The Chicken, the Egg and the Colonel: Three Approaches to Going into Business

Installment 2 of The Plunge.

The first decision a prospective business owner makes is whether to start a business from scratch, buy a franchise, or buy an existing company. This is not a legal question, though there are legal issues that may influence you. Ultimately the question is about fit. Which approach best fits your circumstances and your goals as a business owner?

The Chicken.

Helping people buy or sell existing businesses is a substantial part of my practice, but in truth few first-time business owners buy existing companies. Buying a turn-key operation is a turn-off for some entrepreneurs and too expensive for most of the rest. Buying a company is still attractive as a straight-forward way to get into business, that plus the certainty of most buyers that they will do a better job than the current owners.

Buying a company is actually a complex straight-forward way into business when done right and a straight-forward road to bankruptcy when done wrong. Each step of the way--choosing the right target, conducting due diligence, negotiating, documenting and closing a deal, transitioning between owners, and finally implementing your plan for the business—presents opportunities to stumble.

Assuming I successfully manage this one, another series on the buying and selling of companies is in order. Until then, keep “asset purchase” in mind. From a legal perspective, structure is everything when buying a business. As a general rule, buyers should avoid buying the stock of an existing company. Buying a company’s stock puts you in the legal shoes of the past owner and straddles you with every liability and skeleton-in-the-closet since inception. A stock purchase also puts the buyer at a disadvantage in income tax planning.

The Colonel.

(You get the joke, right? I’m not pushing KFC, but once I thought of chicken and egg I couldn’t resist.) Buying into one of America’s 1100 plus franchise systems, representing over 850,000 franchised operations, is a popular route into business. Some disparagingly say buying a franchise is buying a job, but as Small Business Trends recently observed: what would be so wrong with buying a job today? Certainly a number of successful companies started by buying a single franchise; growing it from a job to a business of many franchises requires the right mix of passion and diligence.

Would-be entrepreneurs should not allow the relative ease of getting into business by franchise (that’s why they exist) to prevent them from being thoughtful and thorough in the process. The franchise agreement and other agreements with the franchisor need to be carefully discussed with competent advisors. Moreover, buying an existing operation from another franchisee should be handled as the purchase of a business and a franchise.

If a franchise is a serious consideration, there are several good resources available, such as the guide to evaluating franchise opportunities, at business.gov.

The Egg.

Start-ups are the well-spring of American entrepreneurship. Building a business from scratch to significance is the dream of many, the reality of few. The first step, of course, is taking the plunge. The rate of new business formation had been trending up for several years before the recession knocked it down in 2008; I suspect (hope, pray) the rate takes a big jump in 2009 and 2010. The concepts in this series will be useful to those who choose the chicken or the Colonel route into business, but the eggs are in my heart as I write.

Survival rates in small business aren’t great. In a normal year, businesses opening their doors outnumber those shuttered or in bankruptcy by only a few percent. While seven of ten new businesses will survive two years (determination/pig-headedness is pretty typical in this crowd), by five years the rate drops to half. Legal problems are typically not the reason new businesses fail. Failure in a start-up usually stems from management, marketing and funding problems, hence my earlier post I Don’t Want Your Money. But attention to the legal issues early on will pay-off in two important ways.

First, if your first or even fifth attempt (I’ve heard of more) at starting a company fails, your attention to legal details helps keep the liabilities of a failing business from becoming your personal liabilities. Second, assuming your business succeeds beautifully, attention to the legal details positions you to avoid issues (the more you succeed, the more you have at risk) and increases your chances of a financially rewarding exit (more on that in the now-promised series on selling a business).

This is the first substantive post of "The Plunge,"and already I’m changing my outline. I’m pushing business plans and budgets into an article about finding the money (capitalizing in legalese), where they probably belonged all along.

Introducing “The Plunge,” A Series of 8 (or so) Posts on Starting a Human-Owned Business

Installment 1.

You can decide whether starting a business in a recession is brave, smart, stupid or nuts, but the fact is that folks are doing it, and it’s a good thing too. Two different surveys this spring confirmed that Americans put their trust in small businesses and entrepreneurs to lead this country forward; much more trust than they have in big business, government or even lawyers.

In the spirit of supporting the small business renaissance that will lead Colorado and the country, I am going beyond my earlier listing of the many free or low cost resources available for new companies. In a series of posts over the next few months, I will summarize the discussion I as a business lawyer would typically have with a client considering starting a human-owned business, otherwise known as “The Plunge.”

My rough outline of future installments for The Plunge, just in case you want to check back:

1. Fundamentals. Buying an existing business or a franchise or building one from ground up? Regardless, don’t skimp on a business plan and a budget.

2. Show Me the Money. Start-up capital is a huge concern for most new companies.

3. The Right Papers: Why use a business entity and how to pick the right kind. Trademarks and name protections. Business licenses.

4. Pre-nuptials. Assuming the business will have more than one owner, how will control, expenses and profits be shared? What happens when an owner leaves or the owners want to split-up?

5. Contracts 101. The contracts new companies need vary with the nature of the business, but virtually all business need to pay attention to contracts that impact their ability to get paid and not get sued.

6. People Power. Simultaneously the biggest headache and most important asset for most human-owned businesses. The best indicator of business success: owners who are redundant, or even better, irrelevant in the day-to-day workings of the company.

7. Insurance. A variety of different flavors, but pay careful attention to the ingredients.

8. The Road. What vision do the owners of the business have for themselves and the company?

My father was a navigator in the U.S. Air Force in the days before modern navigation tools. He guided planes across the Pacific by day using the sun and at night using the stars. If he missed Guam, a mere speck in the Pacific, the plane would run out of fuel and have to ditch in the ocean. He never missed. This series is intended  only to point potential human-owned business owners in the right direction, not to get you to Guam. If you are serious about taking the plunge yourself make sure to work with a good business lawyer and accountant. They should be your guiding stars.

Happy Labor Day: Change Will Do You Good.

At summer’s start, I found myself posting on Memorial Day and the idea that a little reflection on the meaning of our “legal” holidays was somehow important. Then came Independence Day: easy to appreciate, though many Americans still wasted the opportunity.

Out of the major national holidays Labor Day gets the prize for muddled meaning. Maybe our wistful good-byes to summer get in the way, but not many folks will pause to consider why we have a national day-off to celebrate labor. Too many of the few that do think about it will fall into two camps that generally despise each other.

The U.S. Department of Labor tells us that Labor Day “is dedicated to the social and economic achievements of American workers. It constitutes a yearly national tribute to the contributions workers have made to the strength, prosperity, and well-being of our country.” The DOL doesn’t tell us that Labor Day was rushed through Congress by President Grover Cleveland to appease America’s labor movement a mere six days after his controversial use of federal troops forcibly ended the bloody Pullman strike that paralyzed rail traffic, and thus the country, during the summer of 1894.

Cleveland’s gesture didn’t work for him—his Democratic party was slaughtered in the 1894 midterm election—or help the labor movement that much either. Many needed reforms, such as reasonable working hours and safe working conditions, now taken for granted would not be enacted for decades--decades that would include the infamous Triangle Factory fire and Colorado’s own Ludlow Massacre.

So maybe a lesson in working for change is among Labor Day’s messages to modern America. Change is slow and uneven, so take a long view. We seem to need a crisis, or even crises, to move change along, so don’t waste an opportunity when it presents itself. Change is ongoing process, so don’t be disheartened when we don’t get it right.

Crisis and change are on many minds now. Enjoy your day off.

I’ll close with my own farewell to summer: some favorite photographs from the last 3 months.