Five Legal Points to Remember in Starting a New Business
1.Delaware or Georgia – Measure Twice?
As a business founder, when it comes to entity selection you will hear about Georgia and Delaware (mostly). You will hear terms like “S Corporation” or “Limited Liability Company”, or “C Corporation”. Don’t follow the crowd, instead take some quiet time to review with your lawyer the (often many) pros and cons, and practically evaluate your business goals and methods, all so that you can carefully determine which type of entity best fits YOUR needs. Here are some situations you might find yourself in when considering Georgia or Delaware:
- You believe that Delaware has cachet and that it is a universally recognized and popular choice. But if you’ve formed a Delaware corporation and chosen Delaware law in your agreements with a third-party supplier, do you later want your corporation defending a contract claim 800 miles away in a Delaware court?
- You know at the outset that your business will depend on a certain private equity investor’s expected cash infusion—the likelihood that the PE investor will require a Delaware C corp may be so high as to trump all other pros and cons.
- You don’t want to pay Delaware’s high annual franchise taxes merely because your corporation’s articles of incorporation authorize, for example, 100,000 shares.
- The second layer: that because your Delaware corporation’s office or employees are in Georgia, the entity must also register with the Georgia Secretary of State as a “foreign” corporation “qualified to do business” in Georgia. If it doesn’t, in addition to fees and penalties, the corporation will be denied access to Georgia state courts as a plaintiff until it registers.
- You are a majority member of a Georgia LLC with a sophisticated minority member investor. Do you want to miss the opportunity provided under Delaware law (and rarely available elsewhere), to limit your duties to the minority member?
The above are just examples, but as you see a host of factors must be considered before making the choice. When it comes to entity selection, it’s best to “measure twice and cut once.”
- First Priority –A Buy-Sell and Governance Agreement
Many lawyers say that the most important document in a corporation’s minute book is the Shareholders’ and Buy-Sell Agreement, and the most important document in an LLC ’s minute book is the Operating Agreement. The reason: these documents contain the entity’s operating manual and should address every major event that is reasonably likely to happen in the entity’s life.
Like what? Agreements upon: percentage ownership; voting, participation and consent rights; company titles; Board or Board of Managers seats; keeping the S election intact if it has filed an S election with the IRS; and rights to participate in another owner’s sale of ownership interests.
More importantly, the key issues of buy/sell: death, disability, termination of employment and regrettably, disagreement over roles, performance, personality mismatches or the entity’s business direction.
All should be addressed. Finish the charts before the ship sails, don’t wait until the first storm.
- Avoid Unwitting Warranties – Terms and Conditions
Whether you are selling a good or a service, terms and conditions matter. And in the case of goods, “going without” may not have the effect you expect. Because under the Uniform Commercial Code, a commercial seller of goods, absent proper disclaimers or limitations, automatically provides two implied warranties to its buyers, whether the parties know it or not: a) the warranty of merchantability, and b) the warranty of fitness for a particular purpose. So your attention should early on turn to this vital aspect of selling to third parties.
Further, it is rare for businesses to deal with customers without standard and customary terms of sale, limitations on liability, indemnities, and related provisions. Creating and deploying proper terms and conditions at the beginning in a careful, businesslike and tailored way that takes into account the particular needs, risks and features of both your business and its customers, can help shield the entity from future risk.
- Third Party Contracts: Make Sure the Deal You Have Is the Deal You Think You Have
Early in the life of a business, the entity will likely enter into a range of agreements in areas concerning employment, restrictive covenants, supply and vendor relationships, or licensing. For every contract there are at least 2 main enemies: ambiguity and missing pieces. Ambiguity arises from ill-considered or vague word choices. It also arises from contradictory provisions, whether in the same sentence, the same document or even in a separate document. Pieces can “go missing” when one assumes the other’s intentions, or when the drafter intentionally omits a concept as “unnecessary,” or just plain forgets. Follow the “so easy to say rule”—if that’s what you mean, then say it, plainly and clearly.
Finally, a third enemy, public policy: some contract provisions invoke important public policies so that even though the language is perfectly clear, without court modification (if allowed) the provisions are unenforceable on their face, as being against public policy. An example is a beautifully drafted and precise post-employment noncompete – with no time limit or territory, and therefore likely unsalvageable.
Documents demand care to preserve the deal you think you have.
- “Insure It and Forget It”
You’ve heard the phrase “insure it and forget it.” Well, don’t forget –early on– to put in place a businesslike insurance program to protect your new entity’s business and assets. Selling products? Consider product liability insurance. Providing services? Consider an errors and omissions liability policy. (E&O). Have outside directors, or passive investors who are owed fiduciary duties? Consider a directors’ and officers’ liability policy (D & O). Expect to have numerous employees? Consider an employment practices rider to your policy. Premiums generally drop with use of higher deductibles that in effect allow the entity to “self-insure” for smaller matters, while protecting against catastrophic risks.
The above list is not comprehensive. It provides an overview of some steps and decisions that may at first seem unimportant or of low priority—but actually their timely performance is crucial to a healthy start. They, along with other steps and documents, must be part of a carefully constructed startup package that will give your new business the greatest chance for a bright future.