360° Coverage : Top 10 Legal Mistakes By Early-Stage Entrepreneurs

2 Updates
Top 10 Legal Mistakes By Early-Stage Entrepreneurs
Photo Credit: Forbes Business

Top 10 Legal Mistakes By Early-Stage Entrepreneurs

Mar 29 2014, 2:44pm CDT | by

null — Andrew W. Buffmire, Attorney at Law Once in awhile the attorneys do know best. This week I interviewed Andrew Buffmire, attorney for Michael Best & Friedrich LLP’s Salt Lake...

Filed under: news

 
 
 

22 weeks ago

Top 10 Legal Mistakes By Early-Stage Entrepreneurs

Mar 29 2014, 2:44pm CDT | by

null — Andrew W. Buffmire, Attorney at Law

Once in awhile the attorneys do know best. This week I interviewed Andrew Buffmire, attorney for Michael Best & Friedrich LLP’s Salt Lake office. The firm’s Utah team is particularly specialized in the issues of early stage technology companies, although many of the principles he addressed apply to other sectors as well.

On the whole, he notes that Utah is a destination of increasing focus for the development and growth of west-coast born technology companies. (Here’s a recent analysis from Forbes’ Tom Post on the 50 top U.S. cities for early stage ventures.)

Buffmire reports 110 merger and acquisition deals in Utah in 2012-2013 worth a total of $10 billion, and that 39% of the sum came from tech. Not a bad outcome. Yet many early stage companies continue to fail, even in technology and entrepreneur friendly markets.

So what’s up with that? As presented in a recent address to the Utah State Bar Association, Buffmire shared these early-stage companies’ top 10 fatal mistakes.

  1. Getting in business with the wrong team. It’s a given that most, if not all, start-up companies will struggle through some difficult financial and operational times. This is particularly true for technology companies, which must address technology risks as well as managerial, market and financial challenges. Consider carefully who you’d want to have in the lifeboat with you, as well as psychological ability of your early partners to weather those storms. Your partnership and hiring decisions will rank among the most important early business decisions you’ll make.
  2. Failing to form a legal operating entity early. While a Limited Liability Company (LLC) has tax advantages that may appear attractive, bear in mind that investors will want to see a C Corp holding the assets of a company with preference for a Delaware C Corp because of predominant prior investor experience with Delaware law. Without early formation of the entity, you run the risk of verbal commitments, side agreements restaurant napkin business plans casting uncertainty on the technology and company ownership that could make capital raising much more difficult later on.
  3. Not addressing ownership and vesting rights from the beginning. In that same vein, while all can be brothers and sisters in the early Ramen Noodles stage of a company, early-stage founders can fall away and end up not providing the benefits you had hoped for while holding ownership that should be saved for more valuable and productive participants. (“The Social Networkmovie about Facebook’s early days is a great example of early ownership deals gone awry.) Get the ownership and vesting issues determined early. Vesting should occur by time and roles, not by poorly defined objectives or the matter of “who was here first.” This advice is vital: I recently spoke to an early-stage investor as he bemoaned the fate of a company whose initial CEO caved to the pressure to grant stock to a pushy incoming executive without a vesting schedule. The executive didn’t work out and was ultimately fired by the board, but despite the bad behavior was successful in walking away with a major ownership in the company intact.
  4. Failing to do a timely 83(b) election. If the shares you issue are subject to a vesting schedule and carries a “substantial risk of forfeiture” (meaning the individual may depart before actually receiving the stock), the IRS views the purchase not complete until the risk of forfeiture goes away (meaning the stock has vested.) At that moment, the difference between the purchase price and the later fair market value is taxed as ordinary income. But it is vital (repeat, vital) that the company complete an 83 (b) election within 30 days of the initial stock purchase to allow for tax treatment as an initial issuance (when the value and tax is relatively small) and will allow for later capital gains tax treatment. Failure to make this election in the allotted window can have extraordinarily adverse tax consequences for everybody involved.
  5. Not affirmatively protecting intellectual property. The U.S. has now moved from the historic first-to-invent patent system to a first-to-file system. This makes it imperative that you do your patent filings early and often. As you anticipate future filings, be sure to protect all discussions and efforts with NDA’s (Non Disclosure Agreements) and label all associated materials with “Proprietary and Confidential” confirmation in all third-party discussions.
  6. Failing to use experienced advisors in reviewing and responding to financing term sheets. Professional investors use a number of approaches to protect governance, liquidation rights and preferences in financing structure. You, the entrepreneur, enter the negotiations without the advantage of the nuances each investor and agreement will use. It is vital that you engage appropriate counsel to explain to you in detail what each of these ramifications will mean and to guide you in understanding in detail which of the criteria can be pushed back against and which can’t. You also need to understand how dilution will occur over time if you should pursue a venture-funded deal later on.
  7. Failing to address all prior commitments and exposures from prior employers. Require all participants and prospective employees to disclose any prior (or current, if “moonlighting”) noncompete agreements and trade secret agreements and for any of these in force, seek a waiver (or avoid having someone with these limitations participating at a core level in the early days of your venture).
  8. Failing to comply with applicable federal and state securities laws. I will be writing much more about these issues in the months and seasons to come. Review all of these issues with a specialized attorney from the start. Failure to do this could result not only in civil damages but even criminal penalties. Imagine the dire consequence of facing SEC sanctions such as a penalty from seeking further financing for a period of five years or even prison time over something as seemingly innocuous as a “business pitch” that gets broadcast on YouTube and gets interpreted as improper solicitation? Know the laws (which are currently changing, particularly as it pertains to Regulation D disclosure requirements and debt- and equity-based crowdfunding) and adhere to them strictly.
  9. Failing to get the business basics right and in place early on.
    • Business focus. Develop an early business focus that you can articulate clearly. 1) What do you do? 2) Who do you do it for; and 3) What is your unique and proprietary advantage?
    • Customers. Who are your customers; what are your channels of distribution; what is your cost of acquisition; who are your competitors and how are you better than them?
    • Money. Raise the right amount of money and do it without hurting your future money raising potential. Here’s a tongue-in-cheek rule of thumb: Consider that you will need 3x as much as you think, you’ll have 1/3 the revenue you think, and it will take 3x as long as you think to achieve exit. Also consider that too high a pre-money valuation, which may seem like a good thing at the time, will often lead to a painful down-round if and when professional investors come in. When you spend your money, do it frugally—remember that to a start-up, cash is like the jet fuel on a plane—something you don’t want to run out of at the wrong time.
    • Management. Seek to build a team, systems and processes that can ultimately operate and scale without the founder.

    10. Assuming the tough issues can be dealt with later. The simple answer to this assumption is “no.” Failure to address difficult issues early and well can lead to a later total failure and loss. Remember that first mover advantage and time to market are key drivers of growth and value in technology companies. Delay in addressing hard issues is one of the primary mistakes that can kill an early stage business.

Has Buffmire’s thinking frightened you? As I review Buffmire’s ideas he smiles, acknowledging that many (if not most) of the top mistakes he cites are the result  not only of his observations of companies his organization is assisting, but also come from his own painful entrepreneurial lessons learned in years past.

May his 10 hard won entrepreneurial laws be your lesson. With thanks to Andrew Buffmire for the research he contributed to this interview, those who would like to contact Buffmire directly can reach him here at Michael Best & Friedrich LLP.

Seven Common Small Business Mistakes And How To Deal With Them

 

Source: Forbes Business

 
Update
2

3 days ago

Khazanah throws MAS RM6b lifeline

Aug 29 2014 5:01pm CDT | Source: Business Times Singapore

August 30, 2014 1:15 AMKHAZANAH Nasional will inject RM6 billion (SS$2.4 billion) over three years to resuscitate loss-making Malaysia Airlines (MAS) under a recovery plan that includes even an Act of Parliament. Other key moves are migrating its operations, assets and liabilities to a new company (NewCo) and slashing the ...
Source: Business Times Singapore   Full article at: Business Times Singapore
 

 
Update
1

4 days ago

MAS posts loss of RM307m for Q2

Aug 28 2014 5:00pm CDT | Source: Business Times Singapore

August 29, 2014 1:13 AMMALAYSIA Airlines (MAS) registered a loss of RM307 million (S$122 million) for the second quarter to end-June, but warned of worse to come in the second half when the "full financial impact of the double tragedie ...
Source: Business Times Singapore   Full article at: Business Times Singapore
 

 

Don't miss ...

 

<a href="/latest_stories/all/all/30" rel="author">Forbes</a>
Forbes is among the most trusted resources for the world's business and investment leaders, providing them the uncompromising commentary, concise analysis, relevant tools and real-time reporting they need to succeed at work, profit from investing and have fun with the rewards of winning.

 

blog comments powered by Disqus

Latest stories

India offers red carpet, not red tape, Modi hard sells India (Roundup)
Tokyo, Sep 2 (IANS) Prime Minister Narendra Modi Tuesday hard sold India to Japanese investors saying that his country offers only a red carpet and not red tape while dubbing his five-day trip to Japan that ends Wednesday as "very successful".
 
 
Fear grips onlookers as Ebola victim walks through market
Monrovia, Sep 2 (IANS) A video footage has emerged from Liberia showing a person tagged positive for Ebola virus disease (EVD) walking through a busy market, sending hundreds of horrified onlookers fleeing in fear, a media report said Tuesday.
 
 
Half of British young women cannot locate vagina
London, Sep 2 (IANS) Half of young women are unable to properly label a vagina on a medical diagramme, while 65 percent admitted having a problem simply using the words "vagina" or "vulva", a British survey has revealed.
 
 
Nepal, India to hold energy talks
Kathmandu, Sep 2 (IANS) Officials from Nepal and India will be meeting in New Delhi Wednesday and Thursday to hold talks on the much-touted Power Trade Agreement (PTA) between the energy-starved nations.
 
 
 

Latest from the Network

Britain asks citizens to review travel plans to Pakistan
Islamabad, Sep 2 (IANS) The British Foreign and Commonwealth Office (FCO) has advised its citizens to review their planned trips to Pakistan in view of the volatile security situation in the country. "There is a high...
Read more on Politics Balla
 
Jaime King: Motherhood is all that matters
Jaime King says her son is the most important thing in her life now. The 'Sin City: A Dame to Kill For' star welcomed her first child James - her son with husband Kyle Newman - into the world last October and since she...
Read more on Celebrity Balla
 
Chris Brown pleads guilty to assault
Chris Brown has pleaded guilty to assault. The 'Beautiful People' hitmaker was sentenced to time already served by a judge after accepting a plea deal at a Washington DC superior court today (02.09.14), where he was...
Read more on Celebrity Balla
 
Piers Morgan confirms CNN departure
Piers Morgan has confirmed he is leaving CNN after turning down a new deal. The British presenter - whose show 'Piers Morgan Live' was axed by CNN earlier this year - took to his Twitter account on Tuesday (02.09.14)...
Read more on Celebrity Balla
 
Helen Mirren is learning Italian
Dame Helen Mirren is learning Italian. The 69-year-old actress owns a villa in Salento, South-East Italy, with her husband Taylor Hackford and although the couple also have homes in London, Los Angeles and France they...
Read more on Celebrity Balla
 
Number of displaced civilians inside Ukraine doubles: UNHCR
Geneva, Sep 2 (IANS) The UN High Commissioner for Refugees (UNHCR) Tuesday said the number of people displaced inside Ukraine has doubled in the past three weeks since the ongoing fighting in eastern Ukraine is driving...
Read more on Politics Balla
 
15 troops, 50 militants killed in Ukraine clashes
Kiev, Sep 2 (IANS) At least 15 troops and 50 pro-Russian militants have been killed since Monday as Ukrainian forces engaged in fierce fighting against militias in the country's eastern regions of Donetsk and Lugansk...
Read more on Politics Balla
 
India offers red carpet, not red tape, Modi hard sells India (Roundup)
Tokyo, Sep 2 (IANS) Prime Minister Narendra Modi Tuesday hard sold India to Japanese investors saying that his country offers only a red carpet and not red tape while dubbing his five-day trip to Japan that ends...
Read more on Politics Balla
 
Indian woman charged for having illegitimate child
Dubai, Sep 2 (IANS) An Indian man filed a case in a court in the UAE against his wife, who gave birth to a child in 2010 despite their not having sex for eight years, a media reported said Tuesday. The man, who is...
Read more on Politics Balla
 
Captain Marvel 'will not appear' in Guardians of the Galaxy 2
Captain Marvel will not appear in the 'Guardians of the Galaxy' sequel. The movie, which has proven to be an enormous commercial and critical success, has already been lined up for a sequel - but director James Gunn has...
Read more on Movie Balla