Many of my clients are new entrepreneurs who are developing mobile apps, exploiting new renewable energy sources, creating lifestyle brands, etc.  While this is an exciting time, starting a new business can be fraught with countless risks.  

My job as their business legal adviser is to offer counsel that helps avoid or manage the risks inherent in starting a new venture.  Risk management is not about trying to anticipate and mitigate every conceivable risk.  That’s impossible, even with the best team in place. 

Instead, it is about recognizing and mitigating the most obvious risks a new venture will face, and doing so in a cost efficient manner.  The most successful start ups develop a culture that responds to unexpected developments in a calm, methodical, and rational way.

As a legal adviser to startups, I routinely impart advice to clients to reduce some of the risks new businesses will inevitably encounter.  What follows are the top five tips every startup should follow.

1. Know Your Co-Founders Like You Know Yourself

Starting a business with another person is like getting married.  Founders of a business spend as much, if not more, time with their co-founders as they do their spouses.  And, as in marriage, business partners who do not know, like and trust each other should not go into business together.

The beginning of a business relationship should be like a honeymoon with every person on his best behavior, putting her best foot forward, and generally having a great time creating something new.  If the “honeymoon” period is rife with tension, arguments, distrust or deception, then the remainder of the business relationship is going to be infused with these negative traits.  As time passes, these traits will likely only be exacerbated.  When the relationship sours beyond repair, a business divorce is oftentimes more stressful, costly and time-consuming than a marital dissolution.

Tips for Going Into Business with Friends

With that in mind, it is imperative that founders have some clarity about each of the partner’s goals and expectations about the venture.  My clients are given a document to complete that serves as the starting point for conversations about setting the ground rules for how the company will be organized and what happens if things do not go as planned.  It is critical for founders to have an honest conversation and get answers to some basic questions, including:

  • What are the responsibilities of each person in the company?
  • How much time is each founder going to devote to the business?
  • What will each founder contribute?
  • Who is responsible for making what decisions?
  • How and when are the founders going to be paid?

If the answers to these questions are troubling or non-existent, then the partners should not join forces.  In the long run, it is better to find the right people to go into business with than to jump into a bad union, hoping the initial concerns dissipate or disappear.

2. Don’t be Penny Wise and Pound Foolish

Money is the one thing every startup will need to grow.  Whether the money is provided by the founders (or their close friends and family) or from investors, founders must be great stewards of the company’s funds.  With that in mind, there are some things a company should spend money on and other things that can wait.  No startup needs Aeron chairs and stylish Swedish cubicles to bring their product or service to market.  Those things are nice, but usually not necessary.

One thing every startup should budget for is legal services.  Founders must find an attorney who understands the issues inherent in building a company from the ground up, such as protecting the company’s intellectual property and properly documenting various business relationships, especially the one between the business partners.  With this in mind, a friend who practices criminal law is probably not the best person to advise startups.  Like doctors, lawyers have different practice specialties.  Finding a business attorney with start-up experience is key to protecting a promising venture.

Many entrepreneurs learn the hard way the value of legal counsel after getting legal advice from a non-business attorney, using an online service or trying to do it themselves, often with the same negative and costly results: transactions are not properly documented, there is no agreement between the founders, the one-size fits all document did not fit their needs, etc.  Being frugal is admirable and a must in certain situations, but trying to save money by cutting corners on legal advice rarely works to a company’s advantage. 

A trusted legal adviser is worth her weight in gold.  While the initial costs are not cheap, it is far less expensive to properly set up a new company than it is to fix mistakes down the road.  Many startups are just one law suit or dispute away from going out of business.  Sage advice from a business attorney can mitigate that risk.

Why Legal Advice is a Good Investment

3. Get Everything In Writing

Get everything in writing, especially among business partners.  When starting out, the relationship between founders is friendly and building a company is exciting (that honeymoon period).  Without a written agreement, success (and money) inevitably leads to amnesia and amnesia leads to costly litigation.  

Entrepreneurs should hire a business attorney to draft an agreement that spells out that which person is responsible for doing what, how much money each of person will put in, what happens in the event someone needs to leave the company, etc.  Having answers to these and other scenarios can prevent costly in-fighting among founders and disruption of company operations.  A well-drafted Shareholder or Operating Agreement will take the guess work out of questions that arise during the course of a business relationship.

Many founders who do not take the time to memorialize business transactions find themselves on the eve of costly litigation or settlement negotiations.  A transaction that would have only cost a few thousand dollars to document is now going to costs tens of thousands of dollars to settle.  And, that’s the best case scenario. 

The worst is having the dispute go to litigation without any written documentation about the details of the transaction or agreements that are woefully inadequate.   These cases take years to resolve, provided the parties can afford to litigate them to their conclusion.  The moral: it tends to be less expensive to draft an agreement at the beginning of the venture than to try to clean it up after the fact, when the partners are not speaking.

The $20 million Business Divorce

4. Put Together the Right Team

The individuals on the start-up team will be crucial to the success of a venture.  The talents and experiences of the partners should complement one another.  Founders should resist the temptation to be surrounded by “YES” people.  The ideal start-up team should include at least one dreamer and one skeptic who knows what he is talking about.  If founders are surrounded by too many dreamers, too many people who unquestionably follow their lead, these people will merely rubber stamp bad ideas without asking the tough questions.  It is important to have someone who plays devil’s advocate, who says NO and offers good reasons for doing so, and who routinely gives founders a reality check.  Equally as important is that founders LISTEN and HEED that advice.

For one of my clients, we assembled a board of advisers comprised of professionals with industry-specific knowledge and vast experience working with startups.  This board consists of a CFO, CEO, an attorney and an IT specialist.  This allows our founder / inventor to focus on what she does best: create incredible concepts that can be brought to fruition.  People with these skill sets should be a part of the team either as founding members, paid professionals or volunteers:

  • Someone with a finance background to advise on business accounting and financial issues.
  • CPA to address business tax issues.
  • An attorney to advise on business legal issues, including the properly setting up a corporate entity, drafting partnership and buy-sell agreements, and addressing IP and employment issues.

5. Prepare for the Unexpected (or Hope for the Best, But Prepare for the Worst)

One of the most important lessons for founders to learn is that things are going to happen over which they have no control and that are unforeseeable.  No matter how comprehensive the plan and timetable are, expect the roll out and completion of the plan to take much longer than anticipated.  No matter how detailed and well researched the amounts in a budget are, expect actual costs to be more.  Shipments will be delayed.  Technology will fail at the most inopportune times.  Key staff members will quit, others will be fired. 

The founders at successful businesses that have experienced these growing pains and lived to tell about it tend to have something in common: they were prepared for, or able to quickly adapt to, the change in circumstances.  They prepared back-up plans and executed on those plans when necessary.