Ten Legal Pitfalls for Startups and Emerging Companies
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There’s little more exciting than founding a company and nurturing it so it grows and flourishes. As a startup and emerging business owner, you have a lot to manage and balance. However, there can be unforeseen legal challenges that can hold your business back. Here are ten legal pitfalls to avoid that will help your business expand and thrive.
#1 Delays in Seeking Legal Advice
First and foremost, invest in good legal help from the onset! Many startups think they can save money on a lawyer entirely. Alternatively, they hire a lawyer who lacks experience dealing with issues commonly faced by startup businesses. Finding a lawyer who is adept at drafting and reviewing common business contracts and incorporating companies is especially useful.
Cutting legal corners early on will likely lead to headaches later. Many startups pay the price down the road. For example, it would be dangerous to have a lawyer who tells you it is alright to sign a deal contract with a 16% convertible note. Inexperienced lawyers may not fully appreciate the fine print when reviewing contracts. They may lack experience with the types of agreements customary to startups. In addition, they may draft contracts without full protections built in.
#2 Lacking Proper Contracts
Relying on informal agreements or understandings is not a sustainable way of operating a business. The terms of informal agreements must become formal, signed legal documents. It is often hard to imagine what could possibly go wrong in the future, especially when startups are founded by close friends. However, if relationships become fraught and disputes arise, you will not have much legal recourse by citing a mutual understanding between the parties.
#3 Not Entering into an NDA
Startups need to spread the word about their company to help it grow. This entails sharing business ideas, some of which may be sensitive information. At a minimum, all employees should sign a confidentiality agreement with the company. It is a good idea for startups to have nondisclosure agreements (NDAs) with professional advisors and other people the startup shares significant information with.
#4 Insufficient Intellectual Property Protections
Getting proper copyright, patent, and trademark protections early on can be a gamechanger later. This is especially true if your startup hinges on a novel invention or a unique trademark. An inventor can register patents and copyrights at the federal level. In contrast, the holder of a trademark can register it at either the state or federal level. If an invention is not made in-house, and the IP is not assigned to the startup, the inventor can assert IP rights in the event of a legal dispute.
#5 Not Adhering to Employee/Human Resources Procedures
There are several employment laws all companies must adhere to across the United States. States have implemented additional employment laws. Startups may view this administrative paperwork as superfluous and distracting time away from the main business mission. However, failing to follow proper employee protocols can lead to problems.
These requirements may include minimum wages, anti-harassment and discrimination policies, and proper human resource documentation. For example, all employees at a company must complete the Form I-9 at hiring to prove their eligibility to legally work in the United States. Companies usually must have an employee handbook that includes their policies and code of conduct.
#6 Noncompliance with Tax Laws
Violations of tax laws can arise inadvertently due to lack of proper legal guidance or planning. One way startups can reduce tax issues down the road is by submitting an 83(b) election form with the IRS. Startups must declare the date, purchase price, and amount of shares purchased by a shareholder in a corporation on an 83(b) election form.
#7 Issuing Equity on Poorly Timed Schedules
Equity awards keep founders and loyal employees motivated. They also promote dedication to the company’s long-term growth and development. However, vesting schedules that are structured so that the equity vests too quickly may work against this goal.
#8 Having the Wrong Legal Name
It may be too late to address, but choosing the right name for your startup can avoid potential legal problems. This often takes the form of trademark infringement issues. It is wise to do an online search of the US Patent and Trademark Office website to make sure there are no federal trademark registrations with your company’s name. Aside from trademark issues, legal risk can stem from choosing a name that is offensive or creates the wrong public perception.
#9 Exaggerating to Investors
Startup founders are enthusiastic about their businesses and naturally will strongly pitch them to investors. However, startups need to avoid falling into breach of the law. Specifically, making exaggerated claims to investors can lead to liability under U.S. state or federal securities laws or other anti-fraud laws. Stretching growth projections or making materially misleading promises to investors can lead to legal issues.
#10 Lacking Legal Permits and Licenses
Finally, make sure to have the right permits and licenses in place to avoid legal problems. Figuring out permit and licensing requirements can be challenging, so hiring a lawyer to assist is a value-add.