By Garrett Sutton, Esq. & Gerri Detweiler

How do you bring investors into your business? Not the sympathetic Mom and Dad kind of investors — those who love you anyway — but rather the hard-nosed, serious investors who expect quite a lot.

As the author of the book Million Dollar Women, about women entrepreneurs who have created multimillion dollar companies, Julia Pimsleur shares three lessons with other entrepreneurs trying to raise money:

1. Take Risks.

“Women sometimes have a tendency to play it safe, but to raise money you need to embrace the risk involved and move forward despite the fear. No one can know for sure whether their business will be a success,” she says. “I may not have all the answers but I know not to be intimidated about that.” Men can benefit from that advice, too!

2. Know Your Numbers.

“You should have a firm grasp of the key parts of your company’s finances,” she insists. “It wasn’t the part I loved best but getting comfortable with talking about margins, COGs and EBIDTA has helped me tremendously.”

3. Treat Investors as Partners.

In her first two years in business, Julia sent her investors full 10-page reports each quarter. “Keep people interested and informed and they may become bigger investors,” she says.

What About Securities Laws?

The securities laws, as they are called, are known to sophisticated investors. They know that you have to discuss risk factors (problems the company may face in the future) and that you can’t make promises as to performance (otherwise you may be held to those promises).

Your friends and family may be just as likely to not understand the requirements of the securities laws. They will ask: “Why are you scaring potential investors away by overly drawing attention to all these risks? And why aren’t you writing about how well you are going to do for everyone?”

Because you can’t, you will tell them. The securities laws say not to, and you’ll get in trouble if you do.

The securities laws are very strict about disclosure. You’ve got to allow a potential investor to make an informed decision. So you’ve got to tell them everything—the good, the bad and the ugly.

You will tell them up front what the risks are of investing in the company. As well, you can’t get their hopes up by making wild promises about glorious returns. That may never happen, and you know it.

So you’ll tell them the truth; that you will do your best but can make no guarantees. In this light the securities laws make sense: A federal requirement to give people the information they need to make a reasoned decision.

Over time, however, the securities laws got so restrictive that they prevented the formation of capital. For an economy to grow and succeed, new companies need to be able to acquire new monies to pursue new opportunities. When the securities laws severely restrict the flow of information on such opportunities the result is that capital formation and job creation suffer.

To alleviate the problem, Congress passed the JOBS Act in the spring of 2012. The intent is to open up the securities laws to allow for greater investment in new and development
phase companies. (For more information on this read Chapter 15 on Crowdfunding from by book “Finance Your Own Business” and this Crowdfunding article updated with recent changes.)

With the advent and implementation of these new securities laws, many more companies will be financing with equity. That is, they will be bringing money into the company by selling stock (or shares) in the company.

You may find yourself in a position to invest in one of these companies. What lies ahead will help you as both a business owner raising money for your company and as well as an investor looking into opportunities with other companies.

For greater insight into professional investors read our book, “Finance Your Own Business” and these related articles on Angel Investors and Venture Capitalists and crowdfunding.

by Scott Cooper

There are countless services in the marketplace that aim to protect and improve your credit. While many of them can be helpful, some can be dangerous. One of the dangerous, but popular services being offered are credit privacy numbers. These are also known as credit profile numbers or CPNs.

What are CPNs?

CPNs are nine-digit identifying numbers, which promoters claim can be used in place of a social security number in certain situations. Credit repair companies cite the 1974 U.S. Privacy Act’s provision allowing an individual to withhold their social security number when a federal law does not require that they provide it.[1]

While these companies use this statute to justify CPNs, there is no law explicitly allowing their use. Companies offering CPNs claim that they are a fast and simple way to repair your credit, secure new lines of credit and protect your identity. Regardless of what these companies may promise, the Social Security Administration classifies CPNs as a form of social security number misuse, and warns consumers that they are illegal.[2]

Can CPNs clear your credit history?

By no means will a CPN give you a clean slate if you have bad credit. If you are trying to escape bad credit by using a CPN, creditors can still find your credit history through your name or address history.

Your social security number isn’t the only piece of information creditors will use to identify you. While you are not legally obliged to provide your social security number when applying for credit, the creditor is also not required to grant your request for credit.  A creditor can deny your application if you chose to withhold your social security number, or provide a CPN. Additionally, you are still legally responsible for all debts incurred prior to obtaining a CPN as well as all debts incurred on your CPN.

Controversies over CPNs

The rules surrounding CPNs reside in a legal grey area. The U.S. Privacy Act states that an individual cannot be mandated to provide their private social security number, and the FBI claims that CPNs can be used for some credit reporting purposes in accordance with federal law.[3]  On the other hand, the Social Security Administration claims CPNs are illegal. Regardless of what the FBI or Social Security Administration say about CPNs, the industry is ripe with scams.

With companies offering CPN packages costing up to $3,500, it is important to stay vigilant against promoters who would harm you for their personal gain.

How to identify a fraudulent CPN practice

A company promising to fix your bad credit through a CPN is the first sign of a deceptive practice. The Federal Trade Commission identifies a number of signs that indicate a credit repair scam[4]:

• Insist on payment before they do any work on your behalf
• Tell you not to contact the credit reporting companies directly
• Tell you to dispute information in your credit report that you know is accurate
• Tell you to give false information on your application for credit or a loan
• Don’t explain your legal rights when they tell you what they can do for you

Is Using a CPN Illegal?

Companies selling these numbers claim that CPNs are issued by the Social Security Office, so I decided to put this to the test. I called my local Social Security Office, and after speaking to representatives I was told they do not provide CPN applications. Many of these companies will insist that what they are providing is legal, but oftentimes they are selling stolen social security numbers. In some instances they are taken from children or people who are deceased. By using a fraudulent CPN you could unknowingly be committing a federal crime that is punishable by up to 30 years in prison. Additionally, using any number, including a CPN, as a replacement to a social security number is another federal crime punishable by up to 5 years in prison.

Prison Time From CPNs

If you haven’t been scared away from CPNs yet, consider the case of David Day. In 2013, 18 people, including Day, were arrested for taking part in a social security fraud scheme involving CPNs. The providers of the fraudulent numbers as well as people who had purchased them were among those arrested. These people used their CPN numbers to get a variety of loans and credit lines. Day, who was both a user and seller of CPNs, was sentenced to over 7 years in federal prison.[5] This case makes clear that the federal government does not take social security fraud lightly.

Avoiding Fraud

The best way to avoid scammers and jail time is to simply avoid CPNs altogether. The entire CPN industry operates within a grey area of the law. The best way to ensure that you are not getting a fake or illegal product is to seek other credit remedies. On their website, the Federal Trade Commission provides a number of verified resources for consumers seeking help with credit and debt relief.[6] Credit repair companies have no magic solution to fix bad credit that you can’t do yourself.  Only time and good financial behavior can improve your credit profile.

For more steps on how to improve your credit, read Garrett Sutton’s book ABC’s of Getting Out of Debt.

Or, for more information on how to protect yourself from scams, read Garrett Sutton’s book Scam-Proof Your Assets.

Scott Cooper is a political studies major at Colby-Sawyer College in New London, New Hampshire. He wrote this article while a legal intern at Sutton Law Center.

[1] 5 USC 552a

[2] Office of the Inspector General. “Field Hearing on Social Security Numbers and Child Identity Theft. 2001. https://oig.ssa.gov/newsroom/congressional-testimony/field-hearing-social-security-numbers-and-idenity-theft

[3] Federal Bureau of Investigation. “2008 Mortgage Fraud Report”. 2008. https://www.fbi.gov/stats-services/publications/mortgage-fraud-2008

[4] Federal Trade Commission. “Credit Repair Scams”. https://www.consumer.ftc.gov/articles/0225-credit-repair-scams

[5] “Indianapolis man sentenced in identity theft scheme”. The United States District Attorney’s Office: Southern District of Indiana. Nov 25, 2015. https://www.justice.gov/usao-sdin/pr/indianapolis-man-sentenced-identity-theft-scheme

[6] https://www.consumer.ftc.gov/articles/0058-credit-repair-how-help-yourself#help

By Garrett Sutton, Esq. & Gerri Detweiler

Angel investors and venture capitalists (VCs) both provide early funding. The similarities end there. VCs, being nicknamed “vulture capitalists,” are some tough birds. They have to be. They take on risks where even angels fear to tread.

The differences between Angel investors and VCs can be clarified in this example conversation. Three friends were meeting in a coffee house frequented by entrepreneurs and investors. Aubrey had made some money on two difficult but rewarding startups and was now looking to invest her own money into new companies run by others. Victor was a hard charging venture capitalist with a large VC firm. Edgar was an entrepreneur working on a new startup.

“I like what I see,” said Victor, the VC, starting right in. “We can begin the due diligence process next month to fully investigate the feasibility.”

“And that takes how long?” said Edgar.

Victor replied, “At least six months. We’ve got to check everything out.”

“Our angels can decide in two meetings,” said Aubrey.

“That’s more like it!” said Edgar. “We’ve got to be ahead of the market. Waiting six months doesn’t work for our plan.”

“But we can bring the money you need to the table,” said Victor. “I see you needing at least $3 million to fund this.”

“No, $3 million builds the company,” said Aubrey. “That’s for later. You need $300,000 to build the product. And you need to do that now. Our angels clearly see that.”

“Well, we don’t do such small amounts,” said Victor. “It costs us almost that much to do our due diligence research on you.”

“If I went with your VC firm,” Edgar asked, “what else would you need?”

Victor said, “A seat on the board of directors and control over future funding rounds. We will have several industry experts working alongside your management. It is all detailed in
our 90 page deal memorandum.”

Aubrey smiled, “Is that all?”

Edgar laughed. “What do angels need?”

“A few hours of your time. We don’t want a seat on your board and we’re not going to put experts into your company. We don’t want to build a company. Let the VCs do that later.
We just want to prove that the product is viable.”

Edgar said, “And the legal documents…”

“Are a few pages,” said Aubrey quickly. “There is nothing complex about this.”

“Yes there is,” said Victor.

“Not really,” said Aubrey. “We’ll get Edgar what he really needs, a reasonable amount of money to prove up the product. We take no seat on the board, don’t require control of later
rounds and don’t build companies like you VCs do. We just get the idea off the ground.”

“I get it,” said Edgar. “We’ll start with Aubrey’s angels. When the product takes hold, we’ll build the company with Victor’s VCs. Thanks.”

And that briefly identifies the basic differences between angels and VCs. Small investments vs. large amounts of capital. Quick decisions vs. lengthy due diligence. Hands off approach vs. board seats and control. Simple terms vs. complex legal documents.

Each has their place in the economic ecosystem. If your product is proven, angels may not be the right choice as they aren’t as well funded or experienced (or even interested) in
building strong company platforms. And know that you can have angels participating in VC rounds and VCs acting as angels in early rounds. Just be careful that the VC in the angel round doesn’t act like a VC. When you want flexibility and they are headed towards formality, control problems can arise.

It has been reported that it took only $1 million to come up with Facebook’s operating system. It took many millions more to build the company, its systems and its talent pool. Angels can give a product life. VCs are the Seabees, akin to the U.S. Navy Construction Battalion (CBs or Seabees) they build whole enterprise infrastructures on the fly while under fire. It can be useful to have both teams on your side.

Both angels and VCs will investigate a potential candidate for funding the process. Known as due diligence, this can be cursory or comprehensive depending on the firm. A due diligence checklist of items to be considered is found in Appendix A of our book, Finance Your Own Business.

We’ve warned you about risky investments using retirement monies. We’ve said the courts would come down on them.

But the latest case, combined with new Department of Labor regulations, should have scheme promoters thinking about leaving the country to avoid litigation and prosecution.

The newest case is Thiessen vs. Commissioner (of the IRS.) The Tax Court decided the matter on March 29, 2016. James and Judith Thiessen were told by a promoter that they could use their Kroger grocery chain retirement plan monies to buy a metal fabrication shop. The case’s outcome was a disaster for the Thiessens.

A “Colorado CPA” (although the court identified him by name we will use quotation marks for the “professional”) advised the couple to roll their Kroger retirement accounts into self-directed IRAs.

The “Colorado CPA” formed a Colorado C corporation and directed the Thiessens to use their self-directed IRA’s to invest in the new C corporation. In 2003, James transferred $384,000 and Judith transferred $47,000 to buy shares in the new corporation. The “Colorado CPA” confidently told the Thiessens that the IRA rules allowed for them to invest in the shares of the C corporation.

To start the transaction the Thiessens placed a down payment of $60,000 into escrow. The money came from their personal bank account. To complete the financing the Thiessens provided a $200,000 promissory note to the seller, which they personally guaranteed.

It wasn’t until 2010 that the IRS learned of the facts of the transaction. By depositing non-retirement monies into the deal and personally guaranteeing the note the Thiessens engaged in a prohibited transaction. A prohibited transaction doesn’t sound good, and it isn’t.

Mixing your personal and retirement assets is prohibited. The IRS can treat such a transaction as an early (and penalized) withdrawal. They did so here. The IRS demanded $180,000 as a penalty. The Thiessens fought the assessment.

The Tax Court agreed with the IRS. They stated that the Thiessens exercised discretionary control over their IRA monies. The investment into a C corporation was not acceptable when the corporation was acquiring assets for the Thiessens’ use. Investing in Apple stock, for example, was acceptable. But investing in an apple farm you managed was not allowed. The metal shop the Thiessens operated was not a passive, public stock investment.

Importantly, the Tax Court cited the 2013 case of Peek vs. Commissioner in which two unrelated taxpayers did the same type of transaction. Incredibly, the Tax Court specifically pointed out that the Peek transaction was put forth by the same “Colorado CPA” who advised the Thiessens!

Bigger Issues Ahead for Scheme Promoters

I wonder how many other clients of the “Colorado CPA” are now not sleeping at night? Is the IRS looking into transactions that he – and other promoters – have put unsuspecting people into?

All the penalties to be gained from checkbook IRAs amounts to easy money for the IRS. (A recent article in the Journal of Accountancy estimated over half of all self-directed IRA accounts are not in legal compliance.) Will there be class action lawsuits against such promoters as penalized tax payers realize they have been hoodwinked by those with a careless disregard for the law, or no knowledge of the law at all?

The Department of Labor has just put out new regulations requiring those who provide investment advice on IRA transactions to follow a fiduciary standard. This means they must act in the clients’ (and not their own) best interests.

The financial industry is up in arms about these new rules. (“Act in my clients’ best interests!?! There is no way I can possibly do that!”) I will tell you that as an attorney I am held to a fiduciary standard, and it is not hard at all. It actually makes things much easier. There are no questions about it. The client comes first.

But these IRA promoters are in for a rude awakening. Even if they are not licensed, or have no specialized training (which many do not), the new rules apply to them. If someone makes a recommendation or gives advice for direct or indirect compensation on IRA plans and rollovers they are held to the higher fiduciary standard.

Many promoters previously gave no advice on the complexities of the transaction and the frequent need for tax filings with the IRS. But, the days of ‘ignorance is bliss’ are over. Promoters can no longer say they were just providing education and ideas on IRAs. If they take any sort of fee (and they do), they must provide comprehensive impartial advice that is best for the client.

Impartial advice would be to stay away from risky retirement schemes.

Entrepreneurs are typically resourceful when it comes to finding ways to pay the bills or finance growth, but these two sources of small business loans are often overlooked.

Borrowing Against Life Insurance Policies

If you have a life insurance policy with cash value (whole or universal life), borrowing against it should be easy. There is no credit check, the loan generally doesn’t have to be repaid (with caveats below), and the interest rate is usually low.

But there are a couple of possible pitfalls. One is that borrowing against the policy will reduce the benefit to your heirs if you die before the loan is paid back. Make sure you still have enough life insurance. If needed, supplement with a term policy.

The other drawback is that interest will be charged, and if you don’t pay it back, there could be serious consequences. You can instruct the insurer to pay the interest from dividends or from the remaining cash value of your policy, but you may not realize how high the balance has risen. If there is not enough cash value or dividends to cover the loan, your policy could lapse.

Even worse, you may find your owe taxes on the amount you borrowed—plus unpaid interest! Why? Because the insurer is giving you a loan with your insurance policy as collateral. (You aren’t really withdrawing the cash value of your policy; you are borrowing against it.) If you die and the proceeds cover the loan plus interest, your beneficiaries will receive anything that remains. But if the amount you owe (including interest) exceeds your cash value, or if you let the policy lapse or cancel it with a loan outstanding while you are still alive, you run into something called Cancellation of Indebtedness Income.

When you borrow money and don’t pay it back, the IRS considers that cancelled debt taxable income, and the total amount of “income” can include interest that accumulated, but was not repaid. So if you cancel the policy or let it lapse before you repay the loan, the IRS will expect you to include that amount in your income when you prepare your return. Forgiveness of debt is income.

To be safe, you’ll want to watch your policy closely. Make sure you are working with a knowledgeable agent who understands these risks, and consider paying the interest if failing to do so will put you at risk of owing taxes to the IRS.

Life insurance loans don’t show up on credit reports, however. In that sense, this can be an excellent way to borrow without affecting your credit scores.

Credit Union Loans

Credit unions may not be the first place you think of when you think of small business loans, but don’t overlook them.

Many credit unions make loans to small businesses in their community, and during the economic downturn, some were making loans to businesses that were being turned down by other financial institutions.

In addition, some credit unions offer smaller loans than some banks, and usually have very close ties to the communities in which they live and work. Some strive to lend to underserved or overlooked businesses. That makes credit unions one of the first places you may want to consider for a loan for your business.

Find out which credit unions you may be able to join at www.ASmarterChoice.org.

For more information please see my book Finance Your Own Business: Get on the Financial Fast Track.