Episode 14 | You Came Up With a Great Business Idea During the Pandemic - Now What? - A fledging business doesn't just need a solid business plan; it also needs a strong legal foundation. This foundation is not "one size fits all," so it's important to tailor your choices to your specific industry and your risk tolerance, long-term goals and budget. Frantz Ward attorney Alanna Guy joins the podcast to discuss the building blocks necessary to start a new business, from choosing and forming the appropriate legal entity, to preparing documents for managing the entity, to considering what other safeguards might be necessary to set your business up for long-term success.
Podcast First Aired: September 7, 2021
Guest & Host
Chris Koehler: Hello, and welcome to the latest episode of Frantz Ward's podcast series, Shoveling Smoke. I'm Chris Koehler, a partner at Frantz Ward, and I'm hosting today's discussion with my friend and colleague, Alanna Guy, who is going to talk about the building blocks of forming a business. Alanna joined Frantz Ward about a year and a half ago, and has been a fantastic addition to our business and corporate law practice. She spends most of her time representing clients and mergers and acquisitions, in private equity and venture financing transactions, in corporate loan transactions, and in business entity formation, which is the topic we're going to talk about today. She works with clients of all shapes and sizes and across the gamut of industries. Lately, she's been spending a lot of time advising clients in the fast expanding cannabis industry in Ohio. Welcome to the podcast, Alanna.
Alanna Guy: Thanks, Chris. Happy to be here.
Chris Koehler: Alanna may think that we brought her on board for her legal expertise, but the reality is she was the first draft pick for our firm's basketball team because she played hoops in college. Do you still play?
Alanna Guy: A little bit. Obviously COVID and the pandemic put a little bit of a damper on that, but hoping to get back into that this winter. But I've been playing beach volleyball this summer, so that's been a lot of fun.
Chris Koehler: I assume you were pretty competitive when you played. What do you do now to fuel that spirit?
Alanna Guy: Absolutely. I actually started playing golf last summer. I don't know if I'm quite good enough yet to be considered to be competitive in it, but hopefully by next year I will be.
Chris Koehler: Well, golf's a frustrating game. So good luck with that.
Alanna Guy: That it is.
Chris Koehler: Before we get into the specific fundamentals of forming a business, Alanna, why is this topic particularly timely to you right now?
Alanna Guy: Yeah, Chris, so basically what's been going on is when I'm having conversations with people, whether it's at a cocktail party or running into old neighbors on the street, I've been hearing a lot about what business ideas people I've come up with during the pandemic. A lot of people were at home a lot more often than they would typically be over the last 15 or 18 months, and rather than maybe spending all their time watching Tiger King or baking banana bread, some people were really coming up with what we would call a side hustle. And whether it was something that they've had the business idea for a long time, or if they saw a gap in the market, people have been deciding to use that extra free time that they've had to start businesses, which is great for our society. But I've been realizing from talking with a lot of people that they don't necessarily know where to go or how to start legally in forming an entity or getting set up as a business.
Chris Koehler: What are some examples of the side hustles that you've seen?
Alanna Guy: Yeah, it ranges from all sorts of things. I have a friend that wanted to start investing, and his family wanted to invest with him, so they wanted to set up an LLC to start investing in some different companies and funds. I've worked with some people who have started consulting businesses, and on the side they've been either consulting in their field or they've started wedding planning on the side. And a lot of other people that I've spoken with have been developing apps. And that is something that's very important and I see going a great deal of distance in the future.
Chris Koehler: So where do the dreaded lawyers come in this process?
Alanna Guy: So it's different with everybody. For some people, it's they have a question of where do I even begin because they don't know where to start, and we can have a conversation about, "All right, let's see if we should form an entity for you." And for some people, they want to just go along their way and be a sole proprietor and operate maybe under a trade name or a DBA, and that can be okay, but for a lot of our clients, we like to advise them to form an entity to protect them personally and to minimize risk. Other people are doing this already on their own and coming to us later. So when somebody brings this topic to me, what I like to do is first talk about, do you already have an entity or you interested in forming one? And if so, we can talk about what kind of entity to form.
Chris Koehler: And so when you're sitting down with somebody, what are some of the variables that you talk about as to that will inform what type of entity or how you're going to proceed?
Alanna Guy: So if the individual or the group of individuals forming the company are not familiar with limited liability companies, corporations, limited partnerships, we like to first sit down and talk basically about what each type of entity is and the pros and cons of each one. Most often, we are forming limited liability companies and corporations for people, and that way they have personal liability protection, and then we kind of get into the tax advantages of each one of those entities.
Chris Koehler: And along the way, as you're having these discussions, are you or the clients having parallel discussions with tax advisors?
Alanna Guy: In the perfect world, yes. So I am of the opinion that if we're all on the same team from the beginning, it's going to form the best foundation for later. However, the reality is that, especially if somebody is doing this on the side, the budget might be quite tough and it might be not as large. So we generally will suggest that people get an accountant and have tax advisors. Sometimes they already have them, but it's kind of industry specific. So I know you mentioned that I've been working with a lot of medical marijuana companies, and in that instance, it's very important that those companies work with a tax advisor, and we've actually formed good relationships with many of them in town and we can help provide some names if people are unfamiliar.
Chris Koehler: So step one, it sounds like is to form that entity, decide the best entity and form that entity, unless someone's going to go the sole proprietor route. So that's right?
Alanna Guy: Absolutely. And again, I know we've been talking about everybody has a different experience level with business and entity formation when they either come into the office or we get on a call together, and forming an entity is something that sometimes clients decide to do themselves, and they have the experience and the knowledge to go on the secretary of state website and do that. But for others, they want us to handle that for them and make it a smooth process.
Chris Koehler: And each type of entity, a potential type of entity has its own pros and cons. So you walk through that and determine where they want to be as far as potential liability exposure, tax planning, and other things like that?
Alanna Guy: Absolutely. So what I like to do when we're sitting down with these individuals getting ready to start a business is to map out their intentions, their goals, what concerns they're having. Liability and risk is absolutely a concern, but it's helpful to know, is this person going to be operating on their own? The example of the consultant. Is this person going to be operating on their own and just look to have some clients that they work with on the side and not really looking to build this into a company with employees or investors? The app developer, on the other hand, they might be looking to raise some capital and these considerations can drive how we're forming the company. Sometimes investors are adamant that the company be a corporation, or if it is a limited liability company, the investor might be adamant that entity is formed in Delaware. So although we can always make changes later, we can always convert the type of entity, we can always work with the investors to find out what concerns that they have, if we already know that upfront, we can be a little bit more efficient and streamline the process.
Chris Koehler: So it sounds like even if you're working on a small budget and really don't want to invest too much in outside advisors, it helps to have at least minimal discussions to talk about the future and the overall game plan down the road.
Alanna Guy: Yeah, it can. And having a tight budget is something that people don't like to talk about money a lot of times, but it's helpful to know that upfront because we can tailor it. If back to the example of a single member, limited liability company with a consultant, there's no need for an extensive operating agreement. There's no need for us to be talking about transfer restrictions and all sorts of things. It's just not necessary or appropriate in that instance. But if we go back to the example of the family creating an investment company, we need to at least make the client aware of the risks and talk about what our recommendations would be. And if they decide we don't really have the money right now to go down that road and to create extensive documents, let's get something simple in place, and in a year from now, let's reevaluate and we can amend and restate this operating agreement or the regulations, bylaws, whatever the applicable governing document may be.
Chris Koehler: So if step one was the basic formation of the entity, it sounds like step two, you're talking about creating operating documents or some kind of structure for the organization.
Alanna Guy: Absolutely. So we will usually call those the governing documents and the document depends on the entity. So I've mentioned an operating agreement a couple times. We draft operating agreements if we're working with a limited liability company or bylaws. In Ohio, they're called regulations. We draft those if we're working with a corporation. We draft by sell agreements. And this is something that is very tailored to the company, and we can get as specific and detailed as someone would like to be, or we can keep it broad and simple if necessary.
Chris Koehler: So if you're tailoring an operating agreement or these governing documents, and someone wants to keep it simple, where they're on a budget, are there a couple must haves or things that absolutely must be addressed if you're going to put these together?
Alanna Guy: Yes. So the most important aspects to the operating agreement are the talking about management, voting and transfer restrictions. And again, if we just have a single member, limited liability company, those look very different than if we have even two members or six, eight, 10, however many members that we might have.
Chris Koehler: So let me interrupt you for a second. What does management mean? What does that aspect?
Alanna Guy: The management is the day to day operations, and that can be done by managers for managers, or it can be done by the members. And that's, again, just depending on the situation. That's why we like to discuss with the client and explain the options for what their management structure can look like, and then we can go from there.
Chris Koehler: And what about voting? What does voting entail?
Alanna Guy: Voting ties to a couple of things. It can tie back to the management if we do have a board of managers, but we usually think about it in the realm of when do members get a vote. If there are managers, when do members get to vote and how do they get to vote? If we have five members, all with different membership interests and ownership percentage of the company, do they each have one vote or do they vote based on their ownership percentage? And that is a very important topic and something that only the owners can discuss amongst themselves to see how they envision that playing out.
Chris Koehler: And then, third, you mentioned transfer restrictions. What does that refer to?
Alanna Guy: Transfer restrictions really come into play more when we have several members. And the idea is, Chris, if you and I go into business together, we're in business with each other. I don't want you to be able to just give part of your ownership in the company or all of your ownership to somebody else, whether it be your kids, your wife. Your wife's great, but we didn't sit down. We didn't come up with this idea together. And that really ties into thinking ahead to what we called the business divorce. When we're creating this company, it's the honeymoon phase. We're excited. We're happy. We're not thinking ahead about what potentially could go wrong. And so when we talk about the transfer restrictions with clients, we talk about the dreaded worst case scenario.
Chris Koehler: So you're planning ahead, assuming that something's going to go wrong?
Alanna Guy: And that's sometimes why lawyers get a bad rap, assuming something's going to go wrong, thinking worst case scenario. But I like to say hope for the best, prepare for the worst. We're going to hope this all works out and is great and the company is very successful, but in the event the company is not successful or there's a problem between the owners, or maybe one owner gets divorced and their ex spouse in the divorce settlement is entitled to part of the ownership of the company, how are we going to handle these things? Let's talk about it ahead of time so that if it happens, we know how we're going to proceed.
Chris Koehler: Are these uncomfortable conversations sometimes to get people to talk about the divorce?
Alanna Guy: Oh, definitely. Anytime you're talking about death or divorce or money, people get kind of uncomfortable and you try to approach it with as much bedside manner as you can and recognizing that they're uncomfortable topics. But I think after the last year, or I guess year and a half of uncertainty, I've actually been noticing that clients have been bringing the topics up to me without me having to bring it up to them, especially in thinking about death. And we've noticed that clients are being much more proactive about business succession planning over the last year. And that is also something that, in my perfect world, we also talk about when we're at the beginning stages of a company and what that business succession plan may look like.
Chris Koehler: So you're trying to get people to not just think six months or a year ahead, but five or 10 years down the road.
Alanna Guy: That would be the best. But as we've talked about, sometimes that's just not feasible for clients coming in. If they don't have the time or the money to spend on all of this, I think, okay, well, let's get your entity formed. Let's get something in place, some sort of governing document. We can keep it simple and we can reevaluate it in six months, a year, whatever makes sense. These documents that we're creating are not set in stone. It's not just because we draft this in August of 2021, that this is it forever. These documents should be revisited at a minimum if there's a change in circumstance, some of those triggering events we were talking about. That is a great time to revisit an operating agreement.
Chris Koehler: What are some of those triggering events that might cause someone to take a look at their agreements and make sure they still fit?
Alanna Guy: Yeah. Death would be one. Incapacity, if somebody becomes disabled or there's an accident, and they're not able to be fully involved in the business anymore. That is one that may or may not be a triggering event. Depends on if that person is actively involved in the business. Divorce is another one. These are things that results in a change of circumstances for the company. I also think that sometimes if it's a family business and their kids are involved, if one of the children gets married or there's another child born, a grandchild, these are all things that we like to be involved with the client and talking about, and to keep that line of communication open.
Chris Koehler: So if step one is formation and step two is the governing documents, after those documents are in place, what's step three? What do you do next in the formation process?
Alanna Guy: I'm going to give you a classic lawyer answer. It depends. And-
Chris Koehler: You just lost half our audience.
Alanna Guy: Oh no. Well, I'm not done.
Chris Koehler: Okay.
Alanna Guy: It depends on the situation. Our consultant, we've been talking about. She's probably not hiring any employees. She doesn't need any employment agreements, but our app developer, they're probably hiring other software engineers. They might be hiring marketing and advertising folks. They're going to need some employment agreements. They're going to need confidentiality agreements for those employees. They're also going to need, if we even take a step back before they're ready to hire employees, they need confidentiality agreements with their potential investors. They just can't be sharing all this information with people without protecting themselves. So it really depends on what they're looking to do. If they have employees, are they worried about non-compete agreements or non-solicitation agreements? That's why it's important to have the full picture of what our clients are working on so that we can adequately advise them on what type of agreements they might need.
Chris Koehler: Alanna, thanks for providing the fundamentals of starting a business. In each podcast, we've asked every guest to provide two or three quick takeaways so that our listeners can have kind of a thumbnail as to how to proceed. What do you have for us?
Alanna Guy: Yeah. For the takeaways, I think number one is no matter what your budget, no matter what your situation is, let's get something in place. Like we've said, we can come back to it later. We can revise it. We can amend it. We can convert your entity. We can do whatever we need to do later. For number two, I think it's important to remember that not one size fits all. We will tailor whatever the situation is, the circumstances, the budget, we will tailor it to fit the needs of our client. And then, number three is, I think what you said, we're talking about fundamentals here. Without good solid fundamentals, it's harder to have longevity and success in the future. So let's get the fundamental solid, get a good foundation in place so that you can be successful in the future.
Chris Koehler: Thanks. Very helpful. So get something in place, whatever you do. Tailor it to your needs and goals. And if you have that strong foundation, you set yourself up for success in the future. Alanna, thanks very much for riding the basics for our clients. Hopefully they'll take your advice and look ahead to the future and put some of these building blocks in place.
Alanna Guy: Yeah, thanks for having me. It was a great way to end the week.
Chris Koehler: That's it for this episode of Shoveling Smoke. Thanks for joining us. And we look forward to our next discussion. Shoveling Smoke is a production of Evergreen Podcasts. Our producer and audio engineer is Sean Rule-Hoffman. Thanks for listening.