Hanging Your Own Shingle: Building a Successful Solo Practice

I had the pleasure of speaking last week on a panel on going solo with Angela Barker, of the Law Office of Angela Barker, LLC; Allison G. Greenberg of Fensterstock & Partners LLP; Ian E. Scott of Scott Legal Services PC and moderated by Daphney Francois of Francois Legal Services.

I thought it was a very successful panel – the diversity of backgrounds and paths taken to create the varied practcies represented on the panel was very inspiring.

More info on the panel is available here.

May Milestones

May was a great month for the Minton Law Group.  First, the firm signed on its first attorney, Josh Levin.  I had the pleasure to work with Josh at Schulte Roth & Zabel, and was impressed with his work and attitude when we worked together, and I have first-hand knowledge of the high-level training SRZ’s corporate associates obtain.  While helping me, Josh is also an entrepreneur who recently co-founded Flash Tabs (www.Flash-Tabs.com) a mobile app that allows bar and restaurant patrons to open tabs, place orders and make payments directly from their smartphones by processing orders and payments through each venue’s existing point of sale system.  Needless to say, he is very a busy man.

Second, May marked my first month with three deal closings that spanned the gamut of convertible notes, preferred stock and LLC membership purchases.  It was a fantastic month and there are a lot of reasons to think that trend will continue.

Finally, on a personal note, I am pleased to say that I joined the Board of Directors of the Penn Club, and am looking forward to doing a lot of neat things through that position.

6 Legal Requirements For Unpaid Internship Programs

My latest article in Forbes has published:  “6 Legal Requirements For Unpaid Internship Programs“.

“[T]here are some very serious legal considerations every for-profit company –including startups — must be aware of before attempting to use unpaid interns.

Under federal law, every employee in America is entitled to a minimum wage, additional compensation for overtime and certain other benefits. An employment relationship will also have consequences for the employer relating to worker’s compensation, discrimination laws, employee benefits, state labor laws and unemployment insurance coverage. For these requirements not to apply, the employment relationship must fall under applicable legal exemptions.”

Please read the whole thing.

Corporation or LLC for Startups?

The LLC/Corp question seemed like it was pretty settled about two years ago in favor of corporations, but I recently have had multiple clients make inquiries about which to be and why.  For clients who are anticipating having third party investors, employee option pools, etc. I still think the corporate formation is the way to go in the vast majority of situations.
As a starting point, we can do everything with an LLC that we can do with a corporation – this is due to an LLC at its heart being a contractual arrangement.  While there are some things we can do with an LLC that we cannot do as simply with corporations (for instance, divorcing economic interests from control at the equity level), while the flexibility of LLCs are part of their allure, it also makes it much more complicated to mimic aspects of the corporate form with an LLC than to just use a stock corporation.  For instance, it takes a lot more paper to create employee options plans, vesting arrangements, different tranches of equity, etc. with an LLC than it does with a corporation.  This doesn’t even get into the practical reality of your employees being incentivized by receiving “options,” while receiving “phantom membership unit appreciation rights” does not have the same cache.  If a business were to try and do a raise and keep the LLC form, that transaction could end up being much more complicated.  Moreover, while it is relatively simple to convert a Delaware LLC into a Delaware corp, it is not without cost.  Converting a New York LLC to a Delaware Corp, however, requires a full form merger that is a transaction unto itself.  In either case, many of the formation documents that were in place for the LLC would have to be recreated to address the new corporate form.  Put simply, initial legal costs would increase, as would the cost for any future transaction.  As for the tax benefits of LLC’s, with limited exceptions they are duplicated by corporation making an S election.
Regarding investors, I can not imagine ever being in a situation where someone was asked why they were using the corporate form and not an LLC.  Ownership of an LLC can greatly complicate investor’s personal taxation because it is a pass through entity (for this same reason, you should expect that when a Company gets investors it would need to transition from an S Corp to a C Corp, but that is a very simple process) – put simply, owners of pass through entities can be taxed on their proportion of profits even if no money is distributed to them.  Even removing the complication factor, many VC funds are barred from investing in LLCs because they have tax-exempt partners who would lose that tax-exempt status if they received active business income.  Finally, because these profits are K-1 income, it could also open investors to being liable for state income taxes in states where they otherwise would not have to file.

13 Ways to Bring the Entrepreneurial Spirit to the Classroom

I was recently quoted by Upmarket in a post on bringing Entrepreneurship to the Classroom.  My suggestion was to encourage programming at younger ages:

“Every startup needs someone who can fulfill its technological requirements, and there simply are not enough good programmers to fill this demand. Moreover, chief technical officer is a fantastic position from which a future entrepreneur can learn what it means to run a new business.”

Apparently Bill Gates, Mark Zuckerberg and Chris Bosh read my blog.  Great minds think alike.

 

How to Get the Most Out of a Startup Accelerator

I was recently quoted by readwrite.com:

Not all accelerators are created equal. With the growth of the entrepreneurial space has come a similar pop in the programs available for startups. Some are worth their weight in gold, while others are just looking to churn and burn their clients. Do your diligence before signing on – it is easy to find current and past startups of any accelerator who can give you real insight into what you are signing up for and whether the price is right.

The Three Advisors You Need

A recent post I did was distributed by 21times.org, a website focused on helping developers build their businesses.  The full article is available here, with a snippet below.

In my practice representing successful entrepreneurs, I have noticed they share a trait which may come as a surprise to those who believe bootstrapping means doing everything themselves — these entrepreneurs know what they don’t know. They know their limitations, their strengths and their weaknesses, and know that there are times when spending the money on a professional to get the work they need done quickly and correctly is worth avoiding the headache of spending hours attempting to do it themselves, not to mention the peace of mind of knowing it was done right. If you are serious about running your own successful business, there are three types of professionals who it is time to start shopping for.

Seed Round Convertible Debt vs. Preferred Equity

The most common forms of investment in early stage business are convertible debt and preferred equity.  Common stock can also be issued, but in general investors who want equity choose preferred shares because it gives them certain rights that are not shared by the common stock, both in regards to the company and in the case of a follow-on capital raise.

Preferred stock is a new class of stock issued by the company which is given certain rights apart from the company’s common stock.  This can include a dividend right, liquidation preference, conversion rights, pro-rata rights, etc. It is equity and the shareholder has ownership rights in the company (and is owed corresponding fiduciary duties by the board and management).

On the other hand, convertible debt what it sounds like – debt which is convertible into equity at some later point in time.  The angel then receives a discount on the conversion price to reward their risk.  If all goes according to plan, the conversion generally takes place upon receipt of the next round of funding.  The debt can feature many corollaries to the bells and whistles given to preferred shares noted above.  While the intention is for the debt to convert, and many investors think of it as quasi-equity, until it converts it is debt, and needs to be treated as such (with attendant fiduciary duties from the board and management).

The biggest benefit to using the convertible debt model is that it allows for the investment to be made without the company and investor coming to an agreement on a valuation.  As an example, I did a convertible debt deal a month ago where the investor made an investment of $200,000 into a startup with a 20% discount.  The debt will convert upon the startup raising $1m within the next year.  What this means is that upon that startup receiving its next material round of funding, the angel will receive $250,000 ($200k with the 20% discount) worth of shares at the pre money valuation agreed to for that next round, and on equal footing with the new investor (i.e. same class of shares).

In that previous deal, the company believed its valuation to be $5m, but the investor thought it was closer to $3m, and as with all these very early startups, there was no definitive way to break the logjam. Using the convertible debt model, the investor was able to invest, and by the time the next round happens, more information will be available to the company and the investors and that new valuation should be a better reflection of the actual value of the company.

The downside to using convertible debt is that it increases the risk that one party is going to get a sweeter deal than intended.  Continuing with the example above, if the Company receives a valuation of $20m, the investor would have been better off doing a preferred share deal at any valuation below $16m (the effective valuation of the original investment reflecting the 20% discount).  As discussed, a cap can be put in place to shift some of this risk from the investor to the founders, but it cannot be wholly mitigated without agreeing on a current valuation, which negates the point of doing a convertible debt transaction. The cap is also not without a downside, however, as future rounds may view it as a cap on valuation – for that reason it should never be told to a future potential investor before they make an offer. It should be noted that the above-mentioned deal did not contain a cap, and my understanding is that they are not as common as they were circa 2010.

If the parties can agree to a valuation that is a good representation of the value of the company, doing a series seed deal issuing preferred shares makes more sense.  Giving equity gives the angel the full upside for the risks he is taking.  If the valuation is high, however, it also gives the angel the full downside.  For example, if a company is initially valued at the seed stage at $6m, but the next round is done with a $4m pre-money valuation, the equity investor sees an immediate 33% decrease in the value of his investment.  If the valuation is too low, the angel will end up owning a disproportionately large percent of the company compared to the founders, which acts as a disincentive, and limits equity available for bringing on future talent.

Finally, doing a convertible note deal is simpler and cheaper from a legal costs point of view, but the cost difference is not so great that it should be outcome determinative.