You finally have your management team and your business plan in hand. You are ready to launch your startup business after months of analysis and planning. Funds are limited, so you go onto the Internet to find the quickest and cheapest way to form the business entity. With some advice you have gleaned from your Google search and free information from self-help websites, you are ready to form the business entity and launch your startup. You pat yourself on the back for finding a legal self-help service which will actually form your business entity for free! You need only pay the state filing fees. Should it be an LLC or a corporation? Should it be formed in Delaware, Nevada, New York, California or your home state? You have figured that out too, and have saved hundreds, perhaps thousands of dollars in unnecessary legal fees – or so you think.
For many entrepreneurs, one of their most costly mistakes is making a decision to avoid lawyers when starting their business, and go to a do-it-yourself site, such as LegalZoom or RocketLawyer. In the long run, this may prove to be a very costly mistake – resulting in avoidable mistakes that require fixing down the road – at great expense – some mistakes may not be fixable at all. If your startup business is worth all of the time and energy being put into it, it is best to have an experienced business lawyer on your team from the outset.
Case in point: Forming a corporation can be done simply by anyone with access to a PC and a credit card, in many cases simply by visiting the website of the Secretary of State of the particular state. However, one of the principal benefits of forming a corporation, avoiding personal liability, can easily and irretrievably be lost if proper steps are not taken after the corporation is formed. As any law student can tell you, if the corporation does not follow proper formalities in the governance and operation of the entity, the limited liability status of the corporation could be lost when most needed – when a legal claim is made against the individuals operating the corporation.
Lack of foresight and proper planning can also get in the way of success, just as the business is starting to take off. This is especially true when a startup business reaches the point where it is ready to seek outside investors – whether “angels”, or through investment bankers, placement agents, broker-dealers, or crowdfunding. Once outside investors have bought off on your startup’s story, they will look closely at areas that may have been overlooked by management entirely, or improperly structured or documented. Two common areas are the capital structure and protection of intellectual property.
Often intellectual property is not adequately protected from the outset, such as by assuring that all employees and consultants enter into confidentiality agreements. Failure to take proper steps from the very beginning can jeopardize the ability of the venture to capitalize on its ideas or to convince third parties to make a favorable investment decision.
Other common mistakes include failing to properly structure or document initial investments by the founders. These actions must be properly planned when the transactions are entered into: should the capital contribution be in the form of equity or debt, or some combination? If equity, what type of equity should be issued: common stock or preferred stock? Once these decisions are made and implemented, it can be hard, if not impossible, to “unring the bell” if there is not a proper capital structure in place from the outset.
Apart from these questions, in almost all cases, when the entity is formed, there ought to be an agreement among the founders as to matters such as what rights the founders will have over major business decisions or day-to-day operations; and what options will the founders and the company have if there is a parting of the ways by the founders down the road. These are matters which are best addressed by a “founders agreement” or “buy-sell agreement” when the business entity is formed.
So when getting ready to launch your next business venture, carefully weigh the risks involved in a decision to go it on your own at the startup phase without the benefit of experienced corporate legal counsel. If money is tight, as it normally would be, seek out an experienced transactional lawyer who has the flexibility to provide competitive or fixed rate fee arrangements. In some cases it may make sense to consider a reduced fee in exchange for equity in your business – in order to conserve cash and align your legal advisor’s interests with the long term economic success of the venture.
About the Author – Samuel S. Guzik is a corporate and securities attorney and business advisor admitted to practice before the SEC and in New York and California, with over 30 years of experience. During this time he has represented a number of public and privately held businesses, from startup to exit, concentrating in financing startups and emerging growth companies. For additional information regarding Mr. Guzik and his firm, Guzik & Associates, please visit his website at www.guziklaw.com.