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Small Case Study: Riches to Rags

From Riches to Rags

Now that I’m focusing on building a new type of law firm, my friends and family are coming to me with their stories of legal nightmares, and how a law firm like Law 4 Small Business (L4SB) could have helped avoid a catastrophe.

 

One story struck a cord with me, and it’s one that I must repeat. It does, after all, do a great job of describing why it’s important for businesses – no matter their size – to look at legal services from a preventative standpoint, instead of an “oh, boy, lawsuit … better hire an attorney!”

In Albuquerque, a small kitchen and bath remodeler recently closed their business, filed for bankruptcy, and may lose his home. A riches to rags story. How did he get here?

Don’t let nonpaying customers sink your business.

A small handful of customers were refusing to pay their invoices because the cabinets installed didn’t have consistent colors or weren’t quite the color they were expecting. It turns out, the business was operating on low enough margins, with high-cost operations, and just enough cash flow to sustain the business. When just a couple of customers refused to pay the invoice, it started a chain reaction from which the re-modeler couldn’t recover, taking their thriving business from riches to rags.

As an attorney, I can see two serious problems this re-modeler faces today; that could have been avoided with just a little foresight. First and foremost, this entrepreneur could have set up an independent corporation (i.e. LLC).

Never operate as a sole proprietorship. Form a corporation.

One of the primary purposes of a limited liability corporation, or LLC, is to isolate the business owner from financial liability should the business eventually find itself insolvent. I’m sorry to say, this takes more than simply filing the right forms with the State of New Mexico. It requires changing your business practices, so you are actually conducting business through your LLC, and not commingling your personal finances and activities with the business. If you do this, you could face personal liability under the legal practice of “piercing the corporate veil.”

The second problem was having the business in a position of failing, just because a handful of customers refuse to pay their invoices. It’s one thing to fail because there aren’t enough sales. It’s another thing to fail because it costs money to service a customer, and a customer refusing to pay their invoice means you’re not recovering your costs (let alone making any profit).

Your typical law firm or attorney would highlight the need for a strong contract, to address this second problem. In a perfect world, they would be right. However, many customers get spooked when presented with an onerous or lengthy contract. How does one protect themselves from lack-of-payment, without frightening customers with the contract?

The solution requires one to focus on the big picture. Why are customers refusing to pay their invoices?

Look at the big picture, when considering contracts to reduce risk.

What could be done differently, to maintain customer satisfaction? What could be done, to manage customer expectations or provide better disclosure? What does the order fulfillment process look like, and how can it be modified to reduce risks from nonpayment? Some ideas include:

  • Instead of only letting customers view products in a small showroom, where the lighting and environment will invariably differ from their homes or businesses; consider giving (or lending) customers large samples that can be viewed where desired.
  • When the product performance can vary (i.e. color), make it very clear at every stage of the sales cycle.
  • When an order is taken, don’t be afraid to require a deposit (at least one large enough to cover your expenses). People tend to value the things they pay for and are more apt to complete the sale when they are “vested.”
  • Consider a promissory note, aside from a standard contract, for fees or costs to the customer. A promissory note is simple, short and non-threatening; however, it can greatly improve cost recovery from nonpaying customers.
  • Finally, consider creating a win-win situation for customers who want to back out of a deal. Create a formal mechanism for termination. Therefore, if a customer does change their mind, they can terminate (reduces their risk) and you can be sure to at least recover your initial investment.

In this particular situation, my heart goes out to the re-modeler. Hiring L4SB in the beginning could have provided some preventative measures at a fraction of the cost of a bankruptcy. Hiring a law firm who understands business, could have helped with the big picture, and made it possible to either reduce the number of non-paying customers or made it easier to recover costs during a termination. This is called Strategic Planning, and it’s a major practice area for L4SB.

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