14 Top Legal Mistakes & Issues Made By Startups
Many start-ups fail to reach their ten-year anniversaries. Much of which has to do with some simple yet avoidable mistakes.
Learning from others’ missteps gets you a better shot at success in the business arena.
Here are some legal mistakes that you need to steer clear of to build your venture to soaring heights:
1. Not taking enough time choosing a name
When choosing a name for your start-up, you have to consider more than just how it sounds. When you settle on a name you like, research if the name is already in use.
You wouldn’t want to get caught up in domain name problems and copyright infringement issues. Select a name that will not infringe on another business’s trademark.
To avoid such issues and ensure the name you choose is genuinely available to use, research is crucial when choosing a company name.
If it is likely to confuse customers as to the ownership of the products or services, you may be violating someone else’s trademark.
The following actions should be taken to prevent naming issues:
- Create five names you like and test-market them to potential coworkers, business partners, investors, and clients.
- Consider the name’s potential worldwide meanings. For instance, you don’t want to pick one that might have embarrassing or offensive implications in a different language.
- Avoid using the name in odd ways. Future issues and confusion may result from this.
- Be certain the name stands out and is memorable.
- You might think about asking your intellectual property attorney to conduct an expert trademark search.
2. Not having a proper operating agreement
If you are starting a business with co-founders, you need a robust operating agreement to build a successful partnership. The agreement should stipulate the nitty-gritty details of your business relationship.
It has to have a clear outline of everyone’s role. The founder agreement should address how to share equity, how the day-to-day decisions will happen, the roles and responsibilities of each partner, how to navigate when a partner is not complying with the agreement etc.
It should also give a clear guide of how you will handle selling the business if it ever comes to that. Having solid founders’ operation agreements will help you have harmonious relationships with your partners. It will also help avoid any legal troubles in the future.
3. Not paying attention to the legal form of the business
When starting any venture, you need to decide what legal form it will take. The business could either be a sole proprietorship, a general partnership, a C or S corporation, a limited partnership or an LLC.
You are much safer when you start the business as an LLC or corporation. The initial cost of the formation may be higher than that of a partnership or sole proprietorship, but the benefits you will enjoy in the long run are worth the effort.
You can get tax deductions and liability protection in the event of business creditors. Also, it will be easier to raise capital when you need to bring investors on board.
However, it is not all doom and gloom if you started your start-up as a sole proprietorship or partnership. You can convert it to an LLC or corporation further along the road.
However, you will likely incur a lengthy and significantly costly process.
4. Failing to protect intellectual property rights
There are important things to consider before starting a business.
A common mistake that start-ups make is failing to understand the implications of intellectual property. If you have a novel idea, product, technology, or service, you should think about taking the necessary precautions to safeguard your intellectual property.
The founders and investors of the company have a vested interest in seeing that the business upholds its intellectual property rights and refrains from violating those of others.
Here are some typical safety precautions that should be undertaken by startups:
- Copyrights: Copyrights protect original works of authorship, including artwork, copy for advertisements, books, articles, music, films, and software, among other things. The owner has the only authority to create copies of the work and derivative works (such as sequels or revisions) that are based on it.
- Trade Secrets: Trade secrets are types of intellectual property that aren’t commonly known to the public, give their owner an economic advantage because the information isn’t widely recognized, and are the focus of efforts by the owner to keep them hidden.
A trade secret privilege entitles the holder to take legal action against anyone who misappropriates the secret by stealing it or by another dishonest method.
- Employee Confidentiality and Invention Assignment Agreements: Such a contract should be made mandatory for all employees. It fulfills a number of objectives. First, it requires the employee to maintain the business’s proprietary information’s secrecy both during and after employment. Second, it guarantees that any innovations, concepts, ideas, products, or services created by the worker while they are employed and connected to the firm belong to the employer and not the worker.
The best thing to protect it is to get patent protection as soon as possible.
You will not have to worry about your innovation getting infringed by your competition. While at it, you may want to consider trademarking your business name and understanding any copyright issues that could arise with any material in your business.
5. Not getting the required licences and permits
Permits and licences necessary for operations differ from business to business. You need to conduct due diligence to avoid unwanted shutdowns and legal costs that could stifle your business’s success.
Understand the different licences and permits you need. What licences are necessary for your industry? Know if you need a health department permit or a state qualification to conduct your kind of business.
Will you require city and county zoning permits and licences? Know the requirements for operation or seek the help of a professional to guide you.
Startups need certain documents and those that lack the necessary licenses and registrations risk getting caught in legal snares.
Depending on the type of business, you might require the following authorizations, licenses, or credentials:
- Specialized licenses for regulated businesses (aviation, alcohol, etc.)
- State and federal requirements for conducting business
- Licenses and permissions for sales tax
- Industry-focused registrations for regulatory startups
- Permits for home-based businesses
- County and city business licenses or permits
- Zoning approvals
- Seller’s or sales tax licenses
- Department of Health approvals (such as health permits for a restaurant)
- Tax and employer identification numbers from the federal and state governments
6. Selecting the Wrong Legal Support
Entrepreneurs don’t typically hire legal counsel in order to protect their investments alone. A number of legal matters necessitate the assistance of an attorney.
This includes security laws, licenses, employment regulations, federal policies, privacy, standards for the security of personal data, company law, tax regulations, etc.
All of these require adequate legal support. Without it, owners could get themselves in legal trouble.
There are some sections that are only known and understood by lawyers. A legal challenge against a corporate contract is a fault in and of itself.
7. Failing to lawyer up sufficiently
Having reliable legal counsel makes a world of difference. It makes it easier to avoid endless legal problems.
Not having an experienced legal counsel in your corner in the name of saving expenses could come to bite you further along the road.
Identify a lawyer skilled in contract law, employment law, intellectual property law, tax laws, executive compensation and benefits law, franchise law etc. When engaging a competent company attorney, he or she can put an end to the startup’s legal disputes.
Ask for referrals from friends and family, or consider state bar referrals to get a law firm that can handle the areas of expertise your business needs.
8. Not Adhering to Security Laws When Issuing Stock to Friends, Family, Or Angel Investors
Federal and state securities laws will apply to the sale of stock, limited partnership interests, or LLC interests to the founders and investors if the founders form a corporation, limited partnership, or LLC.
Unless the transactions are exempt, the majority of securities regulations demand that such sales adhere to specific disclosure, reporting, and form requirements.
Even if the startup company has lost most, if not all, of the money it raised from investors, failure to comply with appropriate securities laws requirements can result in significant financial penalties for the founding members and the startup company.
This might include a precondition that the company reacquire all shares sold to all investors in the illegal offering at the original issuance price of the shares.
Failure to abide by the securities laws can also result in fines and other sanctions (civil and criminal). Founders should retain skilled attorneys to properly document the sale of shares by such laws to avoid such detrimental, perhaps fatal effects.
9. Failing to have proper employment agreements and offer letters
You will need staff to grow your start-up. Unfortunately, they may be the ones tanking your venture with legal mistakes. Be on the safe side and have a carefully drafted employment agreement and offer letter.
The employment agreement should be as detailed as it needs to be. It should stipulate the job title and the roles and responsibilities, compensation, and leave information, among other things. As a result, an employee is reasonably aware of what is being agreed to. You need to keep your company safe from employee negligence.
Make it clear if the employee can terminate the relationship without penalty. The agreement should also indicate any stock options available to the employee and the terms of any vesting.
Encourage employees to read through it carefully before they sign it.
While still on employees, you need to ensure that you handle and follow the correct procedures when firing them. Consider having an employee handbook that stipulates disciplinary policies for violations. These agreements usually come in handy on a rainy day.
For startups, unorganized employee agreements and the absence of written employment contracts might result in unwelcome legal complications.
10. Lack of proper corporate and HR documentation maintenance
Companies frequently neglect to keep up with necessary corporate and HR-related data.
When the business seeks funding, engages in M&A activity, or is involved in claims or litigation with a worker or regulatory agency, this may become a concern.
Here is a list of the several kinds of paperwork the business ought to think about keeping strictly up to date:
- Resolutions and minutes from the board and shareholders
- Signed agreements and contracts
11. Lack Of Solid Terms Of Service & Privacy Statement For Your Website
- The restrictions placed on users and how the site can be utilized
- Exclusions from warranties
- Liability restrictions for the site’s owner, its officers, affiliates, and directors
- How disagreements will be settled
- Users’ representations and warranties, as well as the site owner’s indemnity
- Rights to intellectual property (e.g., copyrights)
12. Asking In-Person Interview Questions That Are Illegal
Employers are forbidden by federal and state law from basing hiring decisions on protected characteristics such as gender, ethnicity, age, color, religion, handicap, and others.
Even if choices aren’t made based on the answers, asking improper questions could result in a discrimination action against the business.
13. Not Following the Right Procedures Before Firing An Employee
Even “at will” employees are subject to legal risk when terminated improperly or without adequate documentation.
Laws forbid dismissal owing to retribution for sexual harassment, discrimination, , color, national origin, ancestry, gender, race, age, impairment, marital status, religious preference, gender identity, or any other or other unfair dismissal claims made by the employee.
14. Not paying attention to tax considerations
Tax issues can cripple the growth of your start-up significantly. Educate yourself on the different tax issues that you need to understand. Know the tax obligations for your choice of legal entity.
Know what happens if you are a holder of stocks. That could go a long way in making the most of tax savings. You also need to understand the tax incentives available to your nature of business.
Know how to get a tax ID for your company from the IRS. It will make it easier to open a bank account for your business. You do not want to deal with non-remittance legal issues. Procure bookkeeping services to make tax filing more efficient.
A professional bookkeeper will guide you on how to claim your deductions and ensure that you do not overpay. They are your best bet because they clock hours looking into tax law details so that you do not have to do it.
A lawsuit has the potential to tank even the most innovative start-up. You need to know some legal mistakes that you may want to avoid.
That gets you ready in case of any trouble that could threaten to shake the business that you have worked hard to build.