Common Founder Mistakes

Hey everyone, Alex here with some stories to share on some pitfalls for founders to watch out for. While not an exhaustive list, here’s a list of common mistakes I’ve seen founders make that harm the ability to raise funds, maintain a productive workforce, and eventually sell the company.

1. Cutting Corners. This includes, but is not limited to, obtaining the necessary professional advice to build the proper compliance, tax, financial, and legal framework to limit issues investors or a prospective acquirer will discover during due diligence and could kill the deal. Dozens of times a year we have clients come to us who used online services and screwed up important things during the formation stage. They then end up paying new attorneys two to three times more than they would have paid had they worked with a competent attorney from the beginning.

2. Lack of a Data Room. The failure to create an organized data room with company records exposes the company to day-to-day operational issues and hinders long-term success. A cap table management platform can be very helpful, and we also advise our clients to set up a company email such as dataroom@[startupname]. Then, whenever the company has signed contracts, scanned copies of corporate records, or financials, leadership can email it to the dataroom@ email and it should help eliminate corporate records from slipping through the cracks. I had a CEO tell me he was up all night trying to close out a deal because he had to track down NDAs, signed employment agreements, confirmation of 83(b) elections, etc. that were requested by the lead investor’s counsel during due diligence. Utilizing a simple alias like dataroom@ email may have eliminated such a stressful evening.  

3. Understanding the Time Commitment That Goes Into Raising Capital. Raising capital can be a full-time job, and founders wear multiple hats. Finding an appropriate balance between product development, establishing the company culture, and making appropriate hires, all while also attempting to track down investment, is extremely difficult. Having a plan of attack that allows founders to manage their time wisely helps reduce burnout and preserve important cash and resources.

4. No Network. As the saying goes, your network is your net worth. Founders can have a great idea, but no track record or connections. You learn a lot when it is not your first rodeo, and that includes making important connections to help open doors. Having advisors who can make important connections goes a long way to creating a path for success.

5. You Need A Story That People Can Get Excited About. When you’re raising capital, you’re actually a salesperson who is convincing investors why your company and vision are a good investment, and getting investors excited about and invested in where the company is going. 

   For example, startup founders come to me often and say, “I’m going to raise money using a SAFE, should it be a discount SAFE or a valuation cap SAFE, I see these are the two popular options”. When this happens, I encourage them to take a step back and ask first if a SAFE is even a smart vehicle to use. 
   
   The SAFE form was created by YCominbator, a prestigious incubator. Therefore, if you’re a startup that is graduating from the program, you’re going to have a lot of investors interested in investing. However, if you have no track record, a SAFE may be a tough sell as (i) it has no interest rate, and (ii) there is no majority date. Therefore, sophisticated investors may want you to consider a convertible note, which may be a more attractive proposal for the investor.
   
   However, let us say you are using a SAFE and need to decide on if you’re going to use a discount SAFE or a valuation cap SAFE.  The decision is tied to your narrative and what and how you’re selling your company and your vision. If your pitch to investors is that you are raising a bridge fund to float you until a large, fixed price round in the next 3-6 months, then a discount is appropriate. You’re selling that you’ll offer a discount as a “thank you” for investing a few months before the round. However, if your pitch is that you’re doing a SAFE round now and then a larger round in 12-18 months, then unless the discount is very large, investors will expect their investment to offer a bigger return than 10-25% increase in value during a period in which the money was tied up in a SAFE and not earning any interest. They’ll want to lock in a valuation cap to achieve a higher reward as an early investor who invested when the company was at its most risky state.

6. Get a Co-Founder with Different, Complimentary Skills. Starting and building a company, and doing so while trying to avoid the pitfalls mentioned above, takes a varied skill set (and a lot of time). Most people will not be able to unilaterally have a great idea, keep company documents organized, negotiate contracts, manage finances, find and utilize a strong network, tell a great story to investors, and raise capital, all while also building a new product or service. While hiring an effective team can take a lot of this off of your plate, having a co-founder whose skills compliment your own will strengthen company leadership and effectiveness.

Hopefully, after you’ve read this article you’ll be able to avoid these kinds of common mistakes. That said, raising money is complicated, so if you still have questions or are looking for help with legal issues for your business, you are more than welcome to contact us at hello@archetypelegal.com.

Beneficial Owner Reporting - Corporate Transparency Act

In 2021, Congress passed the Corporate Transparency Act (“CTA”), a law requiring a new beneficial ownership information reporting requirement as part of the U.S. government’s efforts to make it harder for bad actors to hide or benefit from improper gains through shell companies or other opaque ownership structures.

Starting January 1, 2024, the CTA will mandate "reporting companies" to submit a report to FinCEN, disclosing info about their "beneficial owners." Those formed before 2024 have until 2025 for their initial report. Proposed regulations issued on September 27, 2023, extend the initial report deadline for companies formed between 2024 and 2025 to 90 days from formation. Companies formed after 2025 must report within 30 days.

A reporting company encompasses entities filed within the US or foreign entities doing business within US states, territories, or Indian tribes. There are over twenty types of entities exempt from the reporting requirements. These entities include, but are not limited to, publicly traded companies meeting specified requirements, banks, venture capital fund advisors, insurance companies, inactive entities, many nonprofits, and certain large operating companies.

"Beneficial owners" are individuals who directly or indirectly control or own at least 25% of an entity's ownership interests and it is normal for companies to have multiple beneficial owners. Accountants and lawyers who provide general accounting or legal services are not considered beneficial owners as standard arms-length advisory or other third-party professional services are not considered to be “substantial control.”

For companies formed after 2024, up to two "company applicants" must be identified. A company applicant is an individual who directly files or is primarily responsible for the filing of the document that creates or registers the company. 

Reports will include full legal names, birthdates, current addresses (or business addresses for company applicants involved in entity formation), and ID information from documents like a US passport, driver's license, or foreign passport if no US document is available. If you are required to report your company’s beneficial ownership information, you will do so electronically through a secure filing system available via FinCEN’s website. This system is currently being developed and not available at the time this blog is published.

You can find the answer to many FAQs here, and as new information comes out we plan to create a helpful checklist and other resources to aid our clients with these new reporting requirements. Archetype is committed to helping our community stay compliant, and don’t hesitate to reach out if there is any assistance we can supply on this matter, or any others.

California's Employee Pay Data Reporting Law

On September 30, 2020, California Governor Gavin Newsome signed SB 973 into law, which requires private employers with more than 100 employees (irrespective of employee’s location) to report certain pay data to the Department of Fair Employment and Housing (DFEH) by March 31, 2021 and on a yearly basis thereafter. While California will be the first state to require such employee data be submitted to state agencies, the general requirements of SB 973 won’t be new to many employers. 

Existing federal law currently requires certain employers file with the Equal Employment Opportunity Commission (EEOC) an annual Employer Information Report (EEO-1) which contains employee data. SB 973 seems to mimic the Federal law and posits that on or before March 31st of each year (starting March 2021), private employers in California with 100 or more employees who are also required to file an annual report with the EEOC, must submit pay data to the DFEH related to its employees covering the prior calendar year. For purposes of SB 973, an employee is an individual on an employer’s payroll whom the employer is required to include in an EEO-1 report and for whom the employer is required to withhold federal social security taxes. 

The DFEH will maintain data for a minimum of 10 years and is generally prohibited from making public any personally identifiable information contained within the data submitted. Personally identifiable information submitted to the DFEH under SB 973 requirements would generally be treated as confidential information and most often will not be subject to a California Public Records Act request. 

Employers subject to SB 973 generally have to report the following: 

1. The number of employees by race, ethnicity, and sex for the following job categories: executive or senior level officials and managers; first or mid-level officials and managers; professionals; technicians; sales workers; administrative support workers; craft workers; operatives; laborers and helpers; and service workers. 

2. The number of employees by race, ethnicity, and sex who make an annual amount within each of the pay bands used by the U.S. Bureau of Labor Statistics in the Occupational Employment Statistics survey (including the hours worked by each employee)
   

Employers with multiple establishments will have to file a single report for each establishment and file a consolidated report that includes all employees.  In submitting the data, employers are permitted to provide clarifying remarks on the data, but are not required to do so. Employers are permitted to submit a copy of their EEO-1 Report to satisfy their reporting requirements under SB 973. Failure to comply with SB 973 or provide the required data may result in the DFEH or the Employment Development Department (EDD) seeking an order requiring compliance and the DFEH or the EDD are entitled to recover any costs associated with seeking such an order. 

On November 2, 2020, the DFEH issued a frequently asked questions (FAQ) page to assist with compliance. The current FAQs provide background information on why this data needs to be collected, whether the pay data submitted will be publicly available, various data privacy and protection concerns, and answers other miscellaneous questions to ensure compliance. More information from DFEH and EDD to assist employer-compliance will most likely be released as we get closer to the filing date requirement.

Accounting Tips for Small Businesses

When entrepreneurs begin the process of turning a business idea into a reality, many of them run into the unfamiliar world of business accounting for the first time. While consulting with specialists like CPAs and tax attorneys is often a good idea, there are a number of basics that every small business owner ought to know.

Separating Accounts

One of the most important steps to take when starting your own small business is to keep your personal expenses and income separate from your business ones. An essential step toward this is opening a business checking account from which you can pay your team, as well as business expenses such as your monthly business credit card statement.  

To open a business bank account, most banks will require you to show (i) your filed Articles of Incorporation (if you own a corporation) or Articles of Organization (if you own an LLC), (ii) your federal Employer Identification Number (often referred to as your business’s EIN), and (iii) operating documents, such as your bylaws or operating agreement.

A separate account is crucial to protect against the claim that the owner failed to take the business seriously and is instead operating as themselves personally, and therefore, should not be granted personal liability protection. One of the key factors a court will look at when deciding if the personal and business affairs were kept separate is the strict use of a separate business bank account.

Create Regular Profit and Loss Statements

A profit and loss statement (P&L) is a financial statement that summarizes revenues, costs, and expenses incurred during a specific period of time. A P&L will look at the total revenue you’ve generated in your business and itemize expenses into costs of goods sold and operating expenses. You obtain your business profit by subtracting your total expenses, including taxes and interest, from your total revenue. 

A P&L is a helpful tool to allow the business owner to understand if they are operating at a profit or a loss, and if done consistently, you can compare this to other time periods. Comparing allows you to understand if business strategies and tactics are taking hold, and give you a better insight into profits and growth.

Track Business Expenses

It’s important to get a receipt for any expenses incurred on behalf of your company. Not only does this practice help you prepare monthly, quarterly and annual P&Ls, but is necessary when it comes time to report your taxes.  In order to claim both partially or fully deductible business expenses you need the receipt for proper verification and tracking. 

Some examples of business expenses that can be deducted, include, but are not limited to: staff salaries and benefits, software and subscription services, business meals, education, insurance, marketing, professional fees, supplies, interest, and travel expenses.

Keep it clean, keep it relevant, keep it actionable

Your books are going to become one of the primary sources of data for tracking and reporting your business’s performance. Your P&L mentioned above is a big part of that data. As such, you want to make sure that not only are books accurate for tax purposes, but they’re also relevant and actionable for your own decision making.

Clean books – in addition to just staying up to date on entering your expenses, make sure they expenses are added with the right date, vendor, and category (to help with deductions). Your P&L will offer few insights (and be a headache for your tax preparer) if the months don’t reflect when expenses were incurred or the categories are inconsistent from month to month. A couple of important tips:

• Avoid categorizing expenses as “miscellaneous” 

• Make sure invoices and payments are paired to avoid double-counting expenses

• When writing checks put the invoice number(s) on the check and indicate what it is for on the memo line
  

Relevant data – besides being accurate, expenses should be in appropriate categories and months to give a clear picture of the business’s performance. Books that are not accurate from a tax perspective may not be giving you a clear picture or be easy to understand. A couple tips: 

• Familiarize yourself with accrual and cash basis accounting (it’s simpler than it sounds) and track expenses in the month they were incurred to avoid months with big jumps in expenses due to timing of payments

• Organize your expense categories to group similar expenses so you can track patterns in spending and draw insights

Take action – 

Setting your records up early with a plan will save a lot of time and effort down the road as you expand your business reporting to gain deeper insights into the business.

Stay on Top of Tax Deadlines

Almost all small businesses are required to file estimated quarterly tax payments.  Quarterly taxes are due April 15, June 15, September 15, and January 15. Set reminders for at least a month before to make sure you don’t miss these deadlines. 

The quarterly tax payments are made up of two types of taxes: income tax on your company’s profits and self-employment taxes. For a business operating in California, this includes California Franchise Taxes, federal taxes, and, for pass through entities such as a standard LLC or an entity taxed as an S-Corp, personal quarterly tax payments based on estimated earnings.

This blog was co-authored by Alex King of Archetype Legal, and Chase Spenst of Ground Control.

Disclaimer: This post discusses general legal and tax issues and developments, is intended to serve as informational only, and may not reflect the most current law or tax regulations in your jurisdiction. These informational materials are not intended, and should not be taken, as legal or tax advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel or tax professional in the relevant jurisdiction.  Archetype Legal PC and Ground Control expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this blog post.

Non-Solicitation Clauses in Employee Contracts are No Longer Enforceable

Employers in California have long understood that non-compete clauses (clauses specifically prohibiting an employee from working for a competitor after their termination) in employment agreements are generally unenforceable. This restriction is based on California Business and Professions Code Section 16600, which states that, “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void,” and California’s “strong public policy of protecting the right of its citizens to pursue any lawful employment and enterprise of their choice.” See Dowell v. Biosense Webster, 179 Cal. App. 4th 564, 575 (2009).

While including a non-compete clause in an employment agreement can in itself risk liability for an employer, other restrictions on an employee’s conduct after their termination have been permissible, including non-solicitation clauses that prohibit former employees from “raiding” an employer’s workforce by reaching out to former coworkers to try to hire them at a new company.  In November 2018, however, the California Court of Appeal for the Fourth District held that employee non-solicitation clauses are also invalid under Section 16600, and two courts in the Northern District of California have since agreed.  

The courts in these cases followed the same logic as those that barred non-compete clauses - non-solicitation clauses limit employees’ job opportunities by creating fear among employees and employers that hiring employees from the same company may risk expensive litigation, even if intentional “raiding” had not occurred. As a result, non-solicitation clauses are now also both unenforceable and grounds for attorney fee awards, and employers should consult legal counsel before including such provisions in an employment agreement.

Employers still have the right to protect their trade secrets and confidential information from use and disclosure by former employees, so employment agreements should be properly drafted to restrict employees’ post-termination actions to protect these assets. However, if employers simply don’t want employees to leave, the employers need to provide incentives to stay, rather than unenforceable restraints on their employees’ job mobility.