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Jackie and Camile – Traveling the Yellow Brick Road

Author: Claudia Raessler, Esq.

In September, we began the story of a small manufacturing company (“SME”) facing a crisis in cash flow. To continue the story, let’s get to know Jackie and Camile, whose dream started them down their yellow brick road.

Six years ago, these two college friends had professional careers in other sectors, yet they decided to take a risk and start a small textile business. Although friends since college, over the last 15 years, they have led very separate lives, and although they now share a common vision, over the years they have developed very different leadership and decision-making styles. This will become important as our story unfolds.

First, the big picture and small U.S. business

Although large corporate America will always be a force in our economy, in 2019, the SBA reminded all of us that small business owners employ 59.9 million people or 47.3% of the private workforce in the U.S. Think of that: Almost half of the employed in our country works for businesses with less than 20 employees. Small manufacturing plants, auto repairs, makers of crafts and specialty foods. These companies are dotted all over your neighborhood, your town. You probably patronize them yourself. These employees are your neighbors, your community, and ultimately – the economic backbone of your state.

If you are reading this series, I suspect you are one of these employers. And, despite the diversity of the products and services offered, we all (including law firms) have one thing in common: access to capital is likely one of our biggest challenges. Expansion, technology, marketing, regulatory compliance all put an increasing and continuing drain on resources.

A recent quote fromSmall Business Trends discussing “ 10 Reasons Small Companies Fail ” describes our environment this way:

“Small businesses need financing to grow, invest and weather bumps in the road.”

This article along with other cautionary tales speak to the heart of a peril now awaiting Jackie and Camile eighteen months following the opening of their doors and their decision to expand into a new production line. We’re going to take a look at this decision and test it against what now seems to be the quagmire described by the author as “expanding too quickly.”

How do we find more cash?

This depends on a few more facts and considerations:

  • Taking a deep dive into financial matters is Step 1 and yet this may not be their cup of tea. Any discussion regardless of the money source will require them to be conversant with existing and immediately available financial resources; the book of business: orders and receivables; and the terms of their current debt structure – both secured and unsecured.
  • Although this sounds like it should all be a no brainer for a business owner, Jackie may be the visionary, the creative one on the team, and reading all that financial stuff at the time of start-up when capital was available, loan documents and operating agreements may not have been her focus. After all, she does not see her role as the sophisticated financial planner, but rather a partner with a love of textiles and a real belief in what she is doing – jobs, economic development and community support.
  • Meanwhile, Camile assumed the helm in her roles as Managing Member of their limited liability company and ran the financial affairs. A drawback, Camile had no manufacturing experience and little familiarity calculating the cost of goods in textile manufacturing so as to calculate the actual net margin.
  • At start up and to meet the company’s financial needs, Jackie and Camile both used their personal resources. Jackie may have access to some family funds, but Camile is now dependent on even the small salary they have been able to distribute. Yet within the next thirty to sixty days, they have to “bridge” the looming cash shortfall.

Step 1 – A fundamental – Who is making the decisions in this limited liability company?

Jackie and Camile are operating their SME as an Oregon limited liability company. Under the operating agreement (“OA”), as 50/50 partners, they signed their OA with the understanding that OAs are contractual like as a legal concept with overlying potential for creating fiduciary responsibilities.Their lawyer – a college friend with an IP background – also explained there was no single template of “one size fits all”. What they heard on formation, was the beauty of LLCs and operating agreements as being incredibly flexible and with forethought, can uniquely address “the scope, structure and personality of the partners’ relationship.

As we look at the situation a year and a half after inception and since we weren’t a fly on the wall when they drafted their OA, the hope is Jackie and Camile along with their lawyer thought about their 50/50 deal; have a process in place for decision making when they don’t agree and/or clear descriptions of roles. The easily identifiable conflicts that could have been flagged……

  • Camile may want to ask family members for additional infusions of cash; Jackie may wish to search out lenders. Who will have the final say?
  • Staying in control. Absent a pathway for immediately increasing sales and collecting receivables or new revenues, almost any other option will likely require a change in ownership, and thus control.
  • Both Jackie has access to a family member, but the potential use of funds comes with the use of personal guarantees.
  • Assuming the business is not “bankable” at this juncture, the potential (as discussed below) is to consider higher risk financing than they have had to contemplate to date.

Any of these decisions are “big ones” in a business with the primary difference sometime just the number of zeros and where an environment in a small company, feels and is typically very “personal.

Legal Point #1: Governance

3 top Factors to consider in a well-drafted OA, are:

  • capital contributions tied to voting rights (not all memberships are created equal),
  • decision making in ordinary course v. extraordinary course transactions and
  • fiduciary duties (more on this next time).

Assuming Jackie and Camile addressed the issues in step1, let’s move on to their next set of tasks, namely obtaining the cash they need to keep the lights on.

Step 2 – Obtaining Immediate Cash – Some (but certainly not all) options and risks?

In thinking aboutsales……….

Recently, John Murphy, the Executive Director of a group of Maine angel investors, theMaine Venture Fundblogged about the importance of sales strategy in the start-up setting. His observations about a typical situation are that often, “revenue projections have been created to justify valuations, and now all that needs to be done is hire a top-notch salesperson. There is the rub! It is not uncommon for a Jackie and Camile to have relied on themselves and organic sales with the company missing the mark as it scales and then subsequently fails in the absence of a well thought out sales strategy. This leads to “legal point” number 2, the key employee concept.

Legal Point #2: – The Key Employee

In a perfect world, Jackie and Camile will be on the same page, that is, they have a “meeting of the minds” regarding bringing in one or more key employees to solve an urgent cash flow problem. The legal landscape now becomes one of sales objectives tied to compensation, ensuring performance consistent with the company culture and DNA (think Ray Dalio and Principles for Success ), non-compete agreements, and terms for highly compensated and/or potential equity participants.

The dollars are short, they are working in acrisissetting with the potential for layoffs and with a new production line. In this imperfect setting, the business gurus will quickly line up to tell Jackie and Camile that failing to manage high impact decisions such as a sales stragegy isn’t far behind as a reason for business failures.SBA Research

In thinking about cashoutside of traditional borrowings…….

Although the balance sheet may look okay and even be at break even, the assumption under our facts is that Jackie and Camile have limited options for traditional borrowings. Assuming lines of credit and other types of bank funding are not an option, the next step may involve Jackie and Camile stepping into the land of factoring and purchase order financing.

Legal Point #3: – Funding of receivables “factoring” or purchase order financing

Factoring and purchase order financing can be a source of “cash” outside of traditional bank financing. In addition to the contract terms, Article 9 of the UCC applies. Factoring as a financing strategy focuses on receivables while purchase order financing typically focuses on booked orders that may not yet be in production. Regardless, either approach should be approached with caution and a clear understanding of how it works.

In thinking aboutoutside investments…….

Partners physically, financially, and emotionally invested in a start-up, assume, “We are smart, and we are going to succeed.” So, it’s not surprising they turn to family and friends as the next stop in their search for capital. After all, in the world of small and family owned businesses, who cares more than Grandma and Grandpa who know and trust Jackie and Camile. And, after all, it will be “less complicated!”. Words of wisdom: Proceed with caution.

Legal Point #4: – Characterizing the Funding

Deciding the nature of the investment from Grandma & Grandpa is key. Will the funding represent an ownership interest in the LLC; a loan, a gift, or advance on an inheritance? Regardless, each deal needs to be documented. The 3 D’s – discuss, decide and document.

Legal Point #5: – the Crowds with a focusing on mission or message and managing the “the herd.”

The whole world of venture capital awaits Jackie and Camile should they choose to enter this universe. One possibility and starting with a pool of angel investors, they will discover the concept of “accredited investors,” and embark on a pathway of learning how to manage outside investments. The legal landscape – one of term sheets, due diligence and investment documents. An alternative and still highly regulated is equity crowdfunding.

In 2011 Obama’s Jumpstart Our Business Startups Act was a major step in expanding the concept of equity with “crowdfunding”.[1] Neither a short-term answer nor easily achieved, equity crowdfunding is an opportunity to explore.Jobs Act 3.0. In 2018, entrepreneur, Howard Marks described for Forbes Magazine, equity crowdfunding simply as “raising capital from the crowd online. Along with the “rules,” there are a number of platforms to consider, the resources and expertise necessary to take a pitch to “the crowd,” as well as managing of the investments.

Conclusion: Where does all of this leave Camile and Jackie on their journey down their Yellow Brick Road; like Dorothy in the Wizard of Oz, over the next couple of weeks they are going to “convene” Tinman, Cowardly Lion, Scarecrow and Toto in deciding next steps. In the end, though and as 50/50 partners – Jackie and Camile will be left with the task to demonstrate their decision making and leadership talent as they move forward.

Next time: In the “weeds” about limited liability companies and operating agreements.

Resources of Interest

Legal Guidance – Regulation Crowdfunding: SEC Small Entity Compliance Guide resources but clear explanations and introductions:;

[1]See also, Jumpstart Our Business Startups Act,