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Common Entrepreneur Mistakes
Presented by Bart Greenberg
Haynes and Boone, LLP

Lloyd Greif Center for Entrepreneurial Studies
Marshall School of Business, USC
May 25, 2011

© 2010 Haynes and Boone, LLP

The Wrong Business Structure


The “De Facto” Partnership

 What is it?
 Problems:
• Ownership of IP
• Vicarious Liability


The “Wrong” State of Formation
 California vs. Delaware
• California is shareholder friendly
• Delaware is management friendly
 Special Case of the So-Called Quasi-
California Corporation
 Why You DON’T Necessarily Want to
Be in Nevada
• You will most likely pay taxes
• The law is not as well defined

Failing to Make the “S Election”
 Consequences of Subchapter S Election
• Pass-Through of Income
• Pass-Through of Losses
—Pros
—Cons
 DON’T Miss Filing Deadline
• RU Dead in the water?
• Retroactive S Election?


Keep it Simple!
 Don’t Over-Build at Start-Up. Avoid the
Following:
• Multiple operating companies or special
business units (Subs)
• Related party engineering, development or
service companies
 Restructuring Can Be Expensive and
Involve Negative Tax Consequences


The Wrong Team


Putting off the Inevitable
 Most Start-Ups Tend to Be Too Quick to
Hire and Too Long to Fire
• Don’t hire Just because someone will work
for equity or for free
• Things will get worse and much more
complicated to unwind
 Avoid Urge to Hire friends & Family
 Avoid Those With “Checkered” Pasts
 Recognize Your Own Limitations

Mishandling the Inevitable
 DON’T Violate California Labor Laws
• An employee who is discharged must be
paid all wages, including accrued vacation,
at time of termination
• An employee who quits must be paid all
wages, including accrued vacation, within
72 hours of quitting
 ALWAYS get releases from liability on
separation (even if you have to pay for
it!)

Failing to Protect the IP


Failing to Get IP into Company
 Two Typical Approaches:
• Contribution for equity
• Licensing arrangements
 Factors to Consider:
• Protection from creditors
• Additional “Fields of Use”
• Tax considerations


Creating Clouds on Title to IP
 The “Moonlighting” Founder
• Under Section 2870 of the California Labor
Code, Employer owns IP unless:
—Employee developed entirely on her own time; and
—Employee did not use employer's equipment,
supplies, facilities or trade secret information
• Exception for any of the following IP, that:
—Relates at time of conception to employer's
business, or actual or demonstrably anticipated
research or development of employer; or
—Results from any work performed by employee for
employer.

Creating Clouds on Title to IP (cont.)
 Other Employment Related Issues:
• Get employment agreement in place before
employee starts work
—Obligations to execute assignments and to
reasonably cooperate
—Non-solicitation of employees, customers and
vendors
• Check for pre-existing duties of confidentiality to
former employer
• Ask to see employment agreement from former
employer

Creating Clouds on Title to IP (cont.)
 Issues Relating to “Work for Hire” (i.e.,
Contractors)
• GET consulting agreement in place BEFORE
consultant starts work
• Without a suitable agreement, you may
“own” nothing more than a limited license
to use what was developed, even though
you paid for the work!
• Negotiate for ownership UP FRONT, before
a deal is pending

Treating Stock Like Water


Oral Promises of Equity
 Oral Agreements ARE Enforceable
 The Problems with Oral Agreements are:
• Terms are never well defined or fully thought
out
• Difficult for employer to disprove claimed
existence of such an arrangement
 “Sleeping Dogs” Tend to Wake Up When
Exit is imminent


Using Equity as Cheap Currency
 Know What is Market. How Much is
Too Much?
 Keep an Accurate Capitalization Table
 Look for Alternative Ways to Finance the
Business: Bootstrap!
 DON’T Forget About Compliance with
Applicable Securities Laws


Not Enough Strings Attached
 Use of Restricted Stock and Vesting
 ALWAYS use a probationary period
 Repurchase Rights Upon Termination
 All Equity Should Be Made Subject to a
Shareholders’ Agreement
• Restrictions on Transfer
• Rights of First Refusal
• Repurchase Rights on Trigger Events
• Tags, Drags and Shotguns
• Proxies and Voting Agreements

Failure to Maintain Corporate
Formalities


What Corporate Formalities?
 Hold and Properly Document Meetings to
Authorize All Requisite Corporate Actions
 Maintain and Keep Separate:
• Minutes Books & Accounting Records
• Bank Accounts
• Insurance & Licenses
• Contracts and Leases
• Letterhead and Stationary
 Don’t Run Personal Items Through the
Company

Consequences to So Maintain

 Alter Ego Liability (aka “Piercing of the
Corporate Veil”) to Third Parties
 Contracts May Be Voidable at Option of
Third Parties
 Liability to Equity Holders for Breach of
Fiduciary Duties
 The Company May be “Unfundable”


Not Leaving Enough Runway


Underestimating Capital Requirements
 Make Sure Your Projections Are Sound
(Then Double Your Cash Requirements!)
 Make Sure Your Capital Sources are For
Real – Get it in Writing!
 Think Long and Hard About Quitting
Your Day Job


Seeking Capital Too Early
 Build the Business First, Then Seek
Capital
 DON’T Lose Focus and Permit the
Business to Suffer While You Seek
Capital
 Only Seek Capital From Appropriate
Sources


Wasting Time by Spinning Wheels
 GET Educated; Learn What is Market
 Network with Appropriate Referral
Sources
 DON’T Work with Finders Unless You
Have a Referral from a Trusted Source
• They will gladly take your money
• They could waste precious time


No Contingency Plan in Place

 ALWAYS Have a Back-Up Plan
 Pull the Trigger BEFORE it is Too Late


Questions?


Common Entrepreneur Mistakes
Thank you!

Presented by Bart Greenberg
Haynes and Boone, LLP
(949) 202-3037
bart.greenberg@haynesboone.com


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