Artistic, charming and indefatigable, Ken K. turned his garage-based business into a multimillion-dollar outfit. But somewhere along the way, he let a couple of crafty investors bail him out of a perilous cash crunch. The details didn't seem important at the time, but the money was. Hastily, Ken signed on the dotted line--not realizing he was also giving up control of the company.
Inevitably, friction developed. Within months, the investors fired Ken from the company he had created, throwing him out of his own office.
Ken couldn't believe they could do that. Yet any lawyer would have told him so--before he closed the deal. Too bad for Ken, because it never would have happened if he'd been able to recognize this arrangement as one of the 10 deals every entrepreneur should avoid:
1. Any deal you don't fully understand. It is written that the big print giveth and the small print taketh away. Legal documents can be treacherous. The fine print often gives one side rights that would make the other side shudder. After all is said and done, the formal contract must answer these questions:
- Exactly what are you responsible for?
- Exactly what are they responsible for?
- What rights do you have if they don't
- What rights do they have if you don't
- How long will the deal last?
- How are approvals, control and ownership divided?
Investors, for example, generally want equity in a company because with it comes ownership and, usually, control of the enterprise through voting rights. Ken didn't keep his eye on the stock ledger; by giving his investors the majority vote, he gave away the store.
Here's the overall lesson: The more important or complex your deal, the more you'd better understand all its consequences. That means asking lots of questions, reading everything carefully and, above all, getting professional help--especially from your lawyer. Otherwise, you may be in for a rude awakening.
2. Any deal requiring lots of money upfront. Deep down, every deal is just a hostage exchange, and it's in those taut moments between the giving and the getting that deal makers are most vulnerable (and con men most effective). Time your performance so you get (or hold on to) as many marbles as soon as (or for as long as) you can.
Structure your exchanges so you don't give up everything at once. Do the deal in stages, take collateral, use an escrow or leave yourself a way to cancel payment. This concept applies to services rendered, rights granted and anything else you exchange. Every lawyer knows possession is nine-tenths of the law. And the con man lives for that special moment when his carefully coddled egg hands over the dough.
3. Any deal you're asked to do in a hurry. Skillful deal-making requires careful deliberation, conceptualization and negotiation on both sides. Very few good deals have to be done "yesterday." Remember, the phony deadline is a classic sales gambit used to maneuver a prospect into a quick close. So whenever you're given one, test it: Press the other side for a detailed, plausible explanation, and be skeptical of what you hear. Ask for an extension to see if their reaction fits their explanation. If you can, contact an expert or someone inside the company for additional verification. Or, if you feel gutsy, call their bluff. Remember: When the other side's hurrying and hassling you, it's because they know if they let you think once, you're sure to think twice.
4. Any deal with people you don't know or companies you've never heard of. If you don't know who you're dealing with, you'd better find out. Discourage lying by letting strangers know upfront that you're going to check them out thoroughly. Then do it. Talk to people in your local business community; call references the other side provides you--and ask your colleagues, friends and customers to find (and call) the ones they didn't provide; get a credit report; verify licensing, professional history and education directly with the appropriate boards, businesses and schools; and contact the Better Business Bureau, the Federal Trade Commission (FTC) or your state attorney general.
Want to go further? Hire a private investigator. It's not devious; 90 percent of what you'll need--and what the investigator will find--is already public record: vital statistics, lawsuits, criminal history, bankruptcies, real estate ownership, corporate filings and the like.
5. Any deal where you're being harangued, manipulated or schmoozed. You don't have to be the brightest candle on the birthday cake to recognize bluster, belligerence, insults, lecturing, screaming and constant interruptions for what they are. Bullies use intimidation because, in the short run, it works.
But you also need to keep your eyes peeled for the sneak attack. One opponent charms your socks off while exhausting you with all-night talks in uncomfortable surroundings. Another plies you with fine food and wine before scrambling data and the fine points of the deal.
If you're being victimized, you have several choices: You can ignore the manipulator and keep talking about the issues. You can tell them (gently) that you know what they're doing. Or you can simply walk away.
6. Any deal that's set up like a pyramid scheme. Multilevel marketing, also called MLM or network marketing, is a way of selling goods or services to consumers through independent distributors. Amway, Avon and Tupperware were built that way. Pyramid schemes resemble legitimate MLM plans but are in fact illegal scams in which earlier participants in the plan are paid with money taken from the new participants they recruit. How can you tell the difference?
"If a company urges you to buy thousands of dollars worth of inventory at the very beginning of your relationship or promises you will earn fantastic amounts of money after only a few weeks in business, run as fast as you can in the opposite direction," says Jeffrey Babener, a Portland, Oregon, attorney and MLM expert.
Instead, Babener recommends looking for companies that offer a legitimate, fairly priced product and aren't afraid to buy back your unsold inventory. When in doubt, remember who built the pyramids: slaves!
7. Any deal involving a tax shelter. "The days of the tax-motivated transaction are long gone," says Jan Krauss, a CPA and business manager in Santa Monica, California. "In days of yore, deals featuring anything from farm land to oil rigs to low-rent housing offered immediate tax savings through accelerated deductions greater than the cost of the investment. But the IRS narrowed the loopholes in 1976 and effectively closed them in 1986. Many taxpayers were badly burned."
Today, Krauss advises anyone approached with a purported tax shelter to "make sure the deal has a real economic purpose, independent of tax consequences." Also, get a good CPA or tax attorney to vet the deal--in writing--before you sign on.
8. Any deal that comes to you through an unsolicited phone call. Although there are plenty of honest telemarketers, the FTC estimates illegal ones fleece the public for more than $40 billion annually. How can you tell the good from the bad and the ugly? Among other things, the FTC's Telemarketing Sales Rules prohibit telemarketers from calling you before 8 a.m. or after 9 p.m. and require that they immediately tell you what they're selling before they pitch you.
Other warning signs include high-pressure sales tactics; refusal to send written material; premature requests for your bank account numbers, credit card numbers or other personal identification; and requests for overnight delivery, including courier pickup, of your check or money order. Be especially leery of prize promotions and investment opportunities.
The next time you're suspicious about a call, turn the tables with some tough questions: "Would you run all this by my lawyer?" or "Which government agency can I contact to check on your outfit?" The National Futures Association in Chicago has a useful pamphlet called Investment Swindles: How They Work and How to Avoid Them. The National Fraud Information Center in Washington, DC, is another great resource.
9. Any deal involving a company whose accountants, bankers, lawyers or insiders have quit. The reasons behind those departures may tell you more than any financial statement or prospectus. Professionals don't usually walk away from work unless there's an ethical problem or they're not getting paid (a red flag either way).
With high-profile companies, this information is often public record; you'll find it in news stories, SEC filings and the like. With smaller firms, the truth is harder to come by. If you're lucky, key players may tip you off by jumping ship mid-deal. If not, you'll need to ask those concerned directly.
Insiders, even at the lower levels, often know where the bodies are buried. Although professional ethics and the fear of lawsuits may keep these people from talking, try them anyway. Work your contacts, and look for clues in financial statements and other documents. For instance, if you notice that a company's financial statements are prepared by a different accounting firm each year, watch out. Unless you can find out exactly what's going on, look elsewhere.
10. Any deal that sounds too good to be true. Of course, they usually are. Everyone wants to get rich quick. And some do. But chances are it won't be you.
Remember, most wealth is accumulated over time through talent, diligence and a little luck. So when that guy on the other side of the deal promises you the moon and you can't figure out how, don't ask "What's the catch?" Ask "Where's the exit?"
- Jeffrey Babener, c/o Babener & Associates, 121 S.W. Morrison St., #1020, Portland, OR 97204, (503) 226-6600
- Jan Krauss, 2020 Pico Blvd., Santa Monica, CA 90405, fax: (310) 450-6787
- National Fraud Information Center, (800) 876-7060
- National Futures Association, (800) 676-4632.
This article originally appeared in the November 1996 issue of Entrepreneur magazine.