Entrepreneurs typically start businesses because they believe the product or service they are offering is either unique in the marketplace or they can do it better than existing providers. In this process, entrepreneurs often recognize the need to establish a formal business entity, but don’t always appreciate that their initial choice can have a wide-ranging effect on how the company operates and grows.
Here are a few variables for entrepreneurs to consider as they set up their new venture:
Owners and decision-making
If a company is founded by multiple individuals, they should have direct conversations with each other about how decisions will be made, and who is needed to make both operational and larger, fundamental decisions.
Decisions can vary in significance from who to hire and what to offer in compensation to whether the company wants to take investment from an outside investor or sell all of its assets in an acquisition. These scenarios are on opposite ends of the spectrum in terms of magnitude, but co-founders should discuss these possibilities. More “operational” and simple decisions may only need a simple majority while larger, fundamental decisions may need a larger vote.
Similarly, co-founders should have discussions on the buy-sell provisions or transfer restrictions they want to impose on themselves or other owners of the business. These provisions can vary in how restrictive they are; having the conversations with an experienced attorney to help guide you through the choices is important.
Although it was true before, it is even more so now in light of federal tax reform: The selection of an entity and how such an entity is taxed (e.g., a partnership versus a S-corp versus a C-corp) can have significant ramifications in the year-to-year operation of the business, but also if the business is sold. The selection of an entity is often dependent on what the business does and its long-term growth plans.
Structuring for growth, investment
Depending on what the business intends to do and whether it will be seeking outside investment, this variable can either be the least or most important. To entrepreneurs looking to form a small business without any outside equity investment, this discussion is often pretty short. However, if you are a scalable startup looking to raise multiple rounds of outside investment, this discussion is often lengthy and nuanced.
Each scenario is unique, but factors that are significant in this discussion are 1) when does the company intend to raise money, 2) who are the first potential investors (individual friends and family, angels or venture capital funds) and how much are they intending to raise, and 3) where do they intend to raise money (i.e., locally, regionally or nationally)? The discussion with a group of co-founders who intend to raise significant capital from venture funds or sophisticated angel investors within the next 6-12 months is different than a group that intends to raise a small amount of capital from friends and family, and do not intend to raise capital from angel or venture capital investors for over a year.
These topics are just the tip of the iceberg when it comes to the topics that are often discussed with clients ahead of formally establishing a business. Having these discussions early is often beneficial, and makes entrepreneurs more knowledgeable and confident that their legal affairs are in order so they can focus on growing their business.
This column was published in the January 29 edition of the Corridor Business Journal; a digital version is available on the Corridor Business Journal website (subscription required).