Avoiding Key Legal Mistakes in Startup Companies: Part 3
Part three of our blog series on common legal mistakes made by startup companies focuses on the importance of documenting the roles and responsibilities of founders. “Define the relationship.” It is a phrase borrowed from the dating world, and one that is frequently associated with a lot of anxiety. If you ever heard your significant other say, “we need to define the relationship,” you may not have been sure whether what was coming next would be positive or negative.
Just like dating, it is important to define the relationship in business. A common mistake I see with startups is a failure to document the roles and responsibilities of founders and investors. It is crucial to define the relationship when it comes to each and every individual or entity involved with your startup. Doing so eliminates ambiguity and demonstrates what is expected out of everyone now and moving forward.
3) Clearly Detail the Founders’ and Investors’ Roles and Responsibilities.
Do not leave a founder or investor’s role with the startup to a simple conversation and handshake. This increases the risk for potential future conflict. Instead, clearly document every individual’s role within the startup. Write it down in clear and unambiguous language. Address everything from a founder’s day-to-day responsibilities, to a founder’s percentage of ownership in the startup. If a founder or investor is giving something up in exchange for ownership in the startup, document that in writing as well.
Address how decisions of the startup are to be made. What types of decisions are to be made by the founders, and what procedures should the founders follow in making them? For those decisions that boil over into disputes, how should such disputes be resolved? It is important to include a mechanism for resolving any impasse the business reaches, whether it be by voting or other means.
Just as everything has a beginning, it also has an ending. People move on, and it is important to address the exit strategy for the business, as well as its founders and investors. If a founder departs from the startup, how will the departing founder’s stock be handled? Will the departing founder retain temporary voting rights until they are completely unaffiliated with the business? Will the founder be temporarily prevented from competing with the start-up?
This is just a small number of the details that are important for any startup to consider. It is crucial to consult with an attorney in order to make sure your startup is adequately documenting the relationship among the founders as well as the relationship between the founders and the startup itself.
Each of these aspects of your business, plus many more, should be documented within an operating agreement. Having an operating agreement that defines the roles and responsibilities of founders and investors is especially good because many banks will ask to see one when you first open a business account anyway.
Defining the relationship is almost always a positive thing when done right. Contact us today to find out how we can help your business avoid this common legal mistake.
In case you missed the earlier posts in this series, check out each of the other parts here: Part 1, Part 2, Part 3, Part 4, Part 5, Part 6, Part 7, and Part 8.
*The material and information in this blog is for general informational purposes only. In no way is this information to be construed as legal advice for a particular situation.*