While there are numerous potential pitfalls to be avoided when forming a new company, below are three of the most common mistakes I have seen in my twenty years of practice.
Failing To Have A Comprehensive Shareholder / Member Agreement
Many entrepreneurs elect to form their business entity on their own. However, when a company has more than one owner, it is critical that they have a comprehensive agreement governing the relationship between the owners and the company. Such an agreement can address complex issues, such as (1) buy sell provisions, which govern the terms under which an owner can or must transfer their ownership interest, (2) "super majority" decisions, in other words, determining what percentage of the owners must agree for certain major decisions (such as sale of assets, borrowing large sums of money, or paying compensation above a set amount), or (3) voting restrictions, such as predetermining whether the owners must vote in favor of certain actions, like a sale of the company. These are but a few of the areas which, if not agreed upon early, can be devastating down the road for a business. Each business is unique, and it is critical that the principals work through such issues in a thoughtful manner before problems arise. Too often, the entrepreneur puts off these difficult discussions until it is too late.
The 50/50 Dilemma
When two people are forming the new business together, there is often the desire to have equal ownership. Whether it is a husband and wife or childhood friends, it does not matter. 50/50 is a bad idea. The potential for deadlock is too great. I have seen it numerous times over my career. Husbands and wives divorce. Family or friends find that they are unable to work together. The result is always difficult, expensive, and often can be the death of the business. Fortunately, there are numerous ways of dealing with the problem. These range from the splitting of economic and governance powers in a limited liability company, to a variety of tie breaking procedures which can be set up by the written agreement of the owners. Careful consideration of how to structure the business ownership from the beginning is key.
The forming of a new business venture is always an exciting time. Often before deciding anything else, the entrepreneur will select a name for their new company. While that name may be available from the State Corporation Commission, the prudent entrepreneur will carefully investigate their preferred name before filing their formation documents. Trademark searches with both the State Corporation Commission and the United States Patent and Trademark Office may reveal that there is another entity already conducting a competing business under a similar name. If the new company envisions an internet presence being an important part of their operations, conducting a domain name registry search is critical, to determine if domain names that would commonly be associated with the new company name are available. Failure to make certain that the new enterprise will not be confusingly similar to an already existing competitor will save the new company the time and the expense of responding to a future "cease and desist" letter from a competitor, and the possibility of having to completely rebrand their business.
The decision to start a new business is a significant step for most entrepreneurs. Careful planning prior to the formation of their new business will allow the owners to help ensure smooth operation of the enterprise, and minimize the potential for costly mistakes.
David Tenzer is business attorney with Glenn, Feldmann, Darby & Goodlatte in Roanoke, Virginia. Visit www.gfdg.com to learn more.