Starting a business is an exciting venture, but it comes with its own set of challenges. Here are some common mistakes that entrepreneurs make during the launch phase and how to avoid them:
Business Entity Formation Issues Entrepreneurs can make multiple initial stumbles when launching their business, from selecting the wrong entity type, failing to properly finish the process of setting up their chosen entity, or negotiating inadequate or incorrect governance provisions. Some examples include setting up a corporation using the default articles of incorporation offered by a secretary of state’s online platform which tend to not speak on material issues such as limiting director and officer liability. Or companies may fail to properly appoint a board of key officers which calls into question the legal validity of future corporate actions. Or in the case of an LLC, business owners may never execute their operating agreement creating confusion on the rights and responsibilities of owners, including what happens when there is a disagreement or if someone wishes to remove a member from the company.
Governance Lapses and Alter Ego Liability When companies take significant action without proper approval, they came be challenged. Many times this challenge may happen well after the company has taken the action resulting in a huge mess. Even worse, failure to abide by proper governance maintenance can threaten business owners’ limited liability protection.
Equity Issuance Mistakes Equity grants are a powerful incentive that startups rely on to attract and retain employees. However, many times companies rush this process or do not paper up their actually agreements with their employees or contractors, prioritizing getting to work and building value in their company. These delays can create multiple issues including adverse tax consequences and destroying company morale. Also, companies should ensure that they have a properly authorized equity incentive plan to issue equity to non-executive employees or contractors. The plan should be approved by both the board and stockholders. Another error a company can make is not placing equity granted to a vesting schedule. Placing equity on a vesting schedule creates a delay effect wherein the grantee will not be entitled to the stock until they work for a company for a set amount of time. This allows the company to recall the equity in the event that the grantee does not perform his or her obligations in a satisfactory manner. This protects companies from creating “dead equity” on their cap table.
Cap Table Errors and Anomalies A cap table shows who owns the shares of a company or has claim to future interest in a company. One mistake companies may make when promising equity to a grantee is promising the equity in terms of percentage, rather than promising a specific number of shares. Doing so can create anomalies in the cap table because 1% can differ depending on the outstanding stock of the company.
Gaps in Financing Documentation Many times founders and business owners DIY their early financing rounds, opting to save on legal spend. As such, these agreements tend to be poorly documented or not documented at all. The latter of which can cause issues regarding if the advances were loans or equity grants, as well as potentially adverse tax consequences. Founders also may fail to make a Form D filing preserving their ability to conduct future raises. All of this can threaten future capital raises as future investors may discover these gaps in their due diligence process.
Intellectual Property Mistakes Failing to properly assign intellectual property rights can pose significant risks to future capital raises and diminish the company's value. Ensure all IP is correctly assigned to the company to avoid disputes and legal complications.
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