As both an attorney and entrepreneur, I have personally experienced the common struggles of the brave, new business owner of the 21st century. Through these experiences, I’ve found that while some pitfalls are experienced more frequently, many of them are completely avoidable if you actually know what to prepare for. As they say, “the best offense is strong defense”.
Some of the biggest blunders a business can make happen before its first sale. Not only are these mistakes costly in a financial sense, but they can ultimately be the undoing of any fledgling endeavor; these problems can lead to distrust between the original founders of your company, poor morale among your employees, and exacerbate the various other inevitable issues you will come across when starting your first business. Since most entrepreneurs know they should incorporate their business I decided to keep this off my list and rather focus on the guidance I didn’t receive when starting my company.
Below, are my top three tips for setting up your business for future success.
- Document Ownership between Founders in “Stock Purchase Agreements”
Ideally, you should have only two to three founders for your business. Founders will enjoy special status in that their ownership shares in the company will likely be vested. This means if they leave the company after even a short amount of time they will still walk away with a significant ownership stake in your business, therefore pick your founders carefully. If you’re not 100% positive that a prospective partner has an interest in staying with the project long-term, have a professional attorney draft provisions that allow other founders to repurchase stock at a pre-set share price in the future if someone leaves or otherwise does not hold their own weight.
- Differentiate between Creditors and Investors
Often new start-ups have a parent, family member, friend, or an otherwise “rich uncle” that will put up initial capital to help the business get off the ground. In many cases, this is the first check a business will receive as start-up capital. The difference between creditors and investors is that a creditor expects to be paid back in cash, while an investor does not expect to be paid back in cash; rather, they are willing to accept long-term “equity” in your business, often in the form of stock options.
While this is a delightful event for many entrepreneurs – be careful! Make sure that you and the person writing the check to you understands what they are writing a check for. Do they expect to be paid back? If so, how soon and at what interest rate? Or, are they expecting to receive “stock” in your company? If so, have you determined whether the amount of stock you are giving them compares similarly to others being provided stock or stock options at the same share price? Perhaps they are simply giving you a gift in the form of start-up capital? Make sure your agreement is well documented to prevent disputes later. Remember, disputes are not likely to happen until you are successful or bankrupt.
- Never Use a Personal Account
Sometimes, founders will use funds from a personal bank account to finance the initial phases of a business or business venture. While often a necessary and noble pursuit, there are better ways to handle this; otherwise, there will not be accountability to your family, the other founders, your investors, or your creditors. You should never write checks for your business expenses from your personal bank account and instead should obtain a business account for your new company first (most banks will require that you first obtain an EIN from the IRS before opening a business account).
Once you have this, any business expense should come directly from that business bank account; even if you choose to use your personal finances for the expenditure, you should first write a personal check to your new business bank account and then proceed to use the funds from there. This may seem tedious but business expenses should always come directly from a business account for ease it brings to auditing, tracking and the peace of mind of everyone at the company. If a founder wishes to use his or her personal funds to finance business growth, they should always follow this procedure to ensure transparency in what exactly is and is not a business expense.
This article presents the views of the author and do not necessarily reflect those of LegalForce RAPC or its clients. The information presented is general information and for educational purposes. No legal advice is intended to be conveyed; readers should consult with legal counsel with respect to any legal advice they require related to the subject matter of the article.