The Risks and Costs of Non-Compliance

Paying lawyers for important tasks such as drafting contracts, preparing employee handbooks, providing securities law advice, and adopting procedural safeguards for export compliance, is expensive. However, prudent companies understand this is simply a cost of doing business and avoiding the catastrophic consequences that can result when you “get it wrong.” So, here’s my question – why do so many companies pay to “get it right” and then fail to follow through – thus exposing themselves to the very risks they paid to avoid? Unfortunately, the answer is typically, carelessness.

Consider the following hypothetical:
• Seller (a U.S. based manufacturer of non-military heavy equipment) contracts to sell “customized” bulldozers equipped with bulletproof glass and gun turrets (no guns) to a new international Buyer. Unbeknownst to Seller, Buyer is a known terrorist.
• Seller’s lawyers have previously prepared (a) an intellectual property manual (that would require foreign patent protection before shipping to this country), (b) an export compliance manual (that would not allow shipment of these goods to any buyer, or any goods to this buyer), and a contract where Buyer is responsible for shipping, insurance, risk of loss, and posting a letter of credit to eliminate payment risk to Seller.
• Despite those procedural and contractual protections, Seller did not review or follow the contract or the IP or export manuals, paid for shipping, did not confirm that either insurance or the letter of credit was in place, and simply shipped the goods.
• Buyer received the goods, and Seller did not get paid.

So, what are the risks/costs to Seller? Likely, the following:
• Seller has certainly violated U.S. export laws and perhaps the laws of the country to which the goods were shipped, exposing Seller to civil fines and penalties and even potential criminal charges;
• Seller has paid shipping charges that were Buyer’s responsibility;
• Seller has not been paid and has no insurance or letter of credit coverage;
• Seller has lost the ability to protect its IP in the country to which the goods were shipped;
• Seller has paid for legal advice that it didn’t follow; and
• Seller has suffered a loss of reputation, opportunity costs, and a potential devastating blow to its business.

The point is simple – if you’ve paid for the advice and protections, follow them.

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Don’t Forget the Laws of Human Nature

It strikes me that both lawyers and clients get so wrapped up in the business, legal and technical issues of a deal or situation that they often forget what I will refer to as “the laws of human nature.” True, these are not the laws I studied in law school, but I can tell you this – failure to understand these laws can often result in the failure of a deal. And what’s so sad about that is it’s completely avoidable in most circumstances.

So what do I mean when I talk about the laws of human nature? Obviously, I’m not talking about statutes or regulations. Simply put, I mean those aspects of the deal-making process that have more to do with human behavior, values, interaction and communication than with the specific parameters of the deal. Failure to understand these “laws” and acknowledge the fact that they fundamentally affect business transactions is just as often the cause of a failed deal as the laws on the books.

So, here are 10 lessons I’ve learned as to these laws:

1. It’s important to know what you AND the other party to the negotiations need, what you want, and what you’ll accept – and how these may change during the course of negotiations.
2. Nobody needs to “win” a negotiation – the best deals are win-win.
3. It’s ok (and in fact, it’s often productive) for the other side to like you.
4. It is imperative that the other side respect and trust you.
5. Emotion is rarely productive in a business discussion.
6. Professionalism enhances the likelihood of success.
7. There’s no value in frustrating or embarrassing the other party or wasting their time.
8. It’s important to know when you’ve pushed far enough.
9. Miscommunication leads to failure just as often as disagreement.
10. The deal is never final until it’s signed.

Consider the laws of human nature the next time you negotiate a business deal, and I’m confident you will enhance your prospects for success.

How to Handle Partners Who Are Bullies

Bullying and bullies are in the news a lot these days. Usually these are kids who physically or mentally torment and intimidate their classmates. In business partnerships, we frequently see a different kind of bully – the partner (who never should have been a partner in the first place) who refuses to listen to other points of view, puts his own interests ahead of those of the partnership, and generally wreaks havoc on the business. So, how do you deal with these bullies?

The first and most effective way is not going into business with them in the first place. There are plenty of articles warning you to choose your partners carefully, so I won’t belabor that point, but it’s worth noting once more – there is virtually no business decision that will affect you more than the decision of who you go into business with – choose well.

Second, have clear, detailed and well thought out organizational and governing documents that all partners understand and agree to at the outset. These documents should cover such basic issues as: (i) who gets to be an owner; (ii) who participates in management and how management decisions are made; (iii) what your general business objectives are; (iv) what happens if the company needs more capital; (v) how you avoid or address disagreements; and (vi) how and when you will make the decision to sell, merge, dissolve or otherwise exit the business or the owners’ partnership.

The third strategy follows logically from the second – having those governing documents in place is not enough – follow them. The easiest way to handle a difficult partnership disagreement is to simply follow the rules that you’ve laid out for the business.

The final strategy is more of an admonition – do NOT allow your difficult partner to bully you into making bad decisions or otherwise treat you or the business unfairly or act unwisely and then claim to be a victim! I see this frequently, and it is NOT an excuse to simply say your partner is a bad person and made you do these things that were bad for you or the company. You’re the caretaker of your business, and no one said it would be easy. Stand up to the bully!

Some Burns Never Heal

I’ve said it many times – Iowa is an easy state in which to network and connect with people. I think this is due to the general nature of Iowans. They’re open, trusting, mentoring and supportive – in business and in life. They understand that supporting another businessperson striving to succeed benefits everyone – which is why it’s so easy to network and establish meaningful and mutually beneficial business relationships in this great state. And once you start establishing these relationships and a reputation for honesty, integrity, hard work and excellence, it snowballs and becomes easier.

This article is not about the ease of networking and connecting with people, however. It’s more of a discussion of the flip-side reality. That is the permanent damage caused to a businessperson’s reputation and ultimate prospects for success when you “burn” someone.

I know – a ridiculously obvious topic for a blog post. But, I also think it’s important. Simply put, you need to avoid “burning” people in business and in life – not just because it’s morally wrong (I’ll let you be the judge of that), but because it will come back to harm you in the end.

Let me be clear, I’m not suggesting that you should be a patsy or that you shouldn’t be a shrewd negotiator or take hard stances in your business transactions. Those tactics lead to business successes and often the respect of your adversaries. Nor am I advocating for some sort of socialism where everyone shares equally in all opportunities. No, I’m a true capitalist. What I am saying is, do it the right way. Fulfill your promises. Meet your commitments. Be honest. Treat people fairly. And always act with integrity. Failure to do so and “burning” someone in the process will have permanent consequences and will not soon (if ever) be forgotten. And just like it’s easy to build a positive reputation in this state, it’s just as easy to build a negative one.

Understand What No Lawyer or Document Can Do For You

I was recently helping a client with a stock purchase in a deal that just felt wrong to me. Each time we asked a question or reviewed a document, it seemed additional issues, questions and concerns arose. Notwithstanding this fact, the investment bankers, company officers and selling stockholders assured us in each instance that there was no problem – usually with the excuse that it was simply bad record-keeping, a lack of attention to detail or a favorable related party transaction that would not adversely affect the company or my client going forward. In fact, they said, it was precisely because of these circumstances that my client had been presented with this amazing investment opportunity. I did not find these explanations to be persuasive or reassuring, even when the sellers agreed to provide a litany of warranties and representations, broad indemnification rights, and other contractual protections.

In this circumstance, I was compelled to explain to my client a very simple fact – while a lawyer can draft an all-encompassing contract in which virtually every possible risk is anticipated and addressed with detailed indemnifications, aggressive remedial provisions, escrows, etc., that does not turn a bad deal into a good one or provide the same level of protection as walking away from a bad deal.

The simple truth is, if your due diligence yields more questions than answers more uncertainty than certainty, and more risks than opportunities – and if you find yourself spending an inordinate amount of time and effort trying to protect yourself from known and unknown legal risks and possible bad behavior or misrepresentations by the other party (versus ordinary course business risks) – no amount of lawyering and no legal document can adequately protect you. In that case, you really only have 2 choices – (1) walk away from the deal, or (2) draft that over-the-top contract with all of the bells, whistles and protections and “hang on for the ride.” And if you opt for alternative 2, understand that a good lawyer and a good contract do not make a good deal.

Negotiating With Investors – Focus on What Really Matters

Negotiations with investors are tough – especially when you’re not accustomed to these kinds of discussions and the party across the table engages in them on a regular basis.  What’s the most important advice (right after hiring a good/experienced lawyer who understands your business) – focus on what’s important – economics and control.

Having stated that you must understand and try to aggressively protect, retain and preserve economic/financial upside and control, it’s also essential to understand that the investor has something you need – money – and it’s inherently reasonable for that investor to expect in return for providing you with that money that he or she will receive both (a) substantial economic upside in the event the company is successful and downside protection if it’s not, and (b) a degree of control in order to protect that investment.

Unfortunately, I can’t provide a detailed explanation in a blog post of all of the terms and variables that arise in negotiating economics and control, but here are a few you must understand (Note – if you don’t know what these terms mean, find out before negotiating):

• Valuation – what ownership share will the investor get for invested dollars?

• Dividends – if the investor is to receive dividends, how much, when, who decides, and are they cumulative?

• Preference – assuming the investor gets paid first upon a liquidity event and that payment is more than the initial investment (i.e., a preference), how much more?

• Participation – after receiving the preference, does the investor get to “participate” in the remaining proceeds, and if so, to what extent?

• Dilution – how can various parties be diluted (including by an employee incentive pool), and what impact will this have on distribution of proceeds?

• Board Seats – who fills the Board seats, and what is the “balance of power”?

• Voting Rights and Protective Provisions – what issues does the investor get to vote on and/or veto?

• Conversion Rights – assuming investors receive preferred stock, when can they convert to common, and what impact might that have?

• Tag-Along and Drag-Along – under what circumstances can parties force others to participate in a sale or allow them to participate in a sale?

The above list is, admittedly, abbreviated, but it should give you an idea of the most important issues in negotiating with investors – everything else pales in comparison.

Know Where You Want to Go Before You Start

You’d never leave on a family vacation without knowing where you’re going and what you’ll do when you get there. So, why would you begin a business negotiation without knowing what your objectives and acceptable outcomes are? My answer – you shouldn’t.

So, am I saying you need to know exactly where your negotiations must conclude before you even begin discussions? Of course not – negotiations necessarily involve multiple parties, all of whom have their own goals and expectations. It would be foolish to think you can predict and control all possible outcomes, and short-sighted and unrealistic to believe the only successful outcome will be exactly the one most beneficial to you. After all, successful negotiations almost always require give and take from all parties to ultimately arrive at a win-win arrangement. Without this, at least one party will, presumably, have no incentive (or not enough incentive) to do the deal.

What is critical, however, is that you not enter into negotiations without giving careful thought to what your objectives are, the ways that you might be able to achieve them, and the outcomes that would be acceptable. Note that I’ve said objectives, ways and outcomes – plural. Just like the old saying, “there’s more than one way to skin a cat” – there’s almost always more than one way to structure a business deal.

I recommend you follow these basic suggestions before entering into business negotiations:

• Identify your ultimate objectives – the primary reasons you’re considering this deal.

• Consider the various ways that you might be able to achieve those objectives.

• Identify your secondary objectives – things that would be nice to get, but are not essential.

• Consider the various ways that you might be able to achieve those without compromising on the primary objectives. Also consider things that you would view as deal-killers.

• To the extent you’re able, go through the same analysis from the other party or parties’ perspective – see the deal through their eyes.

• Now, once again, consider how you can achieve your primary (and hopefully secondary) objectives AND how the other parties might also achieve theirs. Hopefully there are several ways to get there – some of which may be more or less desirable to you, but all of which would be acceptable.

• Having gone through this exercise, it’s now time to negotiate.

Remember, your best way to achieve a successful outcome is to consider what that might look like before entering into negotiations, rather than looking back and wondering what went wrong.