In the early stages of a business, a solo entrepreneur or small group of founders are forced to do it all – business planning, marketing, sales, bookkeeping, management, human resources…the list goes on and on. While founders are focused on all of these roles and accompanying decisions, it’s easy and convenient to look for a quick, easy and inexpensive fixes when it comes to the legal steps to forming a business entity.
Below are the three most common mistakes I see founders make when forming a Pennsylvania business entity:
- Using a seemingly inexpensive online service to form a business entity for you.
One of the first legal issues a new business faces is the formation of a business entity like a limiited liability company (LLC) or a corporation. As I discussed in this article, the primary benefit of setting up a business entity is to shield the owners’ personal assets from liabilities incurred by the business. A quick Google search reveals results like: “Form an LLC in 3 Steps”, “Form an LLC in Pennsylvania – 20% off Exclusive Web Discount”, and “$49 – Form Your PA LLC – Start Your LLC in 10 Minutes”.
While the temptation may be to use one of these services to quickly and inexpensively check this off of your to-do list, I’ll remind you of the age-old saying “you get what you pay for.” I discussed the potential pitfalls of using these services at length in Beware of Legal Forms Obtained Online, but suffice it to say that mistakes or oversights in the formation process can be costly and may severely inhibit the success of a business.
- Jumping to conclusions about the type of business entity you’d like to form.
In our initial consultation, when I ask “what brings you in today?”, entrepreneurs often ask me to help them create an LLC. While some believe that LLC stands for “Lawyer’s Likely Choice”, there are many different types of entities that can be created, which, depending on your current and future plans for the business, may be better alternatives. How many owners will there be? Are you planning on bringing on investors? What type of business do you plan to carry on?
Your attorney, often times with input from your accountant, should go over the options and the pros and cons of each type of business entity.
- Failing to document operating rules when there are multiple owners of a business.
Ownership disputes are costly, time-consuming and can ultimately be fatal to a business at any stage. That’s why creating an operating agreement, bylaws, shareholders agreement or similar document is important from the outset, so that while everyone is getting along, you can agree on certain rules that will apply to everyone in the business in the event of a disagreement down the road. The provisions that are typically covered include:
- A statement of the current ownership of the business.
- Management structure and voting rights on business decisions.
- Dispute resolution provisions.
- Voluntary transfer restrictions on ownership in the business.
- Involuntary transfer restrictions, including what happens if someone dies, becomes disabled, gets divorced or goes into bankruptcy.
- Valuation of the business in the event of a voluntary or involuntary transfer of an interest.
- Tax status of the business.
Your attorney should be able to help you navigate the ins and outs of creating a business entity, as well as identify any other legal issues and risks that may be specific to your business.