By Shannon Liston, Techstars Corporate Council
Just to be clear: This sheet is for informational purposes only and does not constitute legal advice or create an attorney-client relationship. Companies should consult their own attorneys for legal advice on these issues. Because of the generality of the issues discussed in this piece, the information provided may not apply in all situations and should not be acted upon without specific legal advice based on particular situations.
Sometimes, startups fail.
It’s painful and brutal—and nothing to be ashamed of. It’s part of many, many entrepreneurial journeys. But along with the emotional ups and downs, you’ve got to deal with the practical legal side of shutting down your startup.
The legal name for one version of this is corporate dissolution. If you don’t need the protections of bankruptcy (you’ve got low risk of litigation or disputes over claims), corporate dissolution may be right for your startup.
The Techstars legal team has created this best practices sheet to give you guidance and practical tips if your company is facing dissolution. Unsurprisingly, these will be different depending on which state you’re incorporated in—this sheet focuses on Delaware, because of the large number of US corporations incorporated there.
Long-Form v. Short-Form Dissolution
Many smaller companies liquidate without the protections of federal bankruptcy law, as corporate bankruptcy can be very expensive. Instead, you can get some of the same protections through Delaware’s long-form dissolution process—it gives boards of directors similar protections, and provides company creditors with notice, plus an opportunity to present their claims.
Work with your legal counsel to make sure you meet all the formalities of the long-form process, like 60-days notice to all known claimants, including public notice, and a court approval process ( 8 Del. C. 1953, § 280).
The formalities of the long-form process may be overkill for your company, especially if you’ve already sold your operating assets, if you stopped operations a while ago, or if you’re unlikely to have unknown creditors.
In this case, short-form dissolution may be right for you: it’s simpler and less expensive for many companies, and comes with fewer formalities than the long-form process (8 Del. C. 1953, § 275).
7 Steps to Dissolve a Business
- Obtain Board and Shareholder Approvals. Your company’s Board of Directors must approve the decision to dissolve and adopt a Plan of Liquidation. A majority of the company’s shareholders must also approve the decision and the Plan of Liquidation.
- Pay Franchise Taxes and File an Annual Report. You must pay Delaware franchise taxes in full (including the current calendar year franchise tax) and file all applicable Annual Franchise Tax Reports. The Delaware Division of Corporations will not accept the Certificate of Dissolution (see below) until this step is done.
- Notify the IRS. Within 30 days of the Board approving the dissolution (the dissolution resolution date), your company must file a notice of dissolution with the Internal Revenue Service: Form 966.
- If the dissolution involves the sale or exchange of corporate assets, Forms 8594 and 4797 might also be necessary.
- See the IRS checklist for other required filings.
- File for Dissolution with the State. Once the decision to dissolve is properly approved, the company must file a Certificate of Dissolution with the Delaware Division of Corporations.
- If your company has stopped doing business and doesn’t have any remaining assets, it might qualify to file the short form certificate of dissolution.
- If the company is registered to do business in another state, it will have to withdraw or surrender those qualifications.
- Provide Appropriate Notice to Creditors and Stakeholders. Follow state law requirements to give notice of the dissolution to anyone with a claim against the company. Delaware’s long-form dissolution notice requirements are here: 8 Del. C. 1953, § 280.
- “Winding Up”. After the dissolution is effective, the dissolved company is deemed to continue, generally for three years, for the limited purposes of winding up per the Plan of Liquidation. This means:
- Settling and closing the business;
- Liquidating remaining corporate assets;
- Settling claims;
- Resolving any lawsuits;
- Making final distributions to creditors, and if funds remain, to applicable shareholders.
- File Final Federal and State Tax Returns. Review the IRS checklist for closing a business and filing final returns. For the company’s final returns, check the box to indicate the tax return is a final return.
Do’s and Don’ts
Do: Act in accordance with your fiduciary duties.
It’s your responsibility to focus on maximizing the company’s value. For more on your obligations as a Director, see here.
Don’t: Disappear; act in a manner that presents a conflicting interest; arbitrarily pay back one creditor over another; etc.
Do: Send the filed Certificate of Dissolution to investors, describing your decision to dissolve and your efforts to maximize return to shareholders.
Don’t: Use dissolution as an escape hatch.
Dissolution alone does not abate actions, suits, or proceedings begun by or against your corporation prior to dissolution—or, generally speaking, for a period of three years after dissolution.
Do: Educate yourself on the several ways to wind down a company.
Talk with your lawyer about which way to wind down your company is the best choice for your situation—the complexity of your company (number of employees, investors, creditors, etc.) will have a big impact on this.
In your first startup venture you may not think be thinking about the about the legal implications of what you are working on. Your only aim is go and launch.
However, when startups are large enough to afford an attorney, the good news is that it means the business is large enough to afford an attorney, but also large enough for dire consequences if something goes wrong. Many small startups work with services like LegalZoom, but others prefer seeking out dedicated legal counsel.
Working with an attorney can sometimes be frustrating, as it seems the default response from him/her is “No! No! Not possible. Not legal. Too risky.” The wait to go around this is to ask your attorney the “What is the risk of not obeying their recommendation?” Then you can make an executive decision on what to do next.
Let us know about your experiences working with startup lawyers.
This was originally created by Kriti Vichare for #entrepreneurfail: Startup Success.
The decision to become an entrepreneur is not a decision to make lightly. Business ownership requires dedication, as founders work tirelessly to find their path to success. While the life of an entrepreneur can be rewarding, it’s not always easy and is often full of unforeseen circumstances and unique obstacles. Luckily, many problems are avoidable, and others can be easier to overcome, if your company’s essential legal matters are in order.
While working with startups all day, helping them navigate the legal jungle, I see these five (easily avoidable) legal mistakes most often:
1. They use documents they’ve found online
More and more often, up-and-coming entrepreneurs are turning to the Internet to find legal documents (and advice). There are even a few new websites developed over the last year or so that allow entrepreneurs to share their files with one another in an effort to help startups cut costs. The lure of using one of these “ready-made” legal documents may be temping, but beware, they could end up costing your business more in the long run. Legal documents need to be tailored to fit the unique needs of your startup; using one made for another business could leave you exposed to unnecessary risks and might land you in hot water later on. To avoid exposing your business to unnecessary risks, it’s imperative that you have an attorney review your documents prior to use.
2. They don’t have sound agreements
Business owners enter into many agreements, usually with clients, service providers, employees and contractors. Often enough, the details of these legal agreements are overlooked, and many entrepreneurs end up getting the short end of the stick. Always make sure you have a good understanding of the risks you are taking on when it comes to contracts you can make informed decisions and determine what is right for your business.
3. They don’t protect their intellectual property
Because the foundation for most startups is their intellectual property, it’s important to legally safeguard it by filing appropriate trademark, copyright or patent applications. In an instance of infringement, this ensures that you have recourse to protect your intellectual property. In addition, you should always make sure you are given ownership rights to everything a third party is creating on your behalf so you can use it as you see fit.
4. They don’t incorporate their business
It may seem easier and more cost effective to form a sole proprietorship, but incorporating your business will always better protect you from personal liability. As a sole proprietor, any legal liabilities or debts incurred by your business become your personal responsibility and it’s more challenging to secure loans. To avoid personal liability, try exploring a different option, like a Limited Liability Company. LLC’s require minimal record keeping and allows business owners to allocate profits and losses where necessary.
5. They don’t have a founder’s agreement
Many people begin their startup in hopes to escape some of the rigid formality of the corporate world. Those that make the jump with a close friend or former colleague often informally divide work responsibilities amongst themselves during their business’ early stages. While this might work during a startup’s infancy, as the business begins to grow, this informal division of roles becomes a liability. Companies with more than one owner need to have a founder’s agreement in place to avoid future disagreements about expectations and values. This document will outline the details of your partnership and serves as an internal operations guide by laying out each founder’s key responsibilities, explaining how to handle disputes and running through the company’s decision making process.
The road to success isn’t easy and there will be challenges along the way. Having a comprehensive document in place from the beginning, like a founder’s agreement, will help guide entrepreneurs through handling internal issues.
If we got a dollar every time someone told us to sign an NDA (non-disclosure agreement), we’d retire right now. The irony is that NDAs, trademarks, patents and copyrights are very expensive to defend for a small business. Many aspiring entrepreneurs are concerned that their startup will come across predators who will steal their idea, so they invest in these legal tools as a precaution. Little do they realize that protecting their idea could cause them to go out of business!
A couple of years ago, we were sued by a Fortune 500 company for a trademark application that we naively filed. Although lawyers said we had a fighting chance, we couldn’t justify the $250K in fighting dollars to take the case to court. The Fortune 500 company shut down our operations. The moral of the story is that NDAs/trademarks/patents/copyrights/other legal toys are great in theory, but unless you have the pockets to defend them, they are nothing but an expensive hobby.
You’ve heard of FOMO (fear of missing out)? Let’s introduce you to FOSO (fear of stolen opportunities), which is an #entrepreneurfail. Entrepreneurs need to overcome this fear. There is no way the business or product will be successful while in extended stealth mode. The iterative feedback needed to create value only happens when the entrepreneur is an “open kimono”, laying all the vulnerabilities out on the table. Many seasoned entrepreneurs can attest to this. As the CEO of Skillshare, Michael Karnjanaprakorn, mentioned once, it didn’t matter if others were copying his company’s ideas because his vision and execution were always farther ahead. And today Skillshare is leaps further than its competitors.
For a simple business idea, skip the NDA, get the work done, launch and you’ll be one step closer to success. (Of course: it’s probably best to get the final word from a lawyer since this is just our opinion!)
We’d love to hear your thoughts. Did you create an NDA? If so, what were your experiences? Tell us in the comments below!
(Enjoyed this comic and post? It was originally posted on #entrepreneurfail: Startup Success)