Common Issues That Make Startups Sputter

Common Issues That Make Startups Sputter

This online series, written by Wright Lindsey Jennings' Rodney Moore and published by Arkansas Business, examines various legal issues commonly faced by businesses.

The power of entrepreneurship has never been stronger. 

In Arkansas and elsewhere, the mechanisms of creation, promotion and distribution of ideas and products are at the fingertips of most people. The historic barriers for entry into the marketplace are giving way. And perhaps the most exciting aspect of this climate is that nobody knows what the next big thing will be – which means it could be your idea that takes off. 

But many startups miss their opportunity because they sputter before they start. Here's four obstacles to startup success and how to avoid them:

Putting Your Engine in the Wrong Vehicle

One of the first steps for a startup is choosing the type of entity vehicle in which to place its entrepreneurial engine. Limited liability companies, or LLCs, are easy and cheap to establish and work perfectly for many forms of businesses. 

But if the startup needs investors to inject capital (and nearly all do), an LLC likely will not be the best vehicle – indeed it may prove to be the wrong vehicle. For example, professional investors often insist that the vehicle be a Delaware corporation because they prefer the business-minded laws of that state and the corporate structure provides for better equity options than an LLC. 

Failing to Designate a Driver

Successful one-person startups are rare because multiple expertise and effort are typically required to conceptualize and market a new idea. Most often, the talent and sweat of multiple people combine to spark a successful startup. 

Take for example a software company formed by a computer programmer and a marketing person. Often when they set up the entity, the ownership will be allocated 50/50. But what happens if, six months later, they can't agree about an important business decision? Many businesses sputter because the founders reach an impasse. 

To avoid this issue, startups should consider an unequal ownership structure or management agreements that provide a mechanism for breaking an impasse. At a minimum, the founders should consider a “silver bullet” provision, which provides a mechanism to force an end to the joint ownership of the company.

Another problem that arises with equal ownership can occur when one of the founders loses interest in the business. In our software company example, what if the marketing person stops peddling the software? The programmer is stuck with an equal owner who's not carrying his or her weight. 

To address this issue, startup founders should consider vesting schedules for ownership over multiple years with stated expectations for participation of each founder in the development of the business. 

Allowing a Syphoning of Resources

Often startups are born of some new concept or technology. The creators of these types of work have intellectual property rights. Many startups neglect to have these intellectual property rights assigned to the business entity. 

If the founders are the only people involved and they're still getting along, this can be an easy problem to fix. But what if other people were involved in creating the software and they won't agree to assign their rights? 

Purchasing these rights and/or litigating about these rights can be very expensive, effectively syphoning the resources needed for the operation of the startup. So it's best to address intellectual property rights sooner rather than later.

Inviting the Wrong People to Ride

Investors are essential for most startups, and the options — angel investors, venture capitalists, crowd-funding — are expanding rapidly. But soliciting and acquiring capital investors is fraught with danger. 

First, many startups aren't familiar with securities laws and are shocked to learn that taking cousin Eddie's investment may be illegal. 

Second, not all investors are subject to the same rules. Accredited investors, who have a certain net worth or income level, are not protected the same as investors of lesser means – meaning it is advantageous for startups to deal with accredited investors. 

Third, each new investor brings a new agenda and set of concerns. An overly demanding investor can wreak havoc on the operation of a startup. Moreover, potential new investors may be attracted or repelled by the existing investors. Startup owners should exercise diligence in soliciting and selecting investors. 

To avoid these problems, and others, that cause startup businesses to sputter before they start, entrepreneurs should seek advice from attorneys, accountants and other professionals who are familiar with the legal and financial needs of start-up businesses. 

Better to check the health and viability of your startup before it sputters at an inopportune time down the road.