Lots of start-up founders try to do things the easy way and create a corporation online with the Indiana Secretary of State, which has really one of the best, fastest, and easiest to use websites around.  This is a great way to start, and it will indeed form your corporation with Secretary of State and generate a basic Articles of Incorporation for you.  The problem, though, is that most people will stop right there, falsely believing that filing articles is all that is necessary.  That is not the case.  Indiana law requires a number of formalities when setting up a corporation, including the approval of bylaws.

I read an interesting post on Gigaom.com this morning titled “The 10 Ways Startup Advice is Flawed.”  It focuses on advice given by people perceived as successful start-up entrepreneurs – attacking the premise that someones status (i.e. wealth, fame…etc) may not necessarily be related to what they did as a start-up – and that therefore their advice is not sound.  Here is a key excerpt from the post.You can read the whole post here.

1. Maybe the thing they did really didn’t cause them to get rich. A lot of startup stories are after-the-fact rationalizations or outright myths. As they say in Latin (and on the “West Wing”):Post hoc ergo propter hoc. In other words, just because something takes place after something else, doesn’t mean the two have a causal relationship.

2. Maybe they got lucky. After all, as my grandmother used to say, “Even a blind pig eventually finds a truffle.”

3. Maybe they did the thing they said and it was actually a bad idea, but they were in the right place at the right time. A lot of powerful businesses (especially network-effects businesses) are largely resilient to incompetence.

4. Maybe the thing they did worked, but only in conjunction with some other unnamed factor. For example, many visionaries partner with a heads-down, practical type.

5. Maybe the thing they did worked, but it only under certain circumstances. For example, perhaps it worked in their industry and not in yours, or only in certain phases of growth, or for certain kinds of teams.

6. Maybe the thing they did used to work, but it doesn’t anymore. For example, perhaps competitors now know how to counter such a move.

7. Maybe the thing they did worked, but for a different reason than they think. For example, perhaps it was the feedback of their customers, not their grand original idea, that was key to success.

8. Maybe they didn’t really do the thing they said they did. Most of the mythological startup stories are highly misleading. Many of us remember the past the way we wish it had been rather than the way it actually was.

9. Maybe they’re not really rich and/or famous. A lot of startup energy goes into what I call “success theater” –- that is, convincing the world that you and your startup is successful. Next time you’re listening to a guru, ask yourself: How do I really know that they’re successful? What is their definition of success? What’s mine?

10. Maybe they have an agenda. Ask yourself: Does this person stand to benefit if I follow this advice? The VCs I know and trust are honest and very pro-entrepreneur, but I routinely hear others give advice that entrepreneurs should be suspicious of. Fundamentally, their incentives are based on having a portfolio of startups. As an entrepreneur, you have a portfolio of one. Think about that the next time a VC advises you to swing for the fences.

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Most start-up ventures are strapped for cash – and most start-up ventures typically require at least some, if not a significant amount, of legal work to help them get the business up and running.  One great way for a start-up to save itself some money is to negotiate fixed fees for the transactional legal services it receives.  Billable hours have been a cash cow for big law firms for a long time, but most smaller and solo law practices will be more than willing to provide a fixed fee for certain types of work.  In my business law practice, I provide project based fixed fees for all kinds of projects, including entity formation, contract review, trademark matters, and even some larger business acquisition transactions.  Projects that potentially involve significant negotiations with other parties are very difficult to offer fixed fees – there is just no way of knowing how difficult or lengthy negotiations might be.

Seek out attorneys that are willing to provide fixed fees for your projects – and if you can’t find an attorney that markets him or herself as providing fixed fees – don’t be afraid to ask for fixed fees from an attorney – even if it is an attorney you have used in the past who you have historically paid by the hour.  Fixed fees will help you control your costs, and will help you more accurately budget your tight cash flow since you know EXACTLY how much your legal expenses will be.

An operating agreement is the organic document of a Limited Liability Company.  It defines the relationship of the members among each other, the relationship of members with the company, and how the company will be managed / operated.  One important component of an operating agreement, in the context of a multiple member limited liability company, is the inclusion of provisions which restrict the transferability of membership interests.  In the context of a corporation, this would normally be handled in a buy-sell agreement – but for a limited liability company, it is typically addressed in the operating agreement (although it certainly could be addressed in a separate buy-sell agreement among the members.)

The importance of these provisions is to maintain the closely held structure of the LLC.  If members are allowed to freely transfer their interests, or if those membership interests are freely allowed to transfer via involuntary means (i.e. death, divorce, bankruptcy), members who originally started the business with one or more particular members may be forced to continue the business with new members that they do not necessarily approve of.  Putting restrictions on transferability can solve this issue by giving members control over how/when/why membership interests can be transferred.

If you are interested in learning more about what types of things should typically be considered in these provisions, check out my post on buy-sell agreements.

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Limited liability companies (LLCs) can be managed by either their members, or by a board of managers (board of managers is the term used in Indiana – some states differ slightly).  This is something that needs to be specified in the articles of organization for the LLC, and although the articles can obviously be amended at any time to change how the LLC is managed, it is an important decision nevertheless.

A member managed LLC is exactly what it sounds like – an LLC with its daily business managed by its members.  This is obviously not a big deal if you have one, or even two members.  Problems arise when an LLC has multiple members.  Typically, except as otherwise spelled out in a written operating agreement, all of the members will have the authority to act on behalf of the LLC (sign checks, execute agreements…etc).   This is not an ideal situation.

A manager-managed LLC, on the other hand, has its daily business matters managed by a board of managers.  This would be analogous to a board of directors or even officers in a corporation. Members elect the board of managers, and become much more passive in the operation of the LLC.  Members, of course, can also serve as managers.  The flip side of this, and another advantage to having a manager managed LLC is that you can elect managers that are not members.

Any LLC, regardless of whether it is member managed or manager managed should clearly define the authority of its members and managers in a written operating agreement executed by all the members and the LLC.   Check back sometime soon for a follow up post about how this should be handled and what things need to be considered.

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I work with start-ups and entrepeneurs in my law practice all time – one common question / concern I get from my clients is regarding the right time to organize / incorporate their business into a formal, legal business entity.  Some ask because they are trying to save the money associated with the process until they know that their business will be a forward concern, some ask just out of general curiosity.

As a rule of thumb, I typically tell clients they need to form a legal entity separate from themselves anytime (1) there is more than one founder or (2) the business is about to engage ANY sort of third party for ANYTHING.  The first point is obviously based on the need to put down pre-incorporation/organization agreement in writing (i.e. avoid arguments and conflicts among founders), the second based on the need to shield potential liability.

I came across an excellent posting on this topic by Yoichiro (”Yokum”) Taku, a west coast attorney who maintains StartupCompanyLawyer.com.  He has some points that expand nicely upon my second rule of thumb above, some of which I have included below:

Funding.  Obviously, if third party investors want to invest in a startup idea, there needs to be an entity to accept the investment.  Generally, I prefer to incorporate and issue founder’s stock at nominal prices well in advance of a Series A preferred stock financing because it is difficult to justify that common stock should be priced at $0.001 per share while Series A preferred stock is issued at $1.00 per share.

Launching a service/product and general liability issues.  One important reason for incorporating a company is to protect the stockholders against personal liability.  If a company complies with corporate formalities, creditors of the company generally cannot reach the stockholders to satisfy the company’s liabilities.  Thus, a company should generally incorporate before launching a product or a service due to potential liability issues, as the risk of liability to a founder increases with customers or users.

Hiring employees or third party contractors.  Although I’ve run into a situation where the former CEO of a Fortune 500 company personally paid an “employee” out of his own pocket for a year prior to incorporation while incubating an idea, most founders will need to incorporate a company if they intend to hire employees.  In addition, if an entrepreneur needs to engage third party contractors, it generally makes sense to incorporate a company so that the third party enters into an agreement with a company instead of an individual.  In addition, any IP created by the contractor can be assigned to the company instead of an individual founder.

You can find the original posting here.

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Have a great idea and plan on starting a business? Thinking about raising venture capital at some point in the future? You should think twice about forming an LLC. Venture capitalists typically require a “C” corporation when investing in a business. Here are a few reasons why:

• Venture Capitalists like preferred stock, they are familiar with preferred stock, and will usually have already perfected terms for preferred stock.

• Venture Capitalists typically don’t care about / don’t want pass through losses from an LLC.

• Venture Capitalists will invest with an exit strategy in mind. That exit will likely either be an IPO, which is generally only available to “C” corporations, or sale of the company, which would preferably occur via a tax-free reorganization. Only corporations can participate in tax free reorganization.

So why not an “S” corporation? First, “S” corporations, under most circumstances, may not have a shareholder that is not a natural person; most Venture Capital funds are organized as limited partnerships. Second, “S” corporations may not have more than one class of stock. As I mentioned above, Venture Capital funds love preferred stock, and they can’t get it from an “S” corporation.

My business law practice can help you set up your business and plan for raising venture capital.

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If you are starting a business, there are a number of things you need to consider when you are in start-up mode, beyond what you might normally think of (i.e. the business name, business location, sales and marketing…etc).  From a legal perspective, here are a few things you should carefully consider:

• What form of business entity should you choose?  There are multiple entries on this blog dealing with the various types of business entity a start-up can choose from.
• If there will be multiple owners (i.e. shareholders, partners or members), how will control of the business be structured?
• How much and how often will the business owners be paid?
• How will business records be maintained?
• Will the business hire employees, independent contractors, or a mix of the two?
• What type of  / how much liability insurance will the business need?
• Will the business enter into a lease for space?  Or will it buy and develop its own real estate?
• If the business will have employees, will it provide benefits? How will the business handle payroll?
• What types of banking relationships will be necessary?
• Will the business need to raise capital?  If so, will it be through debt or private equity?
• Will any sort of license or permit be required to conduct business?

These are just a few things that should be considered?  Need help sorting through your start-up business questions?  Contact start-up business attorney Brian V Powers.

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Back in the mid 70’s, our economy was  in a recession.  Growth was down,  oil prices skyrocketed, unemployment, interest rates and inflation all rose.  Times were bad, so it seemed.

That was also the time when Microsoft and Apple were founded.

This of course is not to say that every start-up will reach that stratospheric level of success. But it is a sure sign that starting or growing a business during bad economic times is not impossible.  As pointed our by Paul Graham here, success in business is more about who you are, not when you do it.  A bad economy won’t kill you, but a good economy won’t save you.  Sure, investors and customers may be harder to come by now, but play that to your advantage. Come up with a cheaper way of doing something.  Go after investment capital while others are steering clear of it – thinking that nobody is investing (hint: they are still investing).

Want some more proof that good businesses can be founded during and grown out of a recession?  According to Gary Beach at PC World Magazine:

• 35 % of the 2008 Fortune 500 incorporated during a recession.
• 46% of the Fortune 100 incorporated during a downturn.
• 52% percent of the Fortune 50, 64% of the Fortune 25 and seven of the Fortune 10 all opened their doors while economic pain was all around them.

He comes to two very good conclusions.

First, if you are pining to start a company that you believe can scale to be one of the world’s most dominant firms, you shouldn’t be afraid to start it in a recession.

Second, watch your back. That 35 percent of the nation’s 500 largest public companies launched during a period like the one we’re in is stark evidence that-the recession notwithstanding-competitors are starting up all around you.

Now is as good a time as any to start or grow a business.  Adapt to the times.  Don’t focus on the economy.  Focus on your business – let others worry and be driven by fear of the economy.

Zig while others zag.

So, you have come up with the next great idea and you are ready to begin building your fortunes. One of the first questions you should ask is “what type of business should I be,” or as we lawyer-types put it, “what choice of business entity should you make”? Choosing the proper legal entity with which to conduct business is one of the most important decisions a business owner faces. This early decision will determine myriad other issues including responsibility for tortious acts, complexity of the entity, ability to transfer interests in the entity, ease of additional capital infusions, protection of intellectual property, and, of course, liability for the payment of taxes, to name just a few.

So many choices - will you make the right one?

The list of available entity forms is fairly extensive. From the more traditional corporations and partnerships to the more exotic state business trusts and conduits, it seems there is a form for everyone, and in most cases, multiple forms. In some instances, it may be appropriate to forego a separate entity and conduct your business as a sole proprietorship. In a sole proprietorship, the business is conducted in the owner’s individual capacity. Perhaps intuitively, a sole proprietorship offers no protection from liability, but it is the simplest way to conduct business. Generally, no separate documents or records need to be filed with any governmental authority, including the Internal Revenue Service.When a business owner wants to sell his or her sole proprietorship, it will always be a sale of the underlying business assets.

Future blog entries in this series will focusing on the three most common types of entities — partnerships,limited liability companies, and corporations.  Each of these has important characteristics that distinguish one from the others. By recognizing these differences, you can begin to highlight the factors that will influence your decision on which form of entity to select.

My start-up business law practice works with new and prospective business owners to aid in the purchase, structuring and formation of a new business. We also provide convenient, fixed pricing for certain business formation legal services.  Contact us today at inquiries@bvplegal.com.

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