
My $3.3M Mistake - sivers
http://sivers.org/mistake
======
michael_dorfman
All I can say is "amen, brother." Not following his first 3 general purpose
lessons have cost me if not millions, at least many hundreds of thousands of
dollars. I urge others to commit these to memory:

+Really understand something before you sign it.

+Ask all questions, dumb questions, hypothetical questions, extreme-scenario
questions, _what if_ questions, until you’re sure you really fully understand
it as well as anyone on earth.

+It’s also very worth paying for an hour meeting with your accountant, and
asking 100 questions there, too.

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matt1
He writes: _Each separate business venture should usually have its own LLC.
It’s very cheap through companies like LegalZoom, and well worth it._

If I plan to launch a few websites over the next couple years. am I supposed
to create an LLC for each one? I think I've read elsewhere that you can form
an umbrella LLC to cover them all.

What have your experiences been with this?

(FWIW: Before I do anything I'm going to meet with a lawyer... but the more
background knowledge the better.)

~~~
sivers
There are legal ("asset protection") reasons that many taxi companies have
each car as its own LLC, or ski slopes register each slope as its own LLC. So
if someone has a legal problem with one, and you can really show that you've
been treating them separately in your bookkeeping and bank accounts, it's
clear to the creditor that they're not going to be able to go after everything
you've got.

Then of course as they grow there are reasons why you may want to sell one of
your websites, but not the others, etc.

The reasons why to do it are vague and different for everyone, but to me, it's
a "can't hurt" and "why not?" type decision.

You go to LegalZoom (or any similar service) and pay $400. They mail you a
certificate you bring to your bank to open a separate account. Total spent:
$400 and 30 minutes of your time.

California is an exception: They make you pay $800 per year to the state for
each entity. Most states it's only $50 and some states (like New Mexico) you
never need to renew or pay any annual fees at all. If you're a virtual company
with no physical office, you can set up your LLC in any business-friendly
state you want. (Delaware, Nevada, Wyoming, etc.)

Outside the U.S., British Virgin Islands is the quickest, cheapest, easiest
place to do it: <http://www.google.com/search?q=bvi+corporation>

~~~
swencah08
> If you're a virtual company with no physical office, > you can set up your
> LLC in any business-friendly state > you want. (Delaware, Nevada, Wyoming,
> etc.)

I think this issue is very interesting, and I would imagine it's important to
a lot of HN readers. So let's say you're developing software (e.g. for a
website, an iPhone app, etc.) by yourself out of your home. Are you really
"doing business" in your home state?

Unless I'm misinterpreting the parent comment, the answer is no. But if
anything, it seems the opposing view may be more common. Specifically, many
people say yes, wherever you're doing most of your
work/programming/typing/etc. is where the business has "nexus". And if you're
deploying a website, then there's the issue of the location of your
datacenter, which could very well be in a different state.

What are people's experiences and thoughts on this?

~~~
jellicle
In general you're likely to have to file taxes/annual reports in the state you
live/work in, as well as the state the business is incorporated in.

Incorporation in Delaware or another random state is a needless hassle and
expense for small businesses. Incorporate in your home state. When you get big
enough that you have several accountants and lawyers employed by your company,
they can tell you the benefits of shifting the incorporation to another state.
Until then... it's a waste. Premature optimization, as they say.

~~~
sivers
I have to disagree, from experience. CD Baby was a Nevada corporation, though
I was set up in New York when I started and Oregon when I left. I never had to
file anything in Nevada, and there were no "needless" hassles or expenses.

Someone has to be the "resident agent" for the corporation. It's no harder to
incorporate in Wyoming or Delaware than it is in Ohio or Arizona. The expense
really is only $100-$300 a year to have a resident agent, and I've found it
very worth it.

I'd rather have the LLC/corporation domiciled in a state like Wyoming,
Delaware, or Nevada so that I'm free to be location-agnostic with where I
choose to live or work. If you incorporate in California or New York you're
going to really regret it when you move to Texas or London in a couple years.

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vaksel
I don't get it...didn't you need to file before that point? Wouldn't you have
found out this info the first year you paid taxes? At which point you would
have just been starting out, and the "buyout" would have been for pennies
since the company wasn't showing profit

~~~
bobbyi
How would his taxes have reflected the percentage of this company he owned?
You pay taxes on your income, which wouldn't be affected here. You pay capital
gains tax on stock when you sell which he didn't do at any point.

~~~
mediaman
When you are a stockholder in a company -- LLC or subchapter S corp -- you
prepare a K-1 for the owners in the firm, who each pay taxes on the
passthrough income.

In order to calculate personal tax due, the form includes the percentage
ownership, which is also reported to the IRS.

So the commenter is correct; I'm not sure why this wouldn't have been
discovered earlier, unless he wasn't doing his taxes (even if there's a loss,
taxes should be filed to claim carryover losses).

~~~
Retric
If he had 3.3 million to buy out the company he probably was not filling out
his own taxes.

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philjackson
I hope your dad got you a nice Christmas gift that year.

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pclark
Why wouldn't his Dad just give him the $3.3M back after he'd paid it him?

~~~
sivers
It wasn't my dad that lent me the money - it was his company. So his company
couldn't just pay me $3.3M for no reason.

~~~
swombat
Can't it licence your intellectual property to attempt to create a clone of
CDBaby?

Maybe the licencing deal will cost $100k/month, including consulting services
from you to build the service, and unfortunately, it will turn out that the
cloned CDBaby service is not profitable, and so it will be shut down after 33
months.

You'll still have to pay corporation tax on it (or whatever the equivalent is
in the US), but hopefully that's less than trying to extract that money out of
your dad's company.

Note: IANAA

~~~
maukdaddy
Ideas like that get people sent to prison. Better to be ethical and just eat
the $3.3 mil.

~~~
staunch
I agree his idea is probably not a good method to pay the money back but
what's unethical is collecting that $3.3 million, and then saying "oops",
without finding a legal and legit way to give it back.

~~~
brk
How is collecting a payback on a legitimate investment unethical?

His fathers business invested some money in his corporation. Now, from the
story it appears that they didn't expect much of a return on this investment,
but I don't think they acted predatory in any way.

I don't see why there should be any reason for a "payback" here, that is not
how investing works, and quite frankly sounds very selfish and biased to me.
If his business had completely failed and he ended up broke, would he be
looking for a legal loophole to repay that $20,000 investment back to the
company? I would tend to doubt it.

His scenario is almost exactly the model/concept of VC investing... Money is
invested in seed companies knowing that it is highly probable it will be lost,
but the slim chance of a large payoff makes the risk worthwhile.

~~~
jyothi
You are right. But it was his dad advising him. If he saw that his kid's
business is growing big - he would have advised him to buy back shares much
earlier and probably give him a personal debt to buy back shares. Why should
an accountant enlighten him on what he owns.

The only reason I can think of without blaming his investor dad is his dad
wants to shelter his kid all the time and doesn't think of him fit to run
independently or doesn't want him to take that risk at all.

~~~
brk
My interpretation of it was the the $20,000 investment was small change to the
company, and was most likely never given a legitimate second thought by his
father.

~~~
jyothi
Right I understood your point and could be very valid. But for 90% owning, I
have my doubts. Anyway what I felt was later when his dad would have seen his
son's business blooming he should have done something about it. Asked him to
buy back early or at least let him know that for all his work he owns just 10%
and it just the first investment.

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jedc
Ouch. Big mistake, but great advice NOT to ignore the legal paperwork. As
mind-numbing as it can be to go over contracts, NDA's, etc., you need to know
what you're signing.

At least in his case it was his father, so he didn't have to worry about
getting a raw deal there.

~~~
stcredzero
Kudos for publishing this example! I praise you for your civic-mindedness! (It
takes guts to admit a mistake this big.)

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stijnm
Comments like this on a serious well written post with some good advice make
me smile: "Ibod Catooga wrote on May 27th, 2009 Shit, negro, I woulda punched
my dad in the NUTS if he tried that shizzle on me!"
(<http://sivers.org/mistake#comment-15816>)

Beautifully eloquent.

