There are numerous legal hurdles associated with startups. Many entrepreneurs lack the legal knowledge or counsel to successfully navigate the most common pitfalls, especially when it comes to their blind spots: friends and family. Involving friends and family members in a new business venture can give it the financial boost needed to succeed, but it can also cause legal problems down the line. Are you covering the legal bases to protect your business and preserve relationships down the road?
Co-Founding a Business with Family and Friends
When working with people they know, many entrepreneurs skip the appropriate contracts and agreements, instead choosing to rely on personal feelings and blind trust to protect the company. (“Joe would never do anything to hurt me. We are family, and will always look out for each other.”) But when there’s no written contract or legal agreement, it’s easy for bad blood to arise. When co-founding a business with friends or family members, make sure you determine in writing:
- The long term goals of the business and how those will be achieved
- The roles/responsibilities of each founder for the business
- The expectations for each founder’s investment of time and capital (upfront and later)
- Starting salaries and how you will determine raises (both for partners and for future employees)
- The process of making key decisions
- What percentage of the company each founder will own, and whether that percentage is subject to change
- What steps to take if one business partner isn’t investing time or resources according to expectations
- How to approach the sale of the company
- Steps to take in case of legal disputes
Raising Startup Capital
Entrepreneurs often turn to the people closest to them when raising funds to start a business. Family and friends are an easy source of funding, but there are numerous pitfalls associated with raising startup capital from people in your inner circle.
- 90% of new companies fail during the financing stage, and 60% after receiving financing. Many entrepreneurs don’t appropriately convey the downfalls when seeking funding from family and friends.
- Many people aren’t knowledgeable enough to determine if they’re making a good investment or a bad investment, and a familial connection muddies these waters. Entrepreneurs should take care not to fall into the trap of over-valuation of stock.
- During the financing stage, many businesses don’t have set governance or corporate structure to determine how they’ll use the raised capital.
Entrepreneurs often fall into another pitfall when seeking funding from family and friends: ignoring legal requirements. The sale of stock, LLC interests, and limited partnership interests are subject to securities laws and other legal requirements. Failure to adhere to these requirements can result in hefty fines, even if the company has foundered. Before selling stock to family and friends, entrepreneurs should:
- Comply with federal and state regulations for disclosure, filing, and form requirements.
- Fully understand any exemptions (e.g. private issuer exemptions, business associates exemptions, accredited investor exemptions, etc).
- Report all exemptions appropriately and within the required time period.
Avoid the potential pitfalls of starting a business by seeking legal counsel from Brownstein & Nguyen LLC.
