Friday, July 31, 2015

Setting Up Agreements (Tradecraft)

I've just spent the last couple of weeks working on our company shareholder agreement. Game stores don't have a lot of money, so most are likely one man, sole proprietorships. It's easy, simple to form and operate, and doesn't require complicated structures and fees. The down side is it's not set up for investors and offers no legal protection. It's the default.

Most stores that take the next step usually go LLC, since it offers legal protections (in theory), allows for distribution of profits to investors, is simple to understand "pass through" taxation, and requires minimal paperwork and meetings.

I say it offers you legal protection, but in reality, if you work in the business, you essentially give up protection. The investors are protected though, and nobody should give you a dime without an LLC or a corporation in place. Also, no bank or business will loan you money without your personal guarantee. All my leases have the corporation and me on it. Here's something else we've been working on recently:

Corporations are not much different (the federal government looks at LLCs as corps), but may have other benefits. Our state based LLC charges fees on gross, while corps tax on net. Game stores have a lot of gross and not much net, so converting to a corporation saved us thousands of dollars in state LLC fees. There is zero difference in how we operate day-to-day between the two structures.

These types of organizational structures are incredibly complex. You can form them on your own with various kits, but what you end up with is a hollow structure without agreements or protections within your business. Both types of structures usually require a minimum of one meeting a year, and beyond that, it could look like the Wild West in between. I'm always trying to get some sort of written documentation of our conversation in case we're audited.

Corporate structures also don't help you answer the big questions, like how to get people in and out of the corporation in a way everyone agrees upon. For example, you can form a corporation and legally decide upon the value of an initial share, but what happens when a shareholder wants to leave? Valuing shares isn't in any corporate documents, it's part of a possible side agreement (that shareholder agreement). If you've been in a company for a while and watched it grow, you certainly don't want new people coming in at your initial share value. You also don't expect to leave at that initial value, knowing the company has become more valuable over time.

What if a shareholder dies? Are you obligated to do business with their spouse or children? How much can I spend as the CEO without triggering a meeting? Am I violating that if I make a huge Magic purchase on release? What are the limits? What keeps my partner (or me) from opening a competing store in the same town and taking all my customers and know how and abandoning my business? What does shutting down the business look like? Who gets money when?

These are all in the shareholder agreement and the funny thing is, they are all logical, reasonable, with legal precedent for what's normal. It's a boring document to read. Really boring. At least that's true when you read these documents ahead of time. When you're the one trying to sell your shares or the spouse of a deceased shareholder, you might have very different ideas of what's normal and what you deserve. That's why you do these things early (we're in year eleven).

The main trigger for my shareholder agreement was the desire for the business to continue after I'm dead and to keep my family from having to deal with it. In most scenarios, there's a fire sale and your heirs come in and drive the business into the ground with a massive sell off.

In my scenario, there's a "key man" insurance policy on me. When I die the business gets the money, but that's only half the story. What I personally don't want is for my family to be burdened by this complicated business. I want to leave it to my management staff. That requires an agreement that investors get bought out (including my heirs) and the management team gets the business, along with some operating capital so they have time to figure it out, deal with suppliers who have no idea who they are, and keep the store moving with essentially no credit or understandings. The first half of that is part of the shareholder agreement. The second half, my intent to give it to management staff, is an estate plan (my next project).

In any case, you can see we're planning for a Black Diamond Games for many years to come. Once a business is successful, it just seems like the right thing to do, for your family, your employees, and your community.

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