10 Most prevalent mistakes while forming a company
While everyone around seems to have a great business idea, not everyone has the preparation to take the idea to the next level and form a company. And those who do, sometimes don’t know if what they are doing is right or wrong. Many people will tell you that forming a company is easy. In fact, you can form your company online with no advice or guidance from us right now. Unfortunately mistakes are often made that are easily avoidable.
These mistakes can range from being as small as a typo error to being as big as a serious legal issue. Hence, it is always better to be on the safe side and have proper understanding of the process as far as the company formation is concerned.
We have compiled a list of 10 most prevalent mistakes that people make while forming a company.
1. Operating without getting the proper local business licenses
Just because you have registered your company doesn’t mean you don’t have to follow the guidelines of your local municipality when it comes to getting proper licenses and permits. At times the owners discover they are not in compliance with local business ordinances–even if they are properly registered and thus pay thousands in fines or back taxes, or worse, a combination of both with loads of additional penalties. Hence, it is better to be safe than sorry and be compliant to all the local documentation requirements.
2. Not filing periodic paperwork or taxes as required by your state
Even after your company’s registration, a certain amount of maintenance and follow-up is needed to keep your operations in compliance. These could be monthly, quarterly, annual, etc. This might include updates on ownership, any changes in the resident agents, changes in corporate officers, and of course, any tax liabilities for your particular state or municipality. Failure to file current paperwork or taxes, can be a costly proposition for companies that need resources to go to more productive uses than late fees or fines. This is especially true if you have employees and are subject to payroll taxes and other statutory benefits. So, always make sure that you are compliant and no paperwork is pending.
3. Not having enough capital
Lack of capital can be detrimental to a corporation keeping its corporate veil. If at any point of setting up your venture, you are sued as a corporation and you don’t have enough revenues, assets, capital or insurance to cover your liabilities, some courts will aggressively pursue you as an owner and hold you personally liable and you might end up losing your personal assets, hence, it is always good to have enough capital in hand while setting up a company.
4. Appointing minors in the company
As per law it is illegal to employ minors in certain kinds of jobs, however, at times some companies resort to such acts. Under the Companies Act a company director cannot be less than 16 years old. We do not recommend that you appoint anyone under 18 years of age as a company director or shareholder. Doing so can affect your bank account application and business contracts in the future as minors may not be able to legally enter into contracts. Hence, always be careful while hiring any minors.
5. Having too many directors
Being a company director is a very responsible position to be in and hence, it is very important that the director is well aware of his/her responsibilities. It is also very important not to have too many directors for a company. Not all employees should be directors and not all shareholders should be directors. It is important that anyone being appointed as a company director is aware of their legal responsibilities and is happy to accept them.
6. Having too many shareholders
Shareholders are entitled to a share of the profits and have rights within the company. Hence, similar to the above point not all directors ‘running’ the company should be shareholders and ‘owners’ of the company. You should choose your shareholders carefully because like you they will also be the owners of the business.
7. Registering at a wrong address
As a practice, all companies must have an effective address for the registered office. Hence, before forming a company it is very important to finalise the address from where the company will be operating. Any application with a post box address or an incomplete address may be rejected by the department. Hence, always have a address in place which you can register as your office under the companies act.
8. Not having a clear deal with your co-founders
You absolutely have to agree with your co-founders early on what the deal is among you. Not doing so can cause enormous problems later. Pushing this to a later date can get you into legal hassle at times. You should be clear about a few points while striking the deal with your co-founders:
- Who gets what percentage of the company?
- What are the roles and responsibilities of the founders?
- If one founder leaves, does the company or the other founder have the right to buy back that founder’s shares, and at what price?
- How much time commitment to the business is expected of each founder?
- What salaries (if any), are the founders entitled to? How can that be changed?
- How are key decisions and day-to-day decisions of the business to be made? (majority vote, unanimous vote, or certain decisions solely in the hands of the CEO?)
- Under what circumstances can a founder be removed as an employee of the business? (usually, this would be a Board decision)
- What assets or cash into the business does each founder contribute or invest?
- What happens if one founder isn’t living up to expectations under the founder agreement? How is it resolved?
These are just few of the discussion points that you can have, you may increase or decrease the questions based on your business requirements
9. Not having a proper contract
It is very important that your contract is in favour of the company. Almost every company should have a standard form contract when dealing with customers or clients. Here are some key items to come up with your form of contract:
- Get sample contracts of what other people do in the industry. There is no need to re-invent a contract.
- Make sure you have an experienced business lawyer doing the drafting, one that already has good forms to start with.
- Make sure you make it look like a standard form pre-printed contract with typeface and font size.
- Don’t make it so ridiculously long that the other side will throw up their hands when they see it.
- Make sure you have clearly spelled out pricing, when payment is due, and what penalties or interest is owed if payment isn’t made.
- Try and minimize or negate any representations and warranties about the product or service.
- Include limitations on your liability if the product or service doesn’t meet expectations.
- Include a “force majeure” clause relieving you from breach if unforeseen events occur.
- Include a clause on how disputes will be resolved. Our preference is for confidential binding arbitration in front of one arbitrator.
10. Not focusing on the intellectual property protection
If you have developed a unique product, technology, or service, you need to consider the appropriate steps to protect the intellectual property you have developed. Some of the common protective measures undertaken by start-ups include protecting your patents, copyrights, trademarks, service marks, trade secrets, confidentiality agreements, confidentiality and not competition clause for employees. All these form the major intellectual property items which every startup founder should aim at protecting.
It is often best that the founders retain a firm that can handle some, if not many, of the areas of expertise listed above so as to provide continuity between the founders and their lawyers. In addition to the above, there are other mistakes that can be made during the company formation process. Getting sound financial and legal advice may up your cost slightly, but in the long-run, the costs of doing things right pale in comparison to the hard costs of being in the wrong type of corporate structure. Or worse yet, finding yourself subject to fines and penalties you never knew existed. So, make sure that you have all the necessary legal and social requirements in place before forming a company.