Tips for New Business Ventures (Part One)

It’s a new year and perhaps a new time for creating a new business venture or investing in a private business opportunity. It’s a complicated decision. If you are putting money into an opportunity you have to analyze and understand the business plan, the management of the company, the marketplace, and your fellow owners. If you plan to put sweat into the business by working as an officer or employee you have to do all those things plus accept the pressure of generating enough money to pay your salary and those of any other employees. Unless you have a lot of experience or invest professionally, what you are not likely to do is spend a lot of time on the documents that form the company and govern its operations.

Let’s face it —amidst all the competing demands for time and money when a new venture gets going, paying a lawyer to draft the articles of incorporation and bylaws seems like a ministerial task that costs way more than it should. But be careful. A failure to plan well at the beginning can create disaster later on and plenty of owners that poured years of money and effort into generating a successful business have found themselves pushed out of their own companies while the rewards of their work went to others.

Just like a couple eager to get married, it can seem unduly pessimistic to listen to advice on all the way things can go wrong. I get it – the title of this website is Texas Business Divorce – an unlikely place to come for advice on what happens or perhaps should happen at the start. But we repeatedly find ourselves counseling clients on how the documents they signed when things started are affecting and often limiting their options now that they are dissatisfied and need to exit.  So with that in mind, we have a couple of tips for new ventures and new investments. Everything I am going to say is a generality that may not be true in your case.

Tip #1

1. Don’t use the form documents

It happens all the time. Three or four people decide to start a new company. Maybe one or two plan to provide the know-how and work at the business and the other two agree to provide initial capital to fund the startup. They carefully plan how they are going to leverage their pot of capital to start the company. Perhaps they go pull form documents off the internet or maybe they find a lawyer and ask him to represent all four of them by preparing a set of form documents to create their new business. They want to keep the price low so they hire a single lawyer, offer a flat fee, and ask for the most standard set of form documents to start their new company. Maybe they skim through the generic bylaws or company agreement quickly and everything seems routine and harmless.

Let’s talk about why this can be a terrible idea.

When in your life has the standard form document ever been to your personal benefit. Your first apartment lease, car purchase, cell phone contract, cable tv contract, credit card agreement. These kind of form documents almost universally favor whatever business is on the other side and do nothing to help you as an individual. Why would you think that the standard form corporate formation documents would be any different?

Why is this the case? Transactional lawyers get hired by corporations to draft provisions for corporations and those standard corporate formation documents for your new business are drafted to that same end, which is to give your new business all the power and flexibility and rights. But what those form documents almost never do is look out for you as an investor and owner.

But let’s draw an important distinction. If you are going to own 75% of the new business and also going to be its President, you might be very happy with standard form documents that are going to empower the company at the expense of the smaller shareholders who own the other 25%. But if you are one of the 25% shareholders or have to share control with others, those form documents might render your investment almost worthless right from the start. And as we are going to discuss in a later tip, there is a lot of value (and saved legal fees later) to treating people fairly from the outset.  

Understand that form documents are drafted to advantage the new business as an entity and unlikely to do much to protect the rights of individual investors in that entity. And form documents won’t contain provisions that reflect the specific agreements you and your co-owners or co-investors made with each other as part of starting the business.  Those all need to be discussed and added in. This includes things like making additional capital contributions, paying distributions, having owners serve as key employees, handling a request to be bought out, adding new investors, etc. Most of these issues don’t require a lot of ink to address but they do require discussion and agreement and usually one or more lawyers. But how that lawyer gets hired and who they represent is the subject of tip #2.

Part Two in this series will discuss the role of the attorney in starting a new business and the importance of hiring your own.