Every startup entrepreneur is busy—really busy. There are business plans to write, projections to prepare, and products to design. In their earnest desire to get ahead, it’s easy to overlook the very issues that can slow down any fast-moving company.
So what are some of the common 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?
During my days in venture capital and now as an active angel investor, here’s my short list of corporate setup mistakes by high growth potential entrepreneurs:
-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 consider smaller numbers.
-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 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 and a university educator in entrepreneurship. She is the founder of www.takecommand.org, a community service organization that boasts of offering the largest centralized database of startup and small business funding sources in the U.S. Ask Susan your questions at firstname.lastname@example.org