Sunday, March 26, 2006

What Are Some Tips for Financing a Small Business?

We’re speaking with Asheesh Advani, one of the founders of, and the author of “Investors in Your Backyard: How to Raise Business Capital from the People You Know.”

NOLO: Asheesh, perhaps you can start out by explaining what CircleLending is, and what it does.

ASHEESH ADVANI: CircleLending was founded five years ago. We formalize and facilitate loans between family, friends, and business associates. The normal way people do these loans independently of CircleLending is, “Here’s $25,000 for your business; pay me back in five years.” And five years later, even if the business has gone very well, and the family is still living in the home, it’s very difficult to make a lump sum payment of $25,000 dollars; it actually takes a lot of financial discipline to save that kind of money. So, the default rate on these loans is very high. What happens after five years is, the borrower thinks, “Okay, now I’m going to have to start thinking about repaying the loan,” and the lender thinks, “This is when I start getting the full $25,000 back.” And that wasn’t ever communicated clearly at the onset. So, one person hears one thing, and one person says another thing. So the original insight behind CircleLending was to create repayment plans to make these loans work. Because when you look at the default rate on loans administered through a third party plan through a repayment plan, the default rate is much lower. If you want the numbers, the default rate on loans between family and friends that don’t involve CircleLending is around 14%, and the default rate on loans involving CircleLending is under 5%. Actually, for mortgages, it’s under 1%. So, people don’t tend to default on home loans. They tend to default a little bit more often on business loans, and on emergency personal loans.

NOLO: Why do you think the CircleLending default rate is so much lower than bank loans?

ASHEESH ADVANI: Well, I think we administer all the payments using direct debit and direct deposit, and I think that if the money’s in the bank account, we take it, which kind of forces financial discipline on you, and if the payments are late, or if you default, then it can impact your credit rating as well, which tends to really trigger certain types of behavior.

NOLO: Asheesh, let’s talk about your book. It’s a great idea, and an interesting book. But let’s just imagine that you’re a small business owner starting out, and you need maybe ten or fifteen thousand dollars, but you don’t really have any idea on how to focus on getting that money. What are the kinds of questions that you should be asking?

ASHEESH ADVANI: There are two things you need to think about. One is, who’s going to be able to supply the money, and the second is what form it should come in, and I think those questions are very related. There are certain types of people who will only invest money in the form of a loan, not as a gift or equity, and there are certain types of people who would much prefer to invest it as a gift or equity versus a loan. And, be clear about those two questions, as, you know, the first thing to think about that will help frame the conversation.

NOLO: In your book, you talk about the five C’s of lending. Practically, I wonder, when you go into a bank, is the person behind the desk really thinking of these five C’s, and which of the C’s are they focusing on?

ASHEESH ADVANI: That’s an excellent question, and it really gets at the heart of why people borrow money from family and friends. Banks used to make decisions based on the five C’s; that was what the vast majority of banks, say, twenty years ago, would look at. And they looked at all the C’s, but collateral was probably the most important one. Character, capacity, conditions of the business, and your credit history are the other ones. Now what’s happened is that there’s really only one C of credit, and that’s your credit history. Everything else is much less important than the credit score that you bring to the table in your bank application. And that’s true for a couple of reasons. One reason is, banks merged. And when banks merge, they tend to automate. A second reason is the power of your credit score as a predictor of the success of loan has really increased. So as credit reporting agencies have collected data on individuals, they’ve become very, very good at having a high degree of predictability. So banks now have a need to automate, and they’ve got this tool by which they can automate decisions. So now most decisions are made very quickly on small business loans, based on your credit score.

NOLO: So there’s a software component to it now.

ASHEESH ADVANI: Oh, absolutely, it’s completely automated, so that’s why you can apply for business loans online now. So, in fact, if you notice, when you apply for a business credit card, they don’t even ask you what kind of business you have. They don’t ask you the name of the business, they don’t ask you how long you’ve been in business, they don’t ask you your experience with it… they have no interest in your character, because it’s all reflected in your credit score, or so they believe. So, what’s happened in America is, you could have a great business idea and be an honest person with god character, but if for whatever reason you’ve got mediocre credit, you will not be able to get business financing through banks.

NOLO: Does a person who’s taking a loan from a bank always have to sign a personal guarantee?

ASHEESH ADVANI: Banks will definitely ask you for a personal guarantee, for all small business loans. That’s par for the course. Only at the highest end of commercial debt would you ever not involve a personal guarantee. For loans within family and friends, it’s totally optional. It really depends on your relationship, and what your lender is willing to bear in terms of risk. And there are some advantages to a personal guarantee; it tends to make the relationship actually more stable, because then the person feels you’re not hiding income or assets.

NOLO: Is there a particular business form that’s ideal if you’re seeking funding?

ASHEESH ADVANI: The question of which business form to use is a very broad question. Financing is one of ten factors you need to think about. I’ll give you one rule of thumb: if you are raising money for the kind of business that you think will incur a lot of losses in the early years, there’s an advantage to forming it as an S corporation. If you choose to do that, then there are financing implications as well, of the kinds of investors you should get, who may or may not want to pass that through to their personal income as a loss.

NOLO: Often you read that a person starting up a business needs a business plan, but then you also hear that investors or people who want to loan money really don’t want a business plan, they just want to know how likely it is that you’re going to make money, and when that will happen. Is a business plan really important?

ASHEESH ADVANI: A business plan is important for all entrepreneurs who are starting a business. But, if you are raising money from relatives, friends, and business associates, I would in fact not recommend bringing the business plan to the meeting. What they really want to know is, “Will you pay me back?” and “Can I trust you as an individual to find a way to pay me back?” And the way to address that is by looking them in the eye and being really honest and saying, “Here’s what my business’s chances of success are, and here’s what I’m going to do, even if it fails, to pay you back.” Having said that, if you don’t have a business plan to bring to the meeting, you should bring something else. And I recommend in the book that you should bring something tangible to show that brings the business to life: a brochure, a sample product, some piece of press about your or your business, something that helps people go, “Ah, that’s what I’m investing in.”

NOLO: When you’re borrowing from family and friends, there’s an emotional issue, especially if there’s a danger that you’re not going to pay back the loan. How do you deal with the emotional side of borrowing from people that you know?
ASHEESH ADVANI: Yes, I think it’s a very real concern when you’re borrowing money from friends and relatives. One, it could jeopardize the relationship, but it could also be a financial problem if you can’t pay back the loan for your lender or your investor. And both of those, I think, should be factored in, in terms of deciding who to borrow money from. So, don’t go to a person, like a grandmother, who’s on fixed income, to borrow money – bad idea. But having said that, at CircleLending, we’ve seen thousands of people borrow money from friends and relatives, and typically what happens when there’s a default is, the lender understands. The lender says, “Jeez, if I hadn’t created a repayment plan, then I wouldn’t have even got the first half of the loan paid back. So, I’m thrilled I got the first half paid back. Now, I understand this person’s going through difficult times.” Two things to think about: one is, the lender can deduct the loss against their capital gains, if they formalize the loan and show they tried to pay. So, that’s one element or value you can derive just by virtual formalizing. And the second thing to think about is you can restructure the loan so that it works for both parties. It doesn’t have to follow the payment schedule you outlined on day one; you can say, “Okay, I’m only going to pay you back fifty bucks a month for the next twenty months until I’m back on my feet.” So at least after twenty months, you’ve paid back a thousand dollars!

NOLO: It’s true that we can do a lot of this borrowing without lawyers. But are there times that a person needs to bring in an attorney?

ASHEESH ADVANI: Yeah, particularly if you’re raising money in the form of equity, I would consider a lawyer to help create the documentation for that. But for loans, I would say the vast majority of documentation is found either at CircleLending or in the book.

NOLO: Asheesh, thanks so much for talking to us today.


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Monday, March 20, 2006

What's in the Public Domain?

We’re speaking with Attorney Stephen Fishman, an expert on copyright law, and the author of “The Public Domain: How to Find and Use Copyright-Free Writings, Music, Art, and More.”

NOLO: Steve, there’s been a lot of interest in the public domain these days. Can you give us some famous examples of things that are in the public domain?

STEPHEN FISHMAN: Well, there’s a huge amount of material available. For example, the works of William Shakespeare are in the public domain, many, many famous songs, “The Star-Spangled Banner,” “Jeanie with the Light Brown Hair” by Stephen Foster, the King James version of the Bible…

NOLO: So, the fact that these works are in the public domain… does that mean that anyone can copy them? What exactly does it mean if something is in the public domain?

STEPHEN FISHMAN: Yeah, when something is in the public domain, it means that anybody can copy it or use it any other way without paying a permission fee to any copyright owner, because there is none; the work belongs to the public as a whole, and any member of the public can use it any way he or she desires.

NOLO: If a person has an idea, can that be in the public domain? Because, for example, the lawyer for Dan Brown, author of The Da Vinci Code, says, “Dan Brown is free to copy certain ideas, as long as he doesn’t copy the expression.”

STEPHEN FISHMAN: Well, his lawyer is quite right; he’s paying him probably 200 bucks an hour, 200 pounds an hour, I’m sure he’s worth every penny. What he means is that ideas, concepts, thoughts… they’re always in the public domain; no one can own an idea. It’s only when you express an idea, when you put it down on paper, you write it, or if you have a musical idea, you play it, and you record it or write it down as sheet music… only what you express in a concrete form is protected, not the intangible idea itself. Thus, Dan Brown can take the idea of Jesus Christ having a child with Mary Magdalene, and write a novel based on it, as long as he doesn’t copy the actual words from the books of these people who are suing him.

NOLO: Okay, well you were saying earlier that “Jeanie with the Light Brown Hair” is in the public domain. Does that mean that anyone can use a recording of that song and copy it and sell it?

STEPHEN FISHMAN: No, I’m afraid not. Sound recordings and the music have two separate copyright regimes. There’s the sheet music, and then there’s the recording; they’re both separately copyrighted. Most recordings are not in the public domain, whereas all the sheet music published before 1923 -- which includes “Jeanie with the Light Brown Hair” -- is in the public domain, and thus, you can get a copy of the sheet music, and make your own recording. If you want to use an existing recording, you’ll probably have to get permission or pay a license fee.

NOLO: So, the message would be, if you wanted to use a public domain song in your film, the best advice would be to do a new recording of it, because then you wouldn’t have to pay any…?

STEPHEN FISHMAN: Depending on the cost, that probably would be the cheapest thing, although you might be able to get a cheap, cheap permission fee for some music, but certainly, it would be pretty inexpensive to hire a pianist or someone to play any public domain song.

NOLO: Is there a simple way for people to determine if something is in the public domain? For example, in your book, “The Public Domain,” I know you have a chart that’s pretty easy to use. Can you just give us a couple of quick tips on how you can determine if something’s in the public domain?

STEPHEN FISHMAN: Well, one tip is that anything published in the United States before 1923 is in the public domain in the United States. Many works published in the United States between 1923 and 1963 are also in the public domain, because they never had their copyrights renewed. However, you’ll have to research copyright records to determine whether they’ve been renewed or not. Government works, US government works by the federal government, everything they publish and create is in the public domain; the speeches of George Bush, everything published by the US printing office, NASA photographs and films, decisions by federal judges… they’re all in the public domain.

NOLO: Steve, is open source software the same thing as public domain software?

STEPHEN FISHMAN: Open source software is not in the public domain, but it is made available, subject to its very, very liberal license, and this license permits users to modify, distribute, or otherwise use the software, without getting permission.

NOLO: Okay, so, it’s not public domain software; it’s software that’s subject to license conditions. So, you really need to read the license on it.

STEPHEN FISHMAN: It’s software that somebody owns, but they let other people use, free of charge, for many uses.

NOLO: One thing you mentioned earlier was a derivative work; could you just give a brief explanation of what a derivative is, and maybe give us an example of how public domain work can be transformed into a derivative?

STEPHEN FISHMAN: Well, derivative work is any work that is based on or adapted from pre-existing work. For example, if you make a movie based on a novel, the movie is a derivative work. Recently, we’ve had, for example, the movie “Oliver Twist,” based on the novel by Charles Dickens, which is in the public domain. The movie is a derivative work based on a public domain novel.

NOLO: And you can have a derivative where you alter the public domain work, like “West Side Story”?

STEPHEN FISHMAN: Good example, “West Side Story,” loosely based on “Romeo & Juliet.”

NOLO: When you create a derivative, though, you can protect that and stop others from using what’s in the derivative?

STEPHEN FISHMAN: That’s correct. When you create a derivative, the original material you add is protected. The material you’ve copied from the original public domain source remains in the public domain, but anything you add is protected.

NOLO: In your book, you refer to the public domain presently being frozen. What do you mean by that?

STEPHEN FISHMAN: Back in 1998, Congress passed a law called “The Sonny Bono Copyright Extension Act” that extended the copyright terms for all existing copyrighted works by twenty years. As a result of that law, no new works will enter the public domain until the year 2019.

NOLO: Is creative commons the same thing as public domain?

STEPHEN FISHMAN: It can be, but is not always. Creative Commons is a nonprofit group that is trying to foster the public domain, and fare use, and they’ve created several types of licenses that people can use, somewhat similar to open source licenses.

NOLO: And where can you find out more about the creative commons?

STEPHEN FISHMAN: They have an extensive website at where you can find out about all of their licenses.

NOLO: Steve, your book is very helpful in terms of determining whether something is in the public domain or not, but one of the things you do suggest is looking things up on the copyright website. Some people may not be able to do that for one reason or another; is there some way you can pay someone to find out that kind of information?

STEPHEN FISHMAN: Yes, you can pay the Copyright Office; they charge $75 an hour to do copyright research, and there are also private firms that will do it; the best known is called Thompson & Thompson, located in Washington DC.

Sunday, March 5, 2006

How Can You Deal with Medicare, Medicaid and Prescription Drug Programs?

We’re speaking with Attorney Joseph Matthews, an expert on issues relating to elder care, and the author of “Social Security, Medicare, and Government Pensions,” published by Nolo.

NOLO: Joseph, let’s say you’re a person who’s just become eligible for Medicare. If you can give them only one or two tips, what would they be?

JOSEPH MATTHEWS: If you’re becoming eligible for Medicare for the first time, there are several things to consider. The first is to find out what Medigap plans are available, private insurance plans, where you live. These are the plans that supplement Medicare, because you’ll find out as soon as you are enrolled that, in fact, Medicare covers only 50-60% of your overall medical bills. You also have to determine what Medicare-managed care plans are available in your area. It’s difficult to compare the apples and oranges of Medigap and Medicare managed-care plans, but that’s your job when you’re enrolling in Medicare, is to find out which path of coverage is best for you. So, you’ve got to sit down and find out what the coverages are for the different plans that are available where you live, how much those will cost, and, also, how much they will leave uncovered, so you can begin to calculate which ones create the higher risk for you of unpaid medical bills, versus the amount that you would have to pay to enroll in the managed-care plan, or in a Medigap private insurance policy. In order to do that, you’ve got to get firmly grounded on what Medicare does and does not cover, and what Medicare does and does not pay for within its coverage, and that, of course, is what social security Medicare and government pensions does for you; it lays out for you exactly what the coverages are, what the gaps are, and therefore what you have to consider when making your choice.

NOLO: In your book, you note that more than half of the people over 65 buy supplemental insurance. Can you share one or two tips about buying supplemental insurance?

JOSEPH MATTHEWS: One way to address the question is to investigate managed-care, coveraged by managed-care companies, HMOs, PPOS, or the like, which offer comprehensive medical care far beyond what Medicare itself offers, but which require you to go through a number of steps before you can get the care you may want, and, so, is not always attractive for a lot of people. The other alternative for many people is what are called Medigap private insurance plans, and these plans supplement Medicare coverage; they fill in the gaps, portions of your doctors bills that are not paid by Medicare, your hospital in-patient deductibles, things that can run up a considerable amount of money during the course of a year if you have many doctor visits or serious illness. These Medigap plans are controlled by the federal government, in the sense that they only can offer filling of certain kinds of gaps, and, so, there are only ten or twelve plans that you ever have to figure out the rules of. Whether or not you want to get a Medigap plan depends number one, on what your overall medical costs are, and, number two, what plans are available where you live, and how much they cost. The plans are not inexpensive, but, for many people, they provide the kind of security against high medical bills that might wipe out savings that make their cost worthwhile to people.

NOLO: In your book you say that, in return for coverage beyond basic Medicare, managed-care plans restrict the patients’ choices, and they pressure doctors to limit treatments, and the length of hospital stays. If that’s the case, then why deal with managed-care plans?

JOSEPH MATTHEWS: Managed-care, for Medicare patients, and for the population at large, is a mixed bag. Managed-care, under Medicare, presents lower-cost coverage, and coverage that, generally, is broader than what you could obtain through Medicare and Medigap supplements alone. However, there are things that you give up when you enter managed-care, and that is complete freedom of choice of doctors and treatments. The coverage by managed-care is very broad, and the premiums tend to be considerably less than if you buy Medicare or MediGap insurance. However, you are restricted in the doctors that you see, because you must see doctors only who will belong to the managed-care plan that you have enrolled in. Similarly, you cannot see specialists or receive other medical care outside of your primary care doctor, unless that primary care doctor approves of it, and sends you to those other specialists or other care, and those two must be within the “network,” as it’s called, of managed-care doctors and services that your managed-care plan sponsors. So, there are a couple of ways in which your freedom of choice for doctors and other medical care is restricted by managed-care plans. Whether that’s a good choice for you or not depends on several things. If the doctor that you normally see, and like to see, is a member of the managed-care plan that you’re considering enrolling in, then, in general, it’s not a bad choice. However, if you’re going to be forced to switch doctors in order to join the plan, then the choice of joining a managed-care plan becomes a lot riskier. Similarly, if the managed-care plan’s network of doctors and other providers is a relatively small one, and this is true usually in smaller towns, rural areas, and smaller cities, then you have to consider whether or not you are limiting yourself in your choice of doctors and other medical providers in such a way that you may not be able to get to the doctors that you want if and when you have a serious illness or injury.

NOLO: Let’s talk about what happens if your income and your assets are a little too high to qualify for Medicaid. Are there other state options that a person can consider?

JOSEPH MATTHEWS: Medicaid is a program funded by the federal government and operated by the individual states which helps people with low income to pay for the medical bills that are not covered by Medicare; I’m now talking about the Medicare-eligible population. So, if you have low income, and low assets, you may qualify for Medicaid coverage -- that’s called Medical in California -- which pays basically all of your medical bills that Medicare does not cover. However, there are an awful lot of people who cannot afford private insurance, whether Medigap or otherwise, who have no other way to fill the gaps in Medicare coverage, because they don’t quite qualify for Medicaid, or Medical. There are some programs that can help make the extra cost of medical bills go a little easier, even if you don’t quite qualify for Medicaid. There are programs that help to pay for Medicare deductibles and co-payments, very important gaps to be filled, and these programs are operated by the states; they’re called Qualified Medicare Beneficiary, Specified Low Income Medicare Beneficiary, and Qualified Individual. Each one, the qualifications are a little bit different, and what they cover is a little bit different. What’s important to know is that, if you are low-income, and have few assets other than your own home, even if you don’t qualify for Medicaid, you should consider applying with your county’s Department of Social Services, or Social Welfare Department, for these assistance programs, which can help pay for Medicare costs that are not covered by the program, but which these separate programs can help you pay for. The same thing is true for Medicare prescription drug coverage. Medicare prescription drug coverage, if you are on Medicaid, is almost free, and the co-payments are extremely low. However, there is also an in-between category of people who get low-income subsidies, even if they don’t qualify for Medicaid. Again, if you apply, if you have low income and low assets, you can apply for this low-income subsidy at your local Department of Social Services or Social Welfare Department, and it may drastically reduce the amount of money you have to pay for prescription drugs under the Medicare prescription drug program.

NOLO: The new edition of your book devotes considerable detail to the new Medicare program entitled “Medicare Part D.” This new law seems quite confusing, so, for those of us who don’t know how it works, perhaps you can start with just a basic idea of what it’s supposed to do?

JOSEPH MATTHEWS: The new Medicare Part D prescription drug coverage is a massive new program sponsored by the federal government, but run through private insurance companies, to cover some of the cost for prescription drugs for people who are enrolled in Medicare. Now, on the surface, it sounds like it’s a wonderful thing, because Medicare has never covered prescription drugs that people take home, before this new program went into effect. But the fact is, it’s a tremendously complicated system that only pays a portion of the prescription drugs, at a tremendous cost to the federal government, and to beneficiaries, in part because there are no controls on prescription drug costs, and because it’s run by insurance companies who have very high administrative costs, and profits, of course. In many ways, this is simply a massive giveaway to the insurance companies. The insurance companies have an administrative load -- that is, administrative costs that they run up in running their programs -- of around 15%, whereas Medicare itself is run under 5% administrative costs. So, it’s essentially giving away a huge amount of money, simply to permit the insurance companies to make a huge profit. Nonetheless, for anyone who is eligible for Medicare, prescription drug coverage is probably a good thing, if you take any substantial amount of prescription drugs that run up hundreds of dollars a year in costs, as they do with even a minor prescription or two for most people. What the federal government has done is made anyone who is eligible for Medicare entitled to enroll in a specific, private insurance plan that provides this Medicare prescription drug coverage, available geographically, that is, where you live determines which particular plans are available to you. Anyone is eligible; you may have to pay a monthly premium of anywhere between $20 and $35. Some plans offer low or no premiums, but, of course, they may have other costs that balance that out. There’s also, for most people, a deductible, a yearly deductible you must pay, and then there are co-payments for different drugs, depending on what the drug is, whether it’s available as a generic or not… there’s also the famous gap in coverage that people have been talking about - the donut hole - where, after you reach a certain amount of payments by the program, and out-of-pocket yourself, the plans stop paying your drug coverage for a certain amount of time, and then pick up again when you have very high drug costs. So, all in all, it’s an extremely complicated program; it will provide benefits for lots of people, but the program is not without many problems and many faults, and people have to be very careful in signing up for a plan that really fits their needs, and not simply picking a plan that has the most bells and whistles, or has the lowest premium -- something like that.

NOLO: Coverage under the new Medicare Part D prescription drug program isn’t handled by Medicare itself, but it’s managed by private companies who offer different plans in different geographic areas. This seems like it’s going to make things a lot more complicated for people who are trying to choose the right plan. In the new edition of your book, you offer a lot of helpful tips. Can you share a few of those with us?
JOSEPH MATTHEWS: The first thing that anyone who is considering enrolling in a Medicare Part D insurance plan should do is determine which specific plans are available in the geographic area where they live. They should then make a list of all the drugs they take, whether generic or brand-name, how much they pay for them now, and then determine whether or not the specific plans that are available in their area offer those drugs as covered drugs within their plan. Then, they have to determine how those drugs are covered, meaning, are they offered as generics or brand names, what are the co-payments for those drugs, and are there any other restrictions on availability of those drugs. Only by going through the several-step process of determining which plans in your area cover your drugs, and how they cover them, and at what cost, can you then start to make a very rational decision about which drug plan is best for you, if any.

NOLO: What does a person do if they’re part of a managed-care plan that doesn’t offer this Part D prescription drug plan?

JOSEPH MATTHEWS: Many people who have Medicare coverage get that coverage through a managed care plan, an HMO, or a PPO, or other kind of managed-care plan. These are available across the country, and many people use these to get their entire medical coverage, including those things that Medicare does not cover. Now that there’s a new drug coverage, often through Medicare, the question is, can you get that coverage through your managed-care plan, or do you have to go elsewhere? If your managed-care plan, that is, the plan that you’re now enrolled in, does not offer a Medicare prescription drug plan within the overall managed-care plan, you have a couple of options. One, you can buy a stand-alone prescription drug plan, just like anyone else can with or without managed-care. That is, you can investigate what insurance plans are available in your area, and enroll in them. This, of course, will add to your premiums and costs, in addition to what you’re paying now for your managed-care plan. You can also investigate whether there are other managed- care plans available in your geographic area that offer general medical coverage that’s comparable to the managed-care plan that you have now, and also offer prescription drug coverage. If so, you may want to switch to the other available managed-care plan in your area. The question of whether to switch managed-care plans is a difficult one, though, because you have to compare not only your Medicare prescription drug coverage, but also your overall coverage under the two managed-care plans.

NOLO: Joseph, thanks so much for being with us today.

JOSEPH MATTHEWS: Thanks so much for having me.

We’ve been speaking with Attorney Joseph Matthews, author of “Social Security, Medicare, and Government Pensions,” published by Nolo.