Top 5 Problems with DIY Startup Formations

I have a lot of startups and small businesses that walk into my office two or three years after they formed a company without the help of a lawyer. The reason for the delay for first working with a business lawyer is some variation of “they didn’t think it could be that hard” or “they didn’t have the money” to pay a lawyer at formation. It’s always the case that they’ve been meaning to have the company’s legal documents reviewed for awhile and are just now getting around to it. I call this type of work Putting the Legal House in Order or a Corporate Cleanup.

Below is a list of the top 5 most common issues I fix for startups that come to me after forming their company without a business lawyer’s help.

1. Wrong Choice of Entity

For NC startups and small businesses, the choice of entity question often comes down to North Carolina LLC vs. Delaware corporation. Relevant factors for the decision include whether:

  •  the company plans to raise money from sophisticated startup investors,
  •  pass-through taxation would be a positive or negative, and
  •  the company plans to use equity compensation as part of attracting and retaining key employees.

2. Equal Equity Split Among Founders

Now, I’m not saying that splitting the company’s profits equally among the founders is always the wrong answer. But it shouldn’t be the default. Particularly for startups who plan to raise money from sophisticated investors, splitting up equity equally among founders can signal that the founding team is unable or unwilling to have hard conversations, or that they simply aren’t thoughtful.

When thinking about how to split up equity, there’s a multitude of factors to consider, including experience, money invested, IP, and anticipated future role with the company.

3. Absentee Founder

This one is the worst, in my opinion. One example from my clients (names omitted to protect the innocent, and the guilty for that matter): The lead product designer for the company did awesome work for about 6 months before starting to slowly withdraw before ultimately disappearing. That’s right, literally disappearing, for over a year. And then when the other founders finally got in touch with him, he refused to sell his equity, even when the offer was above fair market value.

The absentee founder knew that he could continue to benefit from the ongoing work of the other founders, and he did so despite how questionable that decision was from an ethical perspective.

4. IP not Assigned to the Company

All intellectual property (IP) related to the business should be contributed to the company as part of the formation, and all IP created after formation also clearly should belong to the company. This is not complicated to achieve from a legal documentation perspective, but often overlooked in DIY startup formations.

5. Missing and/or Improperly Drafted Core Documents

This one is less true for LLCs than corporations because LLCs have less paperwork and administrative burdens, but a common problem nonetheless. Whether board approvals, vesting documentation, or effective IP assignments, there always seems to be something missing or wrong among the basic core formation docs.

Fix Issues with a Legal Checkup

At Spengler & Agans, we offer a Legal Checkup – a flat fee package to review your company’s formation and other core documents, and meet to discuss the legal health of your business. If you want to contact one of our attorneys directly, contact us below.

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