Legal Tricks
Startups

8 Legal Mistakes Many Startups Make

Many startups make legal mistakes. Some have minor consequences. Others force companies to shut their doors for good. To avoid the cost and grief of a legal dispute, be sure not to make these eight mistakes.

1. Not Choosing the Right Entity Type

One of the first decisions that startup founders must make is choosing an entity form for the business. Founders often form companies without consulting with lawyers. As a result, they wind up having to pay higher taxes and are subject to significant liabilities that could have been avoided had they chosen the right entity type.

Corporations and LLCs both offer liability protection and have unique tax advantages.

Consulting with a lawyer before forming the business will help ensure that you choose the appropriate entity.

2. Not Creating a Founder Agreement

One of the biggest legal mistakes startups make is not forming a founder agreement. Without an agreement in place, arguments and legal disputes may ensue if partners disagree on how to handle certain situations.

Some key deal terms that must be agreed to include:

  • The roles and responsibilities of founders.
  • Who gets what percentage of the company?
  • What happens if a founder leaves?
  • Is there a buy-sell agreement?
  • Salaries of founders.
  • The factors and circumstances under which the business will be sold.
  • The goal and vision of the business.
  • The way in which key and day-to-day decisions are made.
  • The expected time commitment of each founder.
  • The circumstances under which founders may be removed as an employee.

A founder's agreement will help prevent future issues that could potentially tear a business apart.

According to Erlich Law Office, LLC, business disputes can include breach of contract, negligence and even accounting malpractice. By ensuring that you have a founder agreement in place, you can avoid some of these issues.

3. Failing to Create a Standard Form Contract

A standard form contract is crucial for nearly every business, but the contract must be in favor of the startup.

Look at sample contracts of what other people use in the industry. There is no need to re-invent the wheel.

Talk to a business lawyer to do the drafting of the contract. Pricing, penalties and interest, and due payments should be clearly outlined. A clause should also be included that outlines how disputes will be resolved.

4. Lack of Employment Documentation

Startups can face difficulties if they do not maintain proper employment documentation. To avoid this issue, have a group of employment documents available to be signed by most or all employees.

Some common employment documents include: IRS Form W-4, stock option documents (if necessary), "at-will" employment offer letters, USCIS Form I-9, employee handbook and benefit forms.

5. Not Considering Intellectual Property Protection

If your startup has created a unique product, service or technology, it's important to take steps to protect your intellectual property.

Protections can be sought through trademarks, patents, copyrights, trade secrets, service marks, and confidentiality agreements.

6. Failure to Retain Legal Counsel

Legal counsel is expensive. It is for this reason, startups often hire inexperienced, more affordable legal counsel. This may come in the form of friends, relatives and others who offer steep discounts.

Inexperienced counsel can lead to problems in the future.

Founders should consider interviewing several lawyers and firms before hiring someone. The firm should have experience in contract law, corporation law, employment law, intellectual property laws and/or tax laws.

Check the lawyer's reputation and track record to ensure that he or she has the needed expertise.

7. Not Taking into Account Tax Issues

Startups need to consider key tax issues before launching. In addition to entity type, which will affect the company's tax burden, startups need to consider payroll tax, sales tax and stock options.

The company will need to collect sales tax on sales of its products. Many cities and counties also impose a payroll tax on local businesses.

In addition, founders must determine whether they are able to mitigate potential tax issues when making the IRC Section 83(b) election. Depending on the business type, certain tax incentives may be available, including investment tax credits and energy tax credits.

It's important to speak with a lawyer or an accountant familiar with these issues.

8. Not Considering Business Name Issues

Many startups come up with a name for the company and run with it. But if another business has a similar name, the startup could face trademark infringement problems before it even launches.

It is important to do research before settling on a name to ensure that it will not cause trademark issues. A lawyer can help with this, or the startup can perform a search at the U.S. Patent and Trademark Office.