Legal Misfortune: Accepting the Deal That Is “Too Good to be True” Just May Cost You

Legal Quick Tip
by Furnari Scher LLP
Legal Misfortune: Accepting the Deal That Is “Too Good to be True” Just May Cost You
We represented a client who agreed to sell his electrical contracting business to a competitor. The price he was to receive for the business actually exceeded the client’s expectations, so he was both anxious to close the transaction and hesitant to raise any issues during the sales process that might cause the buyer to have second thoughts.

Because of the nature and location of the client’s business, the client maintained a very specialized license to perform certain types of sophisticated electrical work. As the negotiations on the transaction progressed, the buyer discovered that it would take several months (if not longer) to apply for and obtain these same licenses and made initial overtures into trying to get out of the deal. In order to salvage the deal, the client wanted to allow the buyer to use his name and license after the closing until such time as the buyer was able to obtain its license. We advised the client that this entailed substantial risks, as he would still be personally liable for the work done on the jobs after the closing by the buyer as if the client were still the owner of the business. However, the still felt that the deal was too good to walk away from and was willing to take the risk.

We were able to convince the client, and subsequently the buyer, that the best way to handle the situation was to have the seller enter into an employment agreement with the buyer for a term to last until the buyer obtained its license or one year, whichever occurred first. This would allow the buyer the flexibility to use the client’s license. However, if the client was terminated for any reason (other than for good cause), the client would have the right to immediately terminate the licenses. We also insisted that the buyer indemnify and hold our client harmless from any and all loss or liability incurred by our client as a result of work done by the buyer under the Seller’s license. In addition, the buyer had to agree to (a) allow the client to have the right to control any corrective proceedings that may be required as a result of any violations that were filed against the license due to the buyer’s conduct, and (b) cover all costs and fees associated with the licenses (renewals, etc.), as well as the costs of maintaining an umbrella liability insurance policy for the benefit of the client.

By having a competent business attorney advise him, our client was able to both salvage his deal with the buyer and minimize his risk going forward after agreeing to an extraordinary concession in the buyer’s favor.

Learn about 7 Deadly Legal Mistakes that cost entrepreneurs thousands. Visit www.7deadlylegalmistakes.com to get a copy of our free mini course.

Legal Misfortune: Always Be Aware of Potential Broker Fees

A client was looking to purchase a specific type of business (or, in the alternative, a suitable property upon which to build his new business) and engaged a broker on an exclusive basis in order to assist him in identifying and locating a business or property. According to his agreement with the broker, the brokerage fee was to be paid by the seller and/or any brokerage firm engaged by a seller in connection with the proposed transaction; however, the closing of any transaction was conditioned upon such seller or other broker agreeing to pay the fee.

The seller had also engaged a broker to locate a potential buyer for the property on behalf of the seller. Soon thereafter, the client viewed a business property that he subsequently decided was suitable for his needs. When our client viewed the property, he signed an acknowledgement from the seller’s broker stating that he had viewed the property. The client determined that he wanted to buy the business in question and the seller’s counsel set out to draft a purchase agreement. When we received the initial draft of the agreement, however, there was no mention of the seller’s broker or the fact that they were owed a fee as a result of the transaction. Because of this, there was a risk that the seller’s broker could delay or otherwise threaten to disrupt the closing of the transaction unless and until its fee was paid.

After reviewing the agreement and raising the issue with seller’s counsel, it was discovered that seller was exploring ways to not pay its broker since it already had to pay the fee owed to the client’s broker. Not only did this threaten the closing, but exposed the client to a potential suit after the closing from the seller’s broker. It was decided that the only way the client would allow the deal to move forward was if the seller agreed in the contract to pay all broker fees at the closing and to indemnify and hold the client harmless from any and claims, suits and actions that any broker may bring after the closing seeking to paid a fee as a result of the sale.

Seller agreed with the conditions and the transaction was successfully closed. Without an attorney to review the agreement and advise the client of his options regarding the broker fees, the client may have faced a lawsuit either before or after closing from a broker looking to rightfully receive his fee.

Learn about 7 Deadly Legal Mistakes that cost entrepreneurs thousands. Visit www.7deadlylegalmistakes.com to get a copy of our free mini course.

Business Contracts in Your Personal Name = Bankruptcy

This article is part of a series of stories about the tragic consequences that can result from common (and easily avoidable) legal mistakes that many entrepreneurs make. These are real-life examples that we have seen in our business law practice.

I received a call this week from Jane, an entrepreneur who was shutting down her business. Two years ago, Jane created a company to distribute fabric made from organic and renewable resources using farming methods that had a low environmental impact. She sold wholesale to apparel manufacturers.

This was Jane’s dream business.

I’m sure you can guess how the demise of her business played out. The Dow plummeted, credit dried up, consumers had little money to spend on fashion, and everyone from retailers straight down to the suppliers was crushed.

Suddenly, a once clever (and socially responsible) product niche became a luxury, not a necessity. Jane’s market dried up.

When Jane started the business, she rented a small commercial office space in an office building in Manhattan.

At the time, Jane was going back and forth with her accountant about the best corporate entity for her to use (LLC or S-Corp). In the interim, the rental agent played some high pressure games with Jane. Fearing that she would lose the office while waiting for a corporation to be formed, she signed the lease in her personal name.

This situation is frequently how business owners get burned. Before organizing their corporate entity, in the rush to get things off the ground, they make contractual commitments in their own name. Problem is, if business goes bad, you are still personally on the hook for the failed business’ debt.

This is particularly dangerous for the entrepreneur whose business has a high cost of goods sold. For example, if you have a business where you purchase expensive inventory or supplies on credit, the cost of which is built into the price you charge your customer, if you shut your business down and no longer have customers to pay for the debt, you’ve got a problem on your hands. If you’ve signed for the credit personally, the debts may be much higher than what you could ever afford to repay from your salary if you then go out and get a 9-to-5 (which is what Jane did).

In Jane’s case, she has 11 months left on her lease, or about $14,000 owed to the landlord. While not the biggest business debt, together with the other debts she incurred as a result of her failing business, it has pushed her very close to filing for bankruptcy.

With a quick incorporation that could have been done for $250 by LegalZoom or around $1,250 for a lawyer, Jane would have avoided this mess.

While your vendors and suppliers may be cautious with extending credit to businesses without personal guarantees, there are always other vendors and suppliers who are hungry for your business—especially in this market. Insist that they live with only the corporation being liable for business debts, otherwise, take your business elsewhere.

Learn about 7 Deadly Legal Mistakes that cost entrepreneurs thousands. Visit www.7deadlylegalmistakes.com to get a copy of our free mini course.

Legal Misfortune: Banned From Selling Securities

This article is part of a series of stories about the tragic consequences that can result from common legal mistakes that many entrepreneurs make. These are real-life examples that we have seen in our business law practice.
To circumvent the work of finding potential investors by networking within his personal network, one of our clients purchased a list of accredited investors and began cold-calling the list to see if they were interested in investing in his company. One of the persons he called complained to his state’s attorney general, an investigation ensued, and this person and his company is banned from ever selling securities in that state again.
The mistake could have been avoided with a 10 minute call to a securities lawyer (approximately $50) who could have instructed the entrepreneur how to legally approach the investors on the list that he purchased.
Learn about 7 Deadly Legal Mistakes that cost entrepreneurs thousands. Visit www.7deadlylegalmistakes.com to get a copy of our free mini course.

Legal Misfortune: $20,000 in Legal Fees to Fix “Technical Mistake”

This article is part of a series of stories about the tragic consequences that can result from common legal mistakes that many entrepreneurs make. These are real-life examples that we have seen in our business law practice.
One of our clients permitted their employees to help them find investors, which is legal under certain conditions. As an incentive to getting the job done, the company paid the employees extra compensation, but only if they closed sales of securities—a technical, albeit, illegal, mistake. The company was forced to disclose this information to state and federal regulators, ensuing in an extensive investigation.
Our client was in the middle of raising capital from angels and had to put the offering on hold until it could resolve the problem. Government regulators are notoriously slow when dealing with these types of violations, and the investigation took us six months to resolve.
Afterwards, angels who had previously been interested in the company were too nervous to invest.
The company ultimately filed for bankruptcy and has remained dormant ever since.
Had they worked with counsel to put a procedure together to avoid this mistake (approximately $2,000 in legal fees), bankruptcy may have been averted.
Learn about 7 Deadly Legal Mistakes that cost entrepreneurs thousands. Visit www.7deadlylegalmistakes.com to get a copy of our free mini course.

Legal Misfortune: “Playing Lawyer”: Lost $1,000,000 of VC Funding

Entrepreneurs are boot-strappers, often with shoestring budgets requiring them to use (or develop) new. I’ve been there. I’ve designed websites, set up computer networks, designed logos and graphics, built walls and installed tiles to move my businesses along.
In the long run, I built a lousy website, did not have adequate backup when the network crashed, my logos looked like clip art, my walls were not level and my tiles cracked.
Thankfully my legal skills are much better than my other “professions”.
We self sufficient entrepreneurs often try to “play lawyer” much like I tried to “play computer network professional”. That is, until the network crashed and my business was shut down for two days. So much for the money I thought I saved by doing it myself.
Playing lawyer is a high stakes game, especially for a growing business. Often times, a legal task (like drafting a contract) that would have cost less than $1,000 to complete, can turn into a 7-figure tragedy.
Business lawyers frequently advise clients to complete certain legal actions in their business. You should have written agreements with vendors. You should have IP assignment agreements with your employees and consultants. You should maintain proper books and records and follow corporate formalities. You should have contracts with your partners. Sometimes I think that business lawyers fail to connect the dots for clients about what could happen if they fail to do these things. I’ve certainly been guilty of this.
In this market when investment capital has all but dried up and M&A deals are largely on ice, growing companies can’t afford to have legal screw-ups jeopardize a potential opportunitiese. You may not get another chance.
For the next month or so, I am going to share with you some real-life examples of how “playing lawyer” cost entrepreneurs major opportunities.
Here’s one to get you started:
To “save money” on legal fees, one of our clients failed to consult with an attorney while raising the initial capital for his business. The client sold shares of his company’s common stock without first increasing the company’s authorized shares, essentially, selling stock that didn’t exist--which is fraud. The client was close to closing a critical financing with an VC investor for up to $1 million in funding. When the investor discovered the problem, he got cold feet and took the offer off the table. Additionally, the mistake cost the company $10,000 in legal fees to remedy the problem. Incidentally, the cost to amend the company’s certificate of incorporation, including legal fees would have been no more than $500.
Learn about 7 Deadly Legal Mistakes that cost entrepreneurs thousands. Visit www.7deadlylegalmistakes.com to get a copy of our free mini course.

"Incorporating" an Opportunity

Last week I mentioned that I own another company called Law Firm Incubator Suites (www.lawfirmsuites.com), a professional office suite business. Essentially, we lease a large commercial office space and rent individual offices to lawyers and other professionals. When I started the business, I had to make an assessment about the best corporate entity to use. The analysis I completed for my business is the same that I use my law practice with our clients.
Essentially for this business, I had three choices, work as a sole proprietorship, as a limited liability company or as a corporation.
In a sole proprietorship your personal assets are not protected from the creditors and liabilities of your business. Essentially, if the business gets sued and you lose, your personal assets like your car and personal savings are at risk.
In my real estate business, I have many vendors and I rent office space to several people. I have employees and there are guests who visit the office who could possibly get injured. All these items are potential sources of liability and I didn’t want to be on the hook personally for any business-related debts or lawsuits.
Even more importantly, one of my goals is to build the business and sell it. There’s also a good chance that I may need to raise capital to grow the business down the road. Both would be tough to do as a sole proprietorship.
Ultimately, working as a sole proprietorship was not an option.
An LLC’s management is governed by contract (as opposed to a corporation that is governed by statute). This makes the LLC very desirable when thre is more than one owner. Essentially, contracts can be much more flexible than statutes. Also, in an LLC, business income is taxed at your personal tax rate only. In a corporation, business income is taxed once in the corporation and a second time if you distribute any of the remaining profits to owners through a dividend.
Since I was going to be a one-man-army, I didn’t need the flexibility management that an LLC provides, and my business is qualified to make a S-Corp election (preferential tax treatment for certain small businesses). This allowed me to get the same one-time tax treatment as the LLC.
Also, the State of New York requires that all LLCs publish the formation of the LLC in a local and regional newspaper for six weeks, and make an additional filing with the state when you complete the publishing. For me, the added expense would have been about $1,800. Since my business was going be located in New York, I decided to save my money and form a corporation.
When I filed my Certificate of Incorporation with the Secretary of State via fax, I requested 24-hour expedited service. If you get your documents in before 2PM, your business will be organized by the next day. If you do not use expedited service, it can take 10 to 15 business days to process your filing. The extra cost for expedited service was $25--money well spent. FYI, you can also pay for same-day ($75) and two-hour expedited service ($150).
I filed, and got my response the next day. LFIS, Inc. was officially organized.

The Office Lease: Practical Considerations

In addition to running my law practice, I own a business that is the leading provider of professional office space for solo attorneys and small law firms (www.lawfirmsuites.com). I was recently signing a lease with my landlord for additional space, and I thought I would share some of the concerns I had from an entrepreneurial perspective rather than a pure legal one.

In addition to the obvious things like price per square foot and term, here are some key business items that were important to me:

Option to Renew. I was getting a 10-year lease. However, if I end up selling my business, it will be far more valuable to the buyer if there is an option to renew the space. If the commercial real estate market is hot when the lease expires, the landlord could ask the business to leave after the lease expires. If suitable space is not available, there's no business. The option buys the business another 5 years.

Landlord's Obligation to Pay Build-out Expenses. The landlord is paying for the build-out (well, actually, I'm paying for the build-out over time, he's fronting the cash). I needed to make sure all the work I needed him to do (and pay for) was in the lease. Also, I wanted to make sure that my payment obligations under the lease began when I could take possession, not when he started contruction (and thus be at the mercy of his construction crew. I know from experience, there's no renegotiating after the lease is signed.

Limited Personal Guaranty. My landlord won't rent to a closely held corporate entity (LLC or Corporation owned by a small group of people) without a personal guaranty from the owners unless he gets six months security deposit. Not exactly the best use of cash. That being said, what I guaranteed was that I would (personally) pay the rent if the business stopped paying the rent and didn't vacate the premises under the "Good Guy Clause".

Good Guy Clause. Without getting technical, it's a clause in your lease that lets you surrender the space without further personal liability to the landlord under your personal guaranty if the business is unable to continue to pay for it. The business is still “on the hook” for the full term of the lease, but I am not personally.

Relocation Rights. If we grow rapidly and need more space, our lease permits us to relocate a smaller tenant to a similar space in the building at our own expense. Of course, this right is usually reciprocal. Another tenant bigger than us may like our view better!

Assignment Rights. Again, if the business is sold, I don't want hassles with the landlord about lease assignments to the buyer. I have a good relationship with the management company and they are very flexible. But buildings get sold and you're always just end up stuck with your lease terms. I couldn't negotiate assignment without the landlord's consent (no sane landlord would permit this), but I got terms that won't hold up a deal if I find a buyer.

One more thing--and this was a surprise to me when I signed my first commercial lease--when you rent commercial space, you rent bricks and glass. Literally. When your landlord calculates the square footage of your space, they measure from the outside of the building not from the interior wall, plus, you pay for your space's pro rata share of common spaces, like the lobby, corridors, restrooms, elevators, mechanical rooms, etc. The percentage of the space that you are renting that is not the physical space in your office is called the "loss rate". The loss rate in my building is around 33%, I've heard about some buildings where the loss rate is 65%.

Learn about 7 Deadly Legal Mistakes that cost entrepreneurs thousands. Visit www.7deadlylegalmistakes.com to get a copy of our free mini course.

Organize Your Business Where in The State Where You Are Located

Entrepreneurs starting businesses frequently have notions about organizing their companies in distant jurisdictions. Delaware and Nevada tend to be the jurisdictions of choice for many large companies and start-up entrepreneurs sometimes follow suit.
If you are a large business with many shareholders, or maybe even a public company, there are some legal advantages management may have by organizing in one of these states. However, for most businesses, there is no discernable advantage to organizing elsewhere.
For most businesses, the effect of organizing in a state other than the one where your business is located merely increases your costs. For example, if your business is organized in Delaware as an LLC but it is operating only in New York, not only do you have to pay filing fees, franchise taxes and fees for a registered agent in Delaware, you are also required by law to file as a foreign entity in New York, which includes meeting New York’s publishing requirement (approximately $1,300 in New York County). Essentially, you’ve doubled your start up fees for no appreciable advantage.
If down the road your business grows and there is a material advantage to organizing in a different jurisdiction than your home state, you can change the businesses’ organization state inexpensively through a simple migratory merger. At that point, your business should be in a better position to absorb the extra costs.
Learn about 7 Deadly Legal Mistakes that cost entrepreneurs thousands. Visit www.7deadlylegalmistakes.com to get a copy of our free mini course.

Employment Agreements Not Required for Employees

One of our new clients is a software company that develops trading programs for financial services firms. We were helping them negotiate a 7-figure investment from one of its clients, a major investment bank.

In becoming familiar with our new client, it seemed odd to us that every employee had an employment contract, including the receptionist. When we inquired with our client, the CEO asked, “aren’t we required to have employment agreements with all employees?”

In every job the CEO prior to founding the company, had he always employed pursuant to an employment contract. He just assumed that this was the way business was done.

While it may be advantageous to enter into employment contracts with certain executive level employees or staff with very special skills, in most cases a contract is not necessary and is probably disadvantageous to management.

New York State is an “at will” employment state. This means that employees can be hired and terminated for any reason or for no reason, and at any time, without liability to the company.

Employment contacts alter this “at will” policy, which may give employees more rights than
what was available under the “at will” doctrine. This may expose the employer to liability if the employee was terminated in breach of his or her agreement.

Even though an employment agreement is not required, in businesses where employees are creating any form of intellectual property for the company, it is imperative that the company have the employee enter into an “assignment of inventions” agreement. This is not an employment agreement, but an agreement where the employee irrevocably assigns his or her right to any intellectual property they create for the company while employed there. Without is, in most cases, the employee (not the company) owns any inventions or IP it creates while on the job.

Are you making legal mistakes that can shut your business down? Learn about 7 Deadly Legal Mistakes that cost entrepreneurs thousands. Visit www.7deadlylegalmistakes.com to get a copy of our free mini course.