If you’re just at the beginning phase of opening a new startup, congratulations! You’re going through an exciting and challenging time.
All new business owners will make mistakes from time to time. But having your business set up properly at the outset will help you avoid costly legal mistakes.
Startups are especially vulnerable to setbacks since they are often in a precarious position financially.
Here’s an overview of legal mistakes new startups often make, which can cost them dearly down the line.
1. Mixing Personal and Business Funds
There’s a business principle in law called “piercing the corporate veil.”
This means a business owner can be personally liable for the actions of the business, which defeats the whole purpose of having a separate business entity in the first place — limited liability. Commingling is a factor Court’s look at in determining whether the business is an alter ego of its owner masquerading as a separate business. Keep your business and personal assets separated to avoid this mistake.
Not keeping your business and personal funds separate is paving the path to hassles for your accountants, as well as potentially nightmarish scenarios that can’t be fixed.
When choosing the proper business structure for your startup, you are also creating boundaries between personal and business funds and making everything super clear for your partners and accountant.
2. Lack of Formal Business Structure
Any startup will benefit from establishing a legal business structure initially, which can always change this later.
Whether you’re looking at a partnership, LLC, corporation, or something else, there are many details to work through. Doing this at the very start will help everyone, including your accountant, stay on track when it comes to taxes. It will also keep the founders in line.
3. Ignoring Securities Laws
Since raising capital for your startup can be challenging, it might be tempting to ask friends and family to invest informally.
But whenever you accept money from someone as an “investment,” if that person no longer has control over that money, in its simplest form, that is the sale of a security.
Issuing stocks is something that needs to be taken seriously for a few reasons:
- To avoid conflicts with shareholders
- Avoid conflicts with cofounders
- Stay in compliance with securities laws
- Stay strategic in the process
- Avoid penalties
- Avoid litigation
- Make sure filings and forms are done correctly
- Create shareholder buyout agreements
You face hefty fines and penalties, and even prison, if you mess this up.
The sale of securities triggers a substantial number of laws.
Any withheld information that a reasonable investor would want to know concerning his/her investment with you is something that must be disclosed.
Talk to a business lawyer before issuing stocks – disclosure, filings, and forms and before you make any severe legal mistakes.
4. Not Creating a Founder’s Agreement
Starting a business is exciting, and many entrepreneurs are highly productive people who want to move forward as quickly as possible.
But you need to take some time to make sure everything is covered and discuss everything with your startup cofounders.
Common founder’s dilemmas include:
- How should the division of equity be made among the founders?
- Should the person investing the most money get more equity because, without the funds, the startup would be zero?
- Should the main founder get more equity?
- What happens when your honeymoon is over, and you’re at one another’s throats about how the business should be operated?
Drawing up a legally sound founder’s agreement will help you avoid conflicts and legal mistakes down the line.
5. Lack of Legally Binding Agreements and Contracts
Contracts are essential for any business, including startups. Even if you feel like you trust your partners and have everything under control, do not skip this critical step or believe that informal agreements will be enough.
Examples include:
- IP assignment agreement
- Articles of incorporation
- Founder’s agreement
- Non-disclosure agreements
- Shareholder agreements
- Employee contracts
- Supplier contracts
6. Poor Hiring Practices
When a startup has poor hiring and employment practices, it will probably backfire on them in one way or another.
And since most of us aren’t HR experts, it’s not that hard to slip up and make what you consider to be a small mistake, but that gets you in hot water with a candidate or employee.
Legal mistakes in hiring simply aren’t worth it. Make sure you comply with necessary laws and regulations by consulting with a lawyer or HR professional.
You can also check out this blog about hiring advice for startups.
7. Neglecting Shareholders
Owners of a startup owe a fiduciary duty to investors and shareholders. When you give up a portion of your business to an investor or another shareholder/member, you are opening yourself to obligations owed to those people.
There are two primary fiduciary duties every owner owes to the business and its shareholders/investors. Those are the duty of care and the responsibility of loyalty.
Open avenues of communication are paramount when care and loyalty are on the line.
8. Failure to Protect Intellectual Property
Nothing can ruin your startup faster than a confrontation over who owns its intellectual property.
Every contractor or employee of your business involved in producing content or product for your business should be required to assign any intellectual property rights he/she has over to the company.
What constitutes intellectual property in your startup? This will vary from business to business.
A lawyer can help confirm IP and develop contracts such as confidentiality/non-compete agreements to ensure that everything is adequately protected.
Detailed documentation related to IP is particularly important for tech companies.
9. Legal Mistakes Related to Privacy and Security
From your website’s “terms of use” policy to the EU’s GDPR, every startup needs to practice due diligence regarding privacy and security.
Companies that control large amounts of data need to be especially mindful of security breaches and the possibility of legal violations.
10. Starting a Business Without a Lawyer
Whether you’re a startup entrepreneur, you’re acquiring a new business, or starting as a sole proprietorship, having a trusted business lawyer on your side will be invaluable.
The Contiguglia Law Firm is here to help you make the most of your business every step of the way.
We will help to make sure that you comply with necessary rules and regulations, help you draft essential contracts, offer sound counsel, and more.
Book your confidential consultation today.
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