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5 Small Business Mistakes That Thwart Success

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small business

In recognition of National Small Business Week, we look at what a bankruptcy lawyer knows about business.

Everyone tells you what to do to succeed in business;  you also need to know what not to do if you don’t want to fail.

Running your own business is the classic American dream.  It’s romantic and heroic.

The romance of self determination, market recognition, and profit obscures the fact that the overwhelming percentage of small businesses fail within 5 years.

I love entrepreneurs.  They are creative, determined, skillful, and incredibly  hard working.  And still they fail.

Those failures represent not only dashed dreams, but financial pain.  That financial pain is personal pain as well.

No isolating business debt from personal assets

In thirty nine years as a bankruptcy lawyer, I’ve found themes in why they failed.  Here is my list of five behaviors tied to business failures.

They plan only for success

The business plan assumes steady straightline movement toward growth and profit.  A typical plan may start small and project growth.  But it doesn’t plan for setbacks.

  • What if it takes twice as long to get a toehold in your market?
  • What if capital costs more than you think?
  • What if your pricing model  craters?

Before you take the self employment plunge, you need to assess your ability to survive if your rosy plan for success is off by 25%.

The entrepreneur loves the craft, but not the business

If you’re a great carpenter, a great cook, or a great lawyer as an employee, it’s tempting to set out to ply those skills for your own benefit.  Run your own business, the way you think it should be run, and make more money doing what you do well.

When you go into business, you wear two hats:  the skilled professional AND the business manager.

Many business failures are grounded in the entrepreneur spending all his time on the craft, and less than the bare minimum on management.

Employment laws are ignored, bank accounts aren’t balanced, taxes are postponed.

To be a success in business, you need to attend to business, or to partner with someone who loves the business side of things.

They pay too much for existing business

Buying an existing business seems like the answer to all the start up difficulties.  It’s a turn key operation, often coming with some transitional help from the seller.

And, all too often, too good to be true.

The first question to ask is why the business is for sale.

Frequently, it’s because it isn’t really making it.  It may be paying the expenses of operation, but it isn’t actually supporting the owner who works there.  The hours are too long, the challenges larger than the rewards, and the owner wants out.

Ask yourself, why you want in under those circumstances?

Ask, too: are the books up to date?  Reliable?

Another motivation for sale is that the sellers want to retire and they see the business as their retirement plan.  To substitute for retirement savings, the selling price needs to be generous.

Is the business priced at what the sellers need, or what the business as constituted is worth?

No profit if financed on credit cards

Credit cards are associated with consumers and household budgets.  But all too often, new businesses are started on the owner’s credit cards.

The myth of the business credit card

Plastic is pitched to small business owners as either a convenience, a status item, or the bedrock of business operations.

It’s really hard to make a profit if your seed capital requires interest payments at 22%.

Also, far from simplifying business bookkeeping, credit cards obscure the fact that the debt service you pay on the credit card this month is really paying for a fraction of last month’s costs of operation.

Credit card payments become their own line item in the budget rather than simply a means of paying for inventory or services required last month.

They gamble their retirement on business success

When your retirement account  is the only hoard of money you’ve set aside and you want to go into business, the temptation to draw on your retirement to make it happen is almost irresistible.

You tell yourself you are making an investment in your future.

When you do that, you break one of the basic rules of investing:  diversification.  You have put all of your retirement “eggs” in the business basket.

If the business fails, you have neither a livelihood nor a nest egg for old age.

The phenomenon is not confined to those just starting in business.  Too many folks in my bankruptcy office to deal with a dying business tell me that the business was their retirement plan.

Instead of setting aside earnings for retirement, they plowed their money back into the business.

They expected to sell it to retire.

And now there’s nothing to sell.

Make a better business plan

Give some thought to the  business side of your craft.  Make a plan and go for it.  You can be great.

More

How to sign the corporation’s name to business deals

Your business needs a prenup

Essential  habits for successful entrepreneurship

Image: Pixabay

Closing Up Shop

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What can you/should you do when it becomes obvious that your start up business should wind down?

The hardest part of being in business is recognizing when the business has no future.  Yet the overwhelming majority of new businesses fail within 5 years.

So you’re not alone.

Shutting down an insolvent business presents a tough challenge: honoring the legal rights of creditors while minimizing the damage to the founders and employees.

Not to mention the emotional hit.

Separating the owner from the business

Unless you are a sole proprietor, you and your business are two separate legal entities.

Whether your business operates as a corporation or an LLC, it has its own rights and obligations.  Those rights and obligations  may be different from yours as the shareholder.

For the purposes of this discussion, we’re going to assume the business is a corporation. If you operated as an LLC, the issues are essentially the same as those of a corporation.

  • The board of directors of an insolvent corporation owes its duty of loyalty to the creditors, not the owners.
  • Creditor claims get paid before the shareholder’s ownership claims.
  • Shareholders can be creditors as well as owners.
  • Management can legally pay some creditors and not others.

Keep these precepts in mind once you see the business needs to close.

Bankruptcy or not

There is no clear or universal answer to whether a failed business should file a Chapter 7.

A corporation does not get a discharge in a Chapter 7 case; only a Chapter 11 reorganization erases the debts of a corporation.  And a Chapter 11 is worth the significant time and expense only if the business has a future, or some valuable asset salable only if the business continues until the sale.

So the only purpose a business bankruptcy serves is to liquidate the business assets and satisfy creditors as far as possible.  The unpaid debts will remain enforceable against the corporation for as long as the law allows.

Companies can go out of business without filing bankruptcy: they liquidate their assets and cease operations. Creditors have a right to recover their claims from the assets of the corporation.

If there are no assets, the corporation cannot be further harmed by lawsuits that try to collect from the corporation: a judgment against a company without assets is worthless.

Closing without bankruptcy

It’s perfectly legal and rational to simply close the doors and cease business without involving the courts.

The danger to management in this approach is the tendency of some creditors to assume that the business’s failure to pay means that there is some sort of skullduggery afoot.  Those creditors don’t recognize the legal distinction between the corporation that runs the business and the people who work for and own the corporation.

It becomes easy and reflexive for such creditors to sue the officers as well as the corporation to collect the debt.  The corporation may have no remaining assets but the officers have both assets and future earnings at stake.

While the claim against the individuals may be invalid, the individual has to appear and defend in the lawsuit, or a judgment will be entered against him.

And sometimes, the individuals are liable because the individual guaranteed the debt or even the individual opened the account before the corporation was formed.

Why doing it yourself can work

Personally managing the wind up has advantages, if you are willing to devote the time and energy to the process.

Management can usually get a better price for assets since they know the market, know the asset, and are motivated to get highest recovery.

Outside of bankruptcy, you control who gets paid with the available funds.
You can act swiftly to limit exposure of management or investors by paying first debts guaranteed by insiders, subletting leased space, returning leased equipment, etc.

Creditors are protected from having to give back preferential payments to the bankruptcy trustee.

Assets can be sold to insiders so long as the price is fair.

All desireable outcomes, if it’s possible.

DIY isn’t all roses

But…
Handling the shut down yourself has some down side:

  • May prevent management from accepting new employment
  • May require cooperation from creditors and lessors
  • May increase likelihood that disgruntled creditor will sue individuals too

Bankruptcy is simple

In Chapter 7, the bankruptcy trustee becomes responsible for liquidating assets, returning equipment, and dealing with creditors, freeing management to turn to other endeavors

The trustee has powers under Bankruptcy Code to sell leases despite anti assignment provisions and to avoid levies and writs of attachment, recovering value for creditors that isn’t possible outside of bankruptcy.

Filing bankruptcy seems to reduce the instance of creditors suing individual managers for corporate debt.

The automatic stay prevents aggressive creditors from diverting cash that could be used to pay taxes, employees, and guaranteed debts or recovering property needed for wind up.

But….
If the bankruptcy trustee winds up the business:

  • Trustee unlikely to get top dollar for saleable assets.
  • Insiders may be prohibited from buying technology, intellectual property or projects in development
  • Trustee’s fees and expenses are paid off the top
  • Trustee can recover preferences to trade creditors and to insiders and challenge pre petition transfers of assets if legally fraudulent
  • Bankruptcy process frequently slow and inexact
  • Claims are paid according to priorities in the Bankruptcy Code

Try some of each

The choice of how to wind up doesn’t have to be an either/or decision.

Management can liquidate assets as far as feasible, and file bankruptcy thereafter to let the trustee mop up.

Step back and look at the issues of timing, asset value, and creditor claims.

If the answers seem complex, consult a bankruptcy lawyer for help weighing the alternatives.

More

Payroll tax trouble

Separating the business from the business owner

Myth of the corporate business card

Know who you are when the business files bankruptcy

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While knowing who you are may be central to philosophy and mental health, you wouldn’t think it poses a difficult question in a business bankruptcy.

You wouldn’t think the word “you” would be so challenging.

Yet, small business owners find it hard to separate themselves from the business, even when that business is incorporated.

After all, the owner’s financial livelihood rises and falls with the success of the corporation’s business.

You and your corporate business

Twice in the past two days, I had occasion to point out to clients who own small corporations that when the bankruptcy trustee says “you”, the trustee is talking about you, the individual, not the business that you have been immersed in.

How to sign for your corporation and not be personally on the hook

But the distinction is important.

In the law, the corporation that owns the business is a separate legal “person” from the flesh and blood human being who owns the stock in the corporation and serves as its officer and director.

The debts of the corporation are not necessarily the debts of the shareholder. The corporation can file bankruptcy without the shareholder, and conversely, the shareholder can file bankruptcy without impacting the day to day operations of the corporation.

In analyzing a bankruptcy filing or answering questions from a bankruptcy lawyer or bankruptcy trustee, make sure you know who you are.

More about struggling businesses

Individual bankruptcy and business debts

Is it safe to file corporate bankruptcy

The unexpected benefits of incorporating

When your business needs to wind down

 

More on business bankruptcy on Bankruptcy in Brief.

Three Cheers For Entrepreneurs

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Entrepreneurs

Let’s hear it for entrepreneurs.  Those brave, tireless people with a dream who start or run small businesses.

They possess more energy and perseverance than most of us.  They form the backbone of our economy.

In honor of National Entrepreneurs Day, November 20th, let’s recap Soapbox’s best on being in business for yourself.

It’s probably not surprising that I like entrepreneurs, because I’m  an entrepreneur too.  I opened up my general law practice the day after I was admitted to the California bar.

Over the years, the focus of my law practice has narrowed as I’ve become an insolvency specialist, but I have always worked for myself.

So, small business folk are some of my favorite clients.

Clients I tend to see in my professional role when business struggles.  Here’s what I’ve learned about small businesses and the hardy folk who run them.

business divorceYour business needs a prenup

Anytime you pool your money with someone else, you need a written agreement about how you unwind the joint venture.  Just like marriage, business life changes and today’s partnership may not work at some point in the future.

 

small businessFive mistakes to avoid for success in your business

Culled from my four decades of advising business people, these five things stand out as reasons businesses don’t succeed.  Here’s what NOT to do if you want your business to survive and thrive.

 

incorporation protectsYou’re incorporating for the wrong reason

The best reason to incorporate your business isn’t to protect yourself from the debts of the corporation.  It’s just the opposite: incorporate to protect the business from your debts.

 

How to avoid being on the hook for business debts

You incorporate to limit you exposure to debts of the business.  Don’t throw the benefits of incorporation away by the way you sign corporate contracts.

 

Four essential habits for successful entrepreneurship

Here are four unsexy, but absolutely essential, habits to cultivate in business.  Adopt them from the start of your business:  well begun is half done.

 

Alternatives when the business struggles

closing businessThe hardest choice facing an entrepreneur involves failing.  Take a look at the alternatives available when it seems the business has no future.

 

Here’s hoping we never meet professionally.  Savor National Entrepreneur Day.

 

 

Your Business And You In Bankruptcy

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multi faceted issueFacets on a gem bend light and change how we see things.

The same thing happens when bankruptcy law encounters a small business owner and the business itself.

Seen from one angle of the law, the business is a valuable asset.

Seen from another, it is nothing more than a job for the owner, having no real value without the owner.

It depends on where you stand and where the light hits.

Is incorporating dangerous?

The question comes up when individuals have a small business that provides a living, but the owners have accumulated crushing debt.

I wrote earlier about how incorporation could create a separate legal entity that could continue to operate during the bankruptcy of its shareholders.

My good friend Doug Jacobs pointed out that under some circumstances, incorporation could be seen as a fraudulent transfer.  And that’s not good.

A fraudulent transfer is one where the entity conveying property either intends to put it beyond the reach of his creditors, or, receives less than the asset was worth in exchange, leaving the transferor less able to pay his debts.

The bankruptcy code allows the bankruptcy trustee to recapture assets transferred in fraud of creditors.

My counter argument to Doug’s point is that incorporation hardly conveys away the value of the business, as the debtor simply exchanges his outright ownership of the business for outright ownership of the stock in the corporation that owns the business.

If there is real value there, a bankruptcy trustee can reach it by dissolving the corporation.

My second argument is that before incorporation, the business was indistinguishable from the individual. The idea of “transferring” debts to the newly created corporation is facially pleasing, but cannot relieve the individual of any liability he had before incorporation.

It is an axiom of law that no agreement between two entities can bind a third: that is, the individual and his corporation cannot by agreement cut off the right of the individual’s creditor to look to the individual for repayment, even though the new corporation and the individual might agree that the corporation will be henceforth liable.

This analysis is probably more theoretical than real.

The small businesses my clients usually operate are little more than personal services businesses. Incorporation simply provides cover for the trustee who, because of incorporation, doesn’t have to shut the business down as part of his duties to preserve the assets of the estate.

Law colored by local culture

But whether you see incorporation representing a meaningful transfer or not, the issue highlights the fact that the legal culture does vary from place to place.

I practice in Silicon Valley; Doug practices in the Central Valley. Like it or not, even though the law is the same in both places, judges often bring a slightly different perspective to the bench, depending on where they practice.

For that reason, when you select a bankruptcy lawyer, you want one who knows the judges before whom your case will be heard and understands the legal culture in that community.

Image:  Nemo & Pixabay

Bail Yourself Out Of Payroll Tax Trouble

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parachute-851318_640 (1)

Business owners with unpaid payroll taxes are in deep trouble.

There’s no corporate shield when it comes to payroll taxes. Even if the employer is a corporation, the corporation’s managers are personally liable for the trust fund portion of unpaid payroll taxes.

The trust fund portion of the tax (the amount withheld from employees’ checks) can be assessed against anyone  who could have paid that money  to the IRS.

You are in the IRS’s cross hairs, personally, if the business hands out “net” checks to employees with sending the withheld money in.  A bankruptcy discharge is no help here. [Read more…]

Your Business Partnership Needs A Prenup

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Wedding_2Financial partnerships are at least as challenging as marriages.  And business deals don’t have love to smooth the rough spots in the relationship.

The traditional marriage service ends with the charge that what God has joined together,  let no man put asunder.

That’s great with love, but not so great with money.

Something will likely asunder the business venture.

Yet people pool their money in business, real estate, and investments without a thought to how the partnership will end.

Chances are, it will end, and that end can be very messy and miserably expensive.

My charge to those pairing up for an investment is this:

At the start of any venture involving pooling money, lay out some rules for how you part in the end.

Think of your business wind-up rules as a prenuptial agreement for your business. [Read more…]

How Your Property Gets Sold In Your Partner’s Bankruptcy

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co owned property

It isn’t just marriage that can get you roped in to a bankruptcy case that isn’t your own.

Own community property and a bankruptcy filing by your spouse or your soon-to-be ex can drag you into a bankruptcy court.

But the issue is broader:  joint ownership of any kind of asset in any state, community property or not,  exposes you to a loss of control of your property if your co owner files bankruptcy.

The bankruptcy court has the power to force the sale your property or require you to buy out your co owner.  On a timeline not of your choosing.

Co owners at risk

If your partner in a business or a piece of real property files bankruptcy, the partner’s interest may be sold for the benefit of your partner’s creditors.

Oops!

And since the sale price of just your partner’s interest in the property would probably be less than the fraction of the partner’s ownership, the Bankruptcy Code gives the bankruptcy trustee the power to sell your interest too. [Read more…]

Four Essential Habits For Successful Entreprenuership

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entrepreneur-593362_1280Starting out in business for yourself?  Congratulations.

Small business, and businesses that were once small, form the tapestry of our economy.

I’ve run my own small business for coming 40 years and my favorite clients in my business are other small business people.

But, in the euphoria and exhaustion of starting up, don’t put off doing the dull basics of bigger businesses. Those basics are basic for a reason.

Form habits and routines from the very beginning that will serve your business well as it grows.

Four utterly non-sexy imperatives form the foundation of a small business. [Read more…]

What Asset of Failed Business Is Most Valuable?

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run off with business assetsUsually I rant about mistakes clients made when they incorporated their ongoing business.

Come hard times for the business, those mistakes eat into our options for the owners survival when the corporation goes down.

Invariably,

  • the vendor accounts remain in the name of the proprietor,
  • the stock may not have been issued, and
  • it’s unclear whether there was an explicit transfer of the assets to the corporation.

If the business is beyond saving, I want the incorporated business to go out of business. The business can shut down either through a bankruptcy filing or just by closing the door.

The goal is to let the corporation die without killing the owner in the process.

That requires  as much distinction between the assets and debts of the business and the assets and debts of the business owner as possible.

Yet when the incorporation was sloppily done, that line between owner and business may be murky.

Owner still needs to eat

The challenge when a small business fails is making sure that the owner has a way to make a living after the doors close. [Read more…]

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