Whether you’re introducing a brand new tech product that will revolutionize the way business is conducted or are bringing your amazing baked goods to the masses, starting any business from scratch is no small undertaking. As a startup founder, you have a never-ending ‘to-do’ list that continues to grow. Because startup founders are very busy people who cannot find enough hours in the day, legal issues associated with forming a new business tend to be pushed aside and ignored. This is unfortunate as founders often don’t realize how important it is to have a strong legal foundation for their businesses until it’s too late.
There are some legal issues that need taken care of almost as soon as the idea for a new business has been developed. For instance, one of the first things that must be done is deciding how you will legally structure your business. Should you form an LLC, a sole proprietorship or a partnership? While specific circumstances vary among individuals and individual businesses, there are some general legal guidelines you should follow that will help you make these important law-related decisions. But where in the world do you start? One of the best ways to navigate your way through the legal maze of starting your new business is knowing what the common legal mistakes made by startups are. Here are some of the most common and problematic legal mistakes startups tend to make.
Not Making the Deal with Co-Founders Crystal Clear
It’s of the utmost importance that you agree with your co-founders early on regarding the specifics of the deal between you. If you fail to do this, you’re likely run into very big problems later on. You can look at this agreement as a form of a prenuptial agreement wherein both sides know what to expect if and when the relationship doesn’t go along as planned. The key terms of your deal that must be addressed (in writing) are:
• What percentage of the company does each partner get? And is the percentage ownership subject to vesting based on continued participation in the business?
• What are the specific roles of each founder?
• If one founder leaves the business, can the other founder buy back his or her shares and if so, at what cost?
• What will each founder earn as salary and can that amount be changed if need be?
• Who will make the day-to-day decisions? Will it be just one person or will decisions be made via voting.
• Under what circumstances can a founder be removed as an employee of the business?
• Who will decide if the business will be sold in the future?
Forming the Wrong Type of Business Entity
Many startup founders make the mistake of forming the wrong type of business entity. There are basically six choices here: (1) sole proprietorship, (2) general partnership, (3) limited partnership, (4) C-corporation, (5) S-corporation and (6) limited liability company or LLC. Choosing an entity that’s appropriate for your business will depend greatly on how you plan on running the business and where you hope to take it. It’s highly advisable to consult with a business lawyer or CPA when deciding what type of entity to choose. Even though this consultation will cost you money, it could be one of the wisest investments you’ll ever make as choosing the right business structure is very important.
Failure to Protect Intellectual Property
When you’re putting your startup together, it’s essential that you obtain any relevant trademarks, patents or copyrights before your intellectual property (IP) is out for public consumption. If you don’t do this, your creations are fair game for competitors to steal. This is why startups should include an IP strategy in their business plans. If you will be seeking funding from investors, don’t forget that investors have many opportunities and therefore look for reasons to say no. If you don’t have an IP strategy mapped out in your business plan, potential investors will likely turn you down as unprotected ideas, inventions, trade secrets, logos and names are subject to theft. In addition to having to worry about your competitors stealing your intellectual property, you also must guard against intellectual theft by your collaborators and employees. This is why you should have them sign non-disclosure agreements (NDAs). This way, you’re given the assurance that your creations won’t be snatched away if and when these people stop working with you.
Issuing Stock to Co-Founders Without Imposing Vesting Restrictions
A big mistake to avoid making is to issue stock to co-founders without putting vesting restrictions into place. If you make this mistake as many startups do, one of your co-founders could walk away from your business early on and keep all of his or her equity. This is why you should always draw up and implement a restricted stock purchase agreement with vesting schedules when issuing company stock to co-founders.
Ignoring Employment-Related Issues
One sure-fire way to get into legal hot water is by neglecting employment issues when hiring staff. Whenever a new employee is brought on board, he/she should be required to execute two documents: An offer letter agreement and a confidentiality and IP/invention assignment agreement. The offer letter agreement will spell out the employee’s rights and obligations including the position he/she will hold and the compensation and benefits he/she will receive. The confidentiality and IP/invention assignment agreement is designed to prevent the employee from disclosing any of your trade secrets and other confidential information.
These are just a few of the many legal problems and issues startups face. Setting up a business involves making some of the biggest decisions of your life. An attorney can guide you through the legal labyrinth so your business is protected while helping you avoid costly pitfalls. Once you have all the legal issues under control, you can then focus all your energy on the most important task at hand which is building a successful business.
