Category Archives: Business Value

Protect Intellectual Property Before You Start-up

Entrepreneurs must understand the different types of intellectual property and how to protect each type. Entrepreneurs should then take action to protect their intellectual property as soon as possible – before launch is best.

Protectable intellectual property includes patents, trademarks, copyrights, and trade secrets.  Each of these categories protects a different aspect of your ideas. In this article, I will only discuss how to protect your intellectual property in the United States.  The laws and schemes of other jurisdictions will vary.

Patents protect useful inventions that solve a specific technological problem. In return for disclosing your solution to that problem (the solution may be a product or a process), you are granted exclusive rights to exploit the invention for a period.  After the patent expires, anyone can use the invention.

Trademarks protect the brand names, logos, and slogans you use to sell your product. A trademark grants you the exclusive use of the name, logo or slogan you use, and permits you to stop anyone else from using a name, logo or slogan that is confusingly similar.

Copyrights protect your original artistic or literary works. Like patents, the copyright gives the author certain exclusive rights to use or exploit the copyrighted work for a period.

Trade Secrets are business information, processes, practices, formulas and the like that a business owner has chosen not to patent and that the business owner seeks to protect by limiting access to them.  Trade Secrets are secret as long as you can protect them.  Business owners use laws like the Uniform Trade Secrets Act (in most US States) to help them protect their trade secrets.

Entrepreneurs should take the time – up front – to determine what intellectual property they have and to protect that intellectual property.

For inventors, patent registration is imperative. Not only must your invention be novel and useful, but also you cannot patent an invention once it has been publicly disclosed.  Therefore, patenting your product or process is not something that can be put off until later. You apply to register your patent at the United States Patent and Trademark Office. Before you register, you or your patent attorney must conduct a thorough patent search. You may also need professional drawings and detailed specifications.  Patents are by far the most complex of the intellectual property schemes, and there are many options, including provisional patents, utility patents, design patents and plant patents.  Unless you have considerable patent experience, you should get a patent attorney to help you with this process.

Trademark registration should be thought of as a mandatory, basic expense for almost any small business.  You are going to be putting a great deal of time and money into growing your business’s name recognition in the marketplace. It always hurts when you have finally gotten some traction, and you get that nasty letter from some trademark attorney telling you to “cease and desist” infringing on their client’s trademark. At a minimum, you will be changing your name, possibly your logo, and losing all the traction you have gained in the marketplace. The fact that a state had allowed you to use a name when you formed your business does not give you a trademark.  The fact that you were able to buy the ‘.com’ of the name does not give you a trademark.  In either case, the trademark owner can come along later and make you change the name or give up the web address.  Trademarks are obtained by filing a trademark application online at the United States Patent and Trademark Office.  As with a patent, you or your attorney should conduct a thorough search first, and you may need a professional drawing if you’re trademarking a logo. You may be able to make it through trademark registration without an attorney, but an attorney who knows trademark procedure and has registered trademarks will be money well spent.

Copyrights are the easiest protection to do yourself. The forms are relatively simple, and if you are a person who can follow detailed instructions carefully, you can do it.  One registers a copyright at the United States Copyright Office – a department of the Library of Congress.  There are at least five different type of copyrights (literary, visual art, performing art, sound and serial). Sometimes, this can get a little confusing (a computer program is a ‘literary work’, for example), and a good copyright attorney can be useful.  This is especially the case because there are often sticky issues of ownership, rights, licensure, etc. that surround a copyright.  These issues create a fertile source of small business litigation – better get this right the first time.

A small business protects trade secrets by keeping the information confidential, by identifying what information you consider as secret (marking any document it appears in is a good way) and by including trade secret protection language in your employment agreements, your employee handbook, or your job offer letters, as the case may be.  Trade secret law is local – each US State is different – unlike patent, trademark and copyright law, which is federal and the same in each state.  Your business attorney should be familiar with your state’s particular trade secret law and how to best protect you.

Intellectual property gives your business value, and a well curated portfolio of intellectual property will impress potential buyers and make exit easier and more profitable.  Protecting your intellectual property will also enable you to get full value from your thoughts and ideas, realize the benefits of your marketing efforts, and protect your investment from dead ends like infringement.  The wise entrepreneur protects intellectual property up front, budgeted as a start-up cost, and does not put intellectual property protection off until later.


Create Business Value Now – For a Successful Exit Later

Entrepreneurs create and grow businesses. Eventually, most will want to exit that business, at least partially. Perhaps your dream is to sell your company to a third-party. Perhaps you want to be able to sell the company to a key employee, or even to have your children buy the company from you. Perhaps you just want partners to buy in and take some of the burden off your hands. Unless your goal is just to shut the company down when you’re done, or to give the business to your children without taking any significant cash out for yourself, you will want your company to have value.

Companies don’t just intrinsically have value.

You have to work intentionally to create value.

Creating value is not something that happens overnight. Creating real value in your business takes time – a few years at least – and to be successful you need to understand what factors prospective buyers or investors and their professional advisers (especially their lenders) will be looking at to determine your company’s worth (let’s just call all of them ‘buyers’ for the rest of this article).  The first thing you should note is, when these buyers start looking at your company’s financial and legal information, they are not going to look just at the present year and your projections. The buyers are going to be looking at historical data – 3-5 years at a minimum – and they are looking for trends and for evidence you have done something to artificially improve the company’s financial picture just before the sale. The buyers will look at historical data because it is harder to fake several years.

As an entrepreneur who wants to realize value for your business, then, it is imperative that you start building value early. In any case several years before you think you will want to sell your company or otherwise get some of that value (my friend Brad Cunningham calls it ‘taking some of your chips off the table’. Brad, in addition to being a successful serial entrepreneur, is a poker player).

Here, then, are my top ten ways for entrepreneurs to begin to create that business value now:

  1. Show a Profit. Your tax adviser will disagree, but this is the most common mistake entrepreneurs make. Small business owners reduce their annual profit to zero every year and are shocked when they are told their company isn’t worth anything.
  2. Focus on Revenues. It isn’t all about the bottom line – the top line matters as well. Buyers will want to see consistent gross revenue increase over time. You can’t get comfortable – if you want to sell eventually, you must continually grow those revenues.
  3. Maintain Good Corporate Records. Whether you will eventually sell assets or your company as whole the buyer will be buying from your entity. Most likely, you own either a limited liability company or a corporation. Make sure you have all your corporate records in good shape early.
  4. Protect Intellectual Property. All businesses have intellectual property, even if it’s just a trademark for their name or slogan. You may also have copyrights or patents. Act early to actually file for formal registration of all your intellectual property.
  5. Keep Contracts up to Date. Most businesses will start with some contractual relationships – with suppliers or vendors or customers or landlords or tenants or contractors or employees or even with owners. Someone in your organization needs to have all of your contracts organized, available and kept up to date, and make sure they are renewed when they expire.
  6. Attract and Retain Good Employees. Companies don’t make things, sell things or perform services – people do. If you want your business to have value, it must have good people. Nothing will sour a deal faster than the buyer getting the feeling that employees are unhappy, disgruntled or unproductive. Treat your rank and file well and make sure key employees are not only happy and well compensated but also that you have protected the business with reasonable employment agreements.
  7. Identify Customers. In some businesses, this one is easy – you may have only a few large customers. Often, though, you may have many customers, hundreds or even thousands. A buyer is going to want information on your customer base and buying habits. You should take steps to identify customers, track their spending and habits, and nurture relationships with key customers if you want to build value.
  8. Professionalize Management. There comes a point in the life-cycle of the start-up where the founder (or founders) cannot do it all anymore. You must make the transition from entrepreneur to CEO, and hire some key employees to take over key management tasks. You go from doing it all to managing those who do it. This can be a tough transition, but to realize significant value from your business, it is a transition you need to make.
  9. Replace Yourself. The last step of professionalizing your management is to make the final transition from CEO to owner. You may not take this final step before you sell, but you should be prepared to. If you can demonstrate to a third-party buyer that you have a successor CEO already trained and in your business, you open the door to potential buyers that want to buy a company, but not a job. If you are selling to a key employee, you need to be able to show that employee’s bankers or backers that he is up to the task of filling your shoes. If you can’t do this, be prepared for a buyer to demand that you stick around after the sale as an employee – exactly what you became an entrepreneur to avoid in the first place.
  10. Know Why You’re Leaving. I learned this last one from Brad Cunningham, who has successfully grown and sold several businesses. Brad says he is always asked why he is selling and getting out, and that his answer is important. The buyer wants to know you’re not a rat jumping off a sinking ship – especially if you are selling before you’re over 65. Being clear on this answer will also help you deal with the almost inevitable post-deal blues.

The Insurance Funded Exit

There are many ways to fund your exit from your small business.  You can sell it to someone and “take back” a note for the purchase price, and get paid over time.  You can try to sell to a buyer that can get bank financing or has cash.  You can gradually give the ownership to your kids over time.  But today I wanted to talk about insurance as a funding tool for some buyouts.

I recently had a great meeting with Northwestern Mutual Life agent Ben Worley.  We were discussing small business issues, including exit planning and insurance funding.  Ben is a wealth of information on this stuff, and he has some pretty great ideas.

Most everyone is familiar with the life insurance funded death buy-out.  I want to fill in some details that came out of my meeting with Ben:

There are two good reasons for a business to have life insurance on an owner: key man and buy out.  These are separate things, although I suppose you could have one policy to fund both.

With the key man, the insurance proceeds go to the company, and the company keeps them.  The funds are used to soften the blow of losing the key man.  The company may need to hire temporary help, or it may take a while for the company to cut overhead to account for the lost productivity, or it may take some time to find a new producer to pick up the slack.

To fund a buy-out, the company is the beneficiary, but the company has an agreement with the insured owner (which is binding on the insured’s estate or spouse or heirs or whatever) to buy the deceased partner’s shares.  The company gets the money and pays it to the estate or heirs and gets the shares back in return.   Obviously, this works best when there are two or more owners, but it can also work if you choose a key employee or employees to take over and give them the ability to buy in at the deceased owner’s death or some such.  There are really dozens of ways to set this up, depending on your situation.

Insurance can also be used, however, to fund buy-outs in other ways.  A key employee or partner can buy life insurance and then fund it for some number of years, building up a cash value that the insured can borrow against.  When it comes time for the exit, the potential buyer borrows that cash value from their policy, and uses it either to fund the buyout or as the down payment for the buy-out, followed by a bank loan or seller take back loan for the rest.

Sometimes, these policies can have changeable beneficiaries, allowing the owner of the business to change the beneficiary if the intended buyer/employee leaves the business for some reason.  In the meantime, the death benefit of the policy is a nice employment benefit for the key person – one way to keep a good employee.

This type of setup works best if you have some lead time for the policy to build value.  In the meantime, you can build the value of the business by demonstrating profits, growing gross revenues, and building great customer relationships.

If you begin with a targeted sale price, you can ask a business valuation expert what the numbers need to be to get to that valuation, and set goals accordingly.  That will tell you how much to fund the policy each year, and you can measure your progress toward both the goal of funding the policy adequately and meeting the price goal.

Each of these life insurance strategies has complicated details and tax ramifications, which makes a knowledgeable professional insurance agent like Ben a must.  They also each need clear, well written contracts, so don’t try this yourself or with some junk you found on the internet: hire a good business lawyer (like Ralph Gleaton or John Perkins, if you’re in Greenville).

And if you want a business consultant to help you craft your plan, or to ride along beside you on you journey, call me.

A Word About Buy-Sell Agreements

Negotiating a buy-sell arrangement is complicated.   As my wife, Kristine, pointed out to me yesterday, most people see how complicated it is and just chose not to do it.  After all, it is the heady, early days of the partnership, so who wants to talk about a break up?

A great deal of the stress, I think, comes from the unknown.  What are the options?  Which options should be chosen?  It is difficult for business partners to choose a buy-sell method when they don’t even know what their choices are.

Here, then, are a few of the most popular choices, demystified a little (I hope):

The Appraisal:  A favorite of big firm lawyers, they use the appraisal for almost any buy-sell situation.  Events that trigger a buyout are defined.  They usually include death or disability of a partner, and may also include mechanisms for voting a partner out, retiring, and other events like the ones listed here.  When a triggering event happens, the company hires a business appraiser.  Often these are CPA’s that specialize in business valuation, but they might be some other form of financial analyst, business lawyer, economist, etc.  The appraiser will get the financial documents needed to value the business, and will usually interview the partners to find out if there are any known events on the horizon.  The appraiser then generates a fair market value (or a fair value) for the shares being sold.

The good thing about this kind of buy-sell arrangement is that it works no matter how many partners or what their shareholdings are.  It is important to give the appraiser some guidance about the terms of purchase, and perhaps to specify mandatory discounts when the reason for the buyout is a “bad reason” (like a partner just quits, when the business agreement did not allow quitting or punishes quitting with a discount).

Cost is the biggest problem with this approach.  These types of business valuations are expensive.  A thorough one can cost $10,000 or more.  If you use the three-appraiser variation (where the buyer chooses an appraiser, the seller chooses an appraiser, and the two appraisers choose a third appraiser) you can be in for some serious expense.  Because of the cost, this option is really not appropriate for smaller businesses.

The Standoff:  This is a favorite of my friend Robert Demes.  In this type of buy-sell agreement, the partner who wants the separation, for whatever reason, names the terms of the deal: price, cash down, payments over time (term, interest rate and collateral) and any other deal points.  The other partner then chooses to buy or sell at that price and under those terms.

This is a great way to get to a fair price without a lot of cost.  It is useful only in limited situations, however.

It is difficult to use this process if there are more than 2 partners, or if the partners do not have an equal number of shares.  It is difficult to use this process if the partners have significantly different wealth: the wealthier partner can simply choose terms the poorer partner cannot meet.

It is also useful only for events where both partners may want to or are able to continue the business.  It doesn’t make a lot of sense when one partner has left the business due to death, disability, retirement, quit, etc.

The Escalating Bid:  This is similar to the standoff, except that the partner who wants to buy the other one out proposes a price, and then the partner receiving the offer must either accept the price or counteroffer to buy the first partner out at a higher price.  The rounds of raised offers go on until someone agrees to sell.

To make this buy-sell agreement work, the terms are usually set, as far as percentage down, interest rate, number of years to pay, and security.  The only variable you are negotiating is the price.

This buy-sell agreement is essentially a variant of the standoff, and works well and doesn’t work well in the same situations and for the same reasons.  The escalating bid is less of an all-or-nothing and more of a structured negotiation.

The Set Price:  The set price is meant to be a fair and inexpensive way to have a very flexible buy-sell agreement that can work in all situations and no matter how many partners there are or what the percentage ownership is.  With the set price, the partners set the price of each share of stock (or membership interest or partnership share) each year, usually at the company annual meeting.   The share price prevails for the next year: if any event occurs that triggers a buy-out during the year, the company buys the shares at the set price.  Like the escalating bid, the terms are also usually spelled out, and can include set discounts for minority shares or for certain triggering events (you might get the full price for disability, but not for quitting).

When this works, it can work well.   The set price works best when the partners take advice from their accountant and attorney at the annual meeting and really take care to set a fair price.

This method has a lot of potential pitfalls, though.  First, most partners eventually just forget to keep setting the price every year.  This makes the buyout useless.  Attorneys sometimes try to paper over this by making the last set price good until a new one is set, but that can be a disaster when it has been years and the last set price is grossly out of date.   Second, this method often has partners setting a price when the sale event is on the horizon.  Partners may have a good idea who will be the buyer and who will be the seller, and it may become difficult or impossible to set a fair price.  Worse yet, one set of partners may be tempted to withhold critical information from the partner they think they will be buying out, in order to get agreement to an inadequate price.  If discovered, this can lead to some nasty litigation.

The set price is a nice buy-sell method, buy I recommend you specify a back-up to resolve problems or take over if the price cannot be agreed on or you forget.

The Formula:  This is a cross between the set price and the appraisal, and can work well.  With the formula, the partners, hopefully with the help of an accountant or a business valuation professional, agree up front on the formula that will be used to calculate share value when a triggering event occurs.  The formula can be complex or simple, and can change over time as the company matures.  The formula can include all manner of situational discounts and other bells and whistles.  When a triggering event occurs, the partners plug the company’s data into the formula and determine a share price.  The company then buys the shares.

 This works well if you have a good formula, so it is one of the more expensive up-front options because you pay to have the formula crafted on the front end, and get a relatively inexpensive buyout on the back end.  The method only works as well as the formula, though, and as your company changes over the years, the formula may become dated and inaccurate – you are well served to have the creator revisit the formula from time to time.

 These are a few of the most popular buy-sell options.  There are many others, and unending variations on these.  I may describe some others in a future post.  In any case, getting this done before you have a buy-out event will save you a lot of time, money, heartache, and legal fees.  The method you choose is only as good as the document it is described in, so pay the money to hire a competent business lawyer and get it drafted up properly.

Create Business Value Now (VII) Customers

How can a small business owner create value, so that when he is ready to sell his business he can receive a fair price for his creation?  There are steps he should take, and things he should pay attention to, in order to create that value – and create it in a way that a potential future purchaser can identify it and place a value on it.

We have already discussed, in prior articles, not “zeroing” your books but rather showing a healthy annual profit, as well as paying attention to the top line and demonstrating year over year gross revenue growth.[1]  We discussed keeping good business records, and creating and protecting intellectual property.  We looked at hiring, training and keeping good employees and replacing your contribution as ways to show a potential purchaser that you are not the sole value of your business.  Today, we will talk about customers as assets.

  • Your Customers are an Asset.  Businesses are in business to sell their goods or services.  A potential buyer, for all the other things he might want to see, really wants to know whether he will be able to sell the goods or services after he buys the company and you leave.  One way to demonstrate that to him is to value your truly greatest asset – your customers.

But how does one demonstrate the value of a customer base beyond the financial statements themselves?  A valuable customer base is a loyal customer base, or a diverse customer base, or both.  Specialty shops may want to demonstrate to a potential buyer that they not only have good revenues, but also an excellent reputation among loyal customers.  Shops built on location may want to show that their revenues are broad based, and not artificially pumped up by a random one-time purchase or by significant non-location based sales that may disappear.  But how does one demonstrate these things to a buyer?  You must start now to treat your customers like an asset – meaning to identify and track that asset.

How you will do this depends on your type of business and type of customer.  If you are a location based tourism-driven business, it may be enough to track the zip codes of your purchasers.  Other companies may want to look into loyalty programs to track their shoppers and demonstrate a large segment of loyal, repeat buyers.  Social media sites, like a facebook page or a twitter handle, can sometimes show engagement and customer loyalty.  For large project services providers, the key may be good contracts.  The point is, begin to consider your customers as an asset that helps you to sell your business, and look for ways to demonstrate that value.

[1] My friend John Emery, who has owned his own store for closing in on three decades, tracks this easily.  “I set a goal to pass last year’s gross revenues by December 1”, he told me.  “If I pass it earlier, that’s a really good year.  If I pass last year’s total later, but still before Christmas, we did OK.”  John is an intuitively smart businessman, and knows how to create value.

Create Business Value Now (VI): Employees

A small business owner who wants to create resale value for his business should start early to find, train and maintain good employees.

  • Find, Train and Keep Good Employees.  Finding, training and keeping good employees is really a corollary to replacing yourself – you cannot replace yourself without valuable and trusted employees.  Not only will these employees create value by helping you grow your business, but also they become a key asset in the sale that gives the sold business additional, and strong, value.

 Because the key to all small business is personal relationships, you must have employees that foster those key relationships with your customers, suppliers, and each other.  Nothing concerns me more for the long-term success of a small business than when I walk in and see unmotivated employees doing a terrible job.  But how does one find good employees?  HR Professionals write entire books and teach seminars on this issue, but the basics are to look for people who are competent, resourceful and engaged, and not necessarily in that order.  Competence is, of course, a must.  But job task skills can be taught, and often I find I want to be the one to teach my employees how I want a task done.  That being said, each job has basic skills the employee must come to the table with.  More important is resourcefulness.  It can be difficult to determine this in an interview, but you sure can determine it in the first six months of employment.  Resourceful people solve problems, and when they run out of work, they find something to do that helps the organization – they don’t go into “shut-down mode”.  You want a team full of resourceful employees, and it is hard, but not impossible, to teach this (easier with young people).  Finally, you need employees that are engaged, and by that I mean that they understand what service the company provides its customers and they are fully engaged in the mission of providing that service – even if it means doing a little more, staying a little late, or doing something that not, strictly speaking “their job”.  It is more difficult to teach engagement than it is to teach skills or even resourcefulness, and the way you lead and treat your workers can have a dramatic effect on their engagement.  High engagement levels are not, however, an excuse to overwork or take advantage of your workers, or they will quickly disengage.

Once you find these capable, resourceful, engaged workers, you have to keep them, and to do that you have to create a work environment where everyone is treated with dignity and respect, so people like to work there.  You also have to pay them what they are worth, and enough to live on, so that they are not resentful or distracted.  Providing benefits can be a great help in this area, often providing more goodwill and peace of mind for your employee per dollar than a raise, and setting your company apart from your competitors in the competition for valued labor.  Finally, when possible, give your employees incentives to make the business more profitable.  For key senior employees, you should consider giving them a contract that removes them from the worry of employment at-will and in return commits them to the Company.

When you are ready to sell your business, these valuable employees are a great asset.  Having them will help to convince the potential buyer that you are replaceable, and therefore there is a business apart from you to buy.  The buyer will likely want to come into the business and see the employees at work.  If he sees these kinds of workers, the questions will be focused on how to retain them, and once negotiations begin to focus on retaining assets, you have built value and your bargaining position is strong.  Finally, if you have done a really excellent job of building business value by being profitable, showing revenue growth across time, building intellectual property, and other ways we will discuss, you create the possibility that one or more of your key employees could obtain the financing to become your buyer, and that can be a great result.

Next Time:  Customers as an Asset

Create Business Value Now (V): Replace Yourself

In Part V of Creating Business Value Now, I want to talk to the superhero entrepreneur in you and tell you that, while it is impressive and admirable that you do it all, if you want to sell your business for real value, you must be replaced.

  • Replace Yourself. When you offer your business for sale to that future buyer, the idea (generally) is for you to go and do something else – retire, relax, start a new business, etc.  But if you ARE the business, then how much value does the business have without you.  Entrepreneurs are generally highly motivated, strong performers. It is sometimes easier for them to do it all than to train people to do it for them. But if you want to have value for sale, the business needs to be able to operate and sustain with you gone.

Entrepreneurs who fail this test often find their purchase offers conditioned on long-term employment or consulting agreements. This does not often work out well in the small business arena. The Seller continues to think of the company as his, and the new owners have a difficult time making the company theirs while the old owner is hanging around.

Buyers who see too much value in a selling entrepreneur’s personal work in the company, but who aren’t very excited about the seller hanging around, will also make an “earn-out” offer, where the final purchase price is substantially determined by the actual performance of the company after the sale. If the business is going to flounder when you’re gone, you value is in real jeopardy.

I realize that all business, especially small business, is at its core about personal relationships, and the key advantage a small business has over its large competitors is the ability of the entrepreneur to forge relationships with his customers. So, I am not advocating you become an absentee landlord. But you should train employees to perform the work of the business, while you focus on relationship building and strategy. When the buying entrepreneur steps in, the core business can continue to function, and the new entrepreneur will take over the relationship building.

 Next: Recruit, Train and Keep Key Employees.