Mistakes You Should Avoid During Incorporation
To err is human, they say. However, mistakes in business can be costly and dangerous to your investment. It is best to avoid mistakes at the start that is why it is important to know about the common mistakes that a lot of fresh businessmen make when incorporating their new businesses.
The incorporation stage is the last step to starting your own business. However, its status as the last step is not a measure of its exact importance.
When incorporating, it is important to make certain of a few details as this could cause trouble for you in the future. They may not take effect right away and you could incorporate successfully without minding these details, but it can be difficult for you to secure funding when you need to later on.
First, you should avoid offering only one type of stock to your investors. It is a common mistake between neophyte entrepreneurs to stick only to common stock when authorizing shares to be issued. You should include preferred stock in your authorized shares as well. Some investors may want to purchase preferred stock in a company because preferred stocks guarantee constant dividends regardless of the profits or losses that the company incurs even though they have different voting rights in the company.
Some new entrepreneurs also make the mistake of giving away or issuing a lot of common shares to its investors during the startup stage. This is a major mistake. Although having a lot of investors in the company is a good thing, there should be a limit as to how much should be available to them as a whole An ideal way of allocating stock would be to reserve up to two-thirds of your authorized common shares for future use while issuing the remaining minority to the founders of your company.
It can be tempting as a new business owner to give a high value to your shares as a way of attracting investors. However, this is counterproductive as investors will purchase small amounts of shares to avoid the so-called “phantom tax,” or income tax imposed from the value of the shares issued to them. The best way to come up with conservative share valuations is to calculate the amount of your total assets at the time of incorporation at balance sheet value, and subtract the total value of your existing corporate liabilities.
If you are running a technology-based business, then make sure your company holds all rights to patents under its name. Although it could be understood that the company has the right to use the patents invented by its founders through a license, it still does not own those patents. This can cause problems later on when seeking venture capital or establishing license agreements with other companies.