Atty. Mark D. Holmes: Today’s little talk is going to be basically a Ben Franklin talk. You know that famous saying, “An ounce of prevention is worth a pound of cure.”
I am going to be talking to you today about a lot of prevention, but just keep in mind, in the background silently, there is this dark cloud. It’s called the cure. The cure is really expensive.
When we talk about things that you should do, the not doing part is the really expensive part, and you see that’s where I, as a business attorney, make lot of money. It’s because people don’t do the right thing in setting up or operating their businesses that causes these problems, that show up at my doorstep.
When people ask me, “Can you please resolve these?” I have to say, “Sure, I can try, but it’s going to cost a lot of money.”
Let me give you one example, anybody here ever had a friend or an acquaintance who said, “I am 50:50 partners with somebody,” they are going to pay for my retirement. Why? Because 50:50 partnerships never ever work. Not ever. That’s just the truth.
Sooner or later, they’re going to be at my doorstep saying, “I would like to kill my partner with my bare hands,” and you go, “No, you can’t do that. You’ll go to jail,” and that’s a referral for Kim.
Kim: Here’s a valid tip man.
Atty. Mark D. Holmes: Those are the kind of referrals I’d like to send to Kim because those aren’t winning referrals. Those are really going to be bad.
What you have to do is you have to try to sort those things out. When people hate each other that much, it’s really, really difficult. And guess what, it’s really, really expensive, and you have to bring all of your skills to bare, not just the legal and the business but also the psychological. It is most of the time you’re playing psychologist as well, because it’s a very, very stressful situation.
We’ll talk about why we do the things that we do. If you go through this little handout that I gave you, which talks about flat fees, we talk about the great things you need to do. These great things are, if you’re going to setup a business and you’re going to be serious about it, if you’re not incorporated or operating through an LLC, you just are not doing the right thing.
Why? Because there’s so much risk involved. How many people have a house? Great. How many people want to keep their house? Okay, so if you’re doing business as a sole entrepreneur and you’re making any sort of money, you better be incorporated or operate as an LLC, because there’s no sense in putting your houses, is there. No, there’s not, but people do it all of the time.
What’s the argument for not incorporating or not operating through an entity? It’s just easier that way. “It was less paperwork and I don’t want to give those bastards at the Secretary of State or the Franchise Tax Board the $800 every year. That has got to be the stupidest explanation I’ve ever heard in my life.”
Do you realize you’re putting every asset you own on the block by not incorporating or operating through an entity? How expensive is that going to be? That’s going to be really bad. You know what filing bankruptcy does to you? It’s awful. It’s awful. It sometimes destroys people, literally.
You don’t have to do that. Eight hundred bucks a year, sending it to Franchise Tax Board, that’s cheap insurance. Why? Because it protects your personal stuff, and your family, and you, and gives you peace of mind. And it’s pretty cheap. That’s why we deal it on a flat fee basis.
What’s another way you can protect yourself? You can have proper contracts, proper invoices, proper work orders, and proper estimates. How many contractors do we have in the room? Lots of contractors, right?
If you don’t have proper contracts, you’re asking for it in the State of California. How many people have employees? People have employees. How many people think it’s smarter to be using independent contractors? That’s a really dumb idea. Why? Because you’re usually going to be deemed an employee anyway, when they wake up one morning and decide they don’t like you.
To really do it right, you’re going to have a real independent contractor relationship. I have a 12-page agreement that lines out everything. If you use that agreement, you have a better than average chance of basically escaping what they call a “labor and wage scrape.”
Other than that, you have real problems because if somebody wakes up and says, “No, I am not an independent contractor. I am your employee,” you’ve got big problems – big problems.
By the way, if you’re operating as a sole proprietorship, you’re personally liable for all the labor and wage thing, penalties, interest, damages, all that sort of thing. So essentially, you have to start thinking about how do I arrange my business in the proper way? You have to incorporate, have their contracts.
How many people either have partners? We call partners or co-shareholders, right? No people have it. Do these people have what they call a buy-sell agreement? Do you know what a buy-sell agreement is? It’s basically the agreement that says, “This is what happened if everything bad that we can imagine, happens.”
We plan for this. Entrepreneurs are awful at this because they think nothing bad is ever going to happen. They think everything’s going to be teaching and team. They’re just delusional, right?
Entrepreneurs are delusional. We love them. We really love them because they’re just great visionaries and they have the greatest optimism in the world, but they’re delusional. What they need to do is sit down and say, “If this all goes to hell in hand basket, this is what we’re going to do.”
Why? Let’s give an example. Let’s say Dennis and Chris are partners. Both Dennis and Chris are married. Basically, we say, “Look Dennis, you really like Chris, don’t you? He is a great partner of yours.” He was, “Yah, he’s wonderful.”
Same for Dennis, right? Yeah. And then I say, “Chris, guess what, Dennis just died,” and he goes, “Oh, that’s horrible. No, it’s worse than that.” “Why? But why Chris?” “Because Dennis’s wife is now your partner. She owns half of your business. Isn’t that exciting?”
And Chris goes, “What in the hell is that buy-sell agreement?” [Laughter] But wait, there’s more because you see, even if you have the buy-sell agreement, if you don’t fund it by getting life insurance, hmm, right? Life insurance, life insurance, right?
You’ve got to see your life insurance agent for what they call “key person insurance.” You have to fund it. Why do you do that? Because let’s say Dennis dies. His wife starts saying, “I’d like my money please for half of the business,” and you say, “We don’t have that kind of money to give you right now, dear.”
So you have to have a mechanism in place to take care of it. You can do it contractually. Well, we’ll pay you so much over time, over so many years with so much interest, or we can have a life insurance policy in place that basically takes care of that, and takes care of it from both sides, or all three sides or all four sides, or all twenty sides, if you want to do that.
What’s really important is that you plan for this stuff and have it in place in case of the bad stuff happens. The best part of this is really cool, because you see when we find to get these people to sit down and do a buy-sell agreement, every agreement it says, “You will agree to coordinate this place your will and trust.”
And then there are crickets, because there everybody goes, “Oh, you’ve got to have one of those?” It’s like, “Well, you don’t have to have one but it’s a really good idea,” and they go, “Oh, okay. So what do we got to do?” And so you basically have to setup a will and trust for these people.
Of course that involves more insurance, then involves investment people like the buds. And you have to bring more insurance people to insure the stuff. Everybody gets involved, hopefully the CPAs, to make sure all of this stuff happens.
And then you realize, “Oh, this is a cool way to set things up.” Now, how much money do you think I make on my practice from this type of transactional work?” It’s about ten percent on my practice. It doesn’t make me much money at all.
Now we’re talking about the cure, that dirt shadow looking in the back. That’s where I make all my money, ladies and gentlemen. It’s because I have to cure all these messes, and when I do, it’s just unbelievably expensive. We’re talking hundreds of thousands of dollars sometimes, to do that.
When you talk about, “Oh listen, I want to prevent in sending 800 bucks to those people at the State.” That’s nothing, right? If you’re faced with what you have to do later to fix these types of problems, it’s overwhelming. That minimal amount that you’re throwing or investing to make these things setup right or be setup right, is nothing compared to the hundreds of thousands of dollars you’re going to spend trying to fix it later.
If you want to keep me poor, then do what I ask. Follow my little flat fee schedule. Do those types of things. Get setup right and I won’t make much money at all. But if you don’t, then you’re going to show up some day and say, “I need you to fix this,” and when I tell you I am going to need a $10,000 retainer deposit and I am going to start billing hourly, and I might do that every month for about the next year and a half, then you’re not going to be happy.
That ladies and gentlemen, is the cure you don’t want. Yes sir.
Man 1: Why would incorporation be less than LLC?
Atty. Mark D. Holmes: Why would it be?
Man 1: Yeah, cost-wise. Why being one?
Atty. Mark D. Holmes: Because usually an LLC has an operating agreement and incorporated into the operating agreement is a buy-sell agreement, and it’s a very long document whereas incorporation don’t have that, you have to do that separately. It’s we need one of those two, so we setup a separate agreement, whereas the LLC only have two or more people, you basically put it all together in one packet.
Man 1: So if you have real estate, would you recommend like what …?
Atty. Mark D. Holmes: I think the CPA is usually recommended. Yes, an LLC. Notice I just said the CPA is recommended.
Man 2: Not everything. There are separate ones. Other ways, resident A to building B.
Atty. Mark D. Holmes: Yeah, every CPA I’ve ever worked with has made that recommendation and I have made that recommendation. Probably my most famous case ever was a guy from Cuba who showed up, started as a dishwasher and when he finally showed up at my doorstep, he had 53 rental properties, all in his name.
Yes, and I had a real estate broker friend of mine who was on his knees begging, almost crying, saying, “You have to let him do this. Set him up in separate LLCs, have them all held by a holding company,” and he thought I was ripping him off, that this was a horrible rip off, that this was just a waste.
So two years later, a Metlab blew up in one of his rental properties, and we had to bankrupt that LLC. But he showed up in my office with a box of Cuban cigars. I don’t know how he got them.
Atty. Mark D. Holmes: And I said, “What’s this for?” He goes, “I still have 52 rental properties. Thank you.”
Atty. Mark D. Holmes: Because bad stuff happens. It really does.
Man 3: The life insurance for the [inaudible 00:11:43]
Atty. Mark D. Holmes: Yes.
Man 3: How complicated does that get on a value of company is …?
Atty. Mark D. Holmes: It has nothing to do with the value of the company.
Man 3: But in this, we’ll provide all the other …
Atty. Mark D. Holmes: No, it has to do with what you guesstimate is the value of that person’s share in the company.
Man 3: But eight years later, that’s already be tripled …
Atty. Mark D. Holmes: Then you might at some point …
Man 3: So you have to keep adjusting the life insurance …
Atty. Mark D. Holmes: No, you don’t have to keep adjusting it. You just said you went up dramatically, right?
Man 3: Well, in over eight to ten years.
Atty. Mark D. Holmes: Okay, let’s put your OCD aside for a minute and just say, we also check in every five years and see what happen to the value of the company. If it goes up dramatically then you might want to make a change. But you see, we don’t leave it with just insurance, we also have the contract that says, you also have the option of paying them off over time.
So you’re not left basically out there exposed. You might have to pay something over time if the company dramatically increased in value and you didn’t do anything about the insurance. But you see, if you look at it every five years or so periodically, just to make sure that you’re not in a position or where your insurance doesn’t even come close to covering what your possible exposure is, then I think you’ll be okay.
Because as you said, if the company increases dramatically, you’re going to want to cover that because you don’t have to pay money out of the company. But stuff happens.
Let’s say, basically today you’re a two million dollar company and then in two years, all of a sudden you’re a ten million dollar company, and you’re so busy making money, you forgot about the life insurance, and then of course your partner got dead. We’re not going to leave you exposed contractually. You may not have enough insurance to cover all of that but you can cover the rest of it, basically by paying it out over time.
But the main thing is you’ll at least have a plan in place. That’s why I always tell people, at least get the plan in place. You can always make adjustments. You can also back build and fix things. But not having a plan, as you just pointed out, is a disaster. Not having any insurance is just a disaster if you went from two to ten.
If you have to payout five million and you have no insurance for any of that, that’s just, “Where you’re going to get that?” And you see, that’s what I am advocating for, at least getting something in place.
Let’s say for instance, you only had two million dollars of insurance in place and you have to pay three million. That’s not as bad as having to pay off five. You see my point?
Man 3: Yeah.
Atty. Mark D. Holmes: Okay. I hope that was helpful. Thank you so much guys.
As a business attorney Mark D. Holmes always counsels for good contracts and work agreements to prevent expensive litigation when and wherever possilbe.