New York Small Business Law

Getting Paid - Debt Collections

I don't need to tell you that getting paid by your customers for whatever your small business is offering for sale should be your number one concern.  Here are some pointers for handling this most important aspect of your small business.

Prevention, Prevention, Prevention

Ask for money in advance, whenever possible.  Ask for periodic advance payments, whenever a mile stone has been reached or come up with other periodic payment dates after partial performance.  Send invoices as soon as possible.  Have an agreement with your customer that clearly, unmistakably, sets forth WHEN and HOW MUCH your customer has to pay.  More on that below.

As soon as your customer is late on payment, follow up and start the collection process.  Resend the original invoice periodically, which then, under certain circumstances (check with your lawyer), can become an "account stated" and makes it easier to ultimately collect in court.

But don't harass the customer and consider having someone else make the reminder call in order to protect your relationship with the customer.

Investigation

Once a debtor is unresponsive to all your preliminary debt collection attempts (repeated invoices, calls), do some intelligence work to find out if your debtor has money or assets to pay his or her debt.  You can get a credit report on them (Permissible Purpose to get Credit Report).  

Find out if the debtor has litigation pending by checking the available court resources: For example, Civil Court of New York City, Supreme Court.  Many other courts have ways to check online whether your debtor is already a defendant in any court case.

You do this investigation to avoid spinning your wheels where a debtor is judgment proof, i.e. it would be a waste of time and money to go after them, because they have essentially nothing.

Collection

At this point, you could hire a collection agency to collect the debt for you.    They will usually charge a percentage of the debt.  If the debt is less than 90 days old, the charges may be less.  See here for one debt collection agency's rates (no affiliation, whatsoever).  This goes to show again, that making collecting your outstanding invoices a priority as soon as a customer is late, can mean a difference in actual dollars.

Going to Court

I am sorry, if you actually have to go this far.  In court, you will have to present hard facts, in particular, a legal basis for your claim for money.  In most cases, this will be an enforceable contract between you and your debtor.  As I stated above, it is crucial that you have valid and enforceable agreements with your customers.  This doesn't always mean a lengthy written agreement, it can be the terms and conditions on your website, if the customer is aware of them and agreed to them; the writing on your order forms and so forth.  Most important is that you can show that your customers agreed to your terms.  A signature is best, a click on something on your website that states "by clicking on this you agree......." may work, but this is an area where you can really use a lawyer to make sure that your customer arrangements will hold up in court.  

Aside from the legal implications, for customer relations and avoidance of surprises and disputes, it is also crucial that your customers KNOW what and when they owe you money.  So make whatever agreements or terms you have, very clear and visible. 

EBITDA - say what?

This video is priceless and exactly what most people need to understand this ubiquitous term:  EBITDA (i.e. Earnings before Interest, Taxes, Depreciation and Amortization).  As a business lawyer, I encounter this term in all kinds of agreements, for example in Loan and Security Agreements or in Share Purchase Agreements/Membership Interest Purchase Agreements.  

Why your Personal Credit Score is Crucial for your Business

Find the answer in this recent article in the New York Enterprise Report:  "It's not Personal, it's Business."  The article also describes the differences between your personal credit and your business credit and why maintaining both in good standing is crucial.

**This post is for informational purposes only and does not constitute legal advice**

Another Limitation of "Limited Liability": Personal Guarantees

If your LLC or corporation is getting any kind of loan financing, it is very likely that the lenders will ask you and your fellow business owners for personal guarantees.   Even if your business offers decent collateral, lenders like to see that you put some of your own skin in the game.

Thus, even though you, as a busines owner, are not liable for the debt obligations of the LLC or corporation under the law (limited liability shield), you will become liable under the personal guaranty if the business defaults under the loan.   If the business goes under and can't repay the loan, your assets are on the line.  What is even worse, if the other business owners can't pay under their personal guarantees, you may be on the line for the entire amount of the loan, despite the fact that you may only own part of the business.

CCH offers this really good summary of personal guarantees in the loan context, including possible avenues of negotiation in order to minimize or avoid personal guarantees when executing loan documents.  Remember:  Everything is negotiable!

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Related Post:  Limited Liability Protection of LLC not absolute

SBA Express Loans

As you probably know, the Small Business Administration (SBA) makes loans available to small businesses which would otherwise not qualify for a commercial loan. However, the SBA does not lend the money itself, rather it guarantees loans made to small businesses by commercial banks. 

Many business owners think that SBA loans are a lot of paperwork and that it takes a lot of time to actually receive the money.  This is not necessarily the case.  The SBA offers so called Express Loans which can be approved within 36 hours.

The easiest way to learn about all the available SBA loans and get free assistance in applying for a loan is to visit one of the regional Small Business Development Centers.

Covenant of Good Faith and Fair Dealing no help to Borrowers

As a borrower you may find yourself in a situation where you negotiated and entered into a loan agreement but are still denied a loan advance, because your lender just doesn’t feel like it.  Or at least that is the picture that presents itself from your end of the table.  Most likely the lender will point you to language in the loan agreement that states that the lender is allowed to exercise sole discretion in approving or disapproving loans or making any other decision under the loan agreement.

Fuming at the thought of all the wasted cost and time that went into the negotiation and execution of the loan agreement (and your financial homework to get approved for a loan in the first place), you may think to yourself that lenders should not be allowed to jerk innocent businesses around like that.  Unfortunately, if your loan agreement contains the above-mentioned language, there is little you can do after the loan agreement has been executed.

Even though New York law recognizes a covenant of good faith and fair dealing whereby contracting partners are supposed to refrain from unreasonable and arbitrary exercise of contractual terms, such covenant is construed very narrowly and will probably not help the frustrated borrower.  New York courts have held that where the express terms of a loan agreement allow a lender to exercise discretion in the decision to advance a loan, the lender has a right to deny the loan, even if the decision is unreasonable or arbitrary.  Courts have even gone so far as to hold that where a contract allows a lender to act in a certain way and sets no boundaries on the lender’s right to do so, a lender is not prohibited from unreasonably or arbitrarily exercising such right.

Thus, the time to prevent arbitrary and unreasonable decisions by lenders is during the negotiation stage.  Look for any clauses that allow the lender to exercise discretion and try to negotiate these provisions out of the agreement. You may also want to add provisions that state that any necessary consent by the lender “may not be unreasonably withheld” and that rights may only be exercised “acting reasonably.”  While you may not succeed in getting all such language removed (or added), you may be able to scale back the lender's discretion to a manageable risk you are willing to take.

Crash Course on Raising Money by Beth Polish

Beth Polish, accomplished businesswoman and frequent speaker and commentator on the subject of financing and raising money, offers a free 5-Day Crash E-Course on the subject of raising money through loans or equity investments.

The course explores

• the mindset of the business and whether it is ready to seek out money;
• the mindset of a lender and what it is looking for in a business before lending funds;
• the mindset of an equity investor and what it is looking for in a business before investing funds;
• the traits of a successful pitch to lenders or equity investors; and
• the road to a successful close of a business’s money raising activities.

I’ve been through the course and found it very easy to read, but at the same time full with tips and information not easily found elsewhere.

Sign up for the course here.

Spotlight on Asset Based Finance Loans

Traditional bank loans are granted to a business based on its creditworthiness as reflected in its financial statements and certain financial ratios.

What many small business owners don't know is that, even if financial statements and ratios are nowhere near qualifying for a traditional loan, a business may be able to secure an asset based finance loan if it has valuable accounts receivables and/or inventory.  Banks and commercial finance companies are willing to extend credit to a business secured by the business's accounts receivables and/or inventory.

Of course, a business with accounts receivables worth $1 million will not be able to borrow $1 million against such receivables.   Banks and commercial finance companies have detailed rules and procedures on what qualifies as an “eligible receivable” and how much can be borrowed against such eligible receivable (so called “advance rate”).   Without regard to how much the lender lends against the receivables, the lender will take a security interest in the entire pool of receivables owned by the business.

Because repayment depends on the accounts receivables and inventory, banks or commercial finance companies that grant an asset based finance loan will closely analyze the accounts receivables and inventory and, after the loan has been granted, monitor such assets.  Thus, expect the loan administration for an asset based finance loan to be more involved and burdensome than in a traditional financial statement loan.

An asset based loan typically requires the business to open a dedicated bank account (“cash collateral account”) into which all collections on receivables must be deposited and subsequently applied to the repayment of the loan.

Most asset based finance loans do not require that the debtors on the accounts receivables be notified.  Only the business and the lender will know that the accounts receivables are pledged as security for an asset based loan. 

Documentation of an asset based finance loan typically includes:

a Credit Agreement

setting forth the main terms of the loan, such as the amount of the loan or credit line, interest rate, repayment terms, which receivables and inventory qualify as eligible receivables or eligible inventory, and the advance rate;

a Security Agreement

creating a security interest in all accounts receivables and inventory of the borrower;

a Promissory Note

containing a promise to repay the loan;

UCC Filings

documenting the priority of the lenders security interest in the receivables and inventory as against later security interests;

Borrowing Resolutions

the business’s authorization of the loan transaction;

Personal Guarantee

by the owner(s) of the company.

I know that many small businesses try to negotiate and close even larger asset based loans on their own, not realizing that all terms of an asset based loan are negotiable and that the loan terms can have a major impact on the business.

Don’t be sorry later.  Make an experienced attorney part of your financing strategy.  Ideally, choose an attorney who does not regularly represent banks and commercial finance companies in asset based loan transactions.  How hard is that attorney going to negotiate on your behalf when he or she knows that his or her  bank and commercial finance company clients would like to have small businesses believe that certain terms are “industry standard" and not negotiable.

Where can you find asset based finance lenders?  Ask your bank, accountant or lawyer for a referral.  In addition, you may want to check out the website of the Commercial Finance Association which includes a section called “find financing.”

Follow-up to Raising Startup Capital - New York Times Article on the Topic

My post yesterday, "Raising Startup Capital from Investors- Information Resources,"  mentioned that many small businesses are not in the market for traditional venture capital financing.  Coincidentally, the New York Times today has a very interesting article which reports that many Internet start-ups are foregoing venture capital in their early stages and choose instead to grow on a shoestring. 

Read "For Start-Ups, Web Success on the Cheap."

This happens to be the most e-mailed article in the NY Times today, I wonder why.  Are so many people dreaming of Web success on the cheap? 

Raising Startup Capital From Investors - Information Resources

Starting a business requires money, often a lot of it.  Unless you have the resources yourself or can convince Grandma to give you a generous gift, you will be looking for outside sources of capital. 

You have the option of borrowing money or selling part of your business to investors.  If you decide to go after investors, you must know that the sale of business interests ("securities" in legal lingo) is heavily regulated by federal and state laws and can get you into serious legal trouble if not done correctly.

For an excellent introduction to the laws regulating the sale of securities by small businesses, I recommend this online guide by the Securities and Exchange Commission:
Q&A:  Small Business and the SEC-A guide to help you understand how to raise capital and comply with the federal securities laws.

Since venture capital is out of the question for many small businesses, the first line of investors are often friends, family or wealthy individuals (business angels).  For a very easy to read introduction into the world of raising money, I recommend the book (hardcover or e-book available), Investors in your Backyard:  How to raise money from the people you know by Asheesh Advani.  You could also read one of Asheesh's many articles on the topic on entrepreneur.com.

Finally, once you get more familiar with the subject of raising startup capital, the process involved and the legal documents necessary, you or your lawyer may want to consult model venture capital financing documentation developed by the National Venture Capital Association.  These documents come complete with explanations and are developed by leading venture capital attorneys in the country.  As I mentioned, venture capital may not be in the future for many small businesses; however, the terms and structures found in these documents are often repeated in smaller transactions.