One of the silver linings of a tough economy is that, absent heavy-handed government intervention or regulation, a business will adopt, adapt and improve if it wants to survive. Currently, my real estate developer clients are trying to innovate in an effort to stay alive in a credit freeze.
One of my clients, a commercial developer, tells me that even up to a year ago, when he began a project, he'd have five or six banks competing for his business. Now, however, he has to aggressively search out his own lenders and is lucky to find even one willing to make the loan.
Given this credit drought, I see innovative developers looking for new ways to get the funding necessary to complete their projects. In fact, I'm working with one client to come up with new methods of funding in these difficult times. What are some areas to consider?
1. Private financing. This has been around for a long time. There have always been private individuals or small companies willing to loan money. With large development transactions, I see a few practical issues with this. First, are you going to find any one person or private organization willing to loan you the amount of capital needed--not, say, $100,000 for a house, but perhaps two, three, four, or five million dollars? If not, are you going to have to procure multiple lenders? How will they each be equally secured? Even in boom times, private lenders typically charged a premium interest rate to cover what typically was a higher risk (i.e., if the venture was less risky, the thinking goes, it could've gone to a bank and paid bank rates). I recently saw a loan with a 50 percent interest rate! Most states have interest rate ceilings that mandate maximum interest rates chargeable on loans, but at least in North Carolina, that does not apply to non-consumer development loans.
2. Venture capitalism. I've written in other blog posts about venture capitalism, and v.c. has had a role, and will likely now have an even greater role, in real estate development. The main difficulty for developers is to price the increased cost of this money into its budget plan.
For example, perhaps a developer was creating a build-to-suit lease with an option to purchase for an 80,000 square foot commercial building, with a tenant lined up. The sales price, if the option is exercised, is $4,000,000. Previously, the developer would've created a pro forma (a projection of costs and income), and perhaps the developer worked out that the initial building costs would run at $3,000,000. The developer would also add into this the "carry costs"--i.e., what the loan payments would be. This figure would be pretty easy to figure out, based on standard loan rates or--even better--a promised loan rate from a particular lender.
But what about now? Just to make up numbers, the venture capitalist, approached to enter the deal, may have the money to loan, but may loan the money at a premium rate--i.e., instead of, say, six percent interest, the capitalist is charging 15 percent interest--which means that the carry costs will be higher. In addition, perhaps the venture capitalist wants 25 percent ownership. In such a tough time, these aren't necessarily costs that can be passed on to the tenant through increased rent or purchase price. In the previous example, the developer could count on $1,000,000 profit for taking on a $3,000,000 risk. Now, however, the profit will be less because of the increased carry cost (let's say, hypothetically, $100,000 more costs), and the net profit will then be shared with the v.c., leaving the developer, instead of $1,000,000, $675,000. This is still worth doing, hopefully, but the margins have decreased by one-third, in this example.
3. Stock offerings. Developers will also turn to stock offering in these days to raise capital. Instead of one venture capitalist providing funds, it will be numerous investors. One benefit of such an offering is that the developer's risk is reduced because the money is not a loan but is equity. On the down side, to raise the money necessary for a good sized development, the developer will have to part with a large share of the ownership. Going back to the previous example, if a developer only offered to sell 25 percent of its venture for the $3,000,000 it needs, those stock holders would be entitled, as a whole, to 25 percent of the final profit. Assuming again that the profit was $1,000,000, the stockholders' share would only be $250,000. Are stockholders collectively going to pony up $3,000,000, for a chance at $250,000 (or about eight percent) profit? Probably not. Instead, the developer will have to strike a balance by providing enough of his venture to make stock purchasers want to buy, but leave for himself enough to make it personally worthwhile.
Where will it end? Who knows. If you need advice about investment vehicles for your real estate development, and how to legally structure these vehicles, please contact me at 704-735-0483.
Minggu, 07 Desember 2008
Minggu, 30 November 2008
Business sales and having your own attorney
I'm gearing up to help the purchasers of a business that has gone bad, and I'm mad.
My clients came in, and informed me that they'd purchase ABC Business. Once they bought the business, they quickly found out that--contrary to the seller's representations--the business was loaded with debts which the seller intentionally failed to disclose to my clients. Bad, but seems straightforward enough, doesn't it? Surely that would constitute a breach of the sales agreement, wouldn't it? Well, not so fast--here's where things get interesting.
Seller talked my clients into using his attorney to draw all the documents. The documents, at first blush, looked like a standard set of business sale documents, except for the part where the seller's attorney cut out all warranties of title, and basically provided that the buyers were taking the business "as is."
The lawyer, hired by Seller, had his fee paid equally between the buyers and the seller--all the while knowing that the seller was hiding from them tens of thousands of dollars of liabilities. That's a breach of his ethical responsibility, one that may cost him.
It's too early in the game to discuss details of what I intend to do on my clients' behalf, but let me use this opportunity to offer some advice to other potential business buyers.
1. NEVER use the seller's lawyer to represent you in a business purchase. The case I mentioned above is extreme--most lawyers wouldn't purport to represent both sides yet withhold information from one party that the other is lying. But often, this joint representation is "de facto"--i.e., the lawyer represents that he represents the seller only, but the seller is telling the buyer that he really represents both sides. Don't fall for this trap. You need someone to specifically protect your own interests as a business buyer--especially if (as here) you're a first-time buyer.
2. Make sure your purchase agreement contains all the representations IN WRITING that the seller has been making to you verbally. Sounds easy, right? But often, a seller will make lots of verbal statements that for some reason don't find their way into the written document. And the standard sales agreement also contains a clause providing that the only representations being made are in writing, and that no other representations have been made. If you, as a buyer, sign this, you may not later be able to rely on oral representations made to you earlier. In the instant case, the seller, of course, made all sorts of representations about the business being free of any liabilities. But, in the document cooked up by the seller's attorney, absolutely no representations were made--as to amount of property, as to title to the property, or anything else. Think about it: if a seller expects you to give him money for his business, shouldn't he--AT THE ABSOLUTE VERY LEAST--be willing to say "I am the owner of this business, and have good title to the business?" Of course. But with my clients, the owner wasn't willing to do that. They should've smelled a rat right then.
3. Do your due diligence! Many business buyers are investing their life savings to follow a dream of running their own business, but get so excited with the dream, that they blind themselves to the realities. Take the time to look under the hood. Investigate the business finances, do a background search of the seller, do everything a smart person should do to make sure you don't get yourself into a quagmire!
If you're involved in a bad business purchase in North Carolina and need help, call me at 704-735-0483, and set up an appointment.
My clients came in, and informed me that they'd purchase ABC Business. Once they bought the business, they quickly found out that--contrary to the seller's representations--the business was loaded with debts which the seller intentionally failed to disclose to my clients. Bad, but seems straightforward enough, doesn't it? Surely that would constitute a breach of the sales agreement, wouldn't it? Well, not so fast--here's where things get interesting.
Seller talked my clients into using his attorney to draw all the documents. The documents, at first blush, looked like a standard set of business sale documents, except for the part where the seller's attorney cut out all warranties of title, and basically provided that the buyers were taking the business "as is."
The lawyer, hired by Seller, had his fee paid equally between the buyers and the seller--all the while knowing that the seller was hiding from them tens of thousands of dollars of liabilities. That's a breach of his ethical responsibility, one that may cost him.
It's too early in the game to discuss details of what I intend to do on my clients' behalf, but let me use this opportunity to offer some advice to other potential business buyers.
1. NEVER use the seller's lawyer to represent you in a business purchase. The case I mentioned above is extreme--most lawyers wouldn't purport to represent both sides yet withhold information from one party that the other is lying. But often, this joint representation is "de facto"--i.e., the lawyer represents that he represents the seller only, but the seller is telling the buyer that he really represents both sides. Don't fall for this trap. You need someone to specifically protect your own interests as a business buyer--especially if (as here) you're a first-time buyer.
2. Make sure your purchase agreement contains all the representations IN WRITING that the seller has been making to you verbally. Sounds easy, right? But often, a seller will make lots of verbal statements that for some reason don't find their way into the written document. And the standard sales agreement also contains a clause providing that the only representations being made are in writing, and that no other representations have been made. If you, as a buyer, sign this, you may not later be able to rely on oral representations made to you earlier. In the instant case, the seller, of course, made all sorts of representations about the business being free of any liabilities. But, in the document cooked up by the seller's attorney, absolutely no representations were made--as to amount of property, as to title to the property, or anything else. Think about it: if a seller expects you to give him money for his business, shouldn't he--AT THE ABSOLUTE VERY LEAST--be willing to say "I am the owner of this business, and have good title to the business?" Of course. But with my clients, the owner wasn't willing to do that. They should've smelled a rat right then.
3. Do your due diligence! Many business buyers are investing their life savings to follow a dream of running their own business, but get so excited with the dream, that they blind themselves to the realities. Take the time to look under the hood. Investigate the business finances, do a background search of the seller, do everything a smart person should do to make sure you don't get yourself into a quagmire!
If you're involved in a bad business purchase in North Carolina and need help, call me at 704-735-0483, and set up an appointment.
Sabtu, 25 Oktober 2008
Partnerships -- an issue of trust
Partners in a partnership are said to owe "fiduciary duties" to one another--that is, they owe a duty each to the other to look out after the others' best interests.
Though partnerships are usually meant to be equal (i.e., equal sharing of responsibilities, equal contributions, etc.), they are, in practice, rarely so. Someone, for example, may handle the actual rental of rental properties in a partnership. Another, for example, may handle the bookkeeping and bank accounts of the company.
Regardless of all the plans that partners make, regardless of the legal mechanisms put into place to make the machinery run more smoothly, one thing any partnership needs to thrive is trust.
The past few weeks, I've been representing partners who desired to dissolve their partnership with a remaining partner. When the partners, who'd been friends, decided to wrap up their business, they asked the partner handling the bookkeeping to give everyone copies of the accounts just to reconcile things. This partner was offended, and told them he'd not give them anything, that they should trust him. Of course, then my clients also got their suspicions up, and claims began being thrown by each way.
At the end of the day, after threats of a judicial dissolution, the managing partner provided us the information we needed, and everything is going to be resolved without the need for a lawsuit. The sad thing is that--other than some very minor disagreements about the way certain things were handled--there appears to have been no dishonesty on either side, just a conflict of personalities.
If you're a partner--even if you believe you're doing the bulk of the work--remember that you owe duties to your other partners to be open, honest and forthcoming. Provide your partners with all information. Be upfront, don't be controlling and--most of all--don't get defensive when you're asked for information.
At the end of the day, these ex-partners will have resolved their partnership by splitting everything equally. But if one partner had simply been forthcoming, they could have done this without the added expense of attorney's fees
Though partnerships are usually meant to be equal (i.e., equal sharing of responsibilities, equal contributions, etc.), they are, in practice, rarely so. Someone, for example, may handle the actual rental of rental properties in a partnership. Another, for example, may handle the bookkeeping and bank accounts of the company.
Regardless of all the plans that partners make, regardless of the legal mechanisms put into place to make the machinery run more smoothly, one thing any partnership needs to thrive is trust.
The past few weeks, I've been representing partners who desired to dissolve their partnership with a remaining partner. When the partners, who'd been friends, decided to wrap up their business, they asked the partner handling the bookkeeping to give everyone copies of the accounts just to reconcile things. This partner was offended, and told them he'd not give them anything, that they should trust him. Of course, then my clients also got their suspicions up, and claims began being thrown by each way.
At the end of the day, after threats of a judicial dissolution, the managing partner provided us the information we needed, and everything is going to be resolved without the need for a lawsuit. The sad thing is that--other than some very minor disagreements about the way certain things were handled--there appears to have been no dishonesty on either side, just a conflict of personalities.
If you're a partner--even if you believe you're doing the bulk of the work--remember that you owe duties to your other partners to be open, honest and forthcoming. Provide your partners with all information. Be upfront, don't be controlling and--most of all--don't get defensive when you're asked for information.
At the end of the day, these ex-partners will have resolved their partnership by splitting everything equally. But if one partner had simply been forthcoming, they could have done this without the added expense of attorney's fees
Sabtu, 27 September 2008
Staying afloat in tough economic times
Even in the Charlotte Metro area, which has tended in the last decade to better weather tough economic times than most parts of the country, we're filling the pinch of the current economic downturn.
Many of my clients have told me that their business is down: fewer homes are being buit, materials purchased, real estate sold, and so on. This, of course, is no surprise, and many of my clients are currently retooling their business to help bring in additional income during these times.
But staying profitable isn't just about earning money off of new business; it also means that you need to get paid for the business you have already performed. It's easier to lose one job (and the potential income) than it is to perform the job, expend the effort, labor and materials, then not get paid. For many of my clients, it may take two or three paying jobs to cover the cost of one job for which they didn't get paid.
How, then, can you protect yourself so that you get paid for the work you do, so that you get paid?
1. Written contract. Many of my clients are subcontractors (brickmasons, graders, plumbers, etc.), who work on houses, and they rarely get a written contract with the person or company who hired them. However, this is very important. Obviously, a written contract will show proof there's an agreement, but that's the least important factor (after all, if you've done the work, that's proof as well). No, a contract is more important because it will outline the terms of what you are supposed to do, and when you can collect your money, so that your client can't hold you at bay (e.g., saying, "I'm not paying you until the house is finished by everyone"). Also, in North Carolina, you typically can't collect attorney's fees unless you have a contract providing for it, nor can you collect interest on late payments without an applicable provision in your contract. Sure, if you hire an attorney who successfully collects your fee, you're somewhat relieved; but you'll also be disappointed once you subtract his fee, and realize that your money could've been earning interest over the six months it took to collect. By contrast, a well-written contract could provide that the debtor has to pay you 15 percent attorney's fees and legal costs if you have to sue, and can provide for 18 percent annual interest on bills more than 30 days due.
2. Personal guaranty. Many clients simply do business with the "company," even if the company is a one-man operation. If you're doing business, attempt to wrangle a personal guaranty, in writing, from clients. In other words, if you don't get paid, the person with whom you're dealing should personally guarantee payment of the debt. If you're performing contract work for, e.g., Wachovia Bank, this may not be possible. But I suspect most of your clients are small businesses. These businesses' owners have to guarantee their bank loans; make them guarantee payment for your work. If a business owes two bills, and one of them is personally guaranteed, the bill personally guaranteed will be paid first--simply because that bill shall cause the owner personal liability and therefore is more urgent!
3. Cutting off work early. Nobody wants to quit a job or stop supplying a customer, but as a small business owner, you need to be careful not to extend credit for too much work/supplies, nor should you let the unpaid bills linger. Often, a customer may get further in debt trouble the longer your bill lingers. If you haven't been paid in 30 days, do not continue to supply services, material or labor, or you can be getting YOURSELF further indebted to your customers. Some of my clients used to take a "double down" gambling approach: they know they shouldn't keep supplying goods or services, but don't want to make their customer mad and have them walk away. The problem with this approach is that the more the customer owes you, the more desperate YOUR become, and the harder the debt becomes to pay. Get out early, and collect your debt--by lawsuit if necessary. My clients, under my advice, now cut off credit after 30 days and send accounts to me shortly thereafter. Some of their customers get upset, but in the past two years, many of their customers became insolvent--but we got paid because we called our accounts due while there was still money for us to be paid.
If you have questions about account collections or creditors' rights, please contact me for an appointment at 704-735-0483.
Many of my clients have told me that their business is down: fewer homes are being buit, materials purchased, real estate sold, and so on. This, of course, is no surprise, and many of my clients are currently retooling their business to help bring in additional income during these times.
But staying profitable isn't just about earning money off of new business; it also means that you need to get paid for the business you have already performed. It's easier to lose one job (and the potential income) than it is to perform the job, expend the effort, labor and materials, then not get paid. For many of my clients, it may take two or three paying jobs to cover the cost of one job for which they didn't get paid.
How, then, can you protect yourself so that you get paid for the work you do, so that you get paid?
1. Written contract. Many of my clients are subcontractors (brickmasons, graders, plumbers, etc.), who work on houses, and they rarely get a written contract with the person or company who hired them. However, this is very important. Obviously, a written contract will show proof there's an agreement, but that's the least important factor (after all, if you've done the work, that's proof as well). No, a contract is more important because it will outline the terms of what you are supposed to do, and when you can collect your money, so that your client can't hold you at bay (e.g., saying, "I'm not paying you until the house is finished by everyone"). Also, in North Carolina, you typically can't collect attorney's fees unless you have a contract providing for it, nor can you collect interest on late payments without an applicable provision in your contract. Sure, if you hire an attorney who successfully collects your fee, you're somewhat relieved; but you'll also be disappointed once you subtract his fee, and realize that your money could've been earning interest over the six months it took to collect. By contrast, a well-written contract could provide that the debtor has to pay you 15 percent attorney's fees and legal costs if you have to sue, and can provide for 18 percent annual interest on bills more than 30 days due.
2. Personal guaranty. Many clients simply do business with the "company," even if the company is a one-man operation. If you're doing business, attempt to wrangle a personal guaranty, in writing, from clients. In other words, if you don't get paid, the person with whom you're dealing should personally guarantee payment of the debt. If you're performing contract work for, e.g., Wachovia Bank, this may not be possible. But I suspect most of your clients are small businesses. These businesses' owners have to guarantee their bank loans; make them guarantee payment for your work. If a business owes two bills, and one of them is personally guaranteed, the bill personally guaranteed will be paid first--simply because that bill shall cause the owner personal liability and therefore is more urgent!
3. Cutting off work early. Nobody wants to quit a job or stop supplying a customer, but as a small business owner, you need to be careful not to extend credit for too much work/supplies, nor should you let the unpaid bills linger. Often, a customer may get further in debt trouble the longer your bill lingers. If you haven't been paid in 30 days, do not continue to supply services, material or labor, or you can be getting YOURSELF further indebted to your customers. Some of my clients used to take a "double down" gambling approach: they know they shouldn't keep supplying goods or services, but don't want to make their customer mad and have them walk away. The problem with this approach is that the more the customer owes you, the more desperate YOUR become, and the harder the debt becomes to pay. Get out early, and collect your debt--by lawsuit if necessary. My clients, under my advice, now cut off credit after 30 days and send accounts to me shortly thereafter. Some of their customers get upset, but in the past two years, many of their customers became insolvent--but we got paid because we called our accounts due while there was still money for us to be paid.
If you have questions about account collections or creditors' rights, please contact me for an appointment at 704-735-0483.
Minggu, 14 September 2008
The Art of Killing the Deal
I've had the privilege, in my business law practice, to work on transactions and cases with good lawyers not only in my own state, but in other states as well. Each state (and state's lawyers) brings with it its own subculture and quirks. However, I've never, until a recent transaction, worked with attorneys who seemed hell-bent on picking a deal apart until it died a painful death.
I'll caveat what I write next with the possibility that perhaps I and/or my client were played, and (for whatever reasons) were manipulated for reasons we don't understand. But assuming not, I'll try to provide a few non-identifying details. My client, a commercial contractor, has certain niche construction that it has perfected and gained a reputation for in that niche. So much so, in fact, that it has expanded its operations in numerous states all over the U.S.
My client is run by its astute owner, who understands his own risk tolerance. Therefore, in negotiations, once he's received my advice, he accepts some, and rejects other, and we tend to quickly come to agreements with the other party. We negotiate hard, but we're flexible--and my client has become very successful with this.
But this time things simply have not worked out, and they may now crash and burn. We sent the other party a standard document, and what usually would be a process of a couple of negotiating back-and-forths has turned, instead, into months of excrutiating negotiation from the attorneys, nitpicking over minutae, creating far-fetched scenarios to justify their extreme positions. The result of this is that my client may simply be unable to do a deal with this client, and because of the length of time in these ridiculous negotations may no longer be able to enter into this contract anymore. Here then, are my own thoughts about the role of an attorney in negotiating a business transaction.
1. The attorney's role is to inform and protect. Notice that I didn't say just to protect. Of course, an attorney is supposed to protect his client, but in a business transaction, the client needs to understand what is contained in the contract or transaction. I always tell a new business client something like this: "I can protect you in a contract so that you're as protected as you'd ever want to be--but nobody would probably ever sign it." The point is, a contract that is too one-sided in favor of my client would not be commercially reasonable. Therefore, I try to protect my client as much as I can, but there will be issues on which the other party will not budge (perhaps, for example, the seller of a business will only allow my client 30 days due diligence). My job then is to let my client know the tough spots, let him know the risks, and fully inform my client so that he can make an informed risk decision about what he should do.
2. The attorney's role is not to be a roadblock in the way of the client's goals. Business clients, espcially experienced ones, are not children. Your job as an attorney is not to protect a client from himself, and shouldn't argue and negotiate ad infinitim. Some attorneys seem to get some pleasure in negotiating, haggling, and fighting for even the most minute and unimportant provisions in the contract, mentally chalking up points for every single concession they've obtained. I don't know what the "opposing counsel" feels like the score is in the contract I've been working on, but to me, we both score a big fat zero when a perfectly good deal dies as a result of the lawyers. If you want to fight and beat up your opponent, be a litigator! Transactional attorneys are supposed to HELP their clients accomplish goals.
3. The role of a business attorney is to help a client achieve goals, not to thwart them. This particular client has big goals (as do many of my clients). My job is to help these clients meet their goals: by making sure they comply with applicable laws, by drafting contracts that protect them and by helping them perform careful analysis so their dreams do not turn into nightmares. Yes, there are times when it is my job to tell a client, as I did a week ago, that a particular deal SHOULD NOT be done. But with most deals and most clients, it is a balancing act whereby I try to help my client reach what is a workable goal on a workable deal, while protecting the client.
Does this mean that I'm a "yes man" for my clients? Absolutely not. I often have to tell clients that the way they want to do something will, e.g., violate a contract or will not comply with the law. But for a good business attorney, the work doesn't stop there. My job then becomes how to help my client still reach that goal WITHIN the constrictions of law, contract and all practical considerations.
I look back at my clients, and what they have accomplished, and I am proud that I can say I have had a role (however small) in these accomplishments. Do these lawyers to which I refer take pride in how many deals they've killed?
I'll caveat what I write next with the possibility that perhaps I and/or my client were played, and (for whatever reasons) were manipulated for reasons we don't understand. But assuming not, I'll try to provide a few non-identifying details. My client, a commercial contractor, has certain niche construction that it has perfected and gained a reputation for in that niche. So much so, in fact, that it has expanded its operations in numerous states all over the U.S.
My client is run by its astute owner, who understands his own risk tolerance. Therefore, in negotiations, once he's received my advice, he accepts some, and rejects other, and we tend to quickly come to agreements with the other party. We negotiate hard, but we're flexible--and my client has become very successful with this.
But this time things simply have not worked out, and they may now crash and burn. We sent the other party a standard document, and what usually would be a process of a couple of negotiating back-and-forths has turned, instead, into months of excrutiating negotiation from the attorneys, nitpicking over minutae, creating far-fetched scenarios to justify their extreme positions. The result of this is that my client may simply be unable to do a deal with this client, and because of the length of time in these ridiculous negotations may no longer be able to enter into this contract anymore. Here then, are my own thoughts about the role of an attorney in negotiating a business transaction.
1. The attorney's role is to inform and protect. Notice that I didn't say just to protect. Of course, an attorney is supposed to protect his client, but in a business transaction, the client needs to understand what is contained in the contract or transaction. I always tell a new business client something like this: "I can protect you in a contract so that you're as protected as you'd ever want to be--but nobody would probably ever sign it." The point is, a contract that is too one-sided in favor of my client would not be commercially reasonable. Therefore, I try to protect my client as much as I can, but there will be issues on which the other party will not budge (perhaps, for example, the seller of a business will only allow my client 30 days due diligence). My job then is to let my client know the tough spots, let him know the risks, and fully inform my client so that he can make an informed risk decision about what he should do.
2. The attorney's role is not to be a roadblock in the way of the client's goals. Business clients, espcially experienced ones, are not children. Your job as an attorney is not to protect a client from himself, and shouldn't argue and negotiate ad infinitim. Some attorneys seem to get some pleasure in negotiating, haggling, and fighting for even the most minute and unimportant provisions in the contract, mentally chalking up points for every single concession they've obtained. I don't know what the "opposing counsel" feels like the score is in the contract I've been working on, but to me, we both score a big fat zero when a perfectly good deal dies as a result of the lawyers. If you want to fight and beat up your opponent, be a litigator! Transactional attorneys are supposed to HELP their clients accomplish goals.
3. The role of a business attorney is to help a client achieve goals, not to thwart them. This particular client has big goals (as do many of my clients). My job is to help these clients meet their goals: by making sure they comply with applicable laws, by drafting contracts that protect them and by helping them perform careful analysis so their dreams do not turn into nightmares. Yes, there are times when it is my job to tell a client, as I did a week ago, that a particular deal SHOULD NOT be done. But with most deals and most clients, it is a balancing act whereby I try to help my client reach what is a workable goal on a workable deal, while protecting the client.
Does this mean that I'm a "yes man" for my clients? Absolutely not. I often have to tell clients that the way they want to do something will, e.g., violate a contract or will not comply with the law. But for a good business attorney, the work doesn't stop there. My job then becomes how to help my client still reach that goal WITHIN the constrictions of law, contract and all practical considerations.
I look back at my clients, and what they have accomplished, and I am proud that I can say I have had a role (however small) in these accomplishments. Do these lawyers to which I refer take pride in how many deals they've killed?
Sabtu, 06 September 2008
Venture Capital, Part Two
One of the biggest things to consider when entering into (either side of) a venture capital agreement is to determine whether the capital infusion will be treated as debt, as equity, or a mixture of both. I will write this article from the standpoint of the venture capitalist, although you, the reader, will quickly comprehend the different advantages and disadvantages for the recipient of the capital as well.
When providing venture capital for a startup, should you structure your capital as a loan to the company, as partial ownership in the company, or as some combination of both?
First, consider the advantages and disadvantages to treating the capital infusion as a loan.
Advantage One: Security. Venture capitalism is a speculative matter. That is, you, the capitalist, are putting money into a venture that may or may not succeed. If the business fails, will you get all, some or none of your money back? Part of that may depend on whether, if the business goes bust, you are treated as a creditor or as an owner. When a business becomes financially insolvent, any remaining assets or monies are typically paid out according to certain priorities. There are many nuances, but put simply, creditors will be paid before the owners. Therefore, if the business fails, you have a BETTER chance of getting paid if you have structured yourself as a creditor than if you have structured yourself as an owner.
Advantage Two: Protection. Similar to the first advantage described, structuring the transaction as a loan will give the venture capitalist more protection than as an equity owner. Often, the venture capitalist will not be involved with the day-to-day operation of the company. I have seen numerous instances in which the business operators mismanaged the funds of the "money partner," spending in a deficit until nothing was left. By structuring the capital as a loan--and more importantly, as a loan secured by collateral of the company--the venture capitalist can better protect against the squandering or liquidation of the assets. Using an example, say the operation is run by the two majority shareholders, and you, the venture capitalist, provided $250,000 for a 33 percent stake. If the majority shareholders, who saw the business was floundering, decided to start selling off the company property to keep funds coming (and to pay their salaries), they could do it. And if they did it quickly enough, you would not know about it soon enough to stop it. By the time the company went bust, there would be nothing left to divide. On the other hand, if you were a secured creditor, the shareholder/operators would be unable to sell off the company property without paying you off first (or at least, getting your permission to sell).
Advantage Three: Control. Believe it or not, being a creditor of the company may give you more control than being an equity holder. As a simple shareholder, you can be outvoted on many of the corporate decisions unless you are given a majority of the stock (which is unlikely). As a creditor, however, you can place certain restrictions within the initial loan agreement, such as:
1. Prohibitions against selling off the assets;
2. Prohibitions against the company owners taking excessive salaries or dividends;
3. Prohibitions against taking major company actions without the approval of the creditor.
Of course, there are disadvantages to treating the venture capital infusion as a purely loan transaction. The biggest, and most important, is that a loan limits the amount of profit that can be realized. A loan will contain interest, and some sort of repayment plan. At the end of the day, there is ceiling to what profit the creditor can realize. For example, if the venture capitalist provides a $100,000 loan for five years at eight percent interest,then the capitalist would know that, at best, he would realize a total profit of $21658.36--and that's if the loan is not paid off early! Remember too, that venture capital involves, quite often, higher than average risk, for which a venture capital should expect (if successful), a higher than average reward. There are easier ways to earn eight percent returns than by investing in risky ventures that may completely fail.
Owning equity in the company, of course, allows the venture capitalist a chance to share in both the risks and rewards of the start-up company. In theory, as an equity holder, the capitalist risks losing his investment if the company busts, but shares the potential reward with all other shareholders if the company succeeds.
The disadvantages to being an equity holder are, as you may guess, the converse to the advantages of lending shown above.
1. Security. If the company goes bust, an equity holder is the last in line to get paid from the remaining company assets (and usually, there are none by that time).
2. Protection and Control. As a pure equity holder, the capitalist will have less chance to exert control over the company, and stands a higher chance of being susceptible to abuse by the majority shareholders.
What then is the best approach? There is no solution that fits all, but a typical venture capital deal will try to combine the two approaches: that is, the venture capitalist's money is treated in part, like a loan, but also provides the capitalist an ownership interest in the company. The following are some of the provisions that may be found in this approach:
1. Typical loan provisions, that provide a promise to repay (a promissory note), as well as some sort of security (for example, a lien on company assets).
2. Restrictions that the company cannot take certain actions (selling all of its equipment, for example) while the loan is still outstanding.
3. Sometimes, a provision that, at a given time, part or all of the loan is converted into stock.
4. A certain amount of stock ownership.
5. A guaranteed director or number of directors on the company's board.
6. A shareholder agreement that the company may not issue additional stock without the venture capitalist's approval.
7. A provision that provides the start-up owners the right to buy out the venture capitalist or, conversely, a provision giving the venture capitalist the right to force his stock to be bought.
If you have questions about engaging in a venture capital agreement in North Carolina, please contact me for an appointment at wldeaton@ppd-law.com
When providing venture capital for a startup, should you structure your capital as a loan to the company, as partial ownership in the company, or as some combination of both?
First, consider the advantages and disadvantages to treating the capital infusion as a loan.
Advantage One: Security. Venture capitalism is a speculative matter. That is, you, the capitalist, are putting money into a venture that may or may not succeed. If the business fails, will you get all, some or none of your money back? Part of that may depend on whether, if the business goes bust, you are treated as a creditor or as an owner. When a business becomes financially insolvent, any remaining assets or monies are typically paid out according to certain priorities. There are many nuances, but put simply, creditors will be paid before the owners. Therefore, if the business fails, you have a BETTER chance of getting paid if you have structured yourself as a creditor than if you have structured yourself as an owner.
Advantage Two: Protection. Similar to the first advantage described, structuring the transaction as a loan will give the venture capitalist more protection than as an equity owner. Often, the venture capitalist will not be involved with the day-to-day operation of the company. I have seen numerous instances in which the business operators mismanaged the funds of the "money partner," spending in a deficit until nothing was left. By structuring the capital as a loan--and more importantly, as a loan secured by collateral of the company--the venture capitalist can better protect against the squandering or liquidation of the assets. Using an example, say the operation is run by the two majority shareholders, and you, the venture capitalist, provided $250,000 for a 33 percent stake. If the majority shareholders, who saw the business was floundering, decided to start selling off the company property to keep funds coming (and to pay their salaries), they could do it. And if they did it quickly enough, you would not know about it soon enough to stop it. By the time the company went bust, there would be nothing left to divide. On the other hand, if you were a secured creditor, the shareholder/operators would be unable to sell off the company property without paying you off first (or at least, getting your permission to sell).
Advantage Three: Control. Believe it or not, being a creditor of the company may give you more control than being an equity holder. As a simple shareholder, you can be outvoted on many of the corporate decisions unless you are given a majority of the stock (which is unlikely). As a creditor, however, you can place certain restrictions within the initial loan agreement, such as:
1. Prohibitions against selling off the assets;
2. Prohibitions against the company owners taking excessive salaries or dividends;
3. Prohibitions against taking major company actions without the approval of the creditor.
Of course, there are disadvantages to treating the venture capital infusion as a purely loan transaction. The biggest, and most important, is that a loan limits the amount of profit that can be realized. A loan will contain interest, and some sort of repayment plan. At the end of the day, there is ceiling to what profit the creditor can realize. For example, if the venture capitalist provides a $100,000 loan for five years at eight percent interest,then the capitalist would know that, at best, he would realize a total profit of $21658.36--and that's if the loan is not paid off early! Remember too, that venture capital involves, quite often, higher than average risk, for which a venture capital should expect (if successful), a higher than average reward. There are easier ways to earn eight percent returns than by investing in risky ventures that may completely fail.
Owning equity in the company, of course, allows the venture capitalist a chance to share in both the risks and rewards of the start-up company. In theory, as an equity holder, the capitalist risks losing his investment if the company busts, but shares the potential reward with all other shareholders if the company succeeds.
The disadvantages to being an equity holder are, as you may guess, the converse to the advantages of lending shown above.
1. Security. If the company goes bust, an equity holder is the last in line to get paid from the remaining company assets (and usually, there are none by that time).
2. Protection and Control. As a pure equity holder, the capitalist will have less chance to exert control over the company, and stands a higher chance of being susceptible to abuse by the majority shareholders.
What then is the best approach? There is no solution that fits all, but a typical venture capital deal will try to combine the two approaches: that is, the venture capitalist's money is treated in part, like a loan, but also provides the capitalist an ownership interest in the company. The following are some of the provisions that may be found in this approach:
1. Typical loan provisions, that provide a promise to repay (a promissory note), as well as some sort of security (for example, a lien on company assets).
2. Restrictions that the company cannot take certain actions (selling all of its equipment, for example) while the loan is still outstanding.
3. Sometimes, a provision that, at a given time, part or all of the loan is converted into stock.
4. A certain amount of stock ownership.
5. A guaranteed director or number of directors on the company's board.
6. A shareholder agreement that the company may not issue additional stock without the venture capitalist's approval.
7. A provision that provides the start-up owners the right to buy out the venture capitalist or, conversely, a provision giving the venture capitalist the right to force his stock to be bought.
If you have questions about engaging in a venture capital agreement in North Carolina, please contact me for an appointment at wldeaton@ppd-law.com
Sabtu, 23 Agustus 2008
Venture Capital, Part I
A client came to me last week with the opportunity to be a venture capital investor in a small start-up company. He knew how much he wanted to invest, had some clear ideas about what he wanted back out of the company, and then left it to me to prepare a venture capital agreement.
Venture Capital is simply a term for money obtained by a company that needs to change its position. Perhaps that position is that it needs to actually get started ("start-up capital"). Perhaps the company is on the verge of collapse. Often, as in this case, an already-existing company needs additional money in order for it to successfully grow in order to keep up with its new business.
Often, the business can raise money by debt--that is, by borrowing money (either from a bank or from private lenders). But borrowing, however, is tied in with risk--and most lenders do not want an exceedingly risky loan. If a business is brand new, or is getting ready to expand or change direction, there may be certain risks involved such that a traditional lender is unwilling to take the loan risk, considering that its return would likely be somewhere between six and ten percent per year.
On the other hand, there are investors who may be willing to invest their money or capital in riskier propositions--if they believe the risk will be appropriately rewarded. These are venture capitalists. These investors quite often will infuse money into a company that may have more risk, in return for the possibility of greater reward. In the next few blog posts, I'm going to discuss items to consider if you're asked to invest capital into a small or start-up company. But for today, the major considerations are as follows:
1. Debt versus Equity: Is your investment going to be treated like a loan, like ownership in the company, or like a mixture of the two?
2. Period of the investment: Is this open-ended, or do you want a specific time-frame in which your investment return should be realized?
3. Control: What rights of control will you have in the company?
4. Operation of the Company: What can the company do with your money? How much can the owners pay themselves?
Hopefully, this discussion will help both potential investors, as well as company owners looking to find investors.
Venture Capital is simply a term for money obtained by a company that needs to change its position. Perhaps that position is that it needs to actually get started ("start-up capital"). Perhaps the company is on the verge of collapse. Often, as in this case, an already-existing company needs additional money in order for it to successfully grow in order to keep up with its new business.
Often, the business can raise money by debt--that is, by borrowing money (either from a bank or from private lenders). But borrowing, however, is tied in with risk--and most lenders do not want an exceedingly risky loan. If a business is brand new, or is getting ready to expand or change direction, there may be certain risks involved such that a traditional lender is unwilling to take the loan risk, considering that its return would likely be somewhere between six and ten percent per year.
On the other hand, there are investors who may be willing to invest their money or capital in riskier propositions--if they believe the risk will be appropriately rewarded. These are venture capitalists. These investors quite often will infuse money into a company that may have more risk, in return for the possibility of greater reward. In the next few blog posts, I'm going to discuss items to consider if you're asked to invest capital into a small or start-up company. But for today, the major considerations are as follows:
1. Debt versus Equity: Is your investment going to be treated like a loan, like ownership in the company, or like a mixture of the two?
2. Period of the investment: Is this open-ended, or do you want a specific time-frame in which your investment return should be realized?
3. Control: What rights of control will you have in the company?
4. Operation of the Company: What can the company do with your money? How much can the owners pay themselves?
Hopefully, this discussion will help both potential investors, as well as company owners looking to find investors.
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