28 Jul Frequent Errors In Starting A Business and How To Steer Clear of Them

We sometimes meet with entrepreneurs after they have founded their business and put some of the preliminary legal documents in place. While they may have a great product or excellent marketing plan, I often see several common mistakes in business formation, all of which can be easily avoided, saving both time and money for entrepreneurs down the road.

Common Mistakes

  • Forming a corporation through which you hope to raise angel or venture capital and not including in the charter some blank check preferred stock.
  • Creating an LLC rather than a corporation for an organization that you intend to use to raise money from outside parties and regularly grant compensatory equity awards to service providers. A corporation is a better choice in these situations.
  • Establishing a corporation and not issuing a sufficient number of authorized shares (for example, authorizing 200 shares and issuing 200 shares to the founders). You want to have some treasury stock.
  • Writing initial founder agreements which demand unanimous approval of all of the parties to modify them, allowing one founding member to veto the capability of the organization to progress.
  • Failing to get from the company founders a comprehensible assignment of intellectual property to the organization.
  • Going into equity arrangements with service providers without clear written documentation plainly defining the terms of the agreement and services to be rendered, or over what time frame, or what milestones are mandatory.
  • Not imposing a vesting arrangement on founding members whose continued participation is a requirement to receipt of their shares.
  • Wanting to form an S-corp and not having spouses in community property states fill out Form 2553 (a spouse in a community property state has to fill out the S-election form if the stock in the S corporation is community property, even if the stock is titled in the name of the other spouse; see the Instructions for Form 2553, and see Rev. Proc. 2004-35).

 

Washington State Corporation Mistakes

Another common mistake is establishing a Washington corporation utilizing the articles of incorporation document from the Washington Secretary of State’s web site. If you do this, your business will have the characteristics listed below, which you’ll probably want to avoid:

  • The shareholders will not have the ability to act by less than unanimous written consent. RCW 23B.07.040(ii).
  • You will have cumulative voting, although you’ll want statutory voting. RCW 23B.07.280.
  • The directors will not be released from personal liability to the maximum extent permitted by statute. RCW 23B.08.320 (“The articles of incorporation may contain provisions not inconsistent with law that eliminate or limit the personal liability of a director to the corporation or its shareholders for monetary damages for conduct as a director, provided that such provisions shall not eliminate or limit the liability of a director for acts or omissions that involve intentional misconduct by a director or a knowing violation of law by a director, for conduct violating RCW 23B.08.310, or for any transaction from which the director will personally receive a benefit in money, property, or services to which the director is not legally entitled.”).
  • You will not have granted indemnification to the board of directors to the maximum extent available. RCW 23B.08.560.
  • The company’s stock will come with statutory preemptive rights. RCW 23B.06.300.
  • If you want your business to have maximum ability to move forward to raise money from outside parties, you will want your Washington articles of incorporation to expressly affirm: (1) no cumulative voting; (2) no statutory preemptive rights; (3) shareholders can act by less than unanimous written consent; and (4) maximum protection for the board of directors.

 

Washington State LLC Mistakes

  • Remember that the Certificate of Formation posted on the Washington Secretary of State’s web site does not allow you to indicate whether the LLC will be manager or member managed. It defaults you to member managed, which in most cases isn’t what you want. (The online application, however, does include a prompt and a place to indicate manager or member managed).
  • A common error in forming a limited liability company in Washington state is noting in the Certificate of Formation that it is member managed. This means that any member of the LLC has the nominal authority to bind the company to contracts, even passive investors who aren’t actively involved in the day-to-day operations. You want to state, if you form an LLC, that the entity will be manager managed. This signifies that the management is centralized and that all members do not have the apparent authority to bind the LLC. RCW 25.15.150

If you’re an entrepreneur and want to get started with expert advice and direction, contact us today for a consultation.

These represents only a few of the potential pitfalls in starting a business. This is not legal, business or investing advice. Be sure you seek knowledgeable professional and legal help that knows the law in the state in which you’re intent on working before proceeding down this path.

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