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Zynga shows how us how NOT to form a company

This last February, I wrote a blog article entitled, Not Incorporating is Risky Business, where I highlighted some of the issues of remaining a sole proprietorship, versus incorporating. What that blog article didn’t touch on, and probably should have, is that while there are plenty of advantages in incorporating, it’s also very important to incorporate your company in the right way.

Poor decisions will impact Zynga revenues, value and success.

The Wall Street Journal had a great article this November 10th, 2011, entitled Zynga Leans On Some Workers to Surrender Pre-IPO Shares (subscription required), which sheds light on how incorporating the wrong way could create problems down the road (if you don’t have a subscription to the Wall Street Journal, C|NET has a good overview of the Wall Street Journal article, entitled Zynga to employees: Give back our stock or you’ll be fired).

Zynga shows us how NOT to form (or run) a company.

The wrong tactics can spell disaster

Three immediate problems make themselves apparent, when one reads the articles regarding Zynga’s attempt to consolidate equity. First, is the bad press. No one wants to have their company name plastered on the pages of the Wall Street Journal in such a manner. Second, imagine the poison injected into the corporate environment after such an attempt. And third (and most importantly), the corporate executives at Zynga have basically lied to their employees, by originally asking them to accept lower pay in return for equity, with the promise of a hefty payday in the future. Zynga executives have shown their employees (and now the world) they cannot be trusted and they possess little to no integrity.

Who wants to do business with such a company? All of this, because of poor planning in their formation stage.

Like setting course on the high seas, it’s critical to point your company in the right direction from day one.

How did this come to pass, and what could Zynga have done to prevent such a disaster? The answer lies in properly forming their company, and picking the right tactics to meet their strategic objectives. For example, forming a company for an eventual initial public offering (IPO) requires very different tactics, than forming a lifestyle company with the intent of recurring revenue for the rest of your life.

Just think about those two extremes for a moment, and how you might structure the formations differently. If you want to create a company with the hopes of an IPO, you need to form the company with both common and preferred shares (or units) for investors. You need to include a decent-sized stock option pool, so you can incentivize your best employees. If you believe you will grow fast and large, you need to dole out your stock options sparingly (so you avoid what happened to Zynga). You give corporate pitches to investors and employees that make clear your growth strategies and exit plans.

Forming an IPO requires different tactics, from forming a lifestyle company.

If you want to create a lifestyle company, your formation is completely different from a company intending to IPO. You don’t need (and probably don’t want) to share equity with others, so no stock option pool. You will not be seeking investment from angel investors or venture capitalists, so no preferred shares (or units). You won’t hire employees with the promise of soon-to-be-riches with a robust IPO. You won’t be giving corporate pitches to anyone.

Hire the right help, right from the start

Bite the bullet, and hire a good business attorney.

When forming your company, funds are low and you must make difficult decisions on where to spend your precious few dollars to get your company off the ground. Despite that, don’t forget to seek the advice of a good CPA and a good business attorney or business lawyer. Anyone can download formation documents off the Internet, or pay a small fee to create a LLC through nolo.com or legalzoom.com, however these and similar organizations are not law firms nor consultants. They cannot give you the precise advice you need, to point your company in the right direction from day one, to help ensure you don’t suffer the same fate as Zynga. Hiring the right business lawyer is less expensive than you think, and it will definitely save you money down the road.

Law 4 Small Business (L4SB). A little law now can save a lot later.

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