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Start-up companies and the dangers of generic legal forms

Written by Bart W. Howk - July 30, 2011

The internet is great. It’s dramatically improving our lives in countless ways, one of the most important of which is our instant access to information. For example, a business owner can download generic documents to form a company with minimal time and effort. But instant access to information can be counterproductive when misunderstood or misused. The following are just a few reasons why business owners shouldn’t use generic internet forms to start a company.

A generic form won’t reflect the deal. Every deal and every company is unique. Business owners need to agree on a myriad of issues when starting a company, such as consent rights, capital-call requirements, and how their investments will be treated. These unique agreements won’t be reflected in a form that isn’t tailored for their situation.

A generic form might be for the wrong type of entity. Companies come in different forms: corporations, limited liability companies, partnerships, limited partnerships, and more. Each has advantages and disadvantages, and one or the other usually match a business plan better than the others. Using a generic form to start a company without understanding the differences between these entity types may lead to using an entity type which isn’t best for and could even adversely impact the owners’ business plans.

Generic forms might not comply with Hawaii law. Each State has its own laws regarding organization and management of business entities. A generic set of downloaded corporate bylaws may have been drafted to comply with Michigan law, for example, but might not comply with Hawaii law.

Tailored documents enhance the appearance of legitimacy. Many start-up companies need traditional loans or venture capital. Before determining whether to provide financial assistance, lenders and venture capitalists usually want to review a company’s organizational documents. Submitting properly-tailored, nongeneric documents demonstrates that a company and its owners are serious, organized, and understand the importance of those documents. Given the current economic environment, properly-drafted company documents can make the difference between a start-up company taking off, and one never getting that chance.

The long-term cost and risk of using generic forms will probably exceed the short-term savings. Downloading generic forms is free. Hiring an attorney isn’t. But hiring an attorney upfront to assist in properly organizing a company can prevent common (and costly) problems that could have easily been avoided. The cost of legal assistance to resolve problems after they arise almost always surpasses what the corresponding upfront preventative cost would have been.