Every startup entrepreneur is busy–really busy. There are business plans to write, projections to prepare, and products to design. It’s easy for startup entrepreneurs to overlook the very issues that can slow down their fast-moving enterprise.
So what are some mistakes entrepreneurs make when incorporating their first businesses? What issues force entrepreneurs into a fast document clean up, often with the help of “my-time-is-your-money” legal counsel?
Based on my experience in venture capital transactions and angel investing, here’s a short list of common corporate setup mistakes.
- Authorize preferred stock too. Young companies that expect to raise funds from private investors and venture funds should incorporate with two classes of stock; common stock and preferred stock. Business founders should receive common shares. Preferred shares should be set aside for future investors. While corporate shareholders can vote to increase their company’s authorized share totals essentially at any time, I typically recommend that startup entrepreneurs authorize about 30 million shares of common stock and 20 million shares of preferred stock at the time of incorporation. These sums should satisfy most businesses’ capitalization needs during the first years of operations. Entrepreneurs who incorporate in states like Delaware that charge annual fees based on total authorized shares should learn how to calculate their annual franchise tax fees through other methods.
- Over-allocation of shares. Startup entrepreneurs tend to distribute too many common shares to founders, first employees, and consultants. Here, entrepreneurs should demonstrate restraint and issue about one-quarter to one-third of the authorized common shares to founders and reserve the balance for stock option plans and other corporate needs.
- Omit certain shareholder rights. Entrepreneurs should omit provisions in corporate articles of incorporation that allow shareholders to acquire additional shares in future financing transactions. These rights are best negotiated with investors at the time of each round of funding.
- Assignment of inventions. Technologies that have been developed by founders or consultants prior to business incorporation should be assigned to the new corporation in writing. Investors frequently find during due diligence document reviews that key intellectual property may not be legally owned by the company. This is the fastest way promising companies can lose technology licensing opportunities and funding from angel and venture capital investors. Ouch!
Susan Schreter is a 20-year veteran of the venture finance community, MBA-level educator and policy advocate for small business owners. Her work is dedicated to improving startup operating performance with reduced personal risk to entrepreneurs. She is the founder of www.takecommand.org, which offers the largest centralized database of regional and national small business funding sources in the U.S., including angel clubs, micro-finance lenders, venture capital funds and more. Follow Susan on Twitter @TakeCommand
