Discover the top mistakes to avoid in DIY incorporation. Learn about entity selection, state registration, corporate governance, and more to ensure a successful business launch.
by LawInc Staff
November 30, 2023
With over 415,000 new business formations annually in California alone, company incorporation has become virtually mainstream. However, going the DIY route also comes loaded with legal complexities that business owners often realize too late.
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When starting your corporation, being aware of and circumventing the biggest pitfalls is instrumental to growth. This guide outlines the 10 most significant DIY incorporation mistakes plaguing startups and small business ventures today.
1. Improper Name Selection
Key challenges in selecting a business name for incorporation.
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- Trademark Infringement: Using names too similar to existing brands invites crippling litigation.
- Rejected Filings: Names violating regulatory rules face application rejection, delays and expenses.
- Poor Marketability: Names difficult to find online lose business opportunities with weak SEO.
Example:
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- Miles filed incorporation papers only to redo everything once the name he selected got rejected.
- Maria launched her biz before checking for trademark conflicts, getting sued shortly after.
How to Avoid:
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- Vet names thoroughly before filing incorporation paperwork.
- Search trademark databases to uncover conflicts.
- Assess web visibility, spelling issues, restrictions across state lines.
Frequently Asked Questions:
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- Can my DIY name search fully clear trademarks? No, consider professional screening, especially if incorporating nationally.
- What are other business name risks? Excessive length, confusing spellings, prohibitive words, poor web visibility, etc.
2. Incorrect Business Structure
Exploring the impact of business structure selection.
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- Personal vs Limited Liability: Sole proprietorships and partnerships expose founders’ personal assets to business lawsuits and debts.
- Wrong Investor Appeal: LLCs and corporations have different investor preferences for funding channels like VC, private equity etc.
- Tax Inefficiencies: LLC taxation as sole proprietorships can mean higher self-employment taxes vs corporations.
Example:
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- Lacy launched as an LLC but struggled for funding better suited for C-Corp startups.
- Corey’s sole proprietorship left personal assets vulnerable when his biz was sued.
How to Avoid:
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- Evaluate all impacts of entity types – taxes, liability, investors, operations, profit-sharing.
- Amend later if business needs change after launch.
- Work with a business lawyer to select the optimal structure.
Frequently Asked Questions:
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- What are the most common types of business entities? Sole proprietorships, partnerships, LLCs, S-corps and C-corps.
- Should I amend business structure after launching? Yes, if goals, liability risks, taxes or other factors change.
3. Incorrect State for Registration
The significance of state selection in business registration.
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- Tax Implications: Different state tax rates, laws, compliance rules and operating costs apply.
- Interstate Operations: “Foreign” out-of-state filing requirements create administrative burdens if unaddressed.
- Protected Names: Businesses can’t always use legally approved names from original state when expanding.
Example:
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- Wendy couldn’t use her Delaware LLC name in Florida causing registration rejection.
- Mike’s Texas company paid steep California taxes by not establishing proper nexus rules.
How to Avoid:
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- Consider where you’ll operate before incorporating.
- Understand regulations should your business expand across state lines.
- Research options and plan ahead to avoid administrative headaches.
Frequently Asked Questions:
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- How do I select the right state for my business entity? Factor in location, taxes, interstate operations, compliance needs, etc.
- Can I operate nationwide if incorporating in only one state? Yes, but you must register as a “foreign” corporation in all other states.
4. DIY Corporate Bylaws & Minutes
Understanding the pitfalls of DIY corporate governance documents.
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- Inconsistent Rules: Copy-pasting or winging bylaws leaves gaps inviting legal disputes.
- Shareholder Risks: Poorly crafted operating agreements jeopardize investor rights down the line.
- Deficient Meetings: Skipping or messing up board/ shareholder meeting minutes puts actions and deals at risk.
Example:
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- James lost financing after investors spotted deficiencies in corporate bylaws he drafted.
- Paula’s expansion plans hit roadblocks from skipping proper board approvals and documentation.
How to Avoid:
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- Have lawyer-drafted, customized bylaws and operating agreements prepared.
- Don’t skip proper documentation process for major corporate actions and deals.
- Review bylaws every few years and update as needed.
Frequently Asked Questions:
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- Isn’t following online DIY templates enough for proper bylaws? No, custom drafting aligned to specific business needs is ideal.
- What parts of minutes must I document? Board approvals, major transactions, equity issuances, corporate changes, etc.
5. Skipping Startup Filings
The importance of timely startup filings for compliance.
- State Tax Registration: Skipping business license, sales tax or employer ID registration triggers penalties.
- Annual Reporting: Not filing statements of information or annual minutes risks suspended status.
- Employment Documentation: Lacking worker classification, I-9s, W-2s etc opens liability for labor lawsuits.
Example:
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- Alice couldn’t open a bank account with her new corporation after failing to file regulatory docs.
- Sam faced tax audits and penalties over missing employer ID and staff I-9 forms.
How to Avoid:
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- Use lawyer-assisted incorporation to ensure full compliance filing.
- Mark deadlines for annual report and tax submissions.
- Keep corporate records organized in case of audits or inquiries.
Frequently Asked Questions:
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- What are the most commonly missed regulatory filings? Annual reports, tax registration/returns, trade name/business license applications.
- Where can I find reminders for state compliance deadlines? Check your Secretary of State website or work with a business law firm.
6. Inadequate Company Records
The critical role of maintaining comprehensive company records.
- Ownership Confusion: Failing to issue proper stock certificates and keep shareholder ledgers intact can create disputes.
- Tax Issues: Inconsistent/missing expense receipts, P&L statements etc. heighten chances of IRS audits and penalties.
- Legal Action: Lacking minutes, contracts etc. hampers defense against lawsuits over corporate governance or deals.
Example:
- Wendy couldn’t secure a bank loan lacking proper documentation of assets and finances.
- Ahmed’s expansion plans failed amid shareholder lawsuits from incomplete company ownership records.
How to Avoid
- Use lawyer incorporation services to establish thorough corporate recordkeeping processes.
- Continuously maintain ownership, tax, contracts, HR and financial records.
- Conduct periodic audits to confirm documentation completeness.
Frequently Asked Questions:
- What are the most essential corporate records to maintain? Bylaws, meeting minutes, stock ledgers, licenses, contracts, tax returns and filings.
- Should I organize records digitally or physically? Best to have both. Digital for accessibility and physical copies for signature validity.
7. Unclear Shareholder Agreements
Understanding the nuances of shareholder agreements.
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- Inconsistent Ownership Terms: Conflicting vesting schedules, allocation of shares or classes causes internal disputes.
- Asset Protection Deficiencies: Intellectual property ownership and decision-making authority clauses left incomplete exposes liability risks.
- Leadership Control Issues: Ambiguous voting vs non-voting structures breeds management conflicts that freeze growth initiatives.
Example:
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- Tina’s co-founders blocked her removal attempt due to undefined shareholder agreement terms on founder firing.
- Kai’s startup imploded from co-founder disputes over vague intellectual property ownership clauses.
How to Avoid:
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- Develop founder agreements addressing roles, vesting, exits, voting control from the start.
- Conduct periodic shareholder agreement reviews as ownership changes.
- Address IP ownership rights in operating agreements or separate contracts.
Frequently Asked Questions:
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- What parts of shareholder agreements cause the biggest issues later? Founder control clauses, equity splits, vesting and IP rights.
- When should you amend shareholder contracts? With shifts in ownership stakes, investor arrivals, founders departing, and other material changes.
8. Employee Equity Allocation Errors
The pitfalls in employee equity allocation in startups.
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- Incentive Alignment: Failure to structure performance-based equity results in disproportionate owner-employee incentivization.
- Tax & Regulatory Non-Compliance: Form W-2, fair market valuations, public filings among common oversights diluting equity value.
- Losing Talent: Restricted equity vesting or buyback terms being too strict demotivates employee-owners.
Example:
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- Liam lost his co-founder and engineers after misconfiguring employee stock option plans.
- Eric incurred large tax bills and penalties from improper issuance of staff equity grants.
How to Avoid:
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- Develop strategic employee equity compensation models aligned to value-add.
- Get lawyer support designing watertight equity agreements compliant on all regulatory aspects.
- Balance business growth incentives with motivating staff retention via equity.
Frequently Asked Questions:
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- What legal oversight is vital for employee equity allocation? Tax compliance, fair valuation, corporate authorizations, regulatory filings.
- What equity types can staff receive? Typically stock options or restricted stock units.
Quiz
Common Legal Mistakes to Avoid When DIY Incorporating
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- Q1: Selecting a business name without properly vetting risks: A) Higher taxes B) Trademark disputes C) Excessive paperwork
- Q2: Winging corporate bylaws using online templates can cause: A) Board disputes B) IRS audits C) Inconsistent rules
- Q3: Choosing an entity type like LLC without evaluating owner liability risks: A) Membership rules B) Asset protection C) Tax incentives
- Q4: Not filing regulatory documents properly after incorporating risks: A) License delays B) Bank account denials C) Slower growth
- Q5: Informally issuing equity to staff and co-founders risks disputes over: A) Corporate control B) Legal compliance C) Financial records
- Q6: Failing to appoint officers and issue stock certificates can cause: A) Shareholder lawsuits B) Tax issues C) Ownership disputes
- Q7: Not recording & maintaining key corporate records heightens: A) Operational risks B) Financing denials C) Regulatory oversight
- Q8: Leaving shareholder buy-sell agreements incomplete fuels fights over: A) Leadership changes B) Profit sharing C) Equity rights
- Q9: Informal staff equity compensation risks noncompliance with: A) Tax rules B) Employment laws C) Financial regulations
- Q10: Registering a Delaware corporation then expanding nationally without understanding regulatory obligations can trigger: A) Higher franchise taxes B) Added reporting C) Steep penalties
- Q11: Not valuing equity instruments properly on tax documents leads to: A) IRS audits B) Loss of incentives C) Litigation risks
- Q12: Skipping or botching board resolution meetings/minutes puts corporate decisions like: A) Asset sales B) Hiring contracts C) Loans into question
- Q13: Failure to define roles & responsibilities for multi-founder corporations abets: A) Leadership conflicts B) Stalled growth C) Employee confusion
- Q14: Without a lawyer double-checking your startup filings you risk: A) Suspended status B) Tax penalties C) Registration delays
- Q15: Not recording IP license terms in shareholder agreements leaves asset ownership: A) Ambiguous B) Vulnerable C) Unvalued
- Q16: Botched securities offerings filings can cause: A) Funding delays B) SEC violations C) Devalued equity
- Q17: Failure to define founder vesting forfeits protection if: A) They quit prematurely B) Get fired for cause C) Retire too soon
- Q18: Without accounting expertise, classifying expenses incorrectly risks: A) Tax penalties B) Investor issues C) Financial audit triggers
- Q19: Not tracking employee hours properly can prompt: A) Labor department fines B) Staff leave C) HR problems
- Q20: If corporate records like contracts or tax documents aren’t retained adequately you expose: A) Litigation risk B) Leadership liability C) Audit triggers
Answers: Q1: B Trademark disputes, Q2: C Inconsistent rules, Q3: B Asset protection, Q4: B Bank account denials, Q5: A Corporate control, Q6: C Ownership disputes, Q7: B Financing denials, Q8: C Equity rights, Q9: A Tax rules, Q10: C Steep penalties, Q11: A IRS audits, Q12: C Loans into question, Q13: A Leadership conflicts, Q14: B Tax penalties, Q15: A Ambiguous, Q16: B SEC violations, Q17: A They quit prematurely, Q18: A Tax penalties, Q19: B Staff leave, Q20: A Litigation risk
Summary
While the internet makes DIY incorporation highly accessible, adequate legal, financial and administrative fluency is still vital for laying compliant foundations that fuel scalable business growth.
We hope this guide brought helpful clarity on some overlooked complexities of the incorporation process that often invite preventable yet painful pitfalls down the line if unaddressed early on.
By taking proactive measures and securing the right guidance to counter the most common missteps new business owners make, your venture can avoid potential disputes, liability issues, disputes or dissolution—setting you up for a higher likelihood of long-term success.
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