Venture capital

Legal issues Comparing Loans and Equity Investments

by Fred Abramson on July 5, 2011

Lemonade Stand

Image by cmiked via Flickr

When starting a business, you probably need to finance part of it. After looking at you own pocketbook, which usually includes any savings, raiding your retirement account or if you are lucky any inheritance money from Aunt Matilda you probably need more money. There are two sources of outside funding: equity investment and loans.

Loans: The Pro’s and Con’s.

You probably don’t need me to tell you what a loan is. If you want to open a lemonade stand, your parents lend you $10 with interest of 2% and you promise to pay them back with interest at a later date.

While your dad was able to simply open his wallet to provide you with an infusion of $10 when you were eight, he might not be able to lend you a more hefty sum now. One step is to contact a commercial lender. I have the name of a fantastic bank lender that could help you out. However, the bank needs to make sure that it will be paid back. This requires security, often in the form of a mortgage. Bank loans often require a personal guarantee, which means that you are responsible if the business fails.

The big plus of obtaining a loan as compared to selling an equity stake is that if your business becomes successful and your profit is larger than you interest payment, you keep everything in the future and do not have to share them with investors.

If you have equity investors, you do not have to repay the investment that your investors put into your company if your business fails. However, you can also be subject to a lawsuit by your investors if they think that you misinformed them. Since an equity investor is a shareholder in the company, they may also require a voice in the running of the business.

The Law Office of Frederic R. Abramson represents start-up businesses in New York. If you have a question regarding equity investments and loans feel free to contact me at 212-233-0666.

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3 Important Ideas on How to Attract Angel Investors

by Fred Abramson on January 7, 2011

Angel Investing is expected to pick up in 2011. In the past, tapping a home equity line of credit was a critical way for entrepreneurs to fund their business. But since that avenue for for borrowing has dried up, entrepreneurs have had to look for alternative ways to fund their business. Todd Taskey, writing in Small Businesses Trends takes a “look behind the curtain” to see how one very successful angel investment group tracks and considers its investments.  He looks at 3 factors- 1) Pre Money Valuation, 2) Liquidation Preference and 3) Market Perspective.

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Top Ten Legal Mistakes Made by Entrepreneurs

by Fred Abramson on November 8, 2010 · 1 comment

The life of a start-up can be like riding the Taconic State Parkway, a single mistake can cause serious damage.   Many entrepreneurs try to “play lawyer” to try to save money.  I don’t really understand the concept.  Simply because you know how to change the oil in your car does not make you a mechanic.

Recently Harvard Business School professor Constance Bagley made  a list of the most frequent legal mistakes made by entrepreneurs, everything from hiring the wrong lawyer to puffing up the business plan. I bring you his list, along with my 2 cents.

  1. Thinking any legal problems can be solved later. If you are an entrepreneur, you don’t need me to tell you that you are probably engrossed by your idea. You think night and day about bringing your business to market. I see it all of the time. But when it comes time to thinking about the legal implications 0f your ideas, you procrastinate. “We don’t have enough money.”  “Let’s focus on producing the best product and we’ll deal with the legal issues later.”  Huge mistake.  Legal issues not addressed at the start, such as an inexpensive contract with a web developer can result in expensive litigation later.
  2. Promising more in the business plan than can be delivered and failing to comply with state and federal securities laws. In your business plan that present to potential investors, you have to be honest about valuating your business. If your valuation has no reasonable basis, you can be sued for fraud.  Be aware that there are securities laws that protect your grandmother’s friend Matilda from investing in your venture.
  3. Disclosing inventions without a nondisclosure agreement, or before the patent application is filed. Non-Disclosure Agreements also known as NDA’s are surprisingly cheap for a lawyer to draft. For less than an iPad 3G you can protect your business from someone stealing your ideas.
  4. Waiting to consider international intellectual property protection. First off, my firm handles only trademarks so I won’t discuss the legal ramifications of patents.  However, if you have any inkling that you want you brand to go global, do an international trademark search and register.  You don’t need the headache of dealing with a trademark infringement suit with a company from China.
  5. Negotiating venture capital financing based solely on the valuation. Valuation is not the be all and end all when it comes to financing.
  6. Issuing founder shares without vesting. Some entrepreneurs are great at creating ideas, but hate running a business. If you are planning to start your company with a number of founders, especially a serial entrepreneur, you must protect the founders who stay.  If a founder exits the venture early, then you can get back the shares.
  7. Failing to make a timely Section 83 (b) election. Your eyes are probably glazing over this one.  But the Section 83(b) election is vital for tax purposes, especially if you plan on paying the founders shares rather than a salary. An 83 (b) election allows the tax computation to be made based on the value at the time the shares are issued, which is often minimal.
  8. Failing to incorporate. Without incorporating, your personal assets would be put at risk.
  9. Starting a business while employed by a potential competitor, or hiring employees without first checking their agreements with the current employer and their knowledge of trade secrets. Your employer can argue that the company is theirs, especially if you worked on your project on company time.
  10. Hiring a lawyer not experienced in dealing with entrepreneurs. It is amazing how many entrepreneurs contact my office and only focus on price. “How much do you charge to review my contract.”  Business law is a specialty and requires experience.  Many lawyers don’t understand the 83(b) election, which if improperly drafted, could cost you hundreds of thousands of dollars.  A Venture Capitalist will have a seasoned attorney representing them and they will provide you paperwork that may contain traps. Why risk it?

The Law Office of Frederic R. Abramson represents entrepreneurs and start-up companies. Contact me at 212-233-0666.

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Nurturing Start-Ups is the Path to Creating New Jobs

by Fred Abramson on September 13, 2010 · 2 comments

Two-thirds of net new jobs are created by small businesses.  However, the National Bureau of Economic Research found that once the age of a business is taken into consideration, there is no systematic relationship between firm size and growth.

According to the New York Times, nearly all job growth occurs when businesses are starting up. When businesses mature,  job expansion essentially stops.

Our unemployment rate is at 9.6%. Any serious solutions for creating new must focus on how to create new start-ups and nurture new firms that are in their infancy.

Some argue that raising long-term capital gains, like the Obama administration is proposing, can hurt the prospects of start-ups.  Since angel investors calculate taxes when deciding how much to invest, they may decide to fund less start-ups.

On the other hand, most new businesses make  little or no income. Entrepreneurs focus on making it big, not on taxes. The  New York Times notes that when Microsoft started up, the top income tax rate was at 70%.

One cheap way of fostering start-ups is by granting more residence visas to skilled immigrants, especially those who attend American universities. On February 24, 2010 Senators Kerry and Luger proposed the Startup Act of 2010, which would permit immigrant entrepreneurs to stay or immigrate into the  United States if they have secured “significant” funds to start a new company. Since immigration is a sensitive issue and the mid-term elections are upon us, this bill seems unlikely to pass soon.

Start-ups are always in need of capital. Unfortunately, banks have tightened their lending to start-ups.  Since the private sector is unwilling to lend, the government may have to step in and start lending to start-ups.

Another possible solution is to provide funding for incubators. Currently, there is an excess capacity of commercial real estate. The government should provide tax breaks to landlords to provide below market leases to incubators. Incubators would be required to house no less than three different businesses and be in business for less than 3 years.

What to you think? Is funding incubators a good idea? What are your solutions for job growth?

Frederic R. Abramson is the principal of the Law Office of Frederic R. Abramson, which represents start-ups.

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TED Talk: David S. Rose on pitching to VCs

by Fred Abramson on September 10, 2010

Thinking startup? Since you are reading this blog, you probably are. David S. Rose‘s rapid-fire TED U talk on pitching to a venture capitalist tells you the 10 things you need to know about yourself — and prove to a VC — before you fire up your slideshow.

Here are a few talking points:

  • Integrity and passion are the 2 most important characteristics  of an entrepreneur.
  • Are you knowledgeable?
  • Do you have leadership skills?
  • Charismatic?
  • Are you committed?
  • Do you have a vision?
  • Are you willing to listen and learn?

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Entrepreneurship and Social Change VC NYC panel March 4, 2010

February 27, 2010

On July 4, we celebrate the entrepreneurs who were our founding fathers who made a difference by bringing social change to America. Unlike July 4, there is nothing particularly unique about the date of March 4.  On that date back in 2006 final contact was attempted with Pioneer 10 by the Deep Space Network. Unfortunately, no response was […]

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Startup Immigration Visa for Entrepreneurs announced by Senators Kerry & Lugar

February 24, 2010

Senators Dick Luger and John Kerry introduced today a new piece of legislation entitled “The Startup Visa Act of 2010.” This visa would permit immigrant entrepreneurs to stay or immigrate into the  United States if they have secured “significant” funds to start a new company. The goal of the act is to bring new jobs, […]

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New York Venture Capital Stages a Small Recovery

January 25, 2010

Crain’s New York Business reports that venture funding for New York startups was up about 1 percent in the 4th quarter. However, only 66 companies received funding, as opposed to 86 the year before. Venture funding in New York area is concentrated in three industries: Biotech Medical Devices and Equipment Software Investors appear to be […]

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