Startup Q&A #3: MLMs, Business Incorporation, Pitching Investors and Angel Investing

Hey everyone, Matthew Paulson here. Today we are going to talk about multi level marketing companies, business incorporation, business bank accounts, getting an investor and becoming an angel investor. Let's do this. This is officially episode three of Startup Q and A, the online video show that helps startup founders, entrepreneurs and small business owners grow their businesses faster and achieve their dreams of financial freedom. Whether you're just getting started or you've got a dozen employees, Startup Q and A will give you actionable ideas and advice that you can implement in your own business. Now, I am recording this live from the JW Marriott in Austin, Texas. I was just here for Freedom Fast Lane Live, a great conference. We had speakers like Peter Diamandis, Alicia Silverstone, JP Sears. Great, hilarious guy, had a great time here. This conference has come and gone, but it does happen every December. So I'd strongly encourage you to check out Freedom Fast Lane Live next December in Austin, Texas. Alright, before we dive into the questions today, I want to do the segment that I call the Growth Hack of the Week. The Growth Hack of the Week comes out of a discussion that I had this weekend. It is to stop doing things that are not worth your time to do. So typically the Growth Hack of the Week is kind of a marketing strategy or a tip. Like last week it was web push notifications. But one of the things I really got out of this conference was that as the head of your company, you need to be focused on the activities that are most valuable in your business. So the way to kind of do this and to focus on the most important things and to hand off or delegate or set aside the things that aren't important is to kind of calculate an hourly rate for your time. So let's say you make $100,000 a year and you work approximately 2,000 hours a year. So a 50 hour work week, 40 hours a week. So you're working 2,000 hours. That means your time, you know, 100,000 divided by 2,000, your time is worth $50 an hour as a startup founder or the head of the company. So if there are tasks in your business that you can pay somebody less than $50 an hour, you should probably pay them to do that. Now I'm not going to go crazy and say that you should have people buy your groceries and mow your lawn or shovel snow in your driveway. I mean, you can certainly pay people to do that, but obviously there's diminishing returns of this. I'm talking about the time in your business. You need to focus on the things that create the highest value in your business, this is marketing, product development, sales, anything that is going to get more customers in the door or get your customers to give you more money, those are the types of things you should focus on. So anything that is kind of manual labor, something very repetitive, something that doesn't require a lot of your unique insights, anything that you can pay 10, 20, $30 an hour for, you should definitely do that. I do that at MarketBeat. I've been doing this for years now. For a while, customer service just took up a ton of my time. I answered every email question that came in from people that wanted to cancel their accounts or they wanted to upgrade or they didn't get their emails. I answered everyone. For the first three years of MarketBeat, I just realized that because I was putting so much time into that, I wasn't getting the valuable time to do marketing and growth strategies and all that stuff. So I hired a woman named Stevie. She's fantastic. You know, she gets paid a normal hourly rate for an employee that does customer service and it's a fraction of the dollar amount that I would earn if we did that math equation. But she does a great job. She frankly does it better than I would and it costs me less money and allows me to focus on higher value activities. So I really want to reiterate the fact that you shouldn't be afraid of hiring your first employee. It's almost of the same magnitude of quitting your day job and just the amount of time you have freed up to work on your business. When you have somebody helping you out with lower value tasks, I really encourage you to think, what are the most important tasks in my business? What are those thousand dollar an hour activities that I do? And then what are those lower value activities that I can have somebody else do in my place? So that is the growth hack of the week. Let's dive into the questions. Every week we take five questions that are submitted through Facebook or through our website. So if you have a question you would like to submit to the show, go to StartupQ and A Co and fill out the form that's there and you can have your question answered on a future episode of Startup. Q and A. So the first question today comes from my friend Laura Wingert and she asks, what is your take on MLM and other direct marketing companies worth it or do something solo? How long might a person give themselves before backing out? She goes on to say, I've done direct sales before and I've enjoyed it. But I left for other reasons. Thought this might be a good Question for your next episode. So obviously there are some people that have done multi level marketing companies that have made some money from doing has worked out for some people. I think it's a very small percentage of people that participate in multi level marketing company programs that do well with it. I think most people sign up and then don't take any action or don't do anything with it or they can't make it work and it just ends up being a waste of time. But there are some people I know, a couple of them have done very well with it. So I don't want to dismiss it entirely as a business model, but just recognize going in that it's going to be as much work as any other business and it's not something you just sign up for and then you've got a business and you really have to do a lot of work. And most people that try it or sign up end up not doing anything or it just doesn't work out for them. So a few more thoughts on these. Multi level marketing companies tend to have a very low barrier to entry. So if, say Norwex is doing really well in your community, you're the awesome Norwex person. People see that you're making a lot of money. All of your friends, they can just go sign up with Norwex too and steal some of your thunder, eat some of your lunch, copy some of your success. So I mean, that's a little bit of a challenge for me. I wouldn't want to do something where anybody could just walk in right next to me and start selling the same thing I'm selling. Really, there's no competitive advantage that you have over the next salesperson. That just makes it a little bit more of a challenge and your business is just less defensible than if you were doing your own thing that is harder to copy. Second, multi level marketing companies tend to hijack your kind of existing personal relationships for the benefit of your business. So I don't know how many times my wife has been invited to a party for Norwex or Tupperware or some kind of clothing thing. There's a ton of different things. There's even like a lipstick one now. And products are probably fine. But if you're the person that's only inviting your friends over for parties so they can buy stuff from you and you can profit from them and that's the only relationship you have, you're probably not going to be friends with them for very long. So personally I prefer to keep my friends, my friends and I try not to insert any kind of commercial action into my friendships. I think that can sour a relationship if you don't do it right or if you're too pushy. My wife has had to kind of back off from some people that are just too pushy about their multi level marketing things. If somebody's only more interested in getting you to buy their stuff than to be your friend, they're not really your friend to begin with. I've just seen multi level marketing ruin some friendships. If you're going to do it, you really have to be careful that you don't let that happen. Finally, there is kind of a wide variety or a wide range of quality in these companies. Some of them do a really good job. There's a clothing, it's not a multi level marketing, but it's some kind of direct marketing thing called Lularu. It's a clothing thing so women will buy the clothes wholesale, they'll have parties and they'll sell it. There's not that multi level aspect of this program, but I know a few ladies that do it in my community and they do it really well. Frankly, that company is almost turning my thoughts around a little bit on the direct marketing enterprise opportunity. But there are also some really kind of shady companies that have been shut down by the FTC for making false claims. There was a few years ago that I had some friends that had some multi level marketing thing. It was an energy drink and they tried to recruit me for it and I was like, no, not interested in this. But two years later I saw on the news that the business had been shut down by the FTC for making false promises to their program participants. And now that company is out of business and any money that anybody was making from that program is just gone because that company doesn't exist anymore. So you are really reliant on that one company whose program you're participating in. And if that company has had, if that company changes the rules or if it turns out they're doing something kind of shady, you're the person that suffers because of that. So I guess to wrap up a little bit on this question, yes, some people make money, but it's not a business model that I like particularly because it involves turning friendships into commercial relationships because there's no barrier to entry. Maybe it'll work for you, I don't know. But if you do decide to go down that route, I wish the best of luck to you, Laura. Alright, next question. Ryan McKeever asks what do I need to do to form an llc. And how does that differ from a dba? And when do I need both or neither or one versus the other? So first let me say, obviously I'm not a lawyer. I don't Play 1 on TV. I have no professional capacity to offer any kind of legal advice. But I do know what these things are, so I'll kind of explain them a little bit. And if you do want to do any of these things, obviously consult with a competent legal professional. So DBA means doing business as that just means me. Matthew Paulson as an individual is doing business as a brand that I made up called MarketBeat. And typically, if you want to use just file your own taxes and your own personal stuff and run a business that way. As a sole proprietor, you have to file a little form with your state, with your Secretary of State, saying, hey, I'm running this little business. I'm using this name. So that if somebody has a question or needs to, like, track down a guy or gal that runs this particular business, they can look it up on the Secretary of State's website and know that MarketBeat is really just Matthew Paulson's business. A limited liability company is kind of the next step on the corporate, I guess, framework stair. Step up towards complexity. So LLC means limited liability company. And what that kind of does is it creates a separate legal entity other than you as an individual. So there's Matthew Parson, the individual, there's MarketBeat, LLC. And then Matthew Paulson owns MarketBeat. But the real benefit of the LLC is, say, MarketBeat does something to harm somebody. MarketBeat gets sued. The person that's suing MarketBeat can go after any assets that MarketBeat goes owns, but they can't go after any personal assets that I have that aren't in the business. Bank accounts are owned by the business. You know, an LLC isn't kind of perfect limited or liability protection, because somebody can sue you. Even if you do have an LLC set up, they can just throw your name on the lawsuit. They probably will. And there are people that have kind of. There are suits where people have kind of pierced that corporate veil. So you have to make sure you kind of do everything right. You have to, you know, obviously get paperwork in with the state. You have to keep it active, and then you have to file minutes every year, and a competent attorney can explain all of that to you. So if you do want to set up an llc, you know, a local lawyer can do that for you pretty easily. You can also file a form on the Secretary of State's website. The filing fee is $150 for the first year in South Dakota and then $50 for every year after that. It's really only a one or two page form. It's really easy to do, but if you've never done one before, you should probably have a lawyer do it for you. So if you want so an LLC creates a separate legal entity, but if you want to run your business as a separate kind of entity for tax purposes, there's a little bit more work. Just setting up the LLC doesn't make it make your business a separate entity for tax purposes. So let's say you want to do an S Corp or a C Corp or anything like that. After you have your LLC formed, you would have to file a form with the IRS to get a tax id. Then your business will get its own, effectively a Social Security number or a tax ID or something like that so that you can give people your business tax ID and not your own personal Social Security number, which is a good thing because you don't want that number to get out there after you get your tax ID for your business. If you want to be an S Corp or a C Corp, there's another form and certainly a good business attorney can help you figure that out. Next question, kind of related. Micah Kennedy asks, when would you recommend getting a company credit card, bank account and company specific accounts? Right now I use a personal account because my business is just a side business. Thanks. So I recommend keeping your business finances and your personal finances separated from day one. I think all of your business stuff should be in a business account and all of your personal stuff should be in a personal account. So for MarketBeat, I have a business checking account with Wells Fargo for all the transactions that the company does. It has its own PayPal account, it has its own merchant account, it's got its own credit card account. All of those things funnel into the bank account. Then at the end of each month or at the end of each quarter, when there's profit that I want to take home, I transfer that money into my personal checking account, set aside some money for taxes in a separate savings account, and then I can live off that money. The reason you want to keep your personal finances and your business finances separate is really two reasons. One is it's a lot simpler at the end of the year for tax purposes, if you don't do your own books through QuickBooks or something like that, and you need your accountant to figure out how, or your tax person to figure out how much your business made and do some of your books. It is much easier for them if you have all of your business money in a separate account. That way they don't have to look through each transaction and say, this is business, this is personal, this is business, this is personal. That way it's just clear. In a separate bank statement you know exactly what's from your business and what's not. And then the second reason you would want to keep them separated is it's just a lot easier to tell when you're making money. So if there's money in the end of your business bank account at the end of the month, you know you made a profit. So if I had $1,000 in my business bank account at the end of last month, Now I've got 5,000, at the end of this month I made four grand. It's really that simple. So by keeping your money separate, you're knowing when you're making money and you're knowing when you're not making money. Alright, next question. Lisa Gruen asks what do investors expect from initial contact? A formal pitch or an informal pitch? So first I want to say that it's important to recognize that investment deals in small businesses, they take several months to complete. It's not a high stakes pitch like on Shark Tank where you're going into a room, making this great presentation, wowing an investor and walking out with a check. It just does not happen like that in the real world. Typically there are several conversations. There's negotiation, there's due diligence, they're going to check your credit, they're going to call references, they're going to do a ton of different things to make sure that you individually are on the up and up and that your business is actually a good idea. And then even if it is, are they getting a good a deal that's good for them and good for you? And then there's legal work to put all that stuff on paper and finalize that deal, it takes a long time. It's a drawn out process. It is not an overnight thing. So it's, I would say that first contact, it's not going to be this high stakes. You have to have the best pitch of your life to get the deal. It just doesn't really work like that. So for an initial contact, I think the right way to do it is to first do a lot of research about the investor, know who the person is that you're pitching and then ask them to meet with you for coffee or for a short meeting so that you can talk about your business. Idea and maybe get some feedback from them. I wouldn't jump right into, hey, we're raising money, do you want to give us money? I wouldn't spend a bunch of time bragging about yourself or how great your business is and then like later trying to figure out like what you can get out of that person. Really, you should do your homework ahead of time. You should go in there with a specific mission. You don't need a big fancy formal pitch. But do your homework ahead of time. Know who the investor is, what their interests are, what their skills are, and then focus on a business idea. In that conversation, don't focus on yourself or how great you are. That's a great way to turn an investor off. This actually happened to me yesterday here in Austin. I was downstairs on the third floor for the conference. Some guy I had not talked to all weekend comes up to me and says, hey, can we get 15 minutes of your time? I was like, I suppose, what for? He's like, well, we've got this business idea, maybe we can, maybe we can work together on it. It's like, well, I guess we can talk about it. So the guy walks away, tells his assistant, hey, get this guy's phone number and schedule 15 minutes with him. So like the guy couldn't even be bothered to schedule a meeting with me himself. His assistant did it. He's like, alright, whatever. So I told his assistant, hey, we're going to lunch. If you want to talk to me, you can follow us to lunch and we'll talk. So they sat down at a table. I sat with them for like 15 minutes. And the first like 12 minutes of that conversation was the guy not really taking any time to listen to me. He didn't even know what I did or what my skill set was. He just went on for 10 minutes about how great he is and how great his company is and all the high level people that are on his team and that he has professional football players working for him. But he didn't really even do a good job of explaining what his business was. I think he just really wanted to brag himself, brag about himself and have a big board of advisors with a bunch of well known names. And I guess he wanted to add me to that list. So don't do that. Be humble. Go in genuinely looking for information. Do your homework on the investor ahead of time. Know who they are, what they're about, what other types of things they've invested in, what skills they have. You should know that before you have a conversation with them. I think coffee is kind of a good way to have a first conversation. Ask them for ideas, feedback and advice. You don't have to tell them you're raising money right away, but if they do sound interested at that point, you can say, hey, we are raising money for this. Would you like some more information about that opportunity? Kind of at the end of the conversation they might say yes, they might say no. But they're more likely to at least investigate the opportunity if you know them a little bit and have had a conversation with them kind of about your business. Final question, Kevin Gilbertson asks, what are your successes and failures with angel investing? What do you recommend to someone who might want to get into angel investing and what mistakes have you had or seen from others that the rest of us can learn from? Good question, Kevin. So I've been doing angel investing for about two and a half years now. I've done about 20 investments through angel syndicates, which allow you to kind of piggyback on some more prominent Silicon Valley, California angel investors who have access to better deals than you do. So I've done several of those. I'm part of Jason Calacans syndicate. I've done a few deals through Tim Ferriss Syndicate and a couple other names. So I think I've done about 20 deals. And out of those I've had one exit Dollar Shave Club was sold to Unilever earlier this year. So I owned the stock for maybe 18 months and I think I got three and a half times of my money back on it. So that was obviously a pretty good return for holding an investment for about a year and a half. I've also had two failures, both in the financial space. There was a company called Vouch Financial and then there was another one called Lend street, and they were both trying to do kind of innovative lending models, kind of off the backs of Lending Club and Prosperity. But when Lending Club had that scandal where they were giving out good loans to, or the CEO was giving out good loans to friends and family and stuff like that and got kicked out those companies, there was a scare in the industry and those companies couldn't raise their next round of funding, so they went out of business, I guess. So I've had a couple losses and one pretty decent early return, but I'm still pretty new to it. I've been doing it for two and a half years. You, you think that's a long time, but it's really not because these are long term, high risk, high reward, illiquid investments. And you might not know if you are right on an investment for five to 10 years while that company grows or doesn't grow and works out or doesn't work out. You don't really know whether or not you made a good investment right away. It takes a few years for that company to mature and get bought out or IPO or go bankrupt. You just don't know which one of those things is going to happen right away. So I've got deals that are two and a half years old and I still don't really know whether or not those companies are going to make it or not. So for my local stuff, I've done a couple local deals. I invested in Peppermint Energy, it's a little solar startup. I've invested in a hotel deal. I've got a couple other things that I'm looking at right now. There are a few criteria that I look at as an angel investor in these things and also with the Angellist stuff that I kind of use as my initial filter to say, should I give this investment opportunity a hard look or not? So really my first question is, who is this entrepreneur? What kind of track record do they have as an individual? Have they built and sold companies in the past? Is this their first company? Have they shown a track record of execution? You really need to know if the person that you're investing in has the capacity to launch a business, because business ideas can and do change pretty frequently. As you're in business, you find out if you're going to sell red widgets, and then people don't want red widgets, they want yellow widgets. And it turns out they don't want yellow widgets, they want yellow ducks. So you originally were investing in a red widget business, but then you find out that yellow ducks is really where it's at. And those business ideas, what you invested in initially and what the business might eventually become could be two entirely different things. So because of that, you're investing in the racehorse, the individual as much as you are kind of the race itself. So that's kind of the first criteria. Second, I ask the question, does this have the capacity to scale? Could it get big? Could it do eight or nine figures in annual revenue? And the reason that a business, I look for businesses at scale, and most angel investors do, is because we recognize the risk profile of this type of investment. It's illiquid, long term, very high risk, very high reward. Our assumption is that seven out of 10 companies we invest in, the return is going to be zero on them. So out of every 10 companies I invest in, I assume I'm going to get no money back ever and the company is going to go to zero. So that means the three companies that I do invest in have to have a pretty good return. I assume that out of the three companies that make it, two of them will be a single or double, where I get my money back, two times my money back, three times my money back, something like that. And then hopefully there's one home run that will pay for all of the losses and all of the return that you're hoping to get to generate as part of your angel investing strategy. So because we need those high returns to make up for the losses, you can't really invest in restaurants and local businesses and things that just don't have the capacity to scale. And then finally, I like to my personal criteria is is this a company that I think there's a natural acquirer for, a natural exit strategy for, or even just is this something that people are actually going to use? If they can drive that customer base, one of these big publicly traded companies is going to come knocking and buy them out. And that's what happened. So when I look at a deal, it's what's going to be the exit strategy on this deal? Are there natural acquirers that could come in and buy them and give me a healthy return or do I think it has the capacity to go public? That's really a big criteria because that's these types of companies typically don't pay dividends. I love dividends. But it's a different investment strategy. So the only way you're going to get money back is if they sell out to another company or they ipo. So you really have to think, okay, how is that going to happen in the future? I think that's pretty much it for that question. Alright, let's move into the final segment of the show, the Resource of the Week. In this segment, I recommend a book, a podcast, a tool or something else that will help you grow your business faster or achieve financial freedom. This week's Resource of the week is my new book, Automatic Income. So a little shameless plug here. I published this book. It's about investing in dividend stocks and how dividend stocks can be a great investment strategy that has historically outperformed the s and P500. I think the reason for that is these companies have a better use of capital allocation and you get paid to own them. And obviously I prefer that to not getting paid to own a stock. And owning a portfolio of dividend stocks will give you income you can live off of, you can reinvest that money. Your dividends tend to go up every year by 6, 7, 8% if you invest in the right companies. So let's say you have a portfolio that averages about 4.5%. Those payments go up by 7% per year. Ten years from now, you're getting 9% of your money back on your original investment. Twenty years from now, you're getting 18% back on your original investment. And that's just in the dividends alone, in addition to the capital gains that you'll receive. So I really think dividend investing is a great strategy. If you'd like to learn more about investing in dividend stocks and using that as a strategy in your brokerage account or your retirement portfolio, I'd encourage you to check out my new book, Automatic Income. So that is the resource of the week. 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