Convertible notes, if well structured, can be a simple, flexible and cost-effective way for a start-up to raise funds. Start-ups can offer convertible notes, which are debt instruments that may be converted to equity, to raise capital, instead of offering shares to investors at the very outset.
Common Pitfalls Start-Ups Must Avoid
Are you thinking of setting up your own business?
Do you know what you should be aware of and what to avoid?
Entrepreneurs are, by definition, ambitious and driven and have an exceptional understanding of their industry which is the result of their research and experience. However, new entrepreneurs may nevertheless fail to identify common pitfalls when setting-up and growing their business. Below is a list of common pitfalls to avoid.
Choosing the wrong vehicle
Choosing the appropriate vehicle should never be based on what other entrepreneurs are doing. The business structure adopted should account for your and your start-up’s specific needs. It is crucial to allocate time and resources to obtain the proper tax and structuring advice.
Having the wrong equity structure
From the very beginning there should be an agreement setting out clearly who should be entitled to what. Informal agreements could prove difficult to evidence in the case of a disagreement down the line. Formal allocation of equity is fundamental. At the outset, this should be discussed and resolved to ensure that the structure is formally documented, avoiding confusion and disputes. Allied Legal regularly prepared shareholders’ agreements specific to the needs of its clients.
Purchasing an off-the-shelf constitution
This may seem to be a good way to save money when setting up a new venture. However, an off-the-shelf constitution could leave you exposed later on. A start-up should always take the time to ensure that the right governance mechanisms and protections are in place as this helps provide (among other things) aclear framework for decision making moving forward.
Not understanding financing arrangements
Investment of any form can come at a cost. It is important to make sure that you clearly understand the small-print before committing. Engage legal assistance to ensure that you are clear on the terms and conditions associated with proposed financing arrangements and potential covenants that your start-up must adhere to.
Not protecting assets
At the risk of stating the obvious, protecting the assets of a business is critical to protecting its overall value. If a business holds and relies on intellectual property rights, then these should be registered where it is appropriate to do so or otherwise secured. A contract-based business (eg – service providers), should have clear contracts in place. A business with valuable information and trade secrets should ensure that disclosures are only to the extent required and pursuant to a robust non-disclosure agreement. There are many other mechanisms available to protect business assets. Advice should be sought early to ensure that your start-up’s assets are protected.
Applying the wrong incentives
Equity should not be given away too early or lightly. However, if equity is to be offered, consider mechanisms such as creating a new class of share with limited voting rights or making the issue of shares conditional on the meeting of performance targets.
Misleading the market
Unrealistic performance targets in the early stages can lead to some start-ups going too far with the representations and promises they make. This can lead to distrust and long-lasting negative impact on the credibility of the business and its owners. It is important to remember that false or misleading statements can put customers and investors off-side and may also give rise to serious legal ramifications.
Focusing solely on the present
Dollars in the bank and winning that first contract are extremely important. However, this should not consume all of your time. Allocatingtime and resources to the fulfillment of present and future business goals is more likely to ensure that your start-up will survive and thrive in the long-run. Having someone on board who is able to pre-empt potential mid-to-long term risks and issues is the best way to ensure success.
Neglecting legal issues
Lawyers’ fees may be considered as an unnecessary cost and something that can be avoided. However,this is a very short-sighted perspective. Lawyers do not have to cost “an arm and a leg” and finding the right adviser early will pay dividends in the long run. Having a commercially savvy legal advisor on your side can be critical to your start-up’s success.
Contact Allied Legal
Allied Legal’s commercial lawyers in Melbourne regularly assist entrepreneurs and start-ups and take great pride in seeing them flourish. We provide free 30-minute initial consultations to help understand your needs. Please contact us when you are ready to seek specialist advice: http://alliedlegal.com.au/contact/.