Starting a new business is not an informal process, and should never be treated like a hobby between friends. Unfortunately, as a startup advisor and angel investor, I’ve seen too many ventures with great potential get destroyed or set back by legal and other shortcuts that should never have been allowed to happen. The path to true success does not allow for shortcuts.
I’m not suggesting that any startup needs to demand perfection, but I do recommend that all learn and follow common business practices from the beginning. Mark Zuckerberg can tell you a horror story about how his early informal breakup with a co-founder ultimately cost him a settlement later worth four billion dollars. For many others, shortcuts have cost them everything.
I’m not talking about fraud, or even intentional efforts to mislead anyone. Here are a few examples of situations and results I’ve seen that occurred due to ignorance, poor communication, lack of a paper trail, or procrastination:
Count a discussion between friends as a firm agreement. I’m not suggesting that formal legal documents are always required, but agreements without some paper or email trail are easily forgotten or misconstrued. A co-founder who loses interest and backs out early will likely be back to claim his half after you reach unicorn status.
Delay incorporating until required by investors. This approach has tax implications you won’t like, since the IRS will tax your founder’s shares immediately at the valuation you give investors. If you incorporate much earlier, and file the proper forms with the IRS at that time, there will be no taxes until much later when shares are sold.
Reveal “secret sauce” before filing intellectual property. Filing a provisional patent costs very little if you do it yourself, and it holds your place in line for a year. Trade secrets need to be documented and dated, and business plans labeled as confidential. The alternative is to watch someone else claim first rights of ownership, with no recourse.
Do not disclose your new venture to a current employer. I always suggest an early and open discussion with a current employer about a new venture you are contemplating. Clarify up front the potential for a conflict of interest or violation of a non-compete clause, and confirm the answer in writing. Late surprises lead to lawsuits.
Give away more equity than required to drive the business. A common myth these days is that every startup needs an investor, and large investments are better than small ones. In reality, the most common startup success results from bootstrapping, and too much money leads to poor control and sloppy decisions. Don’t give away your business.
Skip any due diligence verification on interested investors. You may be getting desperate for a cash infusion, assume that money is always green, and forget that every investor is as different as every employee. While fraud is always a potential concern, a more real issue is finding partners who support you rather than seek to control you.
Rely on commitment to a higher cause to get you through. Remember that all businesses, even non-profits, require revenue to survive and prosper. The fact that your business is “green,” or cures world hunger, does not guarantee you investors, or even customers. Reality check first your sizing of the opportunity, competition, and margins.
Running a successful business is all about effective written as well as verbal communication, documented agreements, and conformance to legal and business norms. Too many entrepreneurs assume they can save money or time by shortcutting these early, and catching up later after the business has more traction. They forget that good business practices lead to success, not the other way around.
Actually, the biggest shortcut I see in new entrepreneurs is a lack of planning ahead. I recognize that every startup will encounter challenges that could not be anticipated, but it pays big dividends to avoid the ones that can be anticipated. You won’t survive if you don’t learn first from the mistakes of others, and insist on repeating their expensive shortcuts, as well as inventing your own.
*** First published on Entrepreneur.com on 04/22/2016 ***