Common Mistakes In Starting A Company & How To Avoid Them
I frequently meet with entrepreneurs after they have created their business entity and put some of the initial legal documentation in place. I frequently see the following mistakes, which can be easily avoided and save time and money for entrepreneurs later.
- Forming a Washington limited liability company and indicating in the Certificate of Formation that it is member managed. This means that any member has the apparent authority to bind the company to contracts, even passive, non-actively involved investors. You want to indicate, if you form a limited liability company, that the entity will be manager manged. This signals to the world that the management is centralized and that all members do not have the apparent authority to bind the company. RCW 25.15.150.
- Keep in mind that the Certificate of Formation on the Washington Secretary of State's web site, which you can find here, does not allow you to indicate whether the LLC will be manager or member managed. It defaults you to member managed, which is typically not desirable. (The online application form, by the way, as opposed to the form, does include a prompt and a place to indicate manager or member managed.) I would recommend you use this example certificate of formation.
- Forming a Washington corporation using the Articles of Incorporation form from the Washington Secretary of State's web site. If you do this, your corporation will have the following characteristics, which you generally want to avoid:
- You will have cumulative voting. RCW 23B.07.280.
- You will have statutory preemptive rights. RCW 23B.06.300.
- You will not have the ability for the shareholders to act by less than unanimous written consent. RCW 23B.07.040(ii).
- You will not have released the directors from personal liability to the maximum extent permitted by law. RCW 23B.08.320 ("The articles of incorporation may contain provisions not inconsistent with law that eliminate or limit the personal liability of a director to the corporation or its shareholders for monetary damages for conduct as a director, provided that such provisions shall not eliminate or limit the liability of a director for acts or omissions that involve intentional misconduct by a director or a knowing violation of law by a director, for conduct violating RCW 23B.08.310, or for any transaction from which the director will personally receive a benefit in money, property, or services to which the director is not legally entitled.").
- You will not have provided indemnification to directors to the maximum extent permitted by law. RCW 23B.08.560.
- If you intend for your corporation to have maximum flexibility to move forward to raise capital from third parties, you will want your Washington articles of incorporation to specifically state (i) no cumulative voting, (ii) no statutory preemptive rights, (iii) shareholders can act by less than unanimous written consent, and (iv) maximum protection for directors.
- Not obtaining from the founders a clear assignment of intellectual property to the company.
- Executing initial founder agreements which require unanimous consent of all of the parties to amend them, allowing one founder to veto the ability of the company to move forward.
- Making equity arrangements with service providers without written documentation clearly defining the terms of the arrangement and services to be provided, over what time and what milestones are required.
- Not imposing vesting on founders whose continued service is a condition to their receipt of their founder shares.
- Attempting to form an S corporation and not having spouses in community property states execute the Form 2553 (a spouse in a community property state has to execute the S election form if the stock in the S corporation is community property, even if the stock is titled in the name of the other spouse; see the Instructions to Form 2553, and see Rev. Proc. 2004-35).
What to do if you are an entrepreneur and want to get off on the right foot? Call and ask for an example form of Certificate of Formation or Articles of Incorporation and a free consultation. You can reach me at 206-757-8184 or my partner Stuart Campbell at 206-757-8017.
