Mistake Number Four: We Did It on a Handshake.

Putting an agreement in writing sounds a lot like the professor assigning homework and many entrepreneurs would rather go to the dentist than spend the afternoon working on a long document. I interviewed a potential client who wasn’t even fully certain of who had invested in his company (I refused to even wade into that time bomb).

I think there is a misconception that this is ok because many times an agreement on a handshake does work. As long as the agreement is simple and all parties do their part, it never has to be enforced by a court. Recently the New Yorker profiled New York Mets owner Fred Wilpon and reported that his decades long agreement with his business partner is by handshake only, even though their tax return now exceeds 2,000 pages. Of course, he’s also in trouble for doing business with Bernie Madoff …

A lot of entrepreneurs ask me then more generally, when should something be in writing?

The short answer is almost always.

The legal answer is that certain verbal agreements will be enforced by a court, but certain agreements are invalid unless there is a note or memorandum that is in writing signed by the person to be charged. If your matter is governed by California law, a full listing of the contracts that need to be in writing to be enforced is set forth in Cal Civ Code § 1624.

The answer you’ll remember is this one. At the risk of being offensive, doing business without written contracts is a lot like having unprotected sex. You might get away with it every so often, but if you’re out there every weekend with a different, random man or woman from the bar, you will get an STD. Likewise, if your contracts are not well documented, you might be fine a couple of times, but it’s a numbers game. Eventually you will be in litigation and you very well may lose.

The Lesson. An ounce of prevention is worth a pound of cure.

Mistake Number Three. Dilution Issues

Anyone who watched the much-acclaimed The Social Network directed by David Fincher begins to grasp these issues when cheering on for Eduardo Saverin, who is played by Andrew Garfield. The tech revolution brought on an expectation of wider ownership by more employees and consultants. This is a good thing, but I have seen this desire for ownership manipulated by more senior players who realize that small minority shareholders have limited rights at law. Yes, the management owes fiduciary duties, but these are somewhat “gray” obligations on an issue where you may want to address rights more directly.

In particular, two of my clients received verbal representations that each of them would be 5% owners in the LLC that operated the new website. On one level this was fundamentally true as they each received 5% of the Units of the LLC. Several years later, however, the 90% owner wanted to raise additional capital and to do so meant diluting every member of the LLC.

Although my clients did not agree with this strategy, if the 90% owner met its fiduciary duty, there is nothing inherently wrong with this strategy as raising additional capital could permit the LLC (or any company for that matter) to become much larger. As I’ve explained to many entrepreneurs, I would rather own 10% of a $100 million dollar company than 50% of a $2 million dollar company. So, although it’s tempting, it doesn’t necessary make sense to revert to iron clad restrictions against any dilution.

The Lesson. This area is tricky and there is no one answer. For the promoting entrepreneur, be careful about promising ownership as a percentage of the company, particularly if you are in a business where you will need to raise a lot of capital. For other members of the senior management, make sure you understand what rights you have and when the company can dilute you.