Business

Happens
A Practical Guide to Entrepreneurial Finance for Small Businesses and Professional Practices

MITCHELL D. WEISS

M.D. Weiss LLC, Publisher

Business Happens A Practical Guide to Entrepreneurial Finance for Small Businesses and Professional Practices
Mitchell D. Weiss Cover Design: Ian Pamplona Layout Design: Ronald Sequeira Copyright 2013 M.D. Weiss LLC. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise without the prior written permission of the Publisher. Requests for permission or to purchase product should be emailed to info@mitchelldweiss.com. ISBN 978-0-9848587-8-1 Published in the United States of America

Table of Contents
Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Part I Why the Big Deal about Small Business . . . . . . . . . . . . . . . . 12
Have You Thought It Through? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Do You Have What It Takes? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Do You Understand the Risks? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Do You Know Your Responsibilities? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Do You Have an Idea That Can Stand up to Pen and Paper? . . . . . . . . . . . . . 18 For Your Consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Topical Readings and Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

Part II Organizing and Managing the Enterprise . . . . . . . . . . . .

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Choosing the Right Advisors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Choosing an Appropriate Legal Structure . . . . . . . . . . . . . . . . . . . . . . 27 Sole Proprietorship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 C-Corporation/S-Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Limited Liability Company/Limited Liability Partnership . . . . . . . . . . . . . . . 28 Ownership Interest and Incentives . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 The Size of the Pool . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 How the Shares Will Be Allocated . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Triggers and Transferability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Managing the Finances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Accrual versus Cash Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Balance Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Income Statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Statement of Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 Statement of Shareholders Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

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Analyzing the Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 Cash-Conversion Cycle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 Inventory-to-Sale Conversion Period . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 Sale-to-Cash Conversion Period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 Purchase-to-Payment Conversion Period . . . . . . . . . . . . . . . . . . . . . . . . . 40 Liquidity Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 Current Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 Quick Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 Leverage Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 Total-Debt-to-Assets Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 Debt-to-Equity Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 Interest Coverage Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Profitability and Efficiency Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Gross Profit Margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Return on Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Financial Planning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

Managing the Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 Determining the Likelihood and Estimating the Costs . . . . . . . . . . . . . . . . . 46 Commercial Property Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 General Liability Insurance Products . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 Workers Compensation Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 Business Interruption Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 Developing Policies and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 Reviewing and Revising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 Protecting Intellectual Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 Managing Employee-Benefits Programs . . . . . . . . . . . . . . . . . . . . . . . 48 Health Care Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 Other Employee Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 Organization Design and Process Management . . . . . . . . . . . . . . . . . 49 Social Networking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 For Your Consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 Topical Readings and Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

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Part III Debt, Equity and Coping with Financial Adversity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

Raising Debt Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 The Underwriting Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 Whether to Make the Loan: The 5 Cs of Credit . . . . . . . . . . . . . . . . . . . . . . 56 Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 Capacity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 Collateral . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 Conditions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 Character . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 How Much to Lend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 How Much to Charge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 What Terms and Conditions to Require . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 Personal Guarantees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 Additional Collateral . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 Cross-Collateralization/Cross-Default . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 Affirmative Covenants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 Restrictive Covenants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 Material Adverse Change . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 Representations and Warranties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 Events of Default . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 Indemnification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 Prepayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 Assignment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 Preparing to Borrow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 Purpose and Justification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 Identifying Leverageable Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 Different Borrowing Needs and Different Borrowing Alternatives . . . . . . . . 64 Small Business Administration Programs . . . . . . . . . . . . . . . . . . . . . . . . . 64 MicroLoan Program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64 7(a) Loan Program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64 CDC/504 Program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

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Disaster-Assistance Loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 Industrial-Revenue Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 Bank and Nonbank Lending Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . 65 Financing Products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 Lines of Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 Asset-Based Lending (ABL) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 Term Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 Commercial and Industrial Real Estate Financing . . . . . . . . . . . . . . . . . . . . 69 Leasing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 Vendor Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 Credit Card Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72 Peer-to-Peer Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 Transaction-Structuring Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . 73 Simple versus Compound Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 Fixed versus Variable Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74 Interest Rates versus Annual Percentage Rates . . . . . . . . . . . . . . . . . . . . . 75 Even-Principal Reduction versus Mortgage-Style Amortization . . . . . . . . . 75 Level Payments versus Uneven Revenue Streams . . . . . . . . . . . . . . . . . . . 77 Financing Term versus Asset Useful Life . . . . . . . . . . . . . . . . . . . . . . . . . . 77 Responding to the Four Decisions Every Lender Makes . . . . . . . . . . . . . . . . 78

Raising Equity Capital . . . Debt, Equity and Dilution . Who and Why . . . . . . . . . Company Structure . . . . . Valuation . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . . . . . . . . . . . 78 . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 . . . . . . . . . . . . . . . . . . . . . . . . . . . 81 Subordinations and Disentanglements . . . . . . . . . . . . . . . . . . . . . . . . . . . 82 Coping with Financial Adversity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82 Under the Microscope . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 Self-Directed Restructures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 Operational Restructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84 Financial Restructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84 Asset Restructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84

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Forbearances and Modifications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85 Payment Moratoriums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85 Interest-Only Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85 Abatements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85 Negotiating Tactics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85 Bankruptcy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86 Chapter 11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86 Chapter 7 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86

For Your Consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88 Topical Readings and Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88

Part IV Buying, Selling and Calling It Quits . . . . . . . . . . . . . . . . . . . 90

Mergers and Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 The Difference between a Merger and an Acquisition . . . . . . . . . . . . . . . . . 91 Valuation Methodologies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 Payments and Protections . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92 Graceful Exits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 Succession Planning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 Establishing and Prioritizing Goals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 Orderly Transitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 Orderly Liquidation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 Final Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 For Your Consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 Topical Readings and Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96

Epilogue: From One CEO to Another . . . . . . . . . . . . . . . . . . . . . . . . . . 98 Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103 About the Author . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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Preface
Im a big fan of small business. I love the enthusiasm, drive, creativity. The ability to move

from idea to implementation in very few steps. The challenge of solving puzzles on the fly. Having owned and operated companies that financed commercial and professional enterprises, however, Ive seen too many well-intentioned people charge ahead with too little sense of the fundamentals: legal structures that separate the personal from the professional, financial-management standards and techniques that help keep things on track and in check, negotiating tactics that appropriately balance risks and rewards, and the steps to take if the venture ends up heading in the wrong direction. But rest easy. As much as this book focuses on the financial side of starting and running an enterprise, there is not a semesters worth of finance theory and mathematical calculations in the pages that follow. My goal is to introduce you to the things you really need to know about operating a business, especially if youre planning on having some leftover cash to show for your efforts. The book is organized into five sections. The first encourages you to think about all that goes into a decision to launch an entrepreneurial venture: Do you have what it takes? Do you understand the risks? Do you know your responsibilities? Do you have an idea that can stand up to pen and paper? The second section takes you through the step-by-step process of organizing and managing that venture, from choosing the right advisors to settling on the right legal structure, establishing and sharing ownership interests, managing the finances, protecting the enterprise from harm, safeguarding intellectual property, selecting the right employee benefits programs and shaping an appropriate organizational design and process flow. When you get to the third section, youll be ready for the meat and potatoes of the book: how to borrow the right amount of money or raise an appropriate amount of investment capital from the right places at the right prices, structured in the right ways and subject to the right contractual terms and conditions. The section ends with a discussion about coping with financial adversityin particular, what to do, how to do it and the way to negotiate for what you need. The fourth section addresses your financial harvesting options, whether through a merger or acquisition, sale or transfers to others (including family members), or simply waiting for the checks to come in as you methodically liquidate your holdings. The final part of the book is the epilogue, From One CEO to Anotherthe lessons Ive learned after more than 30 years worth of great and horrible decision making. If good judgment comes from experience and experience comes from bad judgment, I have a lot of experience.
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Preface
Please take the time to explore the linked articles and resources sprinkled throughout the text and at the ends of each of the sections (which is why the book is digitally formatted!), as well as to ponder the questions that are intended to inspire you to do just that. My hope is that youll leave with a little more knowledge and a lot more confidence in your ability to start, run and prosper from the small business or professional practice you have in mind or have already commenced. Youre welcome to contact me at mitch@mitchelldweiss.com with questions or comments.

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Why the Big Deal about Small Business?

to do with the fact that small businesseswhich include sole proprietorships, single and multigenerational family businesses, and professional practices account for more than 99 percent of all employers in the United States. Or maybe its because more than half of all private-sector workers are employed by these firms. Then again, it could be because small businesses are responsible for nearly two-thirds of all net-new jobs (openings versus closings) for most of the past two decades. (These statistics are from the Small Business Administrations Office of Advocacy.) As awesome as these stats may be, its still the God, I wish Id thought of that! moment of entrepreneurial wistfulness that impresses and inspires us the most. Consider the cuisine on wheels concept: seriously delicious rolling nosheries, jockeying for space on busy city streets as they compete for our appetites and a bite out of our wallets and purses along the way. Or the farmers markets that are as much at home in the country as they are on tiny inner-city lots. Or the brilliantly original graphic design work, fearlessly posted by freelancing artists on such sites as crowdSpring in the hope that at least one of their concepts will put them in the running for a project that a restaurant chain, medical group practice or family farm has put out for bid. Perhaps its a machinist who has come up with an ingenious idea for a tool that promises to earn a place in every do-it-yourselfers toolbox. Entrepreneurs need only a moment to see things as they are before theyre off, spending more time than theyd ever admit, thinking about and planning for what they could become. If only. We sketch out our concepts on scraps of paper pulled from nightstand drawers at three in the morning, fine-tune them on sagging Ping-Pong tables in dimly lit basements, finance them with rainy-day saving accounts and happily obsess about them forever. Whether youre launching a new venture, acquiring an existing practice, taking over the reins of the family store or refining something else you may have already started, being your own boss is a rush. That is, until the wheels fall off your entrepreneurial wagon and the full weight of the responsibilities youve shouldered becomes jarringly obvious.
It may have something

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Why the Big Deal about Small Business?

Have You Thought It Through?

According to the SBA, approximately 30 percent of all new businesses fail within the first two years; 50 percent disappear by year five. And while there are many reasons for those statisticsincluding just plain good or bad luckit often boils down to the wrong answers to these four foundational questions:

Do you have what it takes? Do you understand the risks? Do you know your responsibilities? Do you have an idea that can stand up to pen and paper?

Do You Have What It Takes?

Anyone can decide to go into business for himself. If the plan is to have it grow into something thats more than a weekend hobby, however, consider this list of entrepreneurial traits that distinguish posers, as my students would characterize them, from those who play for keeps, as I would say:

Vision Motivation Commitment Focus

Drive Ethics and morals Objectivity Attention to detail

Presence Realistic expectations Limits Social awareness

Vision Are you clear about what you want, how you plan to get it and what youll do with it once its yours? Good ideas can turn into great businesses when specifics outweigh generalities. Motivation Are you doing it for the money? The fame? A rsum bullet? Its best if its because you enjoy the work and youre up for the challenge. Otherwise it will get old fast and your employees will stop caring around the same time you do. Commitment Whether your plan is to make a killing on an opportunity thats short-lived or to build a business thatll endure for years to come, its important that the people you bring aboard know your intentions and the certainty of your engagement. After all, youre asking them to bet their livelihoods on you.

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Organizing and Managing the Enterprise

Now that you have a sense of the basics, its time to talk about the nuts and bolts of mak-

ing your ownership aspirations a reality. In particular:

Choosing the right advisors Choosing an appropriate legal structure Ownership interests and incentives Managing the finances Managing the risks Protecting intellectual property Managing employee benefits programs Managing organizational design and process flow Social networking

Choosing the Right Advisors

No doubt youve heard the old adage A physician who treats himself has a fool for a patient. Whether youre a physician, accountant, attorney, shopkeeper, plumber or owner of a longhaul trucking company, its important to have competent professional advice when youre establishing your business and reporting earnings. Sites such as Martindale, Lawyers.com, CPAdirectory.com, and the Zimmermans Research Guide (which links to review sites for attorneys and certified public accountants) are all good resources. But what it really boils down to are reputation, chemistry and cost. Many years ago, one of my partners and I went shopping for a law firm to handle a complicated financial transaction we were contemplating. He did the legwork by targeting the law firms he knew, asking his colleagues for recommendations and thoroughly researching them all. Ultimately, he put together a list of five or six practices and scheduled meetings with each.
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Organizing and Managing the Enterprise

The interviewing process was really important to us, not only because it afforded valuable insight into each firms experience and expertise but also because it gave us an appreciation for the personalities behind the suits and smiles. We also wanted to feel confident our advisors understood our objectives, respected our concerns and knew how to walk us through complex issues. And, of course, we needed to be satisfied that their fee schedules were reasonable and competitive. We went on our little road trip and met with each of the firms over the course of two or three weeks. All the law practices had great reputations, and the professionals we interviewed had impressive backgrounds and pertinent experience. To be sure, we liked some more than others, but by and large, we knew any one of them could meet our needs. It all came down to chemistry. And cookies. The firm we ultimately selected was the only one to offer us something more than a bottle of water! Seriously, as good as the cookies were, the people were that much better. They counseled and protected us in a first-class manner, for which I am grateful to this day.

Choosing an Appropriate Legal Structure

Once your lawyers and accountants are in place, your discussions with them should then turn to the legal structure that will deliver the best economic outcome with the least amount of risk, given the type of enterprise you have in mind, the work you plan to do and your longer-term objectives. There are four basic types of legal structure, each with its own advantages and disadvantages:

Sole proprietorship Partnership C-corporation/S-corporation Limited liability company/Limited liability partnership Sole proprietorship These are the simplest and least costly entities to create because from both a legal and tax standpoint, there is no distinction between the business and its owner. The owner is the business, and consequently the income he or she earns will be taxed only onceat the personal level. It also means the owner is directly responsible for what the business does or doesnt do. In other words, if you are sued, your professional and personal assets will be at risk. As you might expect, a sole proprietorship will be around for only as long as the sole practitioner is. The structure will also limit your ability to raise equity (investment) capital because those who invest in sole proprietorships become general partners in these
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Debt, Equity and Coping with Financial Adversity

At the start of the book ,

I wrote, Successful, enduring businesses are run by leaders who understand and fully embrace the responsibilities they have to the five constituents who helped make their achievements possible Two of these five constituents are represented by the enterprises lenders and investorswhich often include family membersand the responsibilities entrepreneurs have to them are obvious: to use their loaned and invested capital appropriately, as well as to repay or adequately return on it. Doing so also meets the responsibilities entrepreneurs have to their other core constituentscustomers, vendors, employeesbecause it helps ensure the continuity of the enterprise. The equity capital you raise and the after-tax income you earn enhance the ventures book value as well as its ability to be opportunistic. It also funds the firms continuing growth and development. However, when start-up investments and internally generated funds arent enough as is often the case for rapidly growing firmsthe business will need debt (borrowing) and additional investment capital (equity) to fill the void. The question is, whats the right mix between the two: one part equity to one part debt (50:50); one to two (33:67); or one to three (25:75)? This is yet another reason why corporate financial literacy is so important. Without a solid appreciation for your businesss current financial capabilities and reasonable economic prospects, youll find it hard to know which tact to take. Lets begin by exploring how lending works for raising debt capital, move on to equity capital and, last, analyze how to work through financial difficulties.

There are several types of lenders. The most traditional of these include banks and nonbank commercial-finance companies. From largest to smallest, banks may be national, regional or community in scope, and chartered as commercial, thrift (savings bank) or credit union (nonprofit) enterprises. They may also have specific lending areas of interest and expertise, such as commercial real estate financing (including for construction projects), equipment financing and leasing, and so-called asset-based lending specialtiesfinancing secured by the borrowers accounts receivable or inventory.
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Raising Debt Capital

Debt, Equity and Coping with Financial Adversity

Nonbank lenders may be national, regional or community-centric as well. They may also specialize in narrower bands of financing products, and some may even be affiliated with entities that sell products that are being financed, in which case they operate as so-called captive finance companies of the seller. Theres also the advent of crowdfunding, or peer-to-peer, financing, where ventures and small businesses that may not yet be bankable can still obtain the debt and equity capital they need. There are pluses and minuses to each of these lending institutions. Banks represent the most traditional and, generally speaking, reasonably priced form of financing; however, their credit-underwriting standards can be restrictive and their approval processes slow. As for the nonbank alternatives, what they may lack in the ability to compete on price (in terms of interest rates and fees), they often make up for in shorter turnaround times and, perhaps, more flexible loan structuring and credit-underwriting requirements. And when it comes to crowdfunding, if social lending for small businesses turns out to be anything like what weve seen with microlending for home-based ventures, then total cost, turnaround time and the ease with which loan restructurings and modifications may be accomplished will be important issues to explore.

The Underwriting Process

You contact your bank for a loan. A loan officer sets up a meeting to learn about your business and the financing need that inspired your call. Following that meeting, the loan officer may offer some preliminary guidance about your chances for approval, along with a request for detailed financial information, which the bank would use in its credit-evaluation (underwriting) process as it attempts to make four fundamental decisions:

Whether to make the loan How much to lend How much to charge What terms and conditions to require

Whether to Make the Loan: The 5 Cs of Credit

The first of these decisions hinges on creditworthiness, which lenders boil down to the five credit-underwriting precepts:

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Buying, Selling and Calling It Quits

In the preceding chapter , I discussed business valuations within the context of an entre-

preneurs investment-raising efforts. Now Ill ask you to flip that around a bit when the opportunity to merge with or acquire another enterprise presents itself. Ill also talk about what to take into consideration when it comes time to pass the torch to the next generation. Once again, its important to have good counsel on call. For example, lenders require borrowers to make certain representations and warranties for the loans they seek. Sellers and buyers will also be asked to make certain reps and warrants to one another regarding the entitys good standing, to provide disclosure schedules that explain exceptions to certain representations (which may include unresolved disputes that have the potential to have a negative impact on value) as well as other information thats pertinent to the deal. Your advisors will guide you in this regard. Your advisors will help you with the valuation process and guide you on the reps you can and should make, those you should require from the other party and the disclosures that need to be documented, and theyll suggest strategies for overcoming the objections that may result. Although your advisors are there to help you with contract terms and valuation strategies, its up to you to choose the right merger partners and acquisition targets. I urge you to focus on the dollars only after youve thoroughly researched and objectively assessed the integrity of the people with whom youll be negotiating and those with whom your staff will be interacting once the deal is finalized. Thats because sales of closely held business are often structured with multiyear earn-out agreements, which can represent half the value of the transaction. With so much at stake, its important to feel confident about the intentions of the folks on the other side of the table. For example, the last thing youd want is for an acquiring company to change your firms accounting methodologies or sales-incentive compensation programs after the fact.

Mergers and Acquisitions

Is the contemplated action intended to grow the business or professional practice in a way it would otherwise be unable to achieve on its own? Is it a financial play or a strategic one? As important, what will the resultant entity look like organizationally, operationally and financially? And what protections would be built into the deal to ensure that your plans and projections come to fruition?
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Buying, Selling and Calling It Quits

The need for clearly defined objectives is obvious, if not for the sake of those leading the charge then for those whose support youll need to make the prospective combination work your lenders, investors, vendors, customers and employeesthe same good people without whom you wouldnt be in business in the first place.

The Difference between a Merger and an Acquisition

Two companies merge when each brings something special to the party on their way to forming an entirely new entity in the process. In this case, the merging companies have either determined they can no longer afford to go it alone, or that the ensuing cost savings, broader market reach and cross-selling opportunities have the potential to yield even greater shareholder value. The transaction may take the form of a horizontal merger, where direct competitors agree to blend their customers and product lines; a vertical merger, where a supplier combines with its customer; a market-extension merger, where two companies with comparable products sold in different regions decide to combine; a product-extension merger, where the parties are selling different products and services in the same geographical region; or a conglomeration, where the combining businesses are entirely unrelated. By contrast, when one company acquires the other, the acquiring company is the surviving entity because the acquired companys unique identity is eliminated afterward. You can read more about mergers and acquisitions here and here.

Valuation Methodologies
The valuation process is often quite contentious because the two parties are on opposite sides of the same table: owners want high valuations in order to limit the dilution of their ownership interests while investors want just the opposite. The same holds true for buyers and sellers, which is why business-valuation methodologies are a major focal point. The goal here is not to burden you with the intricacies of the various approaches and their underlying calculations but to make you aware of their existence, so youre able to have a more productive (and less costly) conversation with your legal and financial advisors. The valuation methodologies most commonly used include:

 djusted-book valuation, where the economic value of the companys assets A is expressed in current market terms (which may differ from their carrying values on the balance sheet) and from which the enterprises financial obligations (liabilities) are subtracted. This approach is also used for asset-based valuation purposes, where the pathway to a bigger number may be the difference between retail and wholesale values. If youre on the acquiring side, youll want a conservative asset valuation not only to control the cost but also to help secure
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Epilogue: From One CEO to Another

As I started to construct my outline

for Business Happens, I wondered about how to blend more than 30 years of experience, opinions and anecdotes into a book that would already be covering a daunting list of topics. Then it came to me: this is why God invented epilogues! What follows are a few more of the lessons Ive learned and the ideals I believe are important and true.

Downturns Are Opportunities

My professional career spans the equivalent of more than six official business contractions; the final three occurred when I owned or ran two different companies. What I found most interesting about these downturns were the opportunities they yielded. Recessions are the equivalent of a three-fingered saluteCtrl/Alt/Dela chance to test fundamental business models, execution strategies, organizational designs and process flows. Theyre also a terrific time to acquire new talent and expand market share because, to paraphrase Louis Pasteur, fortune favors the prepared (not to mention the less distracted) and also because the best people are usually the first to leave.

Plan B, C, D
Even though I mentioned this a few times in the book, its important enough to reiterate. I truly believe in having more than one way out of the room. In fact, I would never have succeeded with my last acquisition had I relied on a single path. The key is to be thorough and objective about identifying and ranking all alternatives by taking into account their likely outcomes economic and otherwiseand requisite efforts in terms of cost, time or what you may give up in the process. Youll then know whether to press forward or regroup.

Employee Turnover
I once had a polite but intense argument with a senior executive at a large company who advocated for Jack Welchs fire the bottom 10 percent view of managing for excellence.
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Epilogue: From One CEO to Another

As those of us whove actually signed payroll checks know, it costs real money to hire, train and properly support a new employee. Thats why I feel strongly about two things. First, failing employees that deserve the chance should be considered for alternative assignments. Second, were all accountable in these situationsthe managers who did the hiring as well as those who manage the managers. My son, who works on the investment side of the financial-services industry, once made an interesting observation in this regard. When he evaluates a company for investment purposes, one of the things he considers is something he describes as the velocity of turnover under the CEO. In his view, if the number is high (lots of turnover), its because the CEO doesnt know how to hire or is impossible to work withand, either way, the board of directors is complicit because it hasnt done anything about that. Consequently, he declines the investment opportunity. Speaking as a lender and as a private investor, I agree with him.

Succession Management = Upward Mobility

This one took a while for me to appreciate when I became a first-time manager. The more I tried to control my direct reports performance and the less I decided to delegate to him, the more I ended up limiting my own advancement in the process. Successful hiring is, in effect, replacement hiring. Managers that are concerned about the people they bring aboard shouldnt have hired them, or perhaps the managers shouldnt have been considered for management in the first place.

Encourage Proprietary Interest

Entrepreneurs prod their employees to take an ownership interest in the company. But the truth is, its hard for employees at every level to really feel as if they have a stake thats worth protecting. Ive tried to express this concept a little differently by putting it in terms of personal dollars and cents. For example, my management team once had a lengthy debate about outfitting our new offices. My chief financial officer and I wanted middle-of-the-road, utilitarian furnitureour own offices included. Others petitioned for something more elegant or, as they described it, commensurate with the successful company weve become. So I presented the options to my staff in the following terms: Would you rather sit on your money or have it in your pocket? Guess what we ended up doing.

Hierarchy versus Collegiality

I enjoy being able to move from idea to implementation in as few steps as possible, which is why I prefer the informality thats inspired by few organizational layers. And before you say, Thats fine for small companies, but what about big ones? let me add that our firm grew to more than $1 billion in size with no more than five layers of hierarchy at its steepest point. This flat organizational design had other benefits as well. It helped us control over99