The Other Thing You Learned at College For Your Small Business

Remember sitting in class in college listening to a professor fill you head with knowledge that would eventually form the basis of your business?  Well now the time you spent in the dorm might help as well.  Small and startup business are increasingly sharing office space.  This system of "co-working" - sort of like finding a roommate for your business - is catching on in this economy because it offers more flexibility and lower costs to startup businesses.  According to the Wall Street Journal:

[S]mall business owners and professionals share space and office equipment, and pay short term leases, usually month to month. ... For entrepreneurs, it's a cheaper and more flexible alternative to renting or buying space of their own.... [Tobias] Roedinger estimates he is saving $300 to $400 per month on utility bills and not having to rent space he doesn't need.

Even more interesting is the fact that these co-working spaces are sometimes employing bartering rather than rent. According to Winnie Fung, a manager of a nonprofit co-working space in Brooklyn, N.Y.:

At least three or four people from the 10 in her co-working space have partially or fully bartered their services for desk space. ... Ms. Fung says a few months ago she made a deal with one of her members, a tech start-up owner, to look after the building's computers and Internet service in return for free space.

As I have written about before, start-ups will do themselves a service by bootstrapping as long as possible when getting started in order to maintain control and options for later.  This type of cost-reducing move can not only improve your bottom line, but also provide added networking.

Franchising works, but does it work for you?

We have all been to a McDonald's, Taco Bell, or other franchised restaurant.  No matter where you go, a reliable menu is waiting in familiar surroundings.  These systems are examples of an established business model where independent business owners buy the rights to operate their restaurant with the look and feel of any other restaurant in the system. But franchising is not just for fast food.  Franchised businesses are responsible for $2.31 trillion which represents 11.4% of the total private sector output in this country and up to 40% of all retail sales!  Franchises come in all sizes and flavors - I have personally represented casual dining restaurants, a dog training business, an educational learning center, health club, and other systems.  You can find franchises is just about every industry operating in the U.S. today.  So franchising clearly works.  But will it work for you?

A franchise is born whenever a business relationship meets three criteria:

1. The right to use a trademark or trade name,
2. Some type of marketing plan or system created by the franchisor, and
3. A fee paid by the franchisee.

The parties cannot opt out of the franchise regulation; if you meet the three-part definition, you have a franchise and must comply.  Failure to follow the rules can result in fines and other penalties.

Here is an example:  I was speaking with a business owner who has been operating for several years and has established two successful locations.  He was interested in expanding, but couldn't find financing.  He was approached by entrepreneur who was interested in opening a few other locations based on the established name and concept.  The store owner was willing to grant the entrepreneur the right to use the name of the business, but he expected some type of payment for that right and he wanted to make sure that the new stores would be run in a similar fashion to his since he spent years developing good will with his customers.  It sounds like a win-win situation: the business is expanding, but the business owner does not have to put out the capital to open the additional locations, and the entrepreneur is leveraging the proven model into starting his own business.

However, it is not without concerns.  Franchise regulation is neither a simple nor inexpensive process.  And while many successful businesses have enjoyed rapid growth through franchising, you must have an understanding of the definitional requirements, particularly if you are trying to avoid falling under the regulatory umbrella.  The franchise laws and regulations control the process of selling franchises - everything from the initial meetings, to signing the paperwork, to operating.  And the rules were rewritten last year, making the current state of the law even more complicated.

But before you launch into franchising, consider the following:

• Is the business franchisable? Many businesses are prime candidates for the franchise model, but others are not.  Franchises exist in almost every industry from food and retail to auto parts to education to professional services.  But a business built around a person's unique personality, for example, may not be reproducible elsewhere.
• Is there a need and is the business scalable? You may be able to keep up with current demand by producing your product in-house with a solid team.  But will the need grow with the increased availability of your product or service?  A healthy franchise system will require an exponential growth in the delivery of raw materials or other services underlying your business.
• Are you ready to give up "your day job"? Whatever business you were in before you decided to franchise, you are now in the business of selling franchises.  Creating and maintaining a franchise system requires a full-time effort and attention to business and legal issues surrounding your own company and the needs of your franchisees.
• Are your finances in order? Franchising is a great way to develop a system using other people's capital.  However, there is still a significant capital requirement to get up and running and to provide continuing support services to your franchisees.
• Where will you franchise? State laws will require that you have a franchise plan before you start talking with prospective franchisees.  Failure to comply with state requirements could result in fees and other penalties.  Many franchise systems start in one state or a region and gradually increase their presence to avoid the financial and legal burdens of nationwide compliance all at once.

And of course, there are many more.  Franchising is a proven business development method that has helped thousands of businesses employ millions of workers.  Whether it is right for you will depend on many factors.  By consulting with experienced professionals like franchise lawyers, accountants, and financial experts, you can determine whether you are ready to take the next step for your business.

Top Signs the Economy is Rebounding?

Reading the headlines this morning gives signs of hope that the economy is on the rebound.  Here are some examples:

1. Stocks Recapture 9000 on Profit Surprise (WSJ).   S&P 500 Erases Half Its Loss Since Lehman's Failure on Outlook for Profits (Bloomberg).  The stocks markets are in the midst of a rally that is showing signs that the bottom may be behind us.  However, the threats of a coming commercial real estate bust loom.  Can the upturn in the business sector overpower the coming losses?
2. Housing Starts Increase to Seven-Month High (Bloomberg).  U.S. Mortgage Rates Up, But Housing Optimism Surfaces (CNBC).  Economists React:  Housing No Longer 'Weakest Link'? (WSJ)  The mortgage crisis (among other things) got us into this mess.  Foreclosures are still high and prices are still declining, but three months of increases in housing starts is giving some optimism that we are starting to see a rebound.
3. Samsung, Hynix Rally as Intel Results Boost Hopes (CNBC).  With the semiconductor chip and flat panel business returning to the black, discretionary spending could be returning to people's budgets.  Positive results from the two top chip makers are a hopeful sign that the industry is bouncing back, but it hit the bottom so hard that it has no where else to go at this point.
4. Ford Reports Surprise Second Quarter Profit (MSNBC).  Ford Expects Profitability in 2011 Without Government Loans (BusinessWeek).  The automakers defined the American economy for a generation.  With its recent struggles the automakers are just hoping to survive.  Now with Ford showing promise and a svelter GM out of bankruptcy, could the American auto industry actually recover?

All of this is of course balanced with a heavy dose of continuing negativity.  And we will know more on July 31st when the Bureau of Economic Analysis releases its first estimate of second-quarter GDP, which is expected to provide some good news:

The report is expected to offer evidence that the worst recession since the 1930s is very nearly over, and that a return to growth in the current quarter is very likely.

A report that GDP increased in the second quarter could provide a good stimulus for the rally to continue.  Perhaps we can look forward to good days ahead.

What happens next? Four tips for planning succession in small businesses.

I have been working with a few small companies that are run by founders or the children of founders and they inevitably come to a point where they start thinking about how the business would run without them. Early on, this idea doesn't even cross their minds; they naturally spend their energy on how to run the business and are not thinking about how to leave the business. This often comes up in the context of retirement, particularly where one or more of the partners does not have an "heir" to take their place.  Depending on who the current partners are, those willing to take the helm may or may not be seen as "worthy".

But all small businesses should also think about the dreaded unplanned exits:  what if one member dies or is permanently disabled?  Some planning now in the form of a Shareholder Agreement (sometimes known as a "Buy/Sell Agreement" or "Cross Purchase Agreement") can save the company and its partners stress and expense down the road.

So what should you consider when planning such an agreement?  Like any contract, you can choose from a number of options, but I typically advise as a baseline to consider the following:

1. Restriction on transfers of stock or membership interest.  A small company will likely want to restrict who is coming and going as an owner because of the inherent close nature of the partners's relationship.  The partners may want to prevent one partner from going out and selling his ownership interest to someone undesirable to the other partners.  This is typically done with an outright restriction on transfer unless the interest is first offered to be sold to the company and/or the other partners first.  This offers some stability to the company and the other partners to move forward.  In the event they refuse, then the selling partner may transfer the interest with the inferred consent of the others.
2. What are the "trigger" events for a purchase of a partner's interest?  This agreement generally allows the partners or the company (or both) the right or obligation to purchase one partner's interest in the company in the form of stock or some other membership interest.  Many companies will have a trigger on the event of the partners death so that the interest is purchased from the surviving spouse (this is both as a consideration to the spouse and because the other partners may not be interested in partnering with that spouse).  But you should also consider whether there should be a trigger for a partner's permanent disability preventing them from continuing in the business.  Or, under better circumstances, what if one partner just wants to retire?  The last one is harder because of the lack of objective measures, but will certainly be of interest to the partners at some point.
3. How do you define the trigger events? A partner's death is a pretty easy trigger to recognize, but when is someone considered disabled to the point that the company should repurchase her interest?  Generally, the disability should be described in detail with objective standards (e.g. mental or physical illness that incapacitating a stockholder from performing normal duties as director, officer, or employee for a period of six consecutive months or any six months in a 12-month period).  Obviously, these can change depending on the circumstances, but are an example.  Often, that determination must be made by a licensed physician, or in some cases, more than one if a second opinion is required.
4. How do you fund the cross purchase? (and yes, you should fund it).  When the agreement is triggered and the repurchase of stock by the company or the cross purchase by the other partners is required, what if they don't have the money?  There are insurance products that can help here.  For example, when one of the partners dies, a life insurance policy taken out on her life can be used to pay for the stock repurchase.  But if you have a trigger for disability, you might also want disability insurance to cover (in which case your trigger should match the insurance policy definition of "disability").  This gets a bit more complicated when you decide how to purchase the policies - whether the company is the insured or the individual partners take out personal policies on the lives of the other partners.  The premium prices will be different depending on the age and health of the partners, and there are some different tax treatments depending on whether the company of the partners hold the policies.  Finally, in the event of a partner's retirement, funding cannot be done through insurance so you may consider paying by financing the purchase price over a period of time.  That of course will depend on the nature of the business (and the partner's view of the long-term success of the business).

There are many other considerations you may want to take into account in negotiating among the partners, but these should be considered as a baseline.  Your attorney and accountant can also provide additional thoughts on how your agreement will impact your particular situation.

Things an Angel Investor would never say...

Time for some hump day humor.  Dharmesh Shah put together a great top 10 list - which goes to 11, naturally - of admissions that angel investors would never make.  My favorites:

1. I really want to support entrepreneurs — but just those that are going to make me money.

...

4. I was lying when I said that some of my best friends were VCs.  Even VCs aren’t best friends with VCs.

...

8. I like to invest in cool startups because it helps make up for high school.

...

11. I’m in it to mostly have fun.  If I wanted to do unpleasant work, I’d have my own startup.