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How To Wind Down Your Company – New Series

Of the most popular posts that Brad and I have created are our series on Term Sheets, Compensation, and Mergers and Acquisitions.  One of the subjects that we’ve wanted to tackle has been the dissolution of companies.  It’s never fun to think about failure, but it happens a lot.

Unfortunately, we haven’t gotten around to it yet, so it was with great joy that my friend Roger Glovsky elected to write the series himself.  This is post one of the series and I’m really excited to introduce Roger to our readers.  Take it away, Roger.

This is a follow-up to Jason Mendelson’s recent interview on how to handle start-up failures. It is a timely topic for entrepreneurs who may be running low on cash or worrying about “hitting the wall.” Jason offers critical advice about how entrepreneurs should manage their relationships with directors and investors and why they should reserve enough money to wind down operations in an orderly manner. Although much has been written about how to start a new venture, very little has been written about how to shut down a failed venture. It was Jason’s suggestion that I write more about it. This is the first in a series of blogs about how to deal with business failure, how to minimize liabilities, and how to keep your spirits up and your business reputation intact.

Every entrepreneur or investor who lived through the dotcom bust has their “war stories” or knows an entrepreneur who failed. In fact, the venture capital model is based upon failure. The NVCA estimates that 40 percent of venture backed companies actually fail (another 40 percent produce moderate returns and only 20% actually have high returns). Therefore, failure is part of the business of investing and starting companies. The key to success may be in knowing how to deal with failure, which is what we want to discuss in this series of articles. There may be more than one way to successfully fail and we hope this series will encourage more people to discuss (or perhaps debate) the proper way to shut down a business venture.

Start-up failures are legendary. The classic image is that of a race car driver that hits the proverbial wall at 200 mph. The end result is “crash and burn.” However, if you crash and burn, you don’t live to race again another day. As an entrepreneur, hitting the wall means running out of money and burning bridges; you will likely end up destroying relationships with all the people who supported your start-up venture. If you value the entrepreneurial life, then you may want to do a second or third start-up. You don’t want to hit the wall at 200mph. You want to walk away, and live another day to do a new start-up and pursue a new dream, and this time win the race. Brad Parker, a successful entrepreneur, once described professional racing as a “series of controlled crashes”. I think the same theory applies to start-ups. The operative word is “controlled”. The question is how do you wind down a business in a controlled manner so that you can preserve your relationships and start a new venture again someday.

When a business fails, anyone with a financial interest could have a potential claim on the failed entity including investors, lenders, trade creditors, employees, suppliers, customers, and the government (e.g. the IRS or state taxing authority). If those interests and claims are not properly addressed during the wind down process, the officers, directors and stockholders could be held personally liable. How you treat each of the affected persons is critical to successfully shutting down a business. From the moment you first decide that failure is a possibility, it is important to take control of the process and work with legal counsel as well as tax and accounting professionals to properly address the issues.

The articles that follow will strive to outline the process for shutting down a business in practical terms. The questions we intend to address are: When should you decide to shut down a business? What approvals are needed to shut down a business? Who do you tell first? How should assets be disposed of? What is a fair price for the sale of assets? How do software and web-based businesses differ from traditional bricks and mortar? What happens to intellectual property like software and domain names? What happens to customer lists and customer information? How should debts be paid? What business obligations can you be personally liable for? What business records do you need to have? How long do you need to keep them? When is the business officially terminated? These are just a few sample questions. Feel free to suggest your own.

We welcome your comments on this topic and encourage you to share your own real-life experiences in shutting down a business. Why did you shut down your business? What steps did you take? What would you do differently? How would you advise others?

Roger Glovsky is a founding partner of Indigo Venture Law Offices, a business law firm based in Massachusetts, which provides legal counsel to entrepreneurs and high-tech businesses. Mr. Glovsky is also founder of LEXpertise.com, a collaboration and networking site for lawyers, and writes a blog called The Virtual Lawyer.

The above content is intended to serve as a general discussion of the subject matter and is provided for informational purposes only. It is not legal advice and should not be construed as such. Do not act upon this information without seeking professional advice or rely on this website or use the content as a substitute for consultation with professional advisors.

October 7th, 2009 by     Categories: Wind Downs    
  • http://blog.jparkhill.com Jay Parkhill

    This is a good series idea.

    One of the hardest points for many people to understand, in my experience, is that the end comes well before the bank account hits $0. People who wait that long end up with no resources to conduct an asset sale, wind down employment tax matters or complete an orderly shutdown. The question I would add is “how much cash do I need to reserve for a wind down?”

    • http://www.jasonmendelson.com Jason Mendelson

      It

    • Roger Glovsky

      Great question…we will add it to the list. It is often hard to tell when the company will hit $0 exactly. I like the way you said that the end comes “well before”.

  • PhilSugar

    It is a good idea. I'm sure the legal aspects will be covered but there is one constituency that wasn't mentioned and that is the entrepreneurial community as a whole.

    When you're open on Thursday and closed on Friday and your employees are reeling and your customers are wondering if they are going to get fired for doing business with your company………You've pissed in the entire entrepreneurial well.

    It makes it that much harder for other entrepreneurs to find employees and close customers because people will remember and tell others about “that entrepreneurial company which screwed me” for life.

    I've seen some well funded companies with vc's that I thought were reputable do this.

    • Roger Glovsky

      The community impact is a great theme. Often the community takes great pride in the entrepreneurial successes and benefits from the wins. The question is how are the failures viewed. Are they a black eye for the community and other entrepreneurs? Is there a way to encourage entrepreneurship and risk taking without the negative impact?

  • PhilSugar

    It doesn't have to be a black eye if its done right, and that's why I'm happy you are addressing this issue.

    Huge old companies lay people off and discontinue product lines. Heck, they do it because some outside consultant with a freshly minted MBA and nice suit flew in and said: “its not core…out!”

    So I always think there is less risk with entrepreneurial companies because this is all we do and everybody has a big part in the success/failure.

    The big companies (and good entrepreneurial companies) give some notice to everyone. Might not be as much or the news anybody wants to hear…..no different than what I'm sure you're going to outline.

    However, I've seen some flameouts that had raised 8 figures go into the wall as you say and have left employees without a final paycheck and turned off a service that an employee in a Fortune 100 company bosses' boss had to cut short vacation to figure damage control. Not a good way to make the mortgage and not the attention you want from your bosses' boss.

    I guarantee you…..know for a personal fact…hit me in the face…that guy who had to meet with his bosses boss after she cut short a vacation…..never will buy from a entrepreneurial company again. I also have had people tell me they'd love to work for me but their partner said after their last screw job…no way.

    So do it right and don't piss in the well.

    • Roger Glovsky

      Reminds me of the old adage…nobody every got fired for buying from IBM. In today's fast moving world of new technology that may no longer hold true. Some of the new entrepreneurial products/solutions available today are changing the world. Look at Twitter, Constant Contact & Facebook, for example. I agree with you that there are better ways to shut down companies by providing notice and continuing product support through a transition period. Being a better corporate citizen makes would avoid much of the hardship and hard feelings. Interesting perspective…good food for thought. Thanks.

  • Andrew

    I think the point of failure is different from company to company. The idea that you need to wind down a firm prior to the bank account hitting a certain number makes little sense for a company that has continued sales. Especially underfunded companies often run a tight rope from paycheck to paycheck with little money in the bank. Should they shut down? What about the recovery around the corner. Yes, the entrepreneur may run into a missed payroll and then not recover – but what a shame to kill a company that could have rebounded. I just think that this is not as simple as it seems. There can be no formula for a shutdown – just maintain good communications with all parties that have a stake. (and pay all taxes first)

    • http://thevirtuallawyer.blogspot.com RogerGlovsky

      I agree, there is no “formula” for a shut down. Each company is different and various options for winding down operations need to be considered carefully. The concept of “winding down” presumes that other alternatives such as merger or sale of an ongoing business are not feasible. There is also a notion that the original business plan has “failed” and that existing investors will not re-up. Of course, prior to shutting down a company, part of the process should be for the entrepreneur to consult with their investors or advisors as to viable alternatives. The goal is not to kill a company that could have rebounded, but how to take prudent steps to wind down a company for which there are no alternatives.

  • http://blog.cosential.com Dan

    For a good business person, there should be no such thing as hitting the wall. Someone who is flexible and creative can alway find a way to survive. It may be that inflexible investors who are financial guys as opposed to people who have started and run businesses will keep hitting the gas until the company hits the wall. A good driver will always see the wall and find a way to drive around it.

  • Stephen Hluchanyk

    There are companies such as Great American Group who can assist in these matters. They not only specialize in retail wind-downs but commercial and industrial as well. There are a number of firms who do this.

  • Tony

    I'd like to know: How do you decide to wind down instead of changing direction?

    • http://www.jasonmendelson.com Jason Mendelson

      Never an easy decision.

      • Tony

        Thanks for the advice.

        As an entrepreneur I have to decide between changing direction and winding down to start a new company. It would be easier to raise capital to change direction, although the up-side is seriously limited by the amount of dilution that has happened already.

        As you suggest, my plan is to negotiate with shareholders in order to reach an agreement that all are happy with, but only when I'm in a position to be able to raise capital for the new venture if need be. Otherwise guilt / responsibility of initial failure will trump me in any negotiations.

        • http://thevirtuallawyer.blogspot.com RogerGlovsky

          Tony, you should be mindful of any fiduciary responsibilities you have to your existing venture before raising capital for a new venture. Any premature actions could backfire either professionally or legally.