother)],

This [letter/email] will memorialize our prior [correspondence and] oral agreement concerning the [really important deal].  Based on our discussion, we agreed as follows:

Your company will [describe Caine’s performance (e.g. build a machine that will turn back time and/or guess the winning lottery numbers with 99.355% accuracy, which will be delivered to our warehouse by October 31, 200?)].

My company will [describe your performance (e.g. pay the total sum of $500, which will be due and payable 3 weeks after delivery, and may be payable, at our option, in monthly installments of $100, bearing interest at 4% per annum)].

If the above does not accurately memorialize our agreement, please inform me immediately of any inconsistencies with your understanding.

Sincerely,

Your name.

5.  I’ll gladly pay you Tuesday for a hamburger today (a/k/a putting off legal problems to deal with in the future).

Popeye’s friend, J. Wellington Wimpy, was famous for being lazy and always looking to put-off the pain (of payment) to the future.  Like Wimpy, many entrepreneurs do the same thing and do not deal with their legal issues when they occur, but let those legal issues fester and become legal problems.

Often, legal issues can be resolved expediently and inexpensively when those issues are dealt with early.  If left to grow into a legal problem, the cost to solve those problems tends to be disproportionately expensive.

Because attorneys demand much more attention when contacting a party and we are professional problem solvers, a good business attorney may be able to engage and otherwise non-communicative party and devise a solution that is not readily apparent to the principals of a dispute.  For this reason, it tends to cost much less to consult with an attorney while the issue is small, rather than pay that same lawyer a large litigation retainer to defend a lawsuit.

 

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