The Nevada myth.

I spoke to a client a year ago about setting up a real estate flipping business.  He never hired us, and went his own way.  No problem.  We’re always happy to help even if we’re not hired.  But sometimes… they come back.

He attended a seminar on setting up his flipping business, and they offered a plan to set him up with an LLC and everything else he needed.  And “of course” that would be a Nevada LLC.  Because privacy is better in Nevada with less detailed online records, and filing fees are dramatically cheaper than they are in Illinois.

Both true points.  But unfortunately both points fall apart pretty quickly when you apply Illinois law.  The client went to close on his first property and was told he needs to “register his foreign LLC in Illinois.”  Okay, no problem.  Cost?  Exactly the same as it would have cost to form his company in Illinois in the first place.  So now he has paid full Illinois fees, plus Nevada fees.  How about privacy?  Well, his private information becomes public in Illinois as soon as he completes that foreign registration.  You can stop by his house, it’s listed on the Illinois Secretary of State website.  There are some tricks we can use to avoid this (like creating a manager-managed LLC with a generic named trust as the manager) but privacy wasn’t that critical to this client.  He was just annoyed.

So not only is the client now paying annual filing fees in both states, Nevada recently overhauled their fee structure and his annual fee in Nevada is five times what it is in Illinois.  So forming his company in Nevada has turned out to be a total loss, as opposed to the intended savings.  He called me, saying, “You know all that advice you gave me a year ago?  I didn’t take any of it.  Can you help?”  Yep.  We’ll help and we won’t even say “I told you so.”  It’s all part of the job.

In most cases, form your company in the state where you operate your company.  It’s very common to end up having to file in your home state anyway.  This might be because you own property there, do a certain amount of business there, have employees there, or hold a required license there.  But it’s not always a bad idea to choose a foreign jurisdiction.  Here are a few legitimate reasons to consider forming a company somewhere else:

  1. You are seeking investors.  Investors often like seeing Delaware C-Corps to invest into.  They are used to the Delaware statutes, and the C-Corp prevents any surprise pass-through tax consequences.  There is no real-world benefit to you.  But you don’t get their check unless you do it their way.  That alone is a fairly compelling reason to file in Delaware!
  2. You are seeking consistency of law.  If you operate several locations all over the country, it would be nice to not have to drill down on local law for every single deal you put together.  We have a client who does land development deals all over the country.  When it comes to land ownership, local law always rules.  But when it comes to the terms of his LLC operating agreement, consistency is nice.  We form a separate LLC for each deal, and each deal is a little different in terms of how we bring investors in.  It’s nice to apply the same law to all of those individual LLC operating agreements so we’re not having to redraft every one of them to conform to a specific state law, research state law, etc.
  3. You operate a huge number of companies.  In my story above, a client formed one LLC and did it in Nevada to save money on filing fees.  It backfired but even if it didn’t, the savings would hardly have been worth the hassle.  But I have another client with forty-seven LLCs.  He had them all domesticated in Nevada at first, until Nevada dramatically increased their fees.  Then he moved them all to Montana.  With that many companies, those minor savings per company added up to over twenty-five thousand dollars each year.  For him, it was worth it, even after paying us a little bit to move them all over.

Think twice about choosing a particular jurisdiction just to save on filings fees.  Be sure you don’t still have a local filing requirement which would cancel out your savings, and avoid following the trends of where the entrepreneurial podcasts and articles say is the hot jurisdiction.  Take a bit of time to talk to an attorney and CPA and choose the jurisdiction that’s right for you.  There are more factors to consider (like tax) than are listed in this article.

Go make today awesome.  Thanks for reading.

JDV

Guest Post: 5 Crystal Clear Signs to Consider Hiring

Please welcome guest Blogger Matt Wilhelmi.  His contact and other info is below.

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At the last YourBizDr.com Workshop, I spoke on the importance of a budget and cash flow management. After the workshop, I was approached separately by more than a few people about when and how to expand their workforce. Small business owners are often reluctant to ask questions about hiring. Maybe they think hiring is too expensive, or giving up control will tarnish the brand they’ve strived to create. They all seem to want to know the same thing about hiring, “How do I know when to hire my next (or first) employee?”

Business decisions, and hiring is a great example, can’t be made in a vacuum. So instead of just giving you a list of conditions that, when met, means you must hire an employee, I’m going to give you 5 signs that you should consider hiring. Consider this statement: “If you don’t manage yourself, it’s going to be very difficult to manage someone else.”

Do you know how many hours you worked last week? I mean hours worked, not hours checking Facebook or LinkedIn. What about your last few projects; do you know how many hours it took you to complete? Were you profitable? What pay rate did you pay yourself for that work? What were your margins on those projects? If you hired someone to do that work, and they were 80% as efficient as you (I’m being slightly optimistic) and you paid them a fair rate, what would your margin be? How many more hours would you have to do other things?

Many business owners and entrepreneurs think that hiring employees will make their life easier. Don’t get me wrong. That’s the goal! However, if your operations, process, and finances are messy now, adding staff will amplify this problem. If you have a solid foundation of sound operations, smooth process, and profitable finances, adding staff will help build your organization.

 

Once you’ve ensured that you have solid operational systems in place, look for these 5 Crystal Clear Signs to Consider Hiring:

  1. Decreasing Quality: Missing deadlines due to an abundance of work
  2. Missing Revenue: Turning down opportunities for work because you’re too busy
  3. Work/Life Balance: Spouse or friends complaining because you are too stressed out to enjoy life
  4. Consistent Revenue: You’ve built a steady stream of revenue from a diverse book of business and the work isn’t something only you can do
  5. Objective Measurables: Very efficient way of forecasting and determining profitability

To be clear, this list doesn’t necessitate hiring an employee. I mean that, just because you can check off each one, doesn’t mean you should go out and hire someone right away. These are simply signs you should consider hiring an employee.  As I said earlier, business decisions can’t be made in a vacuum and many other things should be considered before hiring an employee. What’s your Business Strategy? What’s your financial position? How long will it take to train someone? Are your systems set up to handle additional users? I don’t mean to overwhelm you with cautionary questions as they are simply supposed to provoke thought.

So now you are properly framing your thoughts around whether it is the right time to hire. Once you decide to hire, though, you want to be sure to do it right.  In my next guest blog post, I will share 6 Critical Rules to Avoid a Hiring Debacle.

Thanks for reading.

Matt Wilhelmi ( matt@individualadvantages.com )

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Our guest blogger today is Matt Wilhelmi with YourBizDr.com.  Matt is a Business Consultant at Individual Advantages, LLC, the parent company of YourBizDr.Com. Matt is an entrepreneurial minded professional who works well with complicated business strategies and excels in developing and implementing operational processes to achieve business goals.

When to use multiple companies.

Depending on the type of business you are in, you may find yourself owning multiple companies as your business (or businesses, I suppose) grow.  Most people are aware that when you’re doing business with a large global company, it is likely that you are technically dealing with a smaller affiliate of that larger company.  Health insurance is a great example.  I tell people that I have Blue Cross for health insurance.  But technically my insurer is Blue Cross and Blue Shield of Illinois, Inc.  It is a subsidiary or affiliate of a larger company.

There are benefits to this type of arrangement for small business as well.  The times when this is appropriate generally fall into three categories.

  1. Real Estate.  Whether you flip real estate, develop real estate, or hold real estate for rental, it is a good idea to divide up your real estate holdings into separate companies (almost invariably LLCs in today’s legislative environment).  This way, if something happens on one parcel, the others are isolated from those losses.
  2. Cash Cow vs. Liability Pit.  Another reason to separate into separate businesses is when you have one aspect of your business that is a cash cow or has valuable assets and another that is high-risk.  A great example is a distributor that runs its own deliveries.  Trucking is a high-liability operation with trucks on the road, potential accidents and injuries, etc.  Distribution can also be relatively dangerous with expensive equipment and high value inventory.  Why subject the valuable assets of each of these operations to the liabilities of the other?  We would advise that clients consider running one trucking company, and one distribution company.
  3. Profit Balancing.  In the example above, perhaps your distribution operation is running too high a profit and will incur tax.  But your trucking operation just purchased a few new trucks and was able to write them off under Section 179 accelerated depreciation.  So you’ll incur a tax on the distribution side, and a paper loss on the trucking side.  Why not just raise the prices your trucking operation charges your distribution operation to move profits over to trucking where they will be absorbed by the Section 179 depreciation?  The key is to keep your pricing reasonable.  Keep the price increase within reason.  It still needs to be similar to an “arms-length transaction” or it won’t pass muster with the IRS.  But this profit balancing can be a great benefit of operating your business through separate entities.
  4. You own the land where you operate.  A simple rule: If you own the land where your business operates, you always purchase the land through one company (usually an LLC) and operate the business through a separate company (often, but not always, a corporation).  If the business fails, you still have a valuable piece of land you can lease to another tenant.  And there are also profit balancing opportunities here as well, as noted above.

The concepts described here only scratch the surface on what can be a fairly complex business structure.  But there are more benefits to this concept beyond just those listed here including estate planning benefits, and possible benefits when it comes time to sell your business (Exit Strong!).  If you think your operation may be well suited to splitting up into separate companies, talk to your lawyer and CPA about it and see if it’s right for you.

Have an awesome day.  Go launch, build and exit strong!

JDV

Post-Closing Escrow Explained

When you sell your business, the buyer is worried about things that may have happened before the closing that cost the buyer money.  For example, you didn’t pay all of your taxes and the government seeks to collect against the buyer.  This is especially worrisome in a stock deal.  But even in an asset deal, pre-closing liabilities can end up costing the buyer money after the sale.

The tool used to protect the buyer is “indemnification.”  Indemnification means that one person agrees to pay for any losses that another person incurs.  In the sale of the business, the seller indemnifies the buyer, promising to pay for any losses the buyer incurs that result from something the seller did wrong.

It’s a simple concept, but there is a problem.  The buyer just sold the company and has a lot of money.  But where is that money going?  What guaranty does the buyer have that the seller will still have cash available to actually pay for the indemnification provided?  Indemnification is great… unless the person protecting you is broke.  And the four hundred thousand dollars you just paid them may not be there when it comes time to pay up.  What to do?

The buyer is going to ask for an “escrow holdback”.  People call them different things, but the idea is that a portion of the purchase price is set aside into an account and held for a while until the buyer can be more comfortable that the likelihood of incurring a loss is diminished.  The money is held by a third party called an “escrow agent”.  Sometimes that is one of the attorneys for buyer or seller.  Other times it is a totally unrelated party like a title company.  A document is prepared for the rules on how the money is accessed if the buyer has a claim.  And at the end of the escrow period, the escrow agent cuts a check to the seller for whatever is left in the account.

The main points of negotiation are how much to hold back, and now long to hold it.  The seller does her best to hold back as little cash as possible, and for as little time as possible.  The buyer of course tries for exactly the opposite.  There is really not a good rule of thumb as to how much or how long, because every deal is so different.  But you can expect a buyer to be looking for about ten percent of the purchase price, to be held for at least a year.  But I’ve see numbers much higher and lower, and times much longer and shorter.  There really is no “typical” in this situation.

One good tool to consider for a seller is “tail insurance”.  One of the things the buyer is looking for protection from accidents that may have happened, like a slip and fall or some other issue that would have been covered by insurance if the business had never been sold.  For these types of losses, the seller can pay a one-time insurance premium to buy “tail insurance” that will keep insurance in place for these types of issues for a period of time after the closing.  A year or two is typical.  Essentially the buyer decides that would rather pay a little out of pocket today on an insurance premium rather than take the risk of fighting over escrow funds with the buyer for two years.  Tail insurance doesn’t cover all types of losses that an escrow fund might cover, so the buyer will still be looking for some amount to be held back.  But it can be used to negotiate down the amount held back from the purchase price.

This is one of those topics that proves the point that purchase price isn’t the only issue that is negotiated during the sale of a company.  Escrow hold-back is just one of the other issues that may tip a seller to choose one buyer over another.

Have a great day,

JDV

3 Ways to Structure Your Sale

When selling a business, there are a few ways the purchase price can be handled.  For this post, assume the business being purchased has an agreed value of $1,000,000.

  1. Cash at Closing.  The simplest transaction is cash at closing.  The buyer writes a check to the seller fro $1,000,000 and the deal is done.  Most often the buyer has actually obtained a loan for the purchase price.  But from the seller’s perspective, she doesn’t care if the check is from buyer or his lender.  The seller is paid in full as of the closing, and the deal is done.  Simple.
  2. Seller’s Note.  The seller is often asked to provide part of the financing for the sale of their own business.  So the buyer brings $800,000 to the closing as a check (either their own money or from a lender) and executes a promissory note to the seller for $200,000.  The key to negotiating for the seller is to get the amount of the note as low as possible (thereby getting more cash at closing), keep the duration of the note as short as possible (the long the duration, the more risk of default), and secure the note with the assets of the business, buyer’s personal guarantee, or both.  Seller’s notes are common when the buyer is paying by way of an SBA loan.  Often these loans require a certain portion of the transaction to be paid as a seller’s note, and often with a full two year waiting period before payments to seller even begin.
  3. Earn Out.  The highest risk for seller is an earn out.  This is similar to the seller’s note above, but the amount the seller is financing is not fixed.  It’s based on the success of the business after the sale.  So the buyer brings $800,000 cash to the closing.  But instead of setting the remaining amount of $200,000 in stone, the buyer agrees to pay a percentage of revenue or profits for a period of time.  Perhaps buyer agrees to pay seller 5% of revenue monthly for two years.  Seller takes the risk that the buyer won’t earn as much as expected, thereby reducing the amount paid to seller.  Like the seller’s note, sellers should try to reduce the amount dedicated to an earn out, and reduce the time the earn out will be paid.  The only time when this is not true is when the seller has strong confidence that the buyer will actually grow the business after the sale.  If so, the seller would enjoy that growth through his percentage of revenue.  Finally, seller’s should always seek to have the earn out calculated based on gross revenue and not based on profits.  Profits are far too easy to manipulate and disagreements are almost certain as to how to calculate the amount to be paid to seller.

Each of these types of transactions could be a series of posts on their own.  There are far more details and nuances.  And there are also several far more complex transaction structures out there to maximize tax advantages, etc.  But these cover the basic three concepts behind selling your business.

Make today a great day.

JDV