My business partner and I are looking into incorporating our new professional engineer recruitment firm. What should we consider when we prepare these documents? We want to avoid making early mistakes.
Every startup entrepreneur is busy—really busy. There are business plans to write, projections to prepare and products to design. In their desire to get ahead, it’s easy to overlook the very issues that can slow down any promising company.
If you incorporate your business yourself or through online tools offered by most state’s business licensing websites, there aren’t too many mistakes that can’t be corrected with the help of legal counsel. In most cases, attorneys come in to amend or improve the precision of corporate filing to match business needs or requests by prospective investors.
So here are a few things to know as you prepare to incorporate a business:
- Authorize preferred stock too.
Young companies that expect to raise funds from private investors and venture funds should incorporate with two classes of stock: common stock and preferred stock. Business founders should receive common shares. Preferred shares should be set aside for future investors.
How many shares should you authorize? There is no one right answer. High growth businesses that expect to raise funds from investors might start with 20 million shares of common stock and 20 million shares of preferred stock. Entrepreneurs who incorporate in states like Delaware that charge annual fees based on total authorized shares should consider smaller numbers.
- Beware of over-allocation of shares.
Founders tend to distribute too many common shares to founders, first employees and consultants. Here, entrepreneurs should demonstrate restraint and issue no more than say one-eighth or one-quarter of authorized common shares to founders and reserve the balance for stock option plans and other corporate needs.
- Omit certain shareholder rights.
Entrepreneurs should consider omitting provisions in corporate articles of incorporation that allow shareholders to acquire additional shares in future financing transactions. These rights should be negotiated on a per transaction basis.
- Get a stock purchase agreement.
Agreements among business professionals are best laid out in writing to avoid future misunderstandings. And because startup companies typically take longer than originally expected to complete product development or generate revenues, one or more founders can lose career interest in the venture.
At the time of business formation, all founding partners should agree on the length of service that is required in order to “vest” or retain rights to founders shares of stock. These documents are difficult to put in place after founders shares have been issued.
This is a very short article and probably too general for your specific situation. My best advice is to start interviewing capable securities and corporate attorneys who can help on incorporation as well as other big issues for your new company. Hire the attorney who you feel comfortable asking lots of questions without intimidation. Interview three for best comparison purposes!