Common Legal Mistakes Startups Make
By Shradhanjali Sarma
For founders, commencing the startup journey is an exciting process. Brainstorming ideas, planning towards business launch and pitching to investors, building a team for market domination are part of the startup journey. Amidst the excitement, it is easy for legal details to take a back seat, which later might be difficult to clean up. A simple Google search in such a case might not be able to fix it.
In this article, I discuss some of the common mistakes that a startup make, and how to avoid them.
Skipping Written Contracts
In the early stages, it is often natural to operate on trust. In the initial stages, most startups work with people whom they have known for years, such as friends, partners or family members. Due to the level of trust that one places on such relationships, the apprehension of anything going wrong is quite minimal.
However, a lot can go wrong if the startup does not have proper contracts drawn up for different relationships. A lot can go wrong, if not today, then a few months down the line. Failing to have proper written contracts in place can lead to confusion, disputes, and potentially losing control of your company. Learn more about why contracts are important in my earlier post here.
How to Avoid It: Always, and always use written contracts. Whether it’s a co-founder agreement, service provider contract, or client terms of service, getting everything in writing avoids misunderstandings. While it might seem tedious for as a company who is just starting out to sit down and think about contracts, it is much better than saying "We'll figure it out later". Contracts ensure everyone is on the same page and, more importantly, gives you something concrete to refer back to if things go south.
Ignoring Intellectual Property Protection
The entire intent behind the birth of startups was to foster innovation and creativity. Therefore, protecting your startup’s intellectual property is crucial, be it your brand name, brand logo or product design. Failing to secure IP can leave you vulnerable to copycats or disputes over ownership.
How to Avoid It: It is always best to file for trademarks, patents, or copyrights as soon as possible. Register your business name, logo, and any other key identifiers. Also, have NDAs in place with employees, contractors, and potential partners to protect confidential information.
Mishandling Equity
Equity is often handed out too freely in the early stages, mostly to attract talent or secure partnerships. However, failing to properly structure your equity can create serious problems later, especially in situations where a co-founder leaves or if you are stuck with someone who contributes nothing to your company but is sitting with a huge chunk of your company’s equity.
How to Avoid It: As a founder, plan a vesting schedule which distributes equity over a period of time rather than distributing it all at once. Using agreements to put down rights and obligations is the best move forward. Handing out equity is like giving someone a seat on your rocket ship. Make sure they are ready to fuel the journey, not just enjoy the view. You would not want the rocket ship to crash.
Failing to Comply with Employment Laws
Due to day-to-day operational matters, startups might find it difficult to pay heed to employment law matters. Startups often make the mistake of classifying employees as independent contractors or ignoring employment law requirements entirely.
How to Avoid It: Try to understand the difference between employees and contractors. Ensure you’re following local labor laws, including minimum wage, overtime, and benefits requirements. Proper employment agreements are also key, as they clearly outline roles, responsibilities, and protections for both parties.
Not Having An Exit Strategy
While starting out, no one likes plans for co-founder exit or close down of the company. However, it is best to have everything planned out at the initial stages itself to prevent future legal disputes over ownership.
How to Avoid It: It is best to include exit provisions in your founders agreement. Outline what happens in case of a co-founder departure, how shares will be handled, and how decisions will be made if things don’t go as expected. Having a plan in place now avoids chaos later.
In a Nutshell
Do not wait until things go wrong to fix them. It is always best to have a proactive approach than a reactive approach to legal issues, especially when it can have an adverse impact on your business. It is advisable to put the right contracts, protections, and strategies in place from the start for long term success.