Serving startups and small businesses throughout their lifecycle

Startups and small businesses (or SSBs) are as diverse as the people who run them. But generally speaking, they are independently owned and operated, for-profit companies that provide products and services in a limited capacity. 81% of small businesses have no additional employees besides the owner, and 61% of small businesses make less than $100,000 annually.

SSBs are everywhere

Who runs SSBs?

There is no exact profile to fit every startup and small business owner, but learning more about the people you will work with may help you understand their experience and perspective. For example, you may want to approach a younger, less-experienced client with a restaurant differently than you would a seasoned, highly-educated client who runs a tech startup. The following data can help you know what to expect before you reach out to a potential client.

Background

What SSBs do

Much more than a hobby

Starting and running a small business is a very personal pursuit for most entrepreneurs. In 2019, a survey of 2,700 small business owners found that 26% were motivated to open their business by a desire to be their own boss, while 23% said they simply wanted to pursue their passion. For many, the stakes couldn’t be higher, as they often have a significant personal investment in this business. That business is often a defining part of their identity, and its success is their life’s dream. It isn't just a job for them, it is their baby.  Respecting that level of dedication is vital to any lawyer looking to serve them.

Startups vs. small businesses

Despite their similarities, startups and small businesses are not really the same thing below the surface. So, what’s the difference?

By mentally categorizing your clients into one of these business types, you can more accurately predict what their legal needs will be and adjust your counsel accordingly. Generally speaking, there are many more small businesses in the United States then high growth startups, but both face similar legal challenges.

Once you learn what kind of business your new client is building, it is helpful to understand where they are along the business lifecycle. The business lifecycle is a representation of an organization’s stages of development from inception to its eventual dissolution. No matter what size they are, every business goes through a similar lifecycle, encountering common challenges, financial factors and events.

The business lifecycle is divided into five stages:

1. Launch
2. Growth
3. Shake-out
4. Maturity
5. Decline

Not every business will go through these stages at the same pace, and there could be years of operation between each of them. Once you determine which stage your client is in, you can anticipate the legal issues that may be approaching and prepare to guide them efficiently. This is why it is important to understand what makes each stage different and why your client is going through them.

Money matters

The business lifecycle is primarily driven by three financial metrics:

Sales represents the revenue generated by the sale of a business’ product or service. It is most obvious and immediate indicator of their monetary health and direction.

Profit is the net income generated by sales after accounting for the costs of producing a sold good or service. The rise or fall of profits tends to lag behind changes in sales because the costs of development have to be paid off before actual profit is made.

Cash reflects the actual dollars and cents available to a business after counting operational costs. This metric falls even further behind the sales and profit numbers because it includes costs incurred by the initial setting up of the company, such as bank loans and licensing fees.

Over the course of your client’s business lifecycle these financial factors will rise and fall, influencing business owners’ decisions and moving them from one stage of the lifecycle on to the next.

When your client first starts their business there is usually a large financial investment and low sales, resulting in a negative dip of profit and cash. This is followed by a steep increase in profit after the initial costs are paid off. This allows for expansion and an even steeper climb in sales. Then there is a period when finances begin to level out and eventually balance with the costs of day-to-day operation. And finally, there is an important season when a business must either spur new growth in sales or fall into a decline.

As a legal advisor, you don’t really need to know the exact values of these three metrics in order to serve your client. But understanding what a small business or startup is dealing with financially will indicate where they are in their lifecycle and what kinds of legal issues you should expect to handle. We will explain how these three metrics interact and change more as we go on. Now let’s analyze each individual stage, and the legal issues that may come with them.

The lifecycle of every small business and startup begins in the launch stage. At this stage, the company is being conceptualized, entities are formed, and the early days of operations take place. Most will recognize this stage by the introduction of a new product or service into the market. Customers are just starting to come in, so sales are low but hopefully increasing at a steady rate. But because of the cost of starting up, both profit and cash take a dip into the negative. Until these losses are overcome, no actual profit will be made, which makes this stage especially risky for new business owners.

Get ready. Get set.

In the beginning, legal advisors have to guide their clients through the business formation process, establish operation best-practices, and navigate financial investments. The decisions your clients make during these first steps can have a huge impact on the future of their business, so it is especially important for lawyers to understand and be able to clearly explain each step along the way.

One of the most important decisions that a lawyer will guide their SSB client through is choosing what type of entity they should create. It could be a sole proprietorship, an LLC, or some type of corporation. There are a wide variety of options in each state, and each of these types of business entities come with different tax treatment and formalities.

For example, counsel often advise small business owners to form an LLC because they can be structured as pass-through entities to avoid double taxation. Yet, when dealing with high-growth startups, venture capitalists will typically only be willing to invest in C corporations. If you're working with high-growth startups in a technological field, IP issues are also at the forefront. These companies often become valuable because of their intellectual property. So being prepared to explain these issues and their ramifications is especially important.

Common issues at the launch stage include:

• Trademarks, copyrights, and patents
• Capital raising
• Bank loan
• Crowdfunding
• Joint ventures
• Business taxes
• Obtaining qualifications, licenses, and permits
• Doing business across state lines

The second stage of the business lifecycle is the growth period. This is arguably the most exciting time for startup and small business clients, because it is when their hard work really starts to pay off. This is when their business finally breaks even and begins to show increased revenues that will allow it to really focus on growth. This means that the legal decisions encountered here will have an exponential impact on the business’ success.

The more, the merrier. Right?

With business growth comes more work and the need to bring on additional hands to do it. Adding and managing new employees invites a whole host of legal issues that lawyers can help with. During the growth stage, legal counsel often acts as the client’s HR head because of all of the different issues that may come up. These could include defining or explaining rules around recruiting and interviewing, writing job offers and rejection letters, establishing onboarding processes, and keeping the company from running afoul of wage and hour laws. Immigration issues may also come up if the company is hiring people who need visas. And all of that is just to bring on more people. There are many more legal issues that can arise when managing new team members once they are there, and when the company is really starting to grow, every employee makes a difference.

There are many other legal issues that come up during the growth stage, mostly related to expanding operations and managing new risks:

• Paid overtime, minimum wage, and unpaid interns
• Onboarding documents
• Legally-mandated policies
• Employee health benefits
• Stock options
• Severance deals
• Investor compensation deals
• Real estate
• Use of open source licensing
• Service agreement
• Commercial relationships
• Terms and conditions for e-commerce platforms
• Production agreements
• Property and casualty insurance
• Governance agreements

Stage three of the business lifecycle is known as the shake-out stage, because it is when the flurry of activity from the growth stage calms down and the dust begins to settle. This stage is usually shorter than others, acting as a transition from the early life of a business into a more stable one. During the shake-out stage, sales will slow down and peak while profit starts to decrease because of the costs of expansion during the growth stage. This causes the flow of cash to exceed total profits for the first time in the business lifecycle.

At this point, an SSB client will usually be focused on optimizing their own performance in order to meet the demand for their product or services and contend with new competitors. This will help them achieve a level of stability and secure their place in the market as it becomes saturated.

There’s no place like home

The shake-out stage can be framed as the final part of the growth stage. In that light, many of the legal matters you will need to prepare for are related to the previous stage. One good example comes from the field of real estate. Most startups and small businesses will look to move into their own space, but during periods of rapid expansion, they may prefer to rent larger accommodations as necessary. Once they reach the shake-out stage, they can confidently purchase a permanent facility knowing that they will not soon out-grow it. As their trusted legal counsel, it will pay to brush up on real estate matters before you're reviewing leases or purchase agreements.

Common legal issues encountered during the shake-out stage include:

• Stock options
• Commercial leases and zoning
• Construction agreements
• Terms and conditions for e-commerce platforms
• Production agreements
• Property and casualty insurance
• Governance agreements
• Business taxes
• Legal disputes
• Intellectual property issues
• Fair competition laws

The fourth lifecycle stage is what every startup and small business owner strives for. At the maturity stage, businesses attain a measure of stability, security, and marketplace dominance. For a tech startup, this might mean becoming the most recognized and trusted brand in their field. For a small business, this could simply mean becoming a staple of their local community with a consistent list of repeat customers. They are able to survive most unforeseen circumstances, even if the market becomes unstable.

From a financial point of view, businesses in the maturity stage will have relatively level sales, profits and cash flow, with only minor fluctuations. Owners and operators in this stage will be most interested in maintaining that level of success for as long as possible, warding off business challenges to their top spot and searching for the next innovation that could push them even further.

King of the mountain

Being the biggest thing in town also means having the biggest target on your back. When a startup or small business gains this level of dominance and recognition in the market, they tend to deal with a lot more legal challenges and disputes. These could come from wrongful termination claims, intellectual property challenges, or dissatisfied customers seeking legal recourse. When these sorts of issues come up, SSB clients will trust you to help them figure out how to respond and prevent any serious losses. The more you have prepared for potential litigation, the better off you will be when your client’s business reaches maturity.

Here are the most common legal issues faced by startups and small businesses at this stage:

• Commercial and IP disputes
• Patent claims
• Litigation and settlements
• Business liability
• Contract disputes
• Discrimination and harassment
• Marketing and advertising law
• Environmental law
• Fair competition laws
• Regulatory changes

The decline stage is the point where a startup or small business will begin to fail, and sadly, it is the easiest stage for any business to reach. Only about half of all startups and small businesses in the U.S. operate longer than five years. Any business, even a mature one, can lose their competitive advantage, be edged out by a competitor or simply become obsolete or irrelevant. This can be caused by a wide range of factors, but it is usually signaled by a steady drop in sales, profit, and cash flow. Eventually, they will have to shutter their doors one way or another.

At this stage, the goal of most operators is to avoid excessive loses and limit their liabilities while exiting the market.

Bowing out

There are several ways an SSB can cease operations, and not all of them are necessarily negative. While some businesses are forced to close down, others may be sold to another company, which is financially beneficial for the owner. For startups, the act of making an initial public stock offering signifies a major turning point in the business’s history. A law firm’s working relationship with a startup or small business will change accordingly. For businesses that can no longer survive as-is, your relationship may end with you winding them down. This means dissolving the entity and helping them wrap up their operations as smoothly as possible. But companies transitioning to a public entity or new ownership may face equally sensitive legal issues, despite being in less negative situations.

To best serve your client in these trying times, you should be ready to guide them through:

• Final valuation of the business
• Taking the company public
• Sale to a larger company
• Succession planning
• Dissolution
• Settlement
• Distribution of assets
• Wrap-up of daily operations
• Limiting liabilities

Lifecycle extension

In order to avoid going into a decline, most companies will try to extend their business lifecycle by reinventing themselves in some way. This could be done by rebranding, investing in new technologies, focusing on an emerging market, or even just launching a new product. This allows them to reposition themselves in the ever-changing market and refresh their growth. Then the lifecycle will repeat itself. In these cases, look to review, revise, or expand on the legal services you have previously delivered to ensure the continued success of your client.

Success and what to do with it

If you are representing a startup or small business that is doing well, great! Remember that success looks different for every business owner, so while one may be happy just running smoothly, another may keep looking to grow and expand. Highly successful businesses can have just as many legal needs as their struggling peers. Continuing to serve these companies can help drive the growth of your own firm. If they are approaching a new stage of the business lifecycle, you should consider what additional resources or legal experts you’ll need to add to adequately serve them. In some rare cases, lawyers serving highly successful clients might even consider jumping onboard as their in-house general counsel.

If at first you don’t succeed…

Whether you are dealing with a successful exit from a high growth startup or if you're winding down a small business that didn't pan out the way everybody had hoped, most entrepreneurs have it in their blood to try again. And if you have served them well, it is very likely that they will come back to you in their next endeavor. These entrepreneurs can become clients for life, even if their businesses don't last for a whole career. This is part of what makes startup and small business clients so valuable to attorneys.

We can help you do it

Representing startup and small business clients may seem like a daunting task. With such a vast array of potential legal challenges over a long lifecycle, it’s understandable that you might not feel like you or your firm are up to the task. But we can help your firm explore a wealth of opportunities in the small business world using Practical Law.

The Practical Law Startups and Small Businesses Collection has everything you’ll need to serve SSB clients. Here you’ll find a task bar of legal issues organized around the five stages of the business lifecycle, so you can easily find what your client needs when they need them. The SSB Collection also has helpful Toolkits that include:

• Practice Notes that explain legal matters in a narrative format
• Relevant issues of legal practice
• Standardized documents to give you a head start
• Detailed annotations explaining what details, clauses and language to include
• Alternative provisions and how to negotiate and choose them
• Checklists to walk you through the process step-by-step

Every resource in Practical Law is kept up-to-date by our team of expert attorney-editors, who you can message at any time for help.