So, you have come up with a brilliant business idea which is about to materialize, and you’re just a step away from founding your own startup?
That feeling of being on top of the world is intoxicating, and it might cloud your vision to the extent of pushing you into making some rushed legal decisions which can turn out to be mistakes. In time, these seemingly insignificant details you failed to pay attention to might cause a snowball effect and ruin your startup. And yes, it can happen to anybody and this list of the biggest and costliest startup disasters is living proof of that.
Let’s now go through some of the most common legal mistakes and see how to keep potential lawsuits at bay.
1. Selecting the wrong entity type
Choosing the legal form for your business is one of the most fundamental steps in the process of founding a startup. Not only does this give your business the right structure, but it can also have different tax and liability consequences. Many inexperienced startup owners tend to fall into the trap of making this important decision without the help of a legal advisor. It can be challenging to choose the most suitable type of entity if you aren’t sure about their pros and cons for your particular circumstances.
- A sole proprietorship can be tempting because it requires no legal paperwork or fees, just state and local permits. However, it doesn’t provide any legal protection from creditors, which means that they can sue directly the founder, i.e. you.
- General partnerships are an option if there are more founders. They mutually set up the rules and agreements, and that’s pretty much everything positive that can be said about this kind of entity. Namely, in case there’s a disagreement between the founders, state laws and regulations come into effect to cut the Gordian knot. The fact that each partner has unlimited personal liability practically means that your personal assets are at risk of being seized by creditors in case of any debts incurred by the business. So, think twice before opting for this one.
- C and S corporations are similar in the sense that both of them are suitable for startups backed by venture capital. The only difference is that the latter ones get some favorable tax rates if they have up to 100 shareholders. A big con is their elaborate administrative
- Limited liability companies (LLCs) are the most popular entity type because they offer a high degree of simplicity and flexibility when it comes to administrative formalities which plague Another pro is that they provide liability protection.
When talking about business entity types, it’s worth mentioning one equally important factor – choosing a business bank account. Unlike LLCs and corporations which need to have designated bank accounts, sole proprietors usually opt for their personal bank accounts, mainly because their fees are significantly lower. But, on the flip side, this practice can lead to tax and accounting issues, which is why it’s best to separate your business and personal bank account, both in terms of money and liabilities.
2. Not protecting your intellectual property
It’s self-explanatory why the products or technologies you have invented have to be legally protected. And yet, more often than not, fresh entrepreneurs fail to do so, and they lose the ownership of their inventions, brand, or logo. However, this happens to the big guys too. Nestlé, the manufacturer of the KitKat chocolate bar, recently lost a 16-year long legal dispute over trademarking the distinctive four-fingered shape of their snack. In order to prevent this worst-case scenario, you can use some of the following legal rights to protect your brainchildren:
- Trade secrets;
- Service marks.
Additionally, it’s essential that you ask all co-owners, employees, or individual, third-party contractors to sign a Confidentiality and Assignment Agreement, as it will prevent them from leaking sensitive, proprietary business information. This Agreement will also make sure that the rights to a product or technology your employees have developed while working for you belong to the company, and that they can’t claim ownership of the intellectual property.
4. Not making things clear with co-founders
Remember how the story of Facebook turned sour when the company struck gold? That messy legal ownership battle clearly illustrates why you need to have a discussion about your startup’s equity, as well as the management, decision-making, shares, roles, ownership percentages, and responsibilities of the founders very early on, because that way you won’t have to deal with it later when things become complicated by profits or losses. Even if these people are your friends, it’s crucial to make things clear and to have everything in writing. A Founders’ Agreement is a must if you want your startup to run like clockwork.
As a startup owner, you’re most probably focused mainly on growing your business, and legal matters can be so dull. But, if you want your startup to thrive, it’s of critical importance to nip these legal issues in the bud.