Common Costly Legal Mistakes Made by Founders of Early-Stage Companies
Welcome to the WilmerHale Launch blog. I’ve been working with founders and for more than 20 years (OMG—that means I am really old) and I’ve seen some amazing success stories. Great ideas turned into great technologies turned into industry-leading companies.
Unfortunately, I’ve also seen a lot of duds. Lots of times, those duds start out as great ideas with great teams. But often, despite the quality of the idea, somewhere along the way someone steps on a landmine and things fall apart. Sometimes these landmines are unavoidable or at least hard to navigate—the market may not be ready for your idea, or maybe it just turns against the direction in which you’re going. But when it comes to legal landmines, if you just think ahead and get good advice, you can typically avoid them—especially at the outset. And avoiding them means saving money, time and maybe even the life of your company.
I’ve seen the movie play over and over. This post is the first of a series in which I’ll highlight some of the most common and costly mistakes you can make when starting your company. Avoid these things and the success of your company will be decided by the merits of your idea and the quality of your execution—not by a legal stumbling block.
Mistake #1. Choosing the Wrong Type of Entity
If an entrepreneur plans to raise money from VCs or use equity to provide incentives to employees and consultants, forming a Subchapter C corporation makes the most sense. Everyone wants to have an LLC these days—that’s what your best friend’s cousin’s girlfriend (who is a lawyer, of course) says you should have, right?
Well, LLCs can be complicated and expensive to operate. They aren’t necessarily expensive to set up, but if you do anything other than just have a single owner, they are more complicated than corporations. And if you raise any sort of external capital—forget it. It can start costing tens of thousands of dollars right out of the gate. Also, did you know that equity incentives are more difficult to use in an LLC? Most of the tax benefits of LLCs can be obtained by operating a Subchapter S corporation, which can easily be converted into a Subchapter C corporation at the time of financing.
So if you want to start a consulting business, a restaurant that you’ll own or some other small business, an LLC might be OK. But if you want to build a company that will raise external capital (e.g., from venture capital investors), use equity to compensate your employees, etc.—do yourself a favor and incorporate as a Delaware corporation.
Stay tuned for Mistake #2!