3 Common Mistakes to Avoid When Starting A Company
Thinking about starting a new business? Congrats! It’s a crazy, fun, scary, wild ride. You’ll learn a lot, and I mean A LOT, through experience, but there are some lessons that you don’t want to learn from experience. Before you take the leap, be sure to consider (and avoid) a few common mistakes that can cause major problems. We refer to them as the 3Fs: Founders, Former Employers, and Formalities.
Mistake #1 - Starting a company with too many founders
Startups need to be able to work quickly, and large teams invariably slow everything down. More founders leads to more questions, more opinions, more delays to get consensus for even simple actions, more painful conference calls, and a more divided equity pie.
Simple disagreements can lead to unintended alliances. A disagreement between 2 people on a 2 or 3 person team is easily addressed. A disagreement between 2 people on a 5-7 person team can create two camps, and every decision can eventually turn into “us vs them.”
It may seem contradictory, but we’ve also noticed that larger teams are more often to have a workload imbalance among the founders. People assume that someone else is doing something, or they have too many cooks in the kitchen on certain projects and end up doing more work than necessary to execute (again, it slows down the workflow).
Investors know that big teams have these problems, and may be less likely to want to deal with a big team.
Avoid this mistake
Consider your team before deciding to start a company. Who is really vital? Who is going to pull their weight? Who may be likely to question everything and cause conflict?
Mistake #2 - Failing to check your employment agreement before you quit your 9-5 to go all in with your new company
Have you ever read that employment agreement you signed 3 years ago when you started at your 9-5? Most people don’t realize that you could violate your employment agreement with your current employer if you quit your job to build your own company. Your employment agreement very likely includes non-compete, non-solicitation, and confidentiality restrictions. Some of the restrictions may not be reasonable (or enforceable), and your master plan to launch your new business may not violate anything in that agreement, but it’s important to discuss the restrictions and relative risks with your lawyer.
Best Practices:
The risk of breaching your employment contract is lower if you are starting a business that is completely unrelated to anything your employer does, but don’t assume that means you’re in the clear.
Don’t retain or use any information (especially sensitive or proprietary information), documents, or materials from your current employer
Don’t try to poach your employer’s clients, customers, or employees, and be cautious when reaching out to business contacts you made while working for your employer
If you are starting your business before you quit your day job: don’t do anything related to your business during work hours, and don’t use employer facilities, equipment, devices, or supplies (not even a post-it) to do anything related to your business
Avoid this mistake
Get a lawyer to check out your employment agreement before you quit your day job. The review will save you from finding a lawsuit on your doorstep six months into getting your new business off the ground; or at the very least, it will give you peace of mind to know you’re in the clear. Be sure to let your lawyer know what you plan to do in your own business and how you plan to do it.
Mistake #3 - Failing to follow necessary formalities or issue equity right away
You may be thinking you checked the legal box if you got your company incorporated, but there are a few additional steps that need to be completed before you can really get off to the races. If you haven’t figured out whether to incorporate as an LLC or corporation, start with this post.
Corporations
Corporations have more detailed requirements than LLCs when it comes to certain corporate formalities. After you incorporate, you need to do the following (at least):
Create a Board of Directors
Adopt Bylaws
Appoint Officers
Get a federal Employer ID Number (EIN) - necessary to open a company bank account
Open a company bank account
Authorize stock to be issued to founders
Properly issue stock to founders
Failure to complete the tasks listed above could have a domino effect, and potentially cause everything you do after forming your company to be unauthorized or void. The last thing you want is to find out that you didn’t have proper authority as President to sign that big contract for your company. You could also risk personal liability (aka, creditors can get to your personal assets) under some circumstances if you don’t follow the necessary formalities and maintain the company as an entity that is truly distinct from you as an individual. The good news is that these tasks are very simple, and can be accomplished through a few written consents.
The importance of issuing founder stock early is discussed in a previous post, but it is worth repeating that you should not wait to issue common stock to founders. In short, the tax burden associated with issuing stock to founders will increase as the company grows and generates revenue, so you want to issue founder stock immediately to avoid those tax issues.
LLCs
Unlike corporations, LLCs don’t have bylaws and are often managed by one or two “Managers” rather than a Board of Directors. If you are starting an LLC with multiple co-founders, the key document you need to get in place early on is the operating agreement. The operating agreement covers important details about the business, such as:
Who are the members (owners) and what is each of their respective ownership stakes
How will the LLC will be managed
How profits and losses will be allocated to the founders and how taxes will be handled
Whether founders will be expected to contribute capital to the LLC (eg for operating expenses)
What happens if one founder wants to buy out the other founder, how new LLC owners can be added, etc.
Discussing and finalizing the operating agreement terms with your co-founder(s) on the front end will help set expectations and avoid deadlock when conflict arises. LLCs also need to get an EIN number and open a separate company bank account.
Avoid this mistake
You don’t want to start off with incomplete or inconsistent corporate records, so be sure to complete all necessary corporate formalities, issue founder equity early on, and keep organized records.
You can think of your new company like a house. Legal forms the foundation and framework of your house, and no one wants cracks in the foundation. Thinking about starting a new company? Reach out and we can help you get started with a solid foundation!
*This blog provides general information for educational purposes only. It is not intended to constitute specific legal advice and does not create an attorney-client relationship.*