I have a great deal of respect for entrepreneurs. Most are brilliant, capable, creative go-getters who are ready to do whatever it takes to make their startup successful.
That being said, even the most spirited and resourceful entrepreneurs are often shortsighted when it comes to understanding what it takes legally to make a startup venture secure, sound and, well, successful.
So what happens? They take the do-it-yourself approach and bring their multi-million dollar idea to the secretary of state’s office, fill out the paperwork, and start operations. No time to waste and not a dollar to spare, right?
Unfortunately, that mentality can collapse a business before it ever really starts.
We’re not talking $10,000 retainers, here. Securing legal counsel on the front end of entity formation, on average, is likely to cost somewhere between $1,500 and $2,500. But once a legal mistake is made and a lawyer has to backtrack and unweave a cluster of rookie startup mistakes, those fees can realistically become five times greater. Yet this tends to be the rule, not the exception.
In the last year, none of my calls from entrepreneurs have inquired about legal counsel before setting up their new entity. Instead, 100% of calls from entrepreneurs were about some form of legal untangling, which can take weeks, if not months, away from the primary task of building a business and may even stall operations completely until the legal issues are resolved.
The fact of the matter is, if your startup is legally counseled before an entity exists and operations begin, you’ll have a serious leg-up on your future and your competition.
Entity formation is one of the diciest decisions your startup will have to make, because being structured under the wrong entity can prevent you from achieving your specific goals and objectives.
For example, while a Subchapter S Corporation is an ideal structure for many practical purposes and businesses, it can prevent you from raising capital. If you will eventually need to raise capital for your business, a Subchapter S may not be for you. Yet, undoing an entity structure and re-filing can be extremely difficult and time consuming. That’s why it’s essential to get this right from Day One.
A vast majority of entrepreneurs who rent space for their companies put that lease in their personal name, which creates two problems. One, assets will not align correctly on a balance sheet, and two, you may be taking on substantial risk in operational liability that your insurance may not cover because the lease is in your personal name. Rectifying this mistake after-the-fact is a complex and expensive process that can take weeks and thousands of dollars.
Filing papers and paying fees doesn’t always mean you’re ready to operate. What a lot of entrepreneurs don’t realize is that you have to appoint officers and directors into formal roles. You need to draft bylaws and create the detailed components that an actual corporation requires. Legally setting up your company at the beginning means that you’ll also be aware of any annual reports, meetings and fees that need to be filed, conducted and paid so that you retain good standing and can keep business flowing and access to loans and capital available.
Business owners are always seeking the talent that will give their business the competitive edge needed to be successful. However, many owners will offer an ownership stake in the business that is well beyond what is necessary to bring key employees and talents on board, offering 10%, 20%, even 40% interest for what should be 1%, if that.
Lawyers working with startups will always provide advice about what are the best interests of the company, which means helping owners find ways to secure the right employees, without giving the company away in the process.
Before an entity is formally created, you must begin to protect the components of your business that make it your business. Everything from your logo to your color scheme to your taglines, business processes, products, and more must be formally protected through copyright and patent laws. If these protections aren’t filed before you begin operations, don’t be surprised if someone else files to claim them as their own. And once that occurs, it can be nearly impossible to regain control of that property.
Your fundraising process can be devastating if it’s not disclosed properly. Depending on the amount of money raised, investments or gifts could be subject to federal securities disclosure laws. Not to mention, your financial and business standing must be accurately reflected and disclosed to potential investors.
Let’s not forget about the legal issues surrounding crowdfunding–which, though gaining momentum for change, is still under very strict legal regulations under the JOBS Act.
When you’re dealing with other’s people’s money and trust, a mistake can break compliance with state and federal law. Long story short: If not done correctly, you could go to jail.
Without a lawyer, most entrepreneurs don’t even realize they’ve made a serious mistake until it matters–such as when they’re ready to sell, attract new investors, or move their business to the next level.
So what’s my advice? Hire a lawyer on the front end. At least dig deep into these six legal issues and be certain you’re doing things right. Otherwise, your business could crash and burn at any given time.
—Courtney Hollins is a member attorney in the Nashville office of Dickinson Wright, PLLC, a full-service law firm with 12 offices throughout the United States and Canada. Hollins focuses her practice on corporate, real estate, and banking law. Colin Ferguson is also an attorney with the Nashville office of Dickinson Wright and focuses his practice on corporate law.