Big Talk About Small Business
Hosted by Mark Zweig and Eric Howerton. Our Mission is to inspire, empower, and equip entrepreneurs with the knowledge and insights they need to succeed in their ventures. Through engaging conversations with industry experts, seasoned entrepreneurs, and thought leaders, we aim to provide valuable strategies, actionable advice, and real-world experiences that will enable our listeners to navigate the challenges, seize the opportunities, and build thriving businesses.
Big Talk About Small Business
Ep. 105 - The High Cost of Cheap Legal Advice
What's the real cost of cutting legal corners in your startup? Attorney Lucas Regnier explains why your choice of business structure can significantly impact your growth trajectory.
The podcast delves into the often-misunderstood world of business entity selection, examining why LLCs, despite their popularity, may not be the optimal choice for growth-focused ventures. Regnier shares valuable insights about the limitations of LLCs when adding new owners or seeking investment capital, contrasting this with the advantages C-Corporations offer for dynamic businesses.
"A little bit of lawyering five years ago could have saved you ten times the lawyering and the pain later," Regnier explains, recounting situations where entrepreneurs found themselves trapped by poorly structured legal foundations. The conversation illuminates the concept of "corporate hygiene"—the documentation and record-keeping essential for business legitimacy that becomes critically important during investment due diligence or acquisition talks.
Perhaps most eye-opening is the discussion of securities law compliance. Many founders don't realize that selling any interest in their company triggers legal requirements that, if ignored, can create significant liability. Mark, Eric, and Lucas break down what constitutes an "accredited investor," why this matters for fundraising, and how to avoid inadvertently creating what Lucas calls "a loaded gun that investors can point at your head" if relationships deteriorate.
The episode concludes with a passionate discussion about building better bridges between entrepreneurs and investors in emerging startup ecosystems, with practical advice for founders navigating these complex waters. Whether you're just starting or scaling up, this conversation provides essential guidance for creating a legal foundation that supports rather than hinders your business growth.
So no, I tell them this 10 times a semester that lawyers are like anybody else. They're not all the same and you need people who are specialized in the problem that you are encountering. Hey before we get too far into that. This is another episode of Big Talk.
Speaker 3:About.
Speaker 1:Small.
Speaker 3:Businesses. Talk about small businesses.
Speaker 1:All right, we are back. Yes, sir, it's exciting. It's so good to be here with you guys. It it is it in the studio. Today we've got a very special guest, uh, lucas reynier. I call him luke, it's generally what he goes by. I'm sure people probably call you regnier and all kinds of stuff right mangled nine ways to saturday.
Speaker 3:Back again, but reynier reynier say there you go. No one's going to get sued for saying his name wrong.
Speaker 4:You sure about that?
Speaker 2:Yeah.
Speaker 1:Luke's an attorney and has a business here called Startup Boutique that serves startups in other businesses Well all kinds Small cap, mid cap ventures.
Speaker 4:But we get a lot of traffic from our local community of young founders Maybe their first encounter with legal and I get them fresh and green and I get to mold them the way they need to be molded oh my God.
Speaker 1:Beautifully. I love it Like putty in your hands, right.
Speaker 4:Like clay in the canes of a god.
Speaker 1:Hey, before we get too far into that, this is another episode of Big Talk About.
Speaker 3:Small Businesses.
Speaker 4:Best podcast on the web.
Speaker 1:Yeah, so, luke, you know I always tell my students. In fact, last night I had to give them this lecture.
Speaker 3:What do you do to hang out with your students at night? I teach at night.
Speaker 1:Oh, okay, I'm just getting clarity. God, anyway. So no, I tell them this 10 times a semester that lawyers are like anybody else. They're not all the same and you need people who are specialized in the problem that you are encountering. I don't go to you for divorce. I don't go to you for traffic tickets. I don't go to you for my wills, trusts and estates. Can you help me with my?
Speaker 3:DWI though.
Speaker 1:You don't have a.
Speaker 4:DWI. Be careful there.
Speaker 1:But I do go to you for all these ownership-related situations and that's what you know. And I think people think well, I'm going to save money and go to this guy over here because he's cheaper, or it's my mom's sorority friend or sister from college or whatever.
Speaker 4:Right, that's a fantastic point that you actually raise in your book. Confessions of an Entrepreneur is to focus on the people who are able to help you. That goes not just legal, but accounting. Oh, yeah, you know, sometimes you've got a CPA who doesn't understand LLC accounting, yeah, and you find yourself in untangling messes that maybe should have never occurred. Amen to that, exactly right. Never occurred. Amen to that, exactly right, you know. And so you know I do try to steer people where they need to be if they have a legal problem that you know that I can't help with. But for the most part, you know, you're right. There's an old adage beware the high cost of low price.
Speaker 4:Some people will just go for the lowest cost service provider. You know, startups are on a shoestring, we're really conserving costs, and so here's a guy that's cheap, and then you know, what you create is a problem that has to be unwound later at a factor of 10.
Speaker 1:How many times have we encountered that?
Speaker 4:I mean, yeah, it's putting my kids through college encountered that.
Speaker 1:I mean, yeah, it's putting my kids through college. I mean it's so. Yeah, we had one situation like that that you were involved in with that llc conversion to a c corp and you know, as it got too many owners over time with a very poorly drafted LLC operating agreement.
Speaker 3:Yeah.
Speaker 4:I mean Dr Cassini-Spurgeon, if they ever drafted that. It may have been appropriate at the time. But as a business grows, it has new needs and it needs to adapt, and this is another. This is a soapbox. I get on about LLC's. We'll talk about that later if you want. But yeah, that was a tough situation that we're a little bit of lawyering about five years ago could have saved you ten times the lawyering and the pain. Later you find yourself in a position where an absent founder with ambiguous rights maybe has the ability to like bend you over a barrel and squeeze a lot of value out of you. Exactly Everybody goes to their lawyers and realizes nobody knows what our rights are. What could have been a $5,000 legal investment is now maybe a $50,000 piece of litigation.
Speaker 1:Yeah, or $200,000 negotiation, exactly, right. Yeah, it's so true. It's penny wise and pound foolish. Yeah, and I think you know, as you said earlier on, I mean, how you start a business the legal foundation of that enterprise is critical to how it evolves, right, right? You know, it's not just a. It's not just a formality, like go create an llc, you know, is that the best legal form of organization for this business?
Speaker 4:Not always.
Speaker 1:Depends on what I'm going to do with it and what kind of business it is right.
Speaker 4:Right, right. It seems to be the default assumption anymore is that it is an LLC. It is. There's a video that keeps popping up every time I get onto you, mark Cuban, talking about what to do when it's time to start your LLC Not should you start an LLC, but when you're going to start your LLC.
Speaker 1:Not your company, but your LLC. They've automatically decided. It's predetermined, you're right.
Speaker 4:So you know LLCs are.
Speaker 4:They're a very tax-specific type of entity that are very attractive for certain reasons, but I don't find them to be the best way to run a dynamic enterprise where you're looking to scale up and add on new owners. They have a lot of old partnership law grafted onto the gaps. That creates, as we've experienced, mark you and I, some very painful consequences when they're not properly lawyered up. So I frequently encourage my founders if they come in to me with an LLC, let's convert to a C-Corp. If they come in with a blank question, I say why don't we start with at least an S Corp? Then you can change your election later. But let's talk about stock shares, not about percentage Exactly.
Speaker 1:I mean, look at one of the companies that you handle all the ownership-related stuff for now. Okay, I mean, you're doing all the legal stuff that we need the board minutes, the filings that we have to do. Stock sales are coming throughout the year, right, Right, right. You couldn't even do that if it was an LLC. Every time somebody buys stock or sells it, we'd have to redraft the operating agreement and get it re-signed.
Speaker 4:Right, it's not a real organism, I think, for dynamic business development, particularly people who are taking on new owners, and this is a curse of this is a thinking that gets stitched in with a lot of founders is that we think about bringing in new owners. Everyone's thinking in terms of percentages and you try to get people weaned off of that. Let's think about terms of shares numbers of shares.
Speaker 1:I've had that problem. I've thought the same way. I mean, you know I have Right, you do back-of-the-gun look calculations. Right, you've dealt with me on that very problem.
Speaker 4:Okay, it gets worse. But the problem is that. So you start with, you tell one guy he's got 10% and another guy you're giving him 5%, someone else is giving him 3%, but no one's calculating dilution as you go and it creates a situation of ambiguity if it's not properly documented or ill will. Right, oh, I thought I had 10%, now I've got like 6%, how'd that happen.
Speaker 1:I didn't agree to this other stuff.
Speaker 4:Right, right, I thought what did I pay for? So it's problematic. So we're trying to get people weaned off of thinking about percentages and thinking about some sort of objective criteria of ownership.
Speaker 3:So what's the value of an LLC then? I mean there's got to be some value to it, For sure.
Speaker 4:Well, first of all, one of the main values is a pass-through tax entity, so the LLC itself doesn't pay taxes like a C corporation would Like. A C corporation has to file a tax return 1040 if it's on. The LLC is all pass-through, so there's not that curse of double taxation. The LLC makes a hundred grand. It's not like it gets taxed and then you distribute it to everybody and then they get taxed again. Okay, llc, so it's a pass-through entity. Llc will issue what's called a Schedule K every year with everybody's prospective shares of whatever the LLC made Made for tax purposes by the way, you may not have seen a nickel?
Speaker 4:Yeah, exactly. But if the LLC made $100,000, didn't distribute any of it and you own 50%, guess what you just got? 50%—excuse me $50,000 worth of income that you didn't see a nickel off of. So you hope that the LLC operating agreement says we're at least going to distribute enough to cover your tax obligations.
Speaker 1:By the way, I'm glad you—I don't mean to interrupt you but, I think it's a really important point people need to understand, when you've got a pass-through entity like that, that you're taxed based on what your K-1 says, whether you got the money or not. Right, and the way the government looks at it is, if you left it all in there, it's like you made this money, okay, now we're going to tax you, then you reinvest it. That's the way they look at it. But the good news also is you can take money out of that pass-through entity at any time and have no tax obligation on it the cash potentially as long as you've got a positive basis.
Speaker 4:Right. So the LLC is not taxed, it doesn't file its return, it doesn't pay like the whatever percentage it's deemed ordinary income for most people.
Speaker 2:Yes.
Speaker 4:I'm sure I'm going to get nitpicked by some tax folks on that, but it's deemed to be. I'm sure I'm going to get nitpicked by some tax folks on that, but it's deemed to be worth it. The LLC makes a million dollars in revenue and you've got 20%. You just recognized a taxable event of $200,000. You better hope the LLC is going to at least distribute some money to help you cover that. Eric, to answer your question, what I like them for typically is for asset holding, so I think it's a better vehicle for you. You're going to invest, get a piece of real estate, a piece of property, something that's a little more static. I think that's a great way to do it.
Speaker 4:Why is that though listen for the tax purposes and because LLC's are really like low maintenance. You know you don't have to have meetings and it's just like the doc. You file your certificate hopefully you get a good operating agreement and then hand it over to your lawyer and CP. They're pretty low maintenance.
Speaker 3:On the tax side and the legal side. Really, if you're a sole owner of this LLC, it's excellent for asset type of businesses, real estate, yeah.
Speaker 1:I mean, if you and I are going to buy a piece, it doesn't even have to to be a sole ownership. Maybe the two of us are going to buy a piece of real estate, develop it and then sell it.
Speaker 4:Yeah, there's a life, a limited life span of that and we're not going to bring other owners yeah, it's like you keep all your little ventures in a little bucket of a separate legal entity for a whole lot of reasons and I think an LLC is like the easiest, low-cost way to do. If I've got like 15 properties, maybe I'll create a few LLCs as holding companies and deal with it and the tax issues are a little bit easier and the legal side is to kind of protect you from well exactly yeah, good point, Eric.
Speaker 4:that's like why people incorporate these entities to begin with you creating like this veil between you and the world. Sure, I know what you're going with there, Mark, but the practical reality is a little bit different. But the theoretical reality is that you have a veil of non-liability. Somebody slips on the property of Howard and LLC's ice cream shop and breaks their neck, they can take a judgment against Howard and LLC ice cream shop and you don't have that Like just this veil of non-liability. The practical reality is much more complicated. You know, like lenders will always insist on personal guarantees, there's piercing. But that's why we do it Like. That's like the baseline of why do you do this. You're creating an LLC or any sort of juridical entity is a separate personhood with its own separate bucket.
Speaker 3:It's like any kind of like legal situation. Right there's, it's another thing that you have.
Speaker 4:Well, it's a speed bump in the process of somebody suing you for that's right oblivion. Yeah, you know.
Speaker 1:Yeah, that's why we do it yeah, but I'm glad that came up though, because I do want to talk about that. I think you know my students. They all take business law. Did you ever teach that?
Speaker 4:I've never taught business law, for some reason. I thought you did. I teach alternative dispute resolution in the management department and I'm also teaching ethics and corporate responsibility now, which I'm loving. That's cool. They need that.
Speaker 1:But I think a lot of the business law, the business law classes. They tell people, well, you know, this is your protection against liability. They never go past that to say, okay, great, I've got a c-corp, but I'm the only owner of it. I can't say, well, this, this, you know, these people over here did something that created some liability that I'm not necessarily part of because I'm the owner, I'm the board of directors and I'm the officer of the company.
Speaker 3:So, what are you saying? You're saying that some people think that C-Corp doesn't protect you.
Speaker 1:No, what I'm saying is that you're still going to get sued in a lot of cases. Sure, whether it's an LLC, a C Corp, any closely held entity it becomes Luke can tell us more about piercing the corporate veil but it's going to get a bank loan If you want a line of credit.
Speaker 4:You're going to personally guarantee it Exactly. Someone slips and falls and breaks their neck. Of course, the plaintiff's lawyer is going to take a crack at me personally. They're going to try to pierce the veil.
Speaker 1:So you want to carry insurance.
Speaker 4:You want to insure the entity and probably up your personal liability insurance too, Because there's always those single-member entities are a little precarious, you know. It gets better when you've got a more dynamic entity. That's got like a few more board members, maybe more diverse capital structure and you've got like all the trappings of a legit business. You know, as opposed, to just like. This is my alter ego. I'm going to pretend like it's not Luke. It's Luke LLC. So go take a judgment against that and go pee up a.
Speaker 4:That's not. You know, that's a bit different yeah.
Speaker 1:So again, I guess the my point of that is that the liability protection is a fuzzy right thing. Right, I mean, because in any closely held corporation they're going to go after the for sure the owners yeah but yeah, llcs good for limited lifespan, good when the ownership's not changing right. Like you said, it's not a dynamic entity. We don't have like owners coming and going. As soon as we start doing that, then and here's another angle.
Speaker 4:that, mark, is that you know a lot of people here are looking up the ladder a little bit. They're looking for the next big angel investor, and the golden outcome for a lot of local startups is to find a VC, which gets talked about a lot.
Speaker 1:Doesn't happen, often Like one out of 500 or something.
Speaker 4:Right. I mean you really have a good business, but you know these people are going to not. I mean, I think on the East Coast the culture is changing a little bit, but at least for the most part, most VC investors are going to not want to invest in an LLC. They want you to have a C-corp because they're going to want preferred stock and so if you don't do it now, you're going to spend multiple later to convert to the entity that the investors you want want you to be in.
Speaker 1:Right, so why not just wait until?
Speaker 4:then let's just start with the C-Corp right and then you can deal with it, as opposed to later, when you get this fractionalized interest and you need a bajillion consents and it's complicated and you've got this mess of documents that no one's ever looked at. Now you've got that angel that you wanted or maybe, if you strike it rich, the VC investor that you wanted, and they come in and they look and say this is a frigging mess, clean it up, all right. So now you've got a big expense and do LLC members?
Speaker 1:because we don't have stockholders in LLCs. They're members and they have ownership interest. Do they all have, to a certain extent, veto rights over anything, because any change in the LLC operating agreement requires all signatures, does it not? Is that necessarily a?
Speaker 4:mandate yeah, not necessarily, so it depends on the well-written operating agreement can sort of craft your way around that.
Speaker 1:Okay.
Speaker 4:A lot of operating agreements aren't well-crafted and so there's a default like gap-filling provisions that come from a uniform LLC law that a lot of states have adopted. Arkansas has adopted it a few years ago. It just gets more complicated to do that, but the fractionalization of interest becomes a bit problematic. So a lot of LLCs that I see, a lot of ones that I write, now create a sort of a shadow stock. We call them units in an LLC. We've got like how many units are you buying in this LLC? So it's basically mimicking the behavior of stock I see Trying to sort of circle the square of all these problems. But no, the baseline philosophy behind the LLC is sort of like this partnership-type entity and usually partners have lots of rights and so if there's a gap, if we're going to default a lot of times to sort of common law, partnership law and it's problematic. So you know I don't want to poop all over LLCs too much, but I just tend to recommend for my startup and new venture clients that let's just start right now with a corporation.
Speaker 3:Is there a difference in cost to the startup between a C-corp and?
Speaker 4:an LLC. Yeah, a little bit Like I would say—.
Speaker 1:We've got to have bylaws, We've got to have a shareholder agreement right, well, so there is a bit more, eric.
Speaker 4:it's a good point. There's a bit more of a cost.
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Speaker 4:So we begin with. Any entity begins with the filing of a certificate with the Secretary of State for a reason to existence. With an LLC, your next document is just the operating agreement. That may be the only thing you ever mess with With a corporation. So we need, like the incorporator will appoint initial directors. The directors hold an initial meeting, which may just be a piece of paper, adopt bylaws, approve the initial capital structure and then everybody buys their shares.
Speaker 4:That's like a lot of people don't realize. Like you start a company, you actually have to buy your shares. Now, par value for a new corp is usually like a thousandth of a cent or something, so it's not a big investment. But we have, for securities laws purposes, another big topic. We have this sort of structure to where people need to buy it. So it's documented. We begin, we file, we create a corporate minute book. Everything, every step from the founding of this company to the present, is documented, with appropriate board resolutions. Shareholder resolution is necessary. We're keeping the book. I call it. It's called corporate hygiene. Yeah, we need good corporate hygiene If you want to go to founders and funders, angels, crowdfunding entities, et cetera, like I think some of us are doing right now then you need to have a good book.
Speaker 4:Yeah, it does take a bit more maintenance. So maybe it's a bit self-serving for me to say you should do this because I'm a lawyer and I do that you can maintain this, though for a small business. Exactly.
Speaker 1:You can just handle all that and say you guys need to do this X, b, a, b, c, d.
Speaker 4:I'll keep your minute book for you. We'll share the file, you can always access it, and so it's like a little bit self-serving for me to say that, but it's like a dentist. The dentist says go to the dentist every six months is right. Does really is because they don't want you to come back with like a mouthful of root canals.
Speaker 4:you know yeah, we all have objective interest right healthy clients like I want my people to be out. I love aesthetically pleases me to see well-kept corporate minute book where everything is cool it's so hard, though, for small companies.
Speaker 3:Yeah, we got a small business that's trying to get their idea out. Whatever they're not doing, they're trying to build a business. And then now they got to deal with corporate but they're not worried about that stuff.
Speaker 1:Yeah, it's a beer. Well, that it's just stressful.
Speaker 3:I mean, you've always kind of feel a little bit like you're under threat, like you didn't record your minutes, so therefore somebody's gonna, you know, have a big complaint and stuff.
Speaker 1:I mean it's but that's where guys like Luke, though, you could just say, deal with this for us.
Speaker 3:But what does that?
Speaker 4:look like Luke. Yeah, what does it look like? So one of the things I do is.
Speaker 1:It's like fractional in-house counsel Exactly fractional in-house counsel.
Speaker 4:So there's a barrier between I don't have anybody versus I've got to hire in-house counsel, between I don't have anybody versus I got to hire in-house counsel. So there's a sort of increasing business model it's out there, which I do call fractional in-house counsel. Like you basically pay me a monthly retainer, I'll just main manager business. You know, a lot of firms are still on the hourly rate model, yeah, which is painful because you don't know what you're getting. It's like calling the carpenter and you don't know what you're gonna pay. You need a quote of us. Another thing I just try to pick like here's a, here's a flat fee pay. This will be cool. You need to move in the next step, okay, so you can sort of budget it.
Speaker 4:And then again, the idea is to create full transparency so people know what you're into when you're calling a lawyer and again one of the things I want to emphasize for people is that you know, yeah, maybe it's a bit painful, but when, if you like somebody, you found a business, everything is roses.
Speaker 4:You're going to like revolutionize the whatever industry, you're going to move fast and break things Blah, blah, blah, blah, blah, right and everything's cool, cliché, cliché, cliché. Six months or a year down the line, all of a sudden there's a lot of friction between you and your partner. He's picking at your business decisions, he's absent, he vanishes for three months at a time and he's like meditating in india or whatever. And you're like now I'm gonna go to the lawyers, we got a problem and you hand them like this thing you generated off chat, gpt or you download it from rocket lawyer and the lawyer like reads it over, puts their head in their hands and does this and says here's the six ways you're screwed. Yeah, it's gonna cost you fifty thousand dollars. So you know that little bit again, a little bit of like going to the dentist six months ago might have saved you a root canal today. That's sort of my philosophy.
Speaker 1:that's a good analogy, yeah, so let's talk a little bit about, um, this whole thing of, uh, getting investors in privately held companies and the accredited investors or or whatever the terminology is. I think there's a couple different terms that are used. Tell people a little bit about that, yeah, for sure, how that works.
Speaker 4:That's a thing that trips a lot of people up. That people are fluent with is that every time you sell any interest in your company, you've committed, basically, a securities law event. This is a regulated thing. Like I have a worm farm and I sell you a dollar interest in my worm farm, promising you that I'll triple your investment in six months. I just committed something the SEC is probably interested in. Right right Maybe not, but that's the idea. Right right, Maybe not, but that's the idea. Any sale of what is called a security, and that is any sort of equity ownership in your company, is a regulated event and if it is not registered, then it is forbidden. Registered means like I've done an IPO and I'm trading, like on the NASDAQ or NYSE or whatever.
Speaker 1:We all know about that Exactly.
Speaker 4:That's like a bajillion dollars of underwriter fees and all that stuff to go through. So nobody does that in the startup world. What we do instead is we look for what are called exemptions from registration. So I want to sell Mark 500 shares of my company and I'm going to look for an exemption from registration and that needs to be documented because eventually, like a lot of people think, I'm just going to fly under the radar and I'll just sell, nobody will know no one will ever know.
Speaker 4:Maybe no one ever does, but maybe maybe you're that one gazelle in the herd that the lion catches. To make an example out of right, kind of a gross analogy. Gross analogy, but you know, the sec eventually does, and state regulators are interested in this too. If I sold you 500 shares of my company and all I do is say you give me a check and I'll just give you a piece of paper that's a stop certificate on it, we just like laid a minefield in front of us that somebody's going to step on at some point. So what we do again? So we look for the sort of baseline, Easiest way around this is only sell shares to millionaires.
Speaker 4:Millionaires, yeah right, nice little rhyme. Millionaires are for the most part what we call accredited investors. That's a term of art in securities law compliance. That means they're sophisticated enough they can bear the loss. It's not like somebody's grandma. They know the risk, they know the risk, they can bear the risk. And so you sell to what are called accredited investors and there are specific exemptions in securities laws that make that work. But you still need a good stock purchase agreement that says it makes all these representations.
Speaker 4:That person needs to check a box, call it a credited investor questionnaire that you can put in your file in case anyone ever comes looking right. And then here's the big thing a lot of people don't ever screw with. You need to file something with the Securities Exchange Commission. There's a thing called a form D. That just it's very informational. Most of the time nobody ever reads it. But you're supposed to do it and if you don't do it you might lose your ability to rely on this exemption in the future, being able to file a Form D. You're in the Edgar database. Getting the codes can be complex, but it's worth it In doing all this stuff.
Speaker 4:People say why do I have to do all that? Like, nobody does this stuff right. I've never heard of this. I'm just going to sell mark 500 shares and not spend a bajillion dollars. Well, yeah, later the company is going gangbusters. We're making money hand over fist. Now we're ready for VC and they come in and look at it. You've made all these sales. You've got liability, securities law liability lying all over the place.
Speaker 1:Now you're gonna hit the radar of the right. Now you may hit the radar, yeah, but here's even the more tangible bad situation that happens.
Speaker 4:Maybe somebody's not an accredited investor right. They're the close. Or you didn't document it right or you did something wrong. Remember the close. Or you didn't document it right or you did something wrong. What you've done is you've handed them a loaded gun to point at your head whenever they say I don't like this company anymore and I want my money back.
Speaker 1:It was misrepresented, the deal.
Speaker 4:This was a sale of an unregistered security that didn't apply for an exemption. That means the purchaser has the right to rescission of the sale. That means undoing it Interest and attorney's fees. That's a gun that can point at your head whenever they, because invariably some shareholder becomes a problem. We've all experienced it. Somebody becomes a pain in the behind. That person will look they see, the company's not going away. They like that it's going and they're going to hand it to a lawyer. And the lawyer's going to go ha, they see, the company's not going away and they like that it's going and they're going to hand it to a lawyer. And the lawyer's going to go ha, guess what? This was actually in violation of securities laws. And here's the gun we can point back at them. Bend them over a barrel to get your money back, with some extra juice on top of it.
Speaker 3:So that's the risk and I'd add another practical thing to that that maybe entrepreneurs will really get right and be impactful is that if you don't have all that stuff done correctly and you do have VC capital or investors come in, it's going to extend that due diligence process. So what could have closed to get the capital in 30 days, now it's going to be 90 days, six months.
Speaker 1:Or you're going to sell the business and it's the same problem and sell it entirely. That's a really good point and that's where real money hits you in the face right and that's in.
Speaker 3:As an entrepreneur you're like. Well, a capital opportunity is a big deal for you to grow your business.
Speaker 1:If it gets stalled out, it's it's the same thing as having audited financials, a history of audited financials. It's going to speed things up versus. Here's our compilation that came out of QuickBooks okay. I mean there's no faith in that, so there's going to have to be a lot more diligence.
Speaker 3:Yeah, the whole due diligence process. It's just painful, painful, painful.
Speaker 4:Eric raises a fantastic point that the due diligence process gets expensive and the longer it goes on, the more likely it is that a deal will fall through.
Speaker 3:Yes, yes, time's the enemy I agree, well, people just start, you know the buyer starts losing their oomph to it. Right, they just get less excited, or macro events change or whatever.
Speaker 4:Interest rates go whatever.
Speaker 1:Anything happened in the business that makes them concerned?
Speaker 3:Yeah, the CEO decided to do something different.
Speaker 1:Right? I mean, there's just a million things that can go wrong, as we all know.
Speaker 4:The difference between one month of due diligence and three months or six months can be a deal killer 100%.
Speaker 3:And, by the way, if you're the entrepreneur, like the amount of time and energy it takes to go through that is exhaust, that takes you away from the primary business, and then the business itself suffers, and then the valuation suffers or the buyer's concerned right. Yeah, all those things.
Speaker 1:It's bad yeah.
Speaker 3:So to me the attractive thing of really about the C Corp deal is a hundred percent about the, the, I guess the just the energy the legitimacy, the legitimacy the fluid part of having a really clean corporate hygiene so that I can raise capital quickly and get back to work.
Speaker 4:Exactly, Eric. And another thing about a C-Corp, too, is that it has the power to issue multiple classes of stock. Yes, so if you want to issue preferred, like you're going to get here's some guys that I want to bring them in, but unlike my other shareholders, I want to give them a dividend or interest or whatevs then you can do that and you create another class of stock and you can do that with the c corp. You can't do that with s corp and you can do it quickly.
Speaker 4:Yes, you know I'd be to file an amended certificate of incorporation, but it's much, much easier to do with this.
Speaker 3:so let me this practical example like, let's say, Mark is interested in putting money in my business and we agreed, hey, you're going to put $20,000 in right, and my value is this I mean well, first of all, is valuation even such a big deal? Yeah, there's got to be. At that level because I'm going to give you so many shares back for your $20,000,. But there's possibility of dilution down the road, which everybody understands right right right. So that whole discussion evaluation is another sticking point, right like what am I worth?
Speaker 3:yeah, exactly so mark's gonna give me 20 grand. To be honest with you, like I'm, like I don't, 20 grand is not much to me, but it is a little bit helpful. You know, right, my cat, my capital yeah, which is great, but you're not you're not, I'm not exiting.
Speaker 1:No, I don't want to spend 30, 60 days dealing with your 20 grand Exactly.
Speaker 3:Yeah, it's a minor thing, but that's part of my problem, Like I've always had this problem, Like I've got folks that would like to be part of the businesses that I'm doing. They know, they can see, you know the momentum and stuff.
Speaker 1:But like to deal with that all the sort of like yeah, what's your valings value? Well see, that's why I rely on him.
Speaker 3:Well, okay, it solves that problem so you can just say hey, go talk, yeah, no, I don't say hey, go talk to Luke.
Speaker 1:I say, luke, what do I have to do? Paper this up. Give me all the stuff that they've got to fill out or sign in order for this to be legit. Yeah, okay.
Speaker 4:Valuation is a bit more sticky, though, you've got to have sort of a meeting in the mind between you and your investor. Yeah.
Speaker 4:You know, do you need to go get like a back of the envelope valuation? I mean there's a whole cottage industry out there of people that provide valuations of new ventures, or it's arbitrary. That are private company and it is really arbitrary. But if you can just avoid all that, you say look, here's my revenue, here's what the expectations are. If you're cool with it, I'm cool with it, and just try to always make sure that you don't undervalue what the last people put in that, because that creates a lot of stress.
Speaker 3:Yes, but yeah, if you can agree, Because I sold Mark 100 shares for $20,000, but then I sold somebody else 200 shares for $20,000. Yeah that creates a lot of bad lives. That raises Mark off.
Speaker 1:Yeah, if I find that.
Speaker 4:Real fast.
Speaker 1:Can we go? I just want to go back to this some things that came up with the two of you both here. So, first off, define what an accredited investor is for our audience. Absolutely, You've got to have a certain net worth and a certain income, and that net worth has to be outside of your personal home.
Speaker 4:Absolutely so. An accredited investor is somebody that has either $200,000 of income per year over the last two years, as shown there, 1040s or a million dollars in assets excluding their primary residence, and there's a whole slew of subcategories of other things that could be institutions and whatnot.
Speaker 1:Isn't it like $300,000 if you're married?
Speaker 4:If you're married $300,000,. Right, yeah, okay, and then so, but the policing of that is pretty easy. And then so, but the policing of that is pretty easy. So if I'm selling you, if I want to sell you some shares, what I'll just do is hand you an accredited investor.
Speaker 1:Can I question that? Yeah, and I don't have to do.
Speaker 4:I want to qualify that a little bit too because part of that is the SEC doesn't like people publicly advertising. Hey, you can't go on the internet and say here's my company, we're taking investors, now come sign up. Okay, that is a big no-no. Yeah, like I can't even stress how big of a no-no that is. Uh, that's called a general solicitation and a rule from 506b. You're not allowed to do any general solicitations. It needs to be like people you already know.
Speaker 4:If you want to do the general solicitation like I'm just going to cast it out, I could say I'm only going to take accredited investors. Well, if somebody like contacts me off the internet that I don't know from Adam, then at that point I need to see their 1040s. Like I really need like documented proof. I can't just give them a check the box self-cert Like. I have to have proof of my file. The best practice, I think, is to not do what we call general solicitations, which is like put on your website, we're taking investors that just like raises 15. That will get the attention of regulators.
Speaker 1:Let's go back to that income thing for a minute. Let's say I've got a tax return and grossed 1.1 million dollars last year but with all my depreciation on my real estate and everything else, my tax return says I made 82.5. Am I gonna have a problem with that's? Like boy, you got an investor yeah, you got me there. Because, I mean, I think that's common for a lot of people. What's the bottom line on your 1040? There were years.
Speaker 4:What's the bottom line on your 1040 is what I would typically tell people to go by.
Speaker 1:I had $800,000 worth of depreciation. I just reduced my income dramatically.
Speaker 4:In that situation, I'm probably just going to rely on the fact that you probably got more than $200,000 worth of assets too.
Speaker 3:Oh, my assets could be off the chart. But I'm just saying it's either or it doesn't have to be both. Oh, I thought it would say to be both. No, no, no, no, no, it could be either, or oh okay.
Speaker 2:Yeah, you can still have assets, yeah you can basically liquidate in in your yeah, I guess the whole thing to this, so the whole premise, this I think.
Speaker 4:I'm sorry I've been talking backwards for the benefit of the audience. It's a. It's a. It's a million dollars in assets, or $200,000 a year in income. I've been talking backwards. I have too much coffee this morning.
Speaker 1:No, you haven't been talking backwards, I'm confused.
Speaker 4:No, no, no, yeah, it's back. But again, mark, it's an either or it's either the income or the assets. If you check one of those boxes, you're cool and they're just assets.
Speaker 3:It doesn.
Speaker 1:If you check one of those boxes, you're cool Very important to know and they're just asking it doesn't matter Just outside of your real estate.
Speaker 3:It could be stocks, other real estate. Business value all this stuff. Outside of your primary home, primary residence.
Speaker 4:Yeah, primary residence. Anything else is cool?
Speaker 3:I think the thing that's important for entrepreneurs to understand is the reason for those stipulations and those requirements and for the SEC and for all these regulatory is literally to protect the investor, because from the dawn of time people have been ripped off. Oh yeah, crazily sure way before our, our generation 18th century.
Speaker 4:Yeah, the South Seas company and people buying shares and like the New World Ventures yes, yeah sure. And bubbles crash. Bubble crash was the cycle, and finally 1920s. Everyone goes, this sucks. We got to stop this, and so we have the Securities Exchange Act.
Speaker 1:The stock market crash, Exactly the stock market crash in 1929.
Speaker 4:So now we have two major pieces of legislation that follow that with. The idea is to protect the investor from scammers. Of course the whole. I only started on crypto, but that's a whole other question.
Speaker 3:To me that's actually very that kind of connects a lot of dots for me as an entrepreneur, right? And I think hopefully the other listeners are like that. It's like, why do I have to deal with this crap as an entrepreneur? Well, it's not because your business sucks, or it's not because the government wants more money from you and attorneys want more money from you than accountants.
Speaker 1:No, there's a good reason for it. There's a really good reason for it right.
Speaker 2:And.
Speaker 3:I think that if anybody put $1,000 or $10,000 into something, they just don't want it to poof, go away, exactly Because there are a lot of ill-intended snake oil sales things that are going out there. Yep, and to be a bonafide business, and so it actually helps protect you as a true entrepreneur too, because now you're not in this bucket of a bunch of liars. You do it right, you set it up right, you approach investors.
Speaker 4:That's why it's these laws, eric, that have made the United States and I'm going to end on a soapbox no, go with it, I love it One of the best places to invest. Sure, we have risk tolerance as part of our culture, but we have a strong protective system with rules that everybody knows and that everybody plays by. And that is our tradition Everybody plays by, and that is our tradition. That is why we have become above the EU, above so many other markets like the go-to place for this dynamic culture of startup investment.
Speaker 3:I love that statement, and we also have regulators that enforce those things. Yeah, that's the other part of it. It's what gives the confidence in the markets.
Speaker 4:It gives confidence to investors that we have rules. That's right.
Speaker 1:God bless America. God bless America, america, america, I love it Okay, so finally this comes to where I wanted to be Now, wait a second, I want to get off that though for one second.
Speaker 4:Yeah, all right, when are we going next? Can I dunk on America now?
Speaker 1:No, just go on with your question before you lose the momentum of this. What about when these people are our employees? The same rules don't apply. Let's say Eric's got this business, he's got a good manager over there, really wants to tie that person down and sell him?
Speaker 4:some ownership. Great, I'm glad you raised that. It's a whole new category. So a lot of people believe that as long as I'm just selling to employees, that's cool and that, for the most part, is. There's a rule rule 701 that allows you to give equity to people as compensation. But again, there's a framework for that. You're supposed to have a written plan. So when people want to do this, the first thing I tell them is you need what's called a employee equity incentive plan, and it's like a six page document or whatever. I pull it out of my library, custom-tailored to my clients. You've got this plan, you adopt it with your board it's in the minutes and then you make an offer to the employee with a written document called a you know, stock grant or an option what doesn't have to be free?
Speaker 1:what if I'm selling it to them? There's not a grant? Okay, if you're selling it, so I'll finance it, okay? Okay, I'll finance 100 of it, but I'm going to sell you. You're my number one guy. I'm going to sell you 10 of my company for 200 grand and I'm going to write a five-year note and you can pay for it over bonuses or payroll deduction or whatever you want.
Speaker 4:We run into this a lot. So if you're selling, so it over bonuses or payroll deduction or whatever you want. We run into this a lot. So it's one thing to give equity as compensation, but if it's a fundraising thing, then we're out of that. We're back to are you accredited? If you're not accredited, that's— Even an employee. Even an employee.
Speaker 1:I'm a law office. For God's sakes, I'm a corporation, but I've got 10 lawyers yeah, we can get into that.
Speaker 4:But you know, if the purpose of the equity grant is not compensation, if I'm not giving it to you because you're rendering valuable services to me, but instead it's a fundraising device, it's neither.
Speaker 1:It's a retention device, and I want you to be able to get a pot of gold at the end of the rainbow, 20 years from now, when I sell this well, okay, so you're, you're really straddling that line.
Speaker 4:Okay, so what you're telling me is that it was really actually compensation, because I want you to keep it around here. Now, it's true, practically speaking, a lot of these do straddle the fence, right? I always I want people to err on the side of caution, because I'm conservative and I believe in doing the most safe thing. Oh, you're a self-serving, you just want to make money off of law, your fees. No, I just want you to be protected. If it is truly compensation, then we have a whole different category. I want you to be retained, like I'm giving you a discount. If this is like not what I would sell it to another arm's length investor for then that's compensation. And okay, right Now we're in a whole new universe of tax issues too, by the way, when we do that.
Speaker 1:Okay.
Speaker 4:You know, I did that for years in my business, growing it.
Speaker 1:I had 23 or 24 shareholders at the time I sold it. That were employees, that were employees, were employees, all employees, no outside owners. If you grant equity to an employee, didn't grant anything. Everybody signed a note and paid for it through payroll deduction was it market value?
Speaker 4:no, it was discounted. Okay, the discount the IRS is interested in yeah, I know they want to show that as income for right boy, like if you give that, if I give, give you stock that's worth a million dollars but you only paid 500 for it. Like you've just recognized income of 500 grand.
Speaker 3:I understand that that's what the IRS cares about, but isn't that a lot more complicated than just granting out stock to an employee?
Speaker 4:Achieving the same thing.
Speaker 1:I'm not achieving the same thing. I want them to put some skin in the game.
Speaker 4:Let's say, let's just forget. They're putting their money they're sacrificing their income in order to invest in the company. Okay, they got skin in the game. Now let's make the hypothetical a little bit different, so I can discuss the issue clearly and then we can move into that, because you're in, like this intermediate zone, which is really complicated.
Speaker 1:This is the world that I came out of. The professional service industry employs several million people Architecture, engineering, environmental consulting. Okay, that's the way they do it by and large, the majority.
Speaker 3:So it's like an industry kind of vein. That's what they would do, and so you participate in that.
Speaker 1:Kind of like an attorney's set up partnership.
Speaker 3:Exactly, there's the income mechanism.
Speaker 1:You know the value, never really has any. The ownership has no value other than you get more income. That's one model. And then there's the model of You're investing in this company and hopefully it grows, and then you're gonna sell your stock to somebody below you.
Speaker 4:So are through the company I was gonna say so if you're granting equity for less than market value as compensation is to stick around and retention bonus, there's a taxable event there.
Speaker 1:I understand that.
Speaker 4:So what we try to do is try to put brackets around that taxable event. So if it's, just an outright grant the person has received. Like, if I grant somebody stock, but I granted them that because I wanted them to make me a loan, then it may be that you know that grant of stock is like a gift, that guess what? They just received a million dollars worth of stock that needs to go on their 1040. Yeah, I understand that.
Speaker 1:If I you know. But again, that's not the model that my industry uses predominantly, predominantly, the person is paying for that stock. Sometimes they're paying market value. Sometimes the company may have an ESOP that requires an annual appraisal Boom. Company may have an ESOP that requires an annual appraisal boom, and so they're buying stock, though outside the ESOP, at the same valuation that the ESOP set, because it's required to have an appraisal done, all you every year. So, but the other shares that are held outside the ESOP are trading at the same price right that the ESOP shares are.
Speaker 4:Do we have five minutes so?
Speaker 3:I mean, I have to go to nothing, but y'all can keep going, if it's not because I have another show that I have to do, but y'all can keep dialoguing because this is freaking awesome, super valuable it is. I hope you come back, luke.
Speaker 4:Oh yeah, anytime man.
Speaker 1:Yeah, that'd be awesome. Keep going, I'll just slip out, okay, and nobody will ever know that lot up for real quick, okay, well what can we do to? Harass luke while you're here, because I think it's important, we should give him a hard time well, I think well, yeah, but I mean, actually I'm really interested in asking questions.
Speaker 4:I mean, this is kind of like free free so.
Speaker 3:I mean the thing about. You know, I would love to really understand like, how, like, because to me the business is about growing, yeah, having a structure that allows for fast growth. Here's what drives me absolutely insane. I can never get down to a real solid answer. I feel like that Silicon Valley has some sort of secret that we don't have in Northwest Arkansas that allows them to grow rapidly with VCs. It's just like boom, boom, boom, like I mean, I watch the news every day about this stuff.
Speaker 3:It's insane, but you get to Arkansas, and here I am they want to talk multiples of EBIT.
Speaker 1:It's like forget that.
Speaker 3:I know it's like my God man I don't have. Look, my valuation is constantly growing, Like, if I told you it was a million today, it's going to be a million and a half tomorrow and it's going to be 2 million and 3 million. And you're going to be like, well, show me the numbers, no-transcript, and I'm like I don't have time for that. It makes me so aggravated because I feel like I'm running in mud. Yeah, like, how do I build a structure, just something that is fluid, because those guys are doing it, they are doing it all day.
Speaker 4:Luke, we're catching up, though I think that's something about Northwest Arkansas. Is that for all of our rah-rah-rah-ism, we're still behind? But we're getting there. People are getting used to seeing Northwest Arkansas companies and understanding we're the retail capital of the world. Yes, and that there's actually a lot of free money chasing good ideas around here. What we need, eric, is more good ideas, and I think we'll get that. Like West Coast, like the Bay.
Speaker 3:Area's got shit. I got a shit ton of good ideas.
Speaker 4:They got like Stanford and they've got, like you know, culture of like. They've got Y Combinator, they've got well-established accelerators. We're getting there. It's just like it takes some building, building, building, but we're getting there. So okay.
Speaker 3:So, on my perspective, as in the entrepreneurial space, I'm ready for that, we are ready. I know folks that are ready for that. My hurdle is the legal structure of it. So you got when we talk about we got the entrepreneurs over here and we got the investors over here. I know a lot of the entrepreneurs, I know a lot of the investors. My problem is, is that what is the bridge between them? That I can't seem to find out the answer right now to make the bridge comfortable for both parties to walk across and meet and do something. That's a beautiful picture.
Speaker 1:Thank you, mark, it is.
Speaker 3:And I'm so infuriated by this Bridge is not being built, and that's the bridge I'm talking about. That's in Silicon. There is some bridge that is going on there that we don't have here and we've got to build this bridge like in 30 days, because if we don't build it in 30 days, there's going to be some really big missed opportunities and Silicon's going to build so many bridges that they will be the retail capital.
Speaker 3:How scary is that, and I'm not talking in two years, I'm talking in six to nine months. Wow, that's what I see. And so I want to figure out that bridge ASAP, because there is a lot of opportunities that we can grab. And so my question comes okay, is it C-Corp? Sounds like it's C-Corp, and this includes employees instead of us, because that's what they do there too. Sure Options, that's a big way.
Speaker 4:They get good people. What's?
Speaker 2:options versus grants versus ESOP versus all this stuff Just give me the answer.
Speaker 3:I need somebody to give me the freaking bridge. We've got to talk again, okay, all right, cool, hey, appreciate you being on the show, mark. Thank you. Hey, it's my pleasure, I'm going to silently slip out now.
Speaker 1:No well, I think what we need to do is we're going to end the show today and we'll have Luke back again. Oh man, good, we can talk more about ESOPs.
Speaker 4:We've been on an hour.
Speaker 3:There's so much to talk about, let's just have Luke back and this is such a valuable conversation. I love the name of your company, the Startup Boutique. I mean I just want to say thank you for your vision for our founders and startup and entrepreneur. I mean I'm glad to know that you're available because this is such you know. And thank you, mark, for bringing Luke in man. I mean like yeah, it's a good thing, this is such you know. And thank you, mark, for bringing bringing luke in man.
Speaker 1:I mean like yeah, no, it's a good thing the thing is I do want to emphasize, though, to the group uh, our listeners out there luke does deal with more than startups, right, but you know, like we've got a situation and he works outside of the state too, I mean we. He helped me out on a deal in california where we wanted to sell stock to keep people in a company, and so all these issues are, you know, this whole compliance issue and coming up with the method to do it and be legit. You need the assistance of somebody that does this every day.
Speaker 1:I guess that's the point.
Speaker 2:We're never going to know all this stuff people like you and me no exactly, and I would say for our audience.
Speaker 3:you know, because we got, you know, experienced entrepreneurs, and then people are thinking about it. People are just starting up and I mean, I think the testament, I mean the experienced entrepreneurs know how important a legal partnership is, just like accounting partnership. It's Like it's huge, yeah, and you don't know until you need it, which is terrible. But for startups like you, definitely need to go talk with somebody. You need to build a relationship with your legal partners.
Speaker 2:Yes, and it doesn't have to be just one.
Speaker 3:Right, because if we got in an M&A situation, Different strokes for different folks.
Speaker 4:There's a community around here, it's a small community, but I'm very happy to always refer people to other firms around here when I need help.
Speaker 3:And so we're building too the legal to get together and do this. Yeah, because there's some good firms, like when you start talking to a big acquirer, like you might need some specialization, yeah, in those negotiations, right, that know how to how to discuss that negotiate.
Speaker 1:I mean dealing with things like warrants and reps oh god that's that's the whole thing right there. Okay, so generally the buyer wants you to like guarantee all your employees and clients will stay for life, that's right, Okay with unlimited liability and, as a seller, I want the chains off.
Speaker 3:My friend, exactly, I don't want to work for you for five years. That's where a really good attorney comes in A hundred percent and it's also where a really good entrepreneur that's working with a good attorney knows their negotiation leveraging stick, because you can have a vision of how you want to sell, yes and you don't have to succumb to just whatever the buyer gives you.
Speaker 1:No, absolutely. Hey, we're going to pick this up again.
Speaker 2:Great episode. Is that okay yeah? Let's come back.
Speaker 4:I hope people get a hold of Luke, real quick To reach you? Yeah, that was going to be my next question. How do they get a hold of me? Yeah, lucas, renier lucas at renierstartupboutiquecom. You can also just Google Renier Law Firm. You'll see my smiling mug on my website. Shoot me an email. I'm still Renier R-E-G-N as a negative I-E-R. All right.
Speaker 1:Thanks guys Appreciate it, hey, thanks, thanks everybody. This has been another episode of Big Talk about SmallBusinesscom.
Speaker 5:Thanks for tuning into this episode of Big Talk about Small Business. If you have any questions or ideas for upcoming shows, be sure to head over to our website, wwwbigtalkaboutsmallbusinesscom and click on the ask the host button for the chance to have your questions answered on the show. Stay connected with us on LinkedIn at Big Talk About Small Business and be sure to head over to our website to read articles, browse episodes and ask questions about upcoming shows.