Three Landmines When Forming a Company

There are many obstacles to success as a startup. Several are outside your control, but you can clear the known obstacles to increase your chances of success. You know it is important to establish your company on solid legal footing, but what does that really mean? This primer introduces three significant issues that can cause major problems later if not addressed at the outset.

 

What Happens if a Founder Wants to Leave?

 

At some point, it is likely that one of the cofounders will desire to leave the company to pursue other opportunities. Given this eventuality, it is best practices to specify now how this exit will occur. While it is not possible to address everything in advance, it is possible to decide questions of how the business will be valued, who will perform the valuation, who has rights to purchase the business interests being sold first, and others. Every question you and your cofounders answer in advance is one fewer question you will have to answer later when one of the cofounders wants out and after people’s interests have diverged.

 

What Requires Unanimous Consent and What Requires a Majority?

 

In day-to-day operations, it will not be important for each cofounder to contribute to every decision. There are certain actions, though, that you will want to require the consent of each and every cofounder. While the specific actions can vary, some potential actions that may require unanimous consent include the decision to raise additional capital, the decision to sell the company, the decision to purchase another company, or the decision to enter into a new line of business. You may decide that a majority is sufficient for these and other major decisions, but it is worth spending some time considering the matter.

 

Who Gets What Equity and When?

 

Having a clear capitalization table is essential, not just for outside investors but also to stave off conflict between cofounders. Make it clear from the beginning who gets what portion of the equity of the company. Allocate equity in written documents so that no one can later say he or she was cheated out of equity (think about the Winklevoss twins’ litigation against Mark Zuckerberg and Facebook). If some of the equity is in compensation for services performed instead of for a capital investment, you may also want that equity to vest over time.

When you form a new company, you will need to address these and other legal issues to maximize your chances for success. Investing time and money to form a solid relationship with experienced legal counsel is one of the key early investments any new company can make. If you are contemplating founding a company or have recently founded a company and want to work with experts who can guide you through the critical early stages, contact us at info@barlowwilliams.law and we'll be happy to meet with you to discuss how we can help you achieve your business goals.