This First Thing Every Founder Should Purchase

What is the first thing a new startup company should purchase? Right, a hat rack. Wait, what?  You need one because each founder is going to be wearing several hats - organizationally speaking - and it is important to keep the various roles separate. Here is why. I was recently working with a client who is splitting off from a business he started with a partner, taking some of the assets from their company, and putting those assets into a new company in which he is the sole stockholder. As an exiting founder of the old company and the sole founder of the new one, he is taking on several different responsibilities, including as a stockholder, director, and even lender. This is legally significant, even if he does (inaccurately) refer to "my company" or "my equipment".

But when talking about roles, first understand that that I am not talking about titles. The titles that companies often hand out early on have less to do with the business than they do for establishing some sort of status hierarchy. Some state laws even necessitate designations like president, treasurer, and secretary - Massachusetts is an example - but don't get bogged down in titles. The law dictates legal distinctions between stockholders and directors, but don't try to pigeonhole your team into arbitrary titles that don't fit your organization.  Let the work dictate what roles and responsibilities to assign to management.

Why does this matter, you ask? There are several reasons:

  1. Title to property. New founders often erroneously treat company property as personal property. This has ramifications both from a practical standpoint (who owns the property that he wants to take to the next venture) and legal significance (can the company collateralize the property for lenders). If the exiting founder wants to take certain property with him, it is already tied up by a security interest under the company's bank debt? Did the company pay for the equipment or was it using property belonging to its stockholders? Those questions become all the more important when a change of ownership takes place.
  2. Organizational confusion. It is critical to sort out the rights and responsibilities of the organization - who has the ultimate control and authority? Often, a pair of founders will split these management roles equally (see my earlier post on why that may not be the best idea), but that effectively means that every decision requires unanimous agreement. Many important decisions have to get made on a daily basis; without proper role assignment, decision-making can get bogged down or actions may be taken without authority or notice. Even worse, an organization may not understand who is responsible for making key decisions.  Not only does this create problems within an organization, but it could also raise red flags to future investors.
  3. Legal risk. there are also significant legal ramifications should the rights and responsibilities of the owners and managers get muddled. While state law protects owners from personal liability for corporate obligations, a court may sometimes "pierce the corporate veil" and assign personal liability where owners of a company did not maintain the "separateness" of the entity.  Blurring the lines between corporate and personal increases that risk, as does lax handling of roles. It may seem odd for a stockholder to elect a director who authorizes the company to take debt from a lender when each of those is the same person.  But maintaining those distinct roles will help protect you from liability and confusion.

So where does all of that leave business owners? From the start of your business, choose a structure that fits with your business and keep straight what actions you take as a stockholder versus the actions you take as a director.  Then clearly allocate management responsibilities between the founders and the rest of the team and make sure that structure is clear to the rest of the organization. Because your decisions not only have ramifications for the company, but also may directly impact your personal bottom line.