(Biz Law) Essential Steps for Successful Business Expansion
Jun 20, 2024
Michael Palermo / Matt Mittan
Ready to transform your business by expanding its ownership? Join us as we sit down with expert Michael Palermo to uncover the essential steps for bringing in partners, co-owners, or investors. Learn how to create a structured plan and craft clear, written agreements that define roles, contributions, and expectations. Whether you're considering a buy-in, labor contributions, mergers, or pure investment, Michael's insights will guide you through the complexities of different business entity types and potential tax implications.
Curious about the vital questions to ask before investing in a business? Michael reveals what you need to know, from detailing specific contributions and roles to setting up mechanisms for removing underperforming members. Our discussion emphasizes the importance of well-defined terms to prevent disputes and ensure smooth operations. For those seeking further guidance, we encourage you to reach out via email or explore our website for more resources and related podcast episodes. Don't miss this opportunity to gain clarity and confidence in expanding your business ownership!
Ready to transform your business by expanding its ownership? Join us as we sit down with expert Michael Palermo to uncover the essential steps for bringing in partners, co-owners, or investors. Learn how to create a structured plan and craft clear, written agreements that define roles, contributions, and expectations. Whether you're considering a buy-in, labor contributions, mergers, or pure investment, Michael's insights will guide you through the complexities of different business entity types and potential tax implications.
Curious about the vital questions to ask before investing in a business? Michael reveals what you need to know, from detailing specific contributions and roles to setting up mechanisms for removing underperforming members. Our discussion emphasizes the importance of well-defined terms to prevent disputes and ensure smooth operations. For those seeking further guidance, we encourage you to reach out via email or explore our website for more resources and related podcast episodes. Don't miss this opportunity to gain clarity and confidence in expanding your business ownership!
And welcome to another episode of our fantastic biz law series here on biz radio us. Michael palermo is our featured expert in business lawyer who walks us through all these great topics. And you know, before we get started on today's topic, I just wanted to invite people. If you have a special request for either an episode or a blog entry or anything, I'm sure michael is very open to hearing from folks. Am I speaking out of order on that, michael?
Speaker 2:
no, I'm always trying to think of something to write about. It's something I enjoy doing.
Speaker 1:
Yeah, no, and it's really good information and we get good feedback on stuff. So you know, as we go through these things, realize whatever topic you're hearing, scroll back through old episodes and catch up on a lot of great stuff. Check out Michael's blog. We link that off of different whether it's on Biz Radio or if it's on podcast platforms. People can find their way to your website and to the blog entries. But even if you don't find what you're looking for in either of those things, just drop a line to Michael. All right, let's get into today's topic. So we have on tap for us today bringing on a partner, a co-owner or an investor. Talk us through the umbrella overview of that.
Speaker 2:
So everybody, I think, understands what a partner, co-owner or investor is. Just generally speaking, it's more than one person can own a business. So the local coffee shop might have two owners. Chrysler LLC has 5 million owners, and that's what we're talking about. What does it mean to bring on if you own a business and you want to expand the ownership? So you want to expand your business through giving out ownership. What does it look like?
Speaker 1:
All right, and so does that conversation or that consideration. Does it vary based on the legal entity status of how you've structured your business to start? Are there things where people need to look at maybe changing their structure of their business before they do this?
Speaker 2:
There may be taxation issues. So, for example, S corporations are very limited in the number of owners and the status of the owners. By status I mean, for example, foreign nationals I don't think can own shares in an S corporation. There are certain types of restricted entities that can't own shares in an S corporation. So if the business is originally an S corporation, they're going to want to talk to their CPA whether or not they can maintain their subchapter S election or if they need to switch over maybe to a limited liability company which has different taxation rules, and vice versa.
Speaker 1:
And there's also different federal limitations on benefit options if it's an S cor because of declaratory compensation and things like that. So, yeah, definitely I know you have friends in different lines of expertise that you refer people to, whether it's on tax stuff or you know different things like that. But good thing to keep in mind. What are some different ways to do it? To bring on a partner or a co-owner or investor.
Speaker 2:
What I have on tap for today is if there's a buy-in for a share of the ownership, if there's a share of ownership in exchange for time, labor, effort, skill, there could be a merger of similar or complementary businesses, and the last one we'll talk about is just somebody making a pure investment in your business, and that means money for shares and expectation of getting a dividend or an increase in the share value.
Speaker 1:
All right when you look at buy-in. I want to go a little bit deeper into each of those different things you just mentioned. So the first one buy-in for a share of the ownership. What does a business owner have to put in place before they can go and offer shares?
Speaker 2:
Well, they need to have a plan is sort of the main thing. I'm working with a business now that it's some kind of tech business I'm still not quite sure what he does but he wants to bring in his programmers as owners and you can't just say, okay, you're an owner. There needs to be some sort of preliminary setup as to what that ownership is going to look like and what it means to be an active owner in a small business versus just a pure investor.
Speaker 1:
And when you talk about share of ownership for time, labor effort, skills and everything, is that kind of like a standalone contract thing or is that like a shareholder agreement? How does that manifest?
Speaker 2:
So shareholder agreement, it can be any type of agreement, from a handshake to a 30-page agreement defining what it means to be a shareholder. But when we're talking about share of ownership for time, labor, effort, skill or, if you bring on we talked in another episode about key employees or just having a name associated with your business For you Chicago people, I don't think Michael Jordan was cooking steaks at Michael Jordan's restaurant, but he definitely had a share of ownership and he just traded his name for the income part of the income that needs to be in writing. If someone's going to devote time, labor, skill to the business, how much time? 30 hours a week, 60 hours a week, what kind of labor so we talk about? If they're going to give labor to the business, If it's two guys starting an electrical company, certainly they're both going to work as electricians and that doesn't need much defining. But if you're going to give ownership in exchange for labor, let's define what that person is doing.
Speaker 2:
So Michael Jordan probably had to make a certain number of appearances every month or every year, every week, whatever it may have been, and that was defined in the contract. You know you got to show up at seven on Thursdays and stay till 930. Similarly, if you're going to bring in someone as a cook to your restaurant, you want to define what they'll do as a cook, whether it's just cooking recipes from a script or creating new recipes, daily specials, that sort of thing. So I'd like to see that defined in a document. So, as I said in the other episode, contracts keep honest people honest. Let's just put it in there, let's just put it in writing. You're going to be here from 7 to 3 every day. You're going to come up with one unique dish to serve at the restaurant every week and it'll be ready by Thursday so we can serve it on the weekends and so on. Just defining what's going to be done and in exchange for that, you're going to have a 20% ownership in the business or whatever the number is.
Speaker 1:
When you talk about merger of similar or complementary businesses, there's so much underneath that. You talk about debt, you talk about shareholders, you talk about personnel, you talk about your banking and classification of business and everything else. I see a lot of small business, especially in the entrepreneurial level. When people are just starting to grow their business, they're starting to realize oh wait, my idea is actually catching on. I'm getting a little bit of a customer base. That, from my experience, is where people start looking at other people that may be in a similar stage but with a complementary situation. They're like we should merge our efforts. And when you're young as a company I don't mean age, but young as a company and you're hungry and you're starting to see something, that's where I see people make mistakes about mergers or complementary associations in their business. Talk about the importance of making sure that is structured as if you were a million-dollar company.
Speaker 2:
So, as I always get it in writing, what are the roles of the merged business owners going to be? So let's say you're just merging two businesses owned by one person each. Now you have two owners of one business. What are the roles going to be? Make sure it's a good fit. Don't just say, well, I own a coffee shop up here and I want to expand my territory, so I'm going to buy a coffee shop down there. Make sure the business is fit. It's a relationship. It's like dating or marriage or having a best friend or finding a new doctor. You have to be able to work together. So just saying, well, I want market share, I'm going to buy that coffee shop down there, and one might be serving sugar pastries to everybody and the other one might be a holistic serving holistic coffee and grain-free products. So those aren't necessarily complementary businesses. It's really important to make sure the businesses fit and then, of course, get the work split. What are the roles going to be of the two owners once the businesses are merged?
Speaker 1:
All right. And when you talk about pure investment from the perspective of a potential investor, not so much from the business, but what should potential investors ask a potential investment opportunity? What should they be asking that business for when considering whether to do a pure or straight investment?
Speaker 2:
If you watch Wall Street that great movie from back in the 80s I think it was they were always trying to get information on the business that we've. From back in the 80s I think it was they were always trying to get information on the business that we've talked about in other episodes what's the revenue stream? What's the equipment worth? What's their marketing look like? Do they have new products in the pipeline? And he was, you know, he was spending, you know, 20, 30, 50 million dollars to purchase a business. There was no reason why somebody who is going to just invest in a business I'm going to give my nephew $50,000 so he can get started or grow his business, but I don't want anything to do with the business. I just, you know, when the business makes a profit, I want to make my share.
Speaker 2:
So it's exact same questions what's the financial status of the business? What's the growth plan or the five-year plan? What's the financial status of the business? What's the growth plan or the five-year plan? What's the trend been for the last five years? What products are in the pipeline? Are they getting a lot of lawsuits from the new product? Are they getting a lot of employment claims because they're not treating the employees. Right, you can ask all these questions even if you're just giving $50,000 to your nephew and you know if he doesn't want to answer the questions, then he doesn't want your $50,000. But it's the exact same questions you would ask before you invested in Chrysler or Disney or Microsoft. It's just on a smaller scale.
Speaker 1:
All right, one of the things you've mentioned it a few times already, so I just want to circle back to it for a moment moment. When talking about bringing on a partner or co-owner or investor and everything but the clarity in what you get in writing you know you've mentioned it in a few different categories of this episode already, but you know talking about, you know from the new owner or the investor and things, what are the specific types of things they want to make sure that they get measurables on.
Speaker 2:
So I'm a big fan of specificity in writing and intention of the writing. If you call a contractor and say I want a new porch, and he says okay, and then he shows up the next day with a bunch of wood, what are you getting? What's that new porch look like? How big is it? What kind of wood is it made out? Of? What's the foundation look like? Is there going to be a cover on the porch? Is there going to be a railing?
Speaker 2:
You didn't get the clarity that you probably should have had when you asked the guy to put in a new porch. So when you bring on a new partner or a co-owner or an investor, try to get that same clarity. It's scope of work in a construction contract or a services agreement. We would call it a shareholder agreement. What is the new owner bringing with them? Is it just money? Okay, how much money? If they expect profits in return, how are profits determined?
Speaker 2:
I can't tell you how many times I see somebody think they're getting profits but nobody can tell me how the profits are going to be determined. Are they bringing with them skill? Are they going to advise the business? They might want to own the business because they like your business, but they want to be able to direct the business somehow. So will they be a director? Will they just be a consultant? Are they going to be an employee who has authority to bind the business? All of these things can be defined with some certainty. You don't have to be hyper-specific about a lot of things, but you want everybody to be able to point to a phrase in a contract and say, look, this is what you were supposed to do, and you want a judge to be able to look at that phrase and then look at the guy that was supposed to do it and determine whether or not they did it or not.
Speaker 1:
What's the what's the method for someone to eject one of the people that comes on as a new owner or, you know, as a co-owner, investor, you know partner or anything like that? What's a good method to get out of that if they don't come through with what you got all outlined in that?
Speaker 2:
Yeah, we, we mind in that.
Speaker 2:
Yeah, we recently did a podcast on getting rid of unwanted owners in a business, and it's somewhat difficult to do that in advance, but one good way to do it is just if you have a well-defined set of skills or labor that the person is the investor the new co-owner in the business is supposed to bring, and they don't bring it and they don't do what they're supposed to do, put something in there that you can get rid of that person, and it could be something as simple as if Michael Jordan doesn't show up for three Thursdays in a row at his restaurant, then you know we'll give him his money back and go our own way.
Speaker 2:
It could be that simple. You never really want to get to a lawsuit, but if you do get to a lawsuit, you need to be able to point to a reason why you're standing in front of the judge, so you need to be able to tell the judge look, this guy was supposed to work eight hours a day. He told me he was a skilled carpenter. It turns out we couldn't complete 15 projects because of him, and now we're trying to get rid of him.
Speaker 1:
What's the best way for people to get in touch with you if they want to make sure they cross their T's and dot their I's on all the stuff we've talked about here today?
Speaker 2:
As always, email is the best these days. Palermo. At palermolawcom that's also my website, palermolawcom you can see a list of what type of work I do. It's not exhaustive. I work on any type of business transaction and you can listen to the podcast there too, all right, sounds great as always.
Speaker 1:
Thank you so much, michael. Talk to you next time, all right.
