Common Mistakes In Starting A Company & How To Avoid Them

I frequently meet with entrepreneurs after they have created their business entity and put some of the initial legal documentation in place.  I frequently see the following mistakes, which can be easily avoided and save time and money for entrepreneurs later.

General Mistakes

  • Forming an LLC rather than a corporation for an entity that you intend to use to raise money from third parties and regularly grant compensatory equity awards to service providers.
  • Forming a corporation and not authorizing a sufficient number of authorized shares (for example, authorizing 100 shares and issuing 100 shares to the founders).
  • Forming a corporation through which you intend to raise angel or venture capital and not including in the charter blank check preferred stock.
  • Not obtaining from the founders a clear assignment of intellectual property to the company.
  • Executing initial founder agreements which require unanimous consent of all of the parties to amend them, allowing one founder to veto the ability of the company to move forward.
  • Making equity arrangements with service providers without written documentation clearly defining the terms of the arrangement and services to be provided, over what time and what milestones are required.
  • Not imposing vesting on founders whose continued service is a condition to their receipt of their founder shares.
  • Attempting to form an S corporation and not having spouses in community property states execute the Form 2553 (a spouse in a community property state has to execute 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 to Form 2553, and see Rev. Proc. 2004-35).

Washington Corporation Mistakes

Forming a Washington corporation using the Articles of Incorporation form from the Washington Secretary of State’s web site.  If you do this, your corporation will have the following characteristics, which you generally want to avoid:

  • You will have cumulative voting.  RCW 23B.07.280.
  • You will have statutory preemptive rights.  RCW 23B.06.300.
  • You will not have the ability for the shareholders to act by less than unanimous written consent.  RCW 23B.07.040(ii).
  • You will not have released the directors from personal liability to the maximum extent permitted by law.  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 provided indemnification to directors to the maximum extent permitted by law.  RCW 23B.08.560.
  • If you intend for your corporation to have maximum flexibility to move forward to raise capital from third parties, you will want your Washington articles of incorporation to specifically state (i) no cumulative voting, (ii) no statutory preemptive rights, (iii) shareholders can act by less than unanimous written consent, and (iv) maximum protection for directors.

Washington LLC Mistakes

  • Forming a Washington limited liability company and indicating in the Certificate of Formation that it is member managed.  This means that any member has the apparent authority to bind the company to contracts, even passive, non-actively involved investors.  You want to indicate, if you form a limited liability company, that the entity will be manager manged.  This signals to the world that the management is centralized and that all members do not have the apparent authority to bind the company. RCW 25.15.150
  • Keep in mind that the Certificate of Formation 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 is typically not desirable. (The online application form, by the way, as opposed to the form, does include a prompt and a place to indicate manager or member  managed.)  I would recommend you use this example certificate of formation.

What to do if you are an entrepreneur and want to get off on the right foot?  Call and ask for good starting point example documents and a free consultation.  You can reach me at 206-757-8184 or my partner Stuart Campbell at 206-757-8017.

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About Joe Wallin

Joe Wallin focuses on emerging, high growth, and startup companies. Joe frequently represents companies in angel and venture financings, mergers and acquisitions, and other significant business transactions. Joe also represents investors in U.S. businesses, and provides general counsel services for companies from startup to post-public.
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  • http://wac6.com William Carleton

    Good post, Joe, with solid points all around. A footnote thought, for what it may be worth: even if two or three founders of an LLC think they are going to hold it closely and share authority as members, maybe even if the LLC has only one owner, it can still make sense to form the LLC as a manager-managed LLC. A reason for this is to anticipate what kind of information must be disclosed on the annual report form that goes each year to the WA Sec of State. Private corporations don’t typically report the names of their shareholders and it may be that an LLC would just as soon not report the names of all of its members (even if, at the outset, all members may happen to be managers — but nothing about the annual report form requires that you connect those dots).

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