Ann Arbor Area BUSINESS MONTHLY magazine brings the reader the latest business news and information important to the businesspeople in Washtenaw County. Each month articles cover real estate, legal, Internet, employee concerns and the climate of business in the greater Ann Arbor area. There is news about company employees and feature articles on local businesses. We cover business news from Ann Arbor, Chelsea, Dexter, Manchester, Milan, Saline, Whitmore Lake, and Ypsilanti.
Legal Advice Critical
To All Businesses
Fred Steingold (left) and Michael Schroer of Hamilton, Judge, Schroer & Steingold, PLC
By David Baker and Margaret Baker
Without counsel plans fail, but with many advisers they succeed.
Proverbs 5:22
Good legal advice is essential to running a successful business. We wondered what are core legal considerations involved in starting or running a business.
We spoke with four Ann Arbor area business lawyers and asked them to provide advice to entrepreneurs who are either running or plan to start a business.
Uzma Ahmad, J.D., Dykema Gossett PLLC (uahmad@dykema.com)
Ahmad received both her A.B. and J.D. degrees at Harvard and practiced law in Pennsylvania and Massachusetts prior to joining Dykema in Ann Arbor in 2006. Ahmad advises entrepreneurs on mergers and acquisitions and general corporate matters. She also serves on the board of the New Enterprise Forum (www.newenterpriseforum.org), an Ann Arbor-based non-profit organization that helps entrepreneurs prosper and grow. "I'm involved with the entrepreneurial community," Ahmad notes, "and I work with companies of all sizes and at all stages of the company life cycle."
Robert F. Magill, Jr., LLB, LLM, MaGill & Rumsey, P.C. (bmagill@magillrumsey.com)
Magill is a graduate of Williams College (A.B.) and Harvard Law School (LLB) and New York University School of Law (LLM), and has practiced law in Michigan since 1973. Magill's work is primarily in litigation, business transactions and real estate. "Working with entrepreneurs and small businesses is fun. Much of my practice, particularly early on, dealt with litigation and, consequently, small businesses. Seeing early in my career the litigation problems small businesses can face really helped prepare me to advise entrepreneurs in setting up a new business or preparing to buy or sell a business."
Michael Schroer, J.D., Hamilton, Judge, Schroer, & Steingold, PLC
(mschroer@a2mich.com)
Schroer earned his B.S. from The Ohio State University and his J.D. from Ohio Northern University Pettit College of Law. Schroer has been with the practice since 1994. He provides counsel to his clients in estate planning, probate work, and small business work, in addition to his practice in family law, real estate law, construction law, litigation, and mediation & arbitration. "I have a number of clients who are contractors, so I combine my small business experience with advice to contractors and sub-contractors."
Fred S. Steingold, J.D., Hamilton, Judge, Schroer, & Steingold, PLC (fsteingold@att.net)
Steingold received both his B.A. and J.D. from the University of Michigan. Steingold advises clients primarily in small business and real estate law, although he also has in-depth experience with wills, trusts, and probate; litigation, and mediation. He is the author of Legal Guide for Starting & Running a Small Business, published by Nolo Press. "For many years I had my own practice in Ann Arbor," Steingold explains, "and then joined up with Hamilton, Judge, and Schroer in 2008."
10 TIPS FOR SMALL BUSINESSES
Our four experts collectively identified ten tips for entrepreneurs in handling legal matters for the business. The discussion that follows is a general consideration of common legal issues. Comments from these lawyers are not intended to replace legal advice. These experts always encourage entrepreneurs to discuss their legal issues with a lawyer.
1. Get Legal Counsel Early
Whether you currently run a business or are planning to start one in the future, be sure to seek legal counsel early on in the process. Don't rely on an article or conversation you had at a networking event. It costs little to have an initial conversation with counsel to evaluate how much a lawyer can contribute to your business, so you should at minimum have that initial consultation.
Magill: "The very first piece of advice I offer when speaking with an entrepreneur is this: don't be cheap about setting up your organization. See a lawyer. You can incorporate or create an LLC online, but it's the bylaws, the operating agreement, how stock is handled, etc. And not just a lawyer; get one with considerable business experience. A good place to start a search is the Business Law Section of the State Bar of Michigan."
Steingold: "If you see a dispute on the horizon, it's good to get some legal direction on how it can get resolved. Most disputes can get resolved without going to litigation. You need to know what your legal position is and what the alternatives are for resolving the dispute, including mediation or arbitration. These solutions are often quicker, less expensive, and less bruising. We often help clients with mediation and arbitration, as well as litigation."
2. Shield Personal Assets
A surprising number of entrepreneurs fail to structure the business entity and, instead, operate as a sole proprietorship or assumed name.
Schroer: "The most important thing you should do is protect yourself from personal liability. Of course, your business is going to have liability to its customers and to people who come upon the business premises, but if you create a corporation or LLC, your personal liability will be limited to your investment in the business and the business assets. Limiting your personal liability is an essential first step in starting a business."
Magill: "I usually recommend a corporation, which could be C corporation or subchapter S, or an LLC. Both have limited liability pass-through taxation. The subchapter S has a few more rules, such as who can be a member, but it allows you to pass some of the earnings through as dividends at the lower tax rate. I like the LLC, though, because it's a bit more flexible. I don't recommend a partnership. Of all the business forms, a partnership is the one with the most technical and difficult nooks and crannies. It's got a special set of rules, and some of them are counterintuitive. If you insist on a partnership, why not consider an LLC which at least has some protection? "
Ahmad: "Some entrepreneurs get caught in the situation of operating as a sole proprietor because it's low cost and it does not require a lot of paperwork. Filing for an assumed name or filing a simple registration is easy. Others just fall into it, organically growing the business out of activities they may have started as a side business and never thought to take a formal step. What they may not realize is that their personal assets, such as their home or their car, are at risk just as the business assets will be at risk. As lawyers, we really advise people to take time to look at their options."
3. Watch Out for Inadvertent Partnerships
If you're not careful, working closely with another party could actually turn into an inadvertent partnership.
Magill: "This is a situation where you can be found to be a business form even though you didn't intend to do so. If you agree to work with another party where there is co-ownership and shared profits of an arrangement, it's a partnership, and all the rules of a partnership apply. In effect, you've inadvertently chosen an entity off the shelf that fell on top of you and draped you even though you didn't want it."
4. Ensure Good Corporate Governance
Structuring your company as a subchapter S corporation or an LLC is not sufficient. You need also to run the business as a clear, discrete separate entity. Many entrepreneurs fail to do this correctly.
Steingold: "To have that protection from liability, entrepreneurs must take steps to keep their entities separate from themselves. For example, if a person has a corporation, he or she should sign business contracts as an officer of the corporation. He or she should also use a separate bank account for corporate funds. We try to educate people on the things they need to do after they've created a corporation or LLC."
Ahmad: "Good corporate governance can mean a variety of things depending on how the business is organized: a robust board of directors who meet and carry out their role as a board; an advisory board with technical or industry expertise; and maintaining good corporate records, such as contracts and conflicts of interest policies. There's a good deal of research conducted that demonstrates that good corporate governance actually helps maximize the value of growing companies. So it makes sense from day one to put the infrastructure in place."
Magill: "You need to run the company so that the veil is not pierced and the company loses its shield. Somewhere around 40% of court challenges result in a pierced veil. There's a federal case I have now where the court is willing to pierce the veil to hold one of the parties personally liable. Key factors leading to a pierced veil include undercapitalization, failure to keep governance formalities, a low number of shareholders (under 10), and misrepresentation."
5. Don't Mischaracterize Employees
There may be some advantages to working with independent contractors for some areas of your business. Be careful, though, that you're not mischaracterizing employees as contractors.
Ahmad: "The IRS has set aside funds earmarked to pursue employers who have mischaracterized their employees as independent contractors. The IRS has a test to determine whether someone is an employee or a contractor. An entrepreneur can look at this issue upfront and make sure that contractors are correctly handled, including having proper agreements. If you don't do this upfront, you can wind up with a more complicated problem accompanied by penalties, back taxes, and other issues.
6. Be Aware of Your Hats
Entrepreneurs often take on many roles in building and operating a company. Sometimes these roles present some form of a conflict of interest, and entrepreneurs need to be clear on which hat they should be wearing for a given decision or action.
Ahmad: "It's very common for small business owners to wear many different hats. In fact, that's the exciting challenge of being a small business owner. But it's important to recognize the fact and to understand how your role and obligations may vary depending on which hat you're wearing. Take, for example, a situation where a majority shareholder is also on the board of directors. As a director, that individual has the fiduciary responsibility to maximize value for all shareholders of the corporation, putting aside any specific interests he or she may have as a majority shareholder."
7. Clarify in Writing
Because entrepreneurs are busy starting or running the business, it is tempting to put off difficult questions or issues until later. This can be trouble. Tackle these issues early before they escalate.
Steingold: "If the business is a multi-owner business, an owner should have a written agreement with the other owners. For an LLC it's called and operating agreement; for a corporation it's a shareholders agreement. This document should explain what the financial arrangements are, how much of a draw people can get, how the profits will be allocated, and a number of similar items, including succession issues. It's always important to work these things out with your co-owners in advance so that problems don't creep up down the road."
Ahmad: "A surprising number of partners in businesses, for example, have not had a basic conversation about what would happen if one of the owners would leave the company or become seriously ill. We suggest that the owners have that discussion and put together a buy-sell agreement. This agreement can be customized, but it answers common questions, such as what happens to the shares held by the partners upon such events, whether the company has a buy-back option, what happens if there is a voting deadlock, etc. By having these difficult conversations upfront, often times you can find a reasonable solution that is actually much harder to achieve when you're having the conversation in the context of a specific event that is happening."
Magill: "Put everything in writing. People will forget, or they'll want it to be another way, and they'll fight over what they agreed on. And in the process of writing it down, everyone gets clarity on what they mean and what they expect. So put it down in clear, non-vague terms."
8. Ensure Clear Contracts
A few adjustments to your contract language could make a big difference.
Magill: "Sometime a lawyer can add value through adjustments to your contract language. Two examples include the integration clause and the lessor-known non-reliance clause. The integration clause makes clear that the contract is the only document to reference for the agreement. The non-reliance clause ensures that there are no other conversations, discussions, or documents on which the parties are relying to interpret the contract. I currently have a case, for example, in the federal court that would have been settled long ago had our client's in-house counsel inserted the integration and non-reliance clauses."
9. Protect Your IP
As an entrepreneur, you are naturally excited about the IP your company may employ. Be careful, though, to protect your company's interests when discussing your IP with potential investors.
Schroer: "We often talk to clients about how important a name or a trademark might be to their business. If it turns out that it's an essential element to their business plan, then we talk to them about going to the U.S. patent office and getting either a trademark or a service mark.
Ahmad: "Once you've disclosed information to a potential partner, investor, or service provider, it's very difficult to then protect that information going forward. So make sure you have a formal nondisclosure agreement. And if the other party does not sign the agreement (many venture capital firms may not sign nondisclosures), then consider refraining from disclosing too much of your intellectual property to preserve value going forward. Remember, though, that many nondisclosure agreements contain exceptions. This could mean that if you disclose information to a party who then discloses that information to the party who has signed a nondisclosure agreement with your company, the information will not be covered by the nondisclosure agreement. So, don't rely too heavily on the agreements."
10. Avoid Improper Solicitations
Soliciting for funding can be tricky. It is easy to make a mistake with specific aspects of the SEC and, if you're incorporated in Michigan, the Michigan Uniform Securities Act (The Michigan Act).
Ahmad: "Before approaching any potential funding sources, it's very important to consider the securities laws. Generally, federal and state securities laws regulate general solicitations to sell stock. You can't, for example, put it up on your website. And, similarly, you need to have certain registrations or exemptions in order to issue stock. So these are issues about which your lawyer can advise you, but it's worth understanding before you get into a conversation on these issues."
Magill: "There are many common mistakes here. Some entrepreneurs try to avoid the Michigan Act by offering a promissory note instead of selling shares. But under the Michigan Blue Sky laws, a promissory note not backed by a commercial mortgage is considered an investment and, therefore, subject to Blue Sky law registration requirements. "
TAKE THE NEXT STEP
Ahmad: "It is definitely worth it to identify and address legal issues upfront. It's probably helpful to consult with a lawyer as early in the business startup process as possible. Most lawyers are willing to sit down with you for an initial conversation and put a framework together around what your legal issues might be. We are happy to talk to business owners, and some startup and technology-related companies can pay a set fee for a specified suite of services that a company typically needs for the first year of operation. "
Magill: "We charge a nominal fee for the initial meet and greet as we discuss the business situation. For ongoing work, some is done at a fixed cost and some on an hourly rate. Setting up corporate forms or drafting and filing documents is fairly clear, so we often charge a fixed price for such work. The sale of a business, on the other hand, is complicated, so both buyer and seller will probably be charged by the hour by their respective counsel."
Schroer: "We like to have an initial conversation with entrepreneurs. We enjoy talking to people about what we do, understanding their businesses, and discovering how we might be able to help them succeed."
Steingold: "As lawyers, we often think of ourselves as problem solvers. Now that may not be how the general public view us—they may think of us as trouble makers. But we are there really to help smooth the way for people; to get disputes resolved; to see that deals get closed. We're not there to stand in the way or make things hard. We're the oil in the machinery to keep things running."
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