If you are going to raise capital from investors, Angels, Venture Capital or thinking of going Public someday, you need to make sure you have as many contingencies covered as possible. With all these things in place you are saying to potential investors/buyers, "We have our act together and we're ready to make a deal." In fact, anyone who's serious about their business should consider each of these recommendations.
1. Shareholder Agreements – Enter into proper agreements such as management agreements with key executives and personnel, shareholder agreements such as buy/sell agreements, operating agreement for LLC's having solid agreements is a key to being prepared for business and events before they occur.
2. Corporate Records – Maintain corporate records (make sure you keep Board meeting records, Board approvals, a copies of stock certificates- issued and cancelled or redeemed, stock ledger)
3. Board Minutes – When you hold Board meetings (at least once per year), take minutes, put the minutes in your corporation/LLC record book – make sure to keep a copy yourself.
4. Shareholder Loans – If you loan money to shareholders, make good paper records to document the loan (that means promissory note which states: Principal Amount, interest rate, amount, maturity date)
5. Repurchase Rights - Make sure your company has the right to buy back options or restricted stock if employees/shareholders leave the company.
6. Multiple Classes/Series of Shares – Keep your capital structure simple – One class of common stock, and one or two classes of Preferred shares (Too complex a capital structure may alarm investors)
7. Know about Types of Stock Options – Understand Incentive Stock Options and Non-Qualified Stock Options. Each has different tax treatment.
8. Phantom Stock – Consider using Phantom Stock – gives economic value without giving away voting rights (no exercise price and can be better than options as easier to exercise prior to liquidity event) Check with accountants on the treatment of these types of shares.
9. Intellectual Property Protection – use proprietary information and assignment of inventions agreement to ensure the company owns everything employees created. Without it being signed, original investor can come back and claim right to royalties to assets of the company. Have each employee sign when they start. Employ competent legal counsel when patent, copyright and trademarks are involved.
10. Personal Expenses – Where possible avoid running your personal expenses through the business. Investors do not like it when you run the business like your personal piggy bank. If it comes out in due diligence it really makes things look suspicious. Worse still, it can allow the IRS or a creditor to pierce the corporate veil and go after shareholders individually if you co-mingle personal and business because you didn't honor and respect the corporate entity. Travel & Entertainment line item always draws attention from the IRS.
11. Staff Classifications – Be sure you have used the proper classification of overtime and 1099 contractors vs. employees. If you're controlling where and what time folks show up and they're working 40 hrs/week, likely need to be treated as employees.
12. Employee Handbook – Have an employee manual and handbook that sets forth the rules and regulations and protocols, and have it signed by each employee. Have each new hire verify in writing they have not taken any Intellectual Property from their previous employer.
13. Termination Release - When employees leave/quit/are fired have them sign a release. You may have to pay severance.
14. Employment Contracts – Avoid long term employment contracts it's often best to use an at-will employment letter and long probationary period. Remember hire slow and let go fast. If employees are not going to work out find someone else. In the current economy you have options.
15. Insurance – In addition to having auto, general liability, property, workers compensation life & disability insurance; be sure to look into EPLI insurance (employment practice liability insurance),which is different from Errors and Omissions (E&O) and Director & Officers (D&O)insurance. EPLI protects against sexual harassment claims and wrongful termination.
16. Long-Term Business Agreements - Avoid long term contracts that restrict your ability to terminate relatively quickly. Negotiate for max 60 day termination clauses when you enter into 12 month contracts.
17. Rights of First Refusal – Be slow to grant anyone the right of first refusal to buy your company as this can block the sale of a business even if though they are minority shareholders. If you must grant a first right make sure you receive a good faith deposit or an option payment AND allow as short a time period for the party to close on the purchase.
18. Integration Clause – make you include this type wording in all your agreements. It should say something to the effect that, anything we talked about before this final agreement (oral agreements, etc.) is gone and all that matters is what is in this document. This makes it clear that this is the only agreement we have and that everything that went before has been cancelled and is replaced with the document now in hand.
19. Attorney Fees – In contracts have attorney fee provision that says loser pays attorney fees in any litigation.
20. Arbitration vs. Litigation – The main benefit of using arbitration is that the proceedings can be kept private. Where in a court case everything is public. Plus litigation is more expensive both in money and in brain damage. Arbitrators tend to help the parties to arrive at a compromise meeting in the middle. It is less likely that one side will win big. If preferred you can even include a Mediation clause which can be good to put in document as an optional procedure prior to binding arbitration, arbitration is usually non-binding and less expensive.
21. Financial Reporting Systems – Investors like accountability and transparency. A good controller or CFO is worth their weight in gold. Investors want to see revenue and profit data broken out as much as possible (line by line and category). You should to close your books once per year and provide monthly data as well as comparison to most recent prior year for same period. Keep you books cleaned up making all appropriate journal entries and keeping receivables cleaned up or written off.
22. What About Audits – Investors preferred audited financials once the company reaches any scale If your revenue is greater than $1 million per year, you may wish to consider at least having a CPA prepared review. If you don't have audited financials, you need a really solid CFO. Without reliable properly prepared financial statements and financial/book-keeping records investors will look for things that are wrong and will use this as a means to justify a substantial discount or other less favorable terms. By having good financial accounting systems in play you will minimize reasons investors can undercut your valuation.
23. SAS 115 letter (Statement on Auditing Standards)- Make sure your auditor gives you this letter the audit – in part it tells about your financial controls (it's sometimes called a management letter)
24. Management Team & Succession Planning – The company needs to be able to succeed without you. Good management teams do not have indispensable or difficult to replace members. Make yourself less critical to success over time. By providing for these possibilities you demonstrate that it's not all about you having operational control or critical sales relationships. After putting team and a plan in place, do a test — like try leaving for 2-3 weeks and see what happens, if the company is still there and operating like normal, you've done well, anything less or if your cell is ringing every ten minutes while your gone– you might need some more work on this. You should also take care of written agreements and key man insurance and other succession planning matters.
25. Customer Concentration – Make sure your largest single customer accounts for no more than 20% of your total revenue to reduce investor concern. This may be of particular concern to a financial buyer who raises debt to buy your business. A buyer who uses debt leverage to make the acquisition may use the dependance upon a single customer as a way to get you to accept a lower valuation. A strategic buyer who already has a good customer mix may be less concerned about this but still may push for lower valuation.
Should you need further information or in depth assistance with any of these matters please contact us @ 760-469-9201 – You may leave us a detailed message and we will respond as quickly as possible.
