5 Legal Mistakes Startups Should Avoid
6 min. Read
Last Updated: 04/05/2016
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Unless they happen to practice law, most budding entrepreneurs can fall prey to legal mistakes. The worst mistake, of course, is imagining the law has no bearing on your exciting new product or service. In fact, everything in business from trademarks and intellectual property protection to contracts with vendors is legal in nature. To disregard this is to put your new venture at unnecessary risk.
While noting that it's always better to hire a lawyer to handle these matters, here are five key legal mistakes every startup must avoid:
1. Not Forming a Corporation.
Any business can experience a debt crisis or be the target of a lawsuit. To protect your personal assets from the claws of creditors, it's necessary to incorporate or form an LLC. Engage a lawyer skilled in this area to determine whether the entity should be an S-Corporation, C-Corporation, LLC, etc. "Investors generally only put their money in corporations—not LLCs or partnerships," notes Scott Edward Walker, founder and CEO of Walker Corporate Law Group, PLL. "So it's usually best to stick with a corporation when you're getting started." And while corporations are usually formed under the state law where the business is first run, many businesses opt for Delaware, renowned for its advanced corporate laws.
2. Failing to Protect Intellectual Property (IP)
It's difficult to overestimate the importance of trademarks, copyrights, and patents in the world of startups. After doing research to insure you're not infringing on someone else's IP, it's time to register a trademark to shield your brand, obtain copyrights as needed to cover original work (content, images, software, etc.), and, where applicable, get a patent to protect your invention or unique business methodology. Other key legal documents in this area include confidential agreements (also known as Non-Disclosure Agreements) for use with vendors and other entities, and confidentiality and assignment agreements for employees. If you've got a great idea, it's worth the time and effort required to make sure no one steals it from you.
3. Ignoring Security Laws
Once you've formed a corporation, you can't ignore security laws concerning the sale or issuance of stock to family, friends and/or angel investors. Specific disclosure, filing, and form requirements are involved, and failure to comply can be very costly. Significant penalties are involved, says Richard Harroch, a managing director and global head of M&A at VantagePoint Capital Partners," including requiring the startup company to repurchase all the shares at the original issuance price even if the company has lost most, if not all, of its money."
4. Lack of a Standard Form Contract
While recognizing that any contract with a client or customer is "one of a kind," the lack of a legally acceptable standard form contract can potentially result in a loss of revenue for the company. Hire a business lawyer to draw up a standard contract outlining your pricing and payment policies (it's OK to borrow wording from other contracts in the industry) and, Harroch cautions, "Don't make it so ridiculously long that the other side will throw up their hands when they see it." You should also look into designing a standard contract for both employees and vendors.
5. Relying on Online Legal Sites
There are plenty of online legal sites that can provide assistance at rates much less expensive than what a skilled business lawyer will charge. But how much is adequate legal protection of your startup worth? Online sites can't render legal advice, as Scott Edward Walker points out, "nor are they able to create the kind of sophisticated documents you may need to protect yourself and to demonstrate credibility with your prospective investors."
Getting expert legal advice can be costly, but to bypass this service leaves your fledgling business vulnerable to individuals and organizations eager to ensnare unwitting victims in a legal quagmire.