The first few years at a startup come with uncertainty and a little bit of chaos. Often, what many businesses overlook is the need for legal guidance. Startups are especially prone to forgetting about the legal aspect of their business. A busy entrepreneur focuses on building a product or idea from the ground up, so it’s easy to forget about legally giving your business a solid foundation.
Legal trouble can come from anywhere. Whether it’s a battle between co-founders about who has a right to what or not setting your company with the right legal structure, there are a million different things to think about.
So, how does an entrepreneur separate what’s most important from what can come later? While it’s always a good idea to get a legal professional on your side early in the game, there are a few essential things you can work through on your own.
Below, we’ll cover the six most common legal mistakes startups make and how you can avoid them.
Defining Your Roles
These days startups have multiple co-founders, so it’s no surprise that even the best intentions go array when you’re under the stress of creating something groundbreaking. A simple google search will let you know how often co-founders battle it out in court over ideas, percentages, or ownership.
Beyond the legal battles, co-founders that don’t get along can have a serious effect on a startups ability to succeed. Investors can tell when something is amiss and will often hold back from funding the venture. Additionally, it can have an impact on morale. If the co-founders can’t work things out and come to an understanding, how can they expect anyone to get their job done right?
So, how do you avoid damaging your startup’s success and the relationship between you and co-founder? Put an agreement in place.
Here are some critical decisions to make when you decide to co-found a business with someone (even if they’re your best friend).
- The overall business strategy and vision
- Percentage of company ownership
- Roles and responsibilities of each co-founder
- An outline of how company decisions should be made and who is responsible for what decision
- Salary expectations
- Time commitments
- How to handle the dissolution of the partnership
These are a few of the most important decisions to make when you’re starting a company with someone. Having a substantial agreement in place, including an exit strategy should either co-founder need one, will save you from a lot of hassle.
While co-founders can take it upon themselves to draft up an agreement, we suggest you bring in a legal professional to ensure it’s accurate.
Setting up your business
Most entrepreneurs know that you don’t go into business without first setting up the legal definition of how your business operates. However, some make the mistake of not setting it up correctly or defining the business in a way that doesn’t protect them legally.
It’s a lot of paperwork and legal jargon, but deciding to be a Corporation or an LLC has a lasting effect your legal options should someone take action against you.
Let’s take a look at the three most popular legal filings for startups.
Sole Proprietorship
The most common business structure in the U.S. (with over 23 million people filed under this structure), it’s the easiest to set-up and most cost-effective to operate.
With a sole proprietorship, there is only one legal owner. This person is in full control of the company and makes all the decisions as well as all of the profits.
The downside to this option is that your personal finances and business finances are tied together. So, there’s little protection over your personal assets if you get sued.
Corporation (S-Corp/C-Corp)
A corporation gives owners more legal protection in the event of a lawsuit. While there are different tax exceptions and filings statuses for S-Corp and C-Corp, they both allow for management to take part in the business and stay protected under limited liability.
Corporations are easier to form than their LLC counterpart and, depending on which you choose, can be set-up with several different owners taking part in the business. However, it’s essential to keep in mind that there are more federal regulations with a Corporation than with a Sole Proprietorship or an LLC.
LLC (Limited Liability Company)
An LLC is the most protected while remaining less regulated compared to the other two options. Like a corporation, you have protection over your personal aspects and allowance for a limited partnership.
While this is the more popular of the three choices for startups with 2 or more founders, it is also more costly and intensive to set-up. Setting up an LLC requires the help of a lawyer and takes much more paperwork than the other two.
Whatever choice your business makes, taking the time to look through the pros and cons of each structure is vital in setting your startup up for success and protecting yourself from future legal problems.
Patents and Trademarks
The last things entrepreneurs think about when they’re amid the euphoric high of creating a product is ensuring it’s legally protected.
There’s nothing worse than choosing your name, designing a logo, and paying costly printing fees for business cards and flyers only to find out that your name is already trademarked or copyrighted by another business. To check if your business name is available, go to the U.S. Patent and Trademark Office’s website (www.uspto.gov) and do a quick search. From there, you can start the process of trademarking your name.
As for patents, it’s imperative that you’re protecting your product before anyone else has the chance to claim a patent. This can make or break your ability to raise funding and get ownership over your ideas and inventions. The U.S. provides a one year grace period between the first public announcement of an invention, but that does not stop anyone else from filing the paperwork before you get to it. So, it’s better to keep your ideas to yourself until your patent is submitted.
Intellectual Property Protection
To keep a business functioning, you need employees. In the early stages of a startup, those employees might be developing ideas and working on code that is specific to your business. Before bringing anyone on, whether full-time or contract, make sure you have a written document that prevents employees from claiming ownership or rights to the intellectual property they’re working on.
The last thing any new startup needs is someone walking away with pivotal pieces of their business puzzle. Work with a lawyer to draft an agreement that protects your ideas and build the signing of the document into your onboarding process.
Defining your securities
Stock and equity are a crucial aspect of startup culture. For employees, investors, and sometimes even family members, being assigned stock in the company is one of the reasons they’ll take a job or stick around for an extended period of time.
However, securities law is a legal area where you need a professional. There are compliance issues to think about and structure to put in place that someone without knowledge simply doesn’t understand. Not complying with state and federal laws can risk the future of your company and keep you from raising additional funding.
If you’re eager to grant equity or stock for your employees as you get the business off the ground, the first place to go is to a securities lawyer.
Not seeking a legal professional
Startups come with many different legal obstacles, and it’s necessary to have someone on your side that knows how to overcome them. While it’s best to get a lawyer that deals specifically in the various fields you might be dealing with (or a law firm that has the in-house knowledge), that may not be possible at the very beginning.
Still, having someone on your side that can help draft agreements, file paperwork, and ensure that you’re protecting your assets, can make all the difference. Look for a general business lawyer that specializes in the typical issues you might face and start there.
Here are some areas where most startups need legal help:
- Employment Law
- Intellectual Property Law
- Real Estate Law
- Partnerships and Tax Filings
- Securities Law
Startups are facing an uphill battle to succeed every day. From trying to raise funding to protecting intellectual property, there are a million and one things to think about. It’s easy to see how the legal jargon and stressful paperwork gets put on the back burner.
However, for any entrepreneur, the legal aspect of their business should at the top of their to-do list. By thinking through these six essential legal issues, you can protect your business and ensure it’s a success at the same time.
