The Four Biggest Legal Mistakes Startups Make

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Having the combined expertise of starting four companies and representing startups for over 15 years, I have learned a few lessons the hard way. Even more alarming than my personal lessons learned has been witnessing my clients make costly mistakes. Mistakes that could have been easily avoided.

Let’s be honest, most entrepreneurs hate lawyers. Who wants to spend money on intangibles, services that do not help you get your product to market? The truth, however, is the legal framework on how you set-up your business is the foundation for your business. Without the foundation, it’s like trying to guide a ship without a lantern. Add some stormy weather and a broken compass to that ship without a lantern and the outcome isn’t pretty. Unfortunately, it can make you or break you.

Therefore, it’s important to know when you need to ask for legal help. I have outlined below the four areas of law that I have seen founders make the biggest mistakes by not asking for the imperative legal help they needed in a timely manner.

Forming the Right Entity. You can waste a lot of time and money by not creating the right legal entity for your business. There are many factors to consider when you are starting a company that influence what type of entity is the best structure for your business. For example, if you are a tech startup that is going to seek out angel investors and venture capital, it is best to create a Delaware C-corporation. Delaware law has a long history with corporate law and is the most favorable forum for corporations. This is the standard in the industry for angel investing and venture funds. If you started the business in your own state, and later have to reincorporate in Delaware, you actually have to merge the old corporation with the new Delaware corporation which is time consuming and costly.

Just ask Mark Zuckerberg how costly and what a PITA it was convert from a Florida limited liability company to a Delaware corporation. An obvious no-brainer is that if you are a canna-business in Oregon, you do not want to form your business under any other state; and I would definitely seek outside counsel before qualifying to do business in another state. Do it right the first time, and save yourself the headache down the line. I offer a flat fee for Delaware C-corp package that includes drafting and filing the Certificate of Incorporation, Bylaws, Organizational Minutes and Founders Stock Purchase Agreements.

Outlining Agreements with Co-Founders. Quick non-legal advice – make sure you pick the right co-founders. Take time to date before jumping in bed with a co-founder. It’s a marriage, and it should be treated as so. Be scrupulous about who you choose to get in business with. Once you have vetted the co-founder, make sure you put the details of your arrangement with the co-founder in writing. Depending on the type of entity, it may be a founder agreement or an operating agreement.

Either way, it’s kind of like a pre-nuptial agreement. In business, a pre-nup is analogous to an exit agreement. Work with an experienced lawyer who can help you and your co-founder think through all the possible scenarios and record them on a legally binding document. If you have seen the movie “The Social Network” about the start of Facebook, you can see how costly it can be not getting clarity around the roles and responsibilities of the founders. Personally, I’ve had my own experience in this area. Trust your lawyer when they tell you not to go into partnership 50/50. You should always try and get voting control, which is at least 51%, better yet 60/40.

IP Ownership Issues. Make sure you own all your IP, and then make sure you are protecting your rights to it. A simple example to illustrate this is in the area of trademark law. I have seen so many times an entrepreneur get attached to the name of their business without having done any type of trademark search, and then go spend money on packaging, brochures, letterhead, websites, and all the branding and marketing, only to get a cease and desist letter from a bigger, well-funded, established business with a team of IP experts that work in-house.

What a waste of time and energy and money that could have been avoided if you talked with lawyer in advance. I can do a Google search or a USPTO search for client that only takes a few minutes, and at least find out if there is not already something out there that you should be aware of. Additionally, I do the trademark registration for a pretty nominal flat fee for my clients.

Another IP legal issue to be aware of is that if you hire independent contractors to build your suite of products or services, like software, the IC owns the work product unless you have entered into a written agreement that states otherwise. Make sure you have all your ICs sign IC Agreements which include a confidentiality provision and assignment of rights provision. There are legal terms of art, like “work made for hire”, that have to be included in the agreements to be able to protect your right to ownership of the work product. Therefore, it’s best to get your agreement from an attorney or at least run it by them before you start outsourcing the building of company jewels.

Securities Law Issues.  I have found that this area of law thoroughly bores and confuses most entrepreneurs. They want their money, and they want it now regardless of where it is coming from. I get it. Without funding, there is not much you can do as an entrepreneur, but the problem is that if you take money from the wrong people without complying with the laws, you will have much bigger problems down the road. This is an area that entrepreneurs really need to ask for legal help.

Many entrepreneurs make the mistake of giving up equity in their business to friends and family who pitch in $10,000 to $50,000 to help them get started. The problem is that many times these friends and family don’t have the net worth to invest in startups – in other words, they are not accredited investors. This can result in a major cluster@$%$. Another potentially disastrously mishandled situation could be if you are a canna-business in Oregon and you start soliciting investors in other states; you may be considered engaging in interstate commerce and inadvertently be in violation of the Controlled Substance Act.

Ironing out the legal details of your startup can be tedious, but the protection and knowledge gained through legal consult are essential building blocks for the integrity of your new business. I think of it kind of like marital counseling, it may be painful and costly in the moment, but it does create a foundation and stability to build a fruitful venture free from costly pitfalls. The legal framework is the guiding lantern of any good ship. Make sure you set yourself up for success.

Jennifer Clifton specializes in entrepreneurial law at Viewpoint Law Group. Viewpoint Law Group represents clients in Oregon and California in all corporate matters, from startup counseling and general corporate matters to angel and venture capital financings to mergers, acquisitions and sales of businesses.

Viewpoint Law Group
jclifton@viewpointlg.com
541-797-9995
www.viewpointlg.com

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Jennifer Clifton at Viewpoint Law Group

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