Business formation is more than just registering your name; it’s also planning for every eventuality to make your business work for you. Despite the importance of creating an LLC or other entity for a new company, many owners opt to download form documents from the internet, assuming these will provide all the protection they need.
The worst thing about a DIY approach isn’t that it’s filled with holes and cracks, but that owners have no way of knowing that those holes and cracks exist. The documents might work for somebody’s business, but they might not work for you—and you won’t know that without someone who knows the law.
As a corporate law attorney, I have seen some great (and not-so-great) corporate documents cross my desk. When it comes to business entity formation, I recommend three key factors that owners and partners need to address FIRST:
Many business owners are working so furiously to bring their products to market that they haven’t considered whether they will be able to stay in that market. Capitalizing the business is definitely important, but you need an accurate business and financial plan that accounts for every line item (marketing costs, legal costs, tax costs, etc.) and how you will create enough revenue to support these requirements on an ongoing basis.
Of course, the more profit you generate, the more likely you are to lose that profit to lawsuits, unforeseen costs, and taxes. For example, Florida has a corporate liability statute telling business owners how they can collect, use, and repay investor funds. If your neighbor gives you $5,000, he’s going to want that back eventually—and he may not be understanding if the first year of your profits are spent on overhead.
I’m not talking about hurricanes or flooding (which you should definitely be insured against), but rather the most common problems that arise and threaten a business. When two or more people come together to create a business, they often assume that they will agree on everything and don’t need a written agreement to guide them. So many problems can be avoided ahead of time if partners create an enforceable operating agreement or bylaws that cover theFive Ds: Death, Disability, Divorce, Distress, and Disagreement.
Believe it or not, the Disability or Death of a business partner may not be the worst things that can happen throughout the life of your company. At some point, you and your partner will have differing opinions on the best way forward. Disagreement is especially likely if two people working together have different specialties, such as one engineer and one marketing professional. You need clear rules about how disputes will be handled and the options for resolving tension without hurting the business relationship.
Divorce can also have a significant impact on business interests. The most trusted advisor to a small business owner is the accountant, but a close second is the owner’s spouse. Depending on the structure of the business, a spouse may know everything about the company but have no say in day-to-day operations—or the spouse could inherit the business with no idea how it is (or should be) run. You need to be clear about the role any spouse will play in the business and how big a spouse’s profit share will be. Business formation is also vital for keeping marital assets separate from corporate assets, preventing spouses from claiming part of the business in divorce proceedings.
Finally, Distress needs to be addressed at the very beginning of formation. This doesn’t just include a “bad quarter” or lower profits than usual at Christmas; financial hardship that comes from outside the business can impact profits for years to come. For example, your opening value skyrockets, and your business partner uses his dividends to buy a house. Now that the market has settled, your partner’s personal spending is way over his head. As a result, he may start making business decisions that are lucrative in the short term, ignoring the effect they will have on the company in the long run.
I once had a client who started a business with his former employer. My client was an attorney himself, so he drafted his own business documents. Unfortunately, he did so by using a mix of old documents and some downloaded from a variety of websites, editing them to suit the purpose. I looked them over and found a number of problems. First, since the client adopted an a la carte method, the boilerplate documents referenced other forms and clauses that were not included in the plan. Imported text also attested that a certain law firm was hired to draft the documents, which it wasn’t. To make matters worse, there was no document on file acknowledging the potential for an ethical conflict of interest between the two parties and their previous employer-employee relationship.
When I meet with new corporate clients, I always ask, “Are you going to be running this business until you retire?”
Indeed, only a fraction of a percentage of those prospects have considered the answer to this question.
Assuming your business has been properly organized and capitalized to survive past the five-year mark, what happens next? If someone leaves, how will the role be filled? If your goal is to sell, how are profits distributed? What happens if you want to stay on as an administrator after retirement, stay in the same role, or serve as CEO?
Many people have no idea. They haven’t even prepared for the teen years of their business, let alone what the far future will hold. The surest way to success is to begin with the end in mind. All it takes is a little math, some critical thinking, and a lot of experience to help you meet your goal retirement age.
As you can see, a failure to form your business entity correctly can cost you five times as much as doing it right from day one. Our Florida business law team is standing by to spot potential problems and guide you on your new path. Call Yolofsky Law today to get answers to your questions.