In the business world, legal issues in startups can be one of the most overlooked areas. Since legal issues are so varied and diverse in nature, founders often find themselves overwhelmed with information overload. However, some of the best companies in Silicon Valley have made legal mistakes, and it is essential to know what they are before you make them yourself.
Remember that legal mistakes can be some of the most costly. If you make any of those that we outline below, you could find yourself embroiled in a lawsuit or unable to raise much-needed funds. In some instances, legal issues can even bring a startup crashing down before it ever has the chance to succeed.
To help prevent that from happening, we will discuss three legal mistakes that you should avoid at all costs if you want your startup to succeed and thrive. So, keep reading and take notes! (Consider bookmarking this article.)
Using informal or non-written agreements with co-founders
One of the major mistakes many new business owners make when launching a startup is scribbling out a quick agreement with a co-founder on a napkin or engaging in only verbal agreements. Should there ever be a major falling out between you and your co-founders, informal or non-written agreements just aren’t going to fly.
Besides that, there are other practical reasons to have a formal legal agreement with your co-founder. For example, without a formal, written contract in place, it could be difficult for either person to sell their shares if they wanted to leave the company down the road. It’s therefore essential to ensure that you have a formal legal document in place before your startup launches and while everyone is on friendly terms.
A legal document can protect each partner’s vision and investment for the future of the business going forward so that all parties know what is expected of them and how you will resolve any disagreements should they arise. It can also help make sure there aren’t any misunderstandings about who owns any intellectual property and more.
It’s also important to have formal, legal agreements in place with your investors. In most cases, an investor wants a share of the business and expects to be involved in decision-making for that company. They may want certain rights or protections such as “first right of refusal” if you choose to sell the company down the road – but again, legal documents can make everything clear up front, so everyone knows what they’re getting into before signing on.
Not starting the company as a C corporation
Another mistake startup founders often make is in their choice of legal business entity. Many think a limited liability company (LLC) will suffice, or perhaps an S Corporation. However, this is because they often haven’t taken the time to seek guidance on financial and legal issues. They’re in a rush to launch their business and start making profits.
However, these impatient entrepreneurs probably don’t realize that many investors won’t invest in either of the previously mentioned legal entities. To make matters worse, converting an S Corporation or an LLC into a C Corporation can be incredibly expensive and create tax issues.
Moreover, if you don’t launch your startup as a C Corporation from the very beginning, you won’t be entitled to take advantage of the Qualified Small Business Stock (QSBS) exemption. The QSBS exemption can allow you and any investors you might acquire to possibly write off 100 percent of the investment proceeds from taxes.
With that said, there are a few other legal benefits to owning an official C corporation, including:
- More protection and legal liability than if the business was started under another type of legal entity (LLC or S Corp)
- You have personal legal protections from potential lawsuits related to the company’s actions before it becomes profitable while also retaining some control over how any future profits will be distributed among them
- Shareholders get tax breaks stemming from items purchased by the business with its own funds, such as office supplies and computers. In addition, shareholders may deduct up to $50,000 per year in losses on their individual income taxes depending upon other factors
Choosing a business name that has trademark issues
You need to do your due diligence beforehand when deciding upon a company name or a domain name. You want to be able to identify any legal concerns or possible trademark infringement issues that could prevent you from using the names you’ve chosen.
Besides, if you’re starting a company with the intention of building your business to be sold one day for millions and then retire on the profits, why would you want legal hurdles in front of that goal? Choosing an original company name may seem like a lot of trouble now, but it will save you plenty in the long run.
Apart from concerns about trademark issues, you’ll also want to ensure that any name you choose is distinctive, memorable, and easy to spell.
In closing
With a bit of awareness and foresight, you can avoid most of the common legal mistakes other startup entrepreneurs have made. However, there are many other legal pitfalls outside of the few major ones discussed in this article. Because of that reality, it’s a best practice to consult with an experienced legal team to ensure you successfully avoid them too. Investing in a good legal foundation from the start can substantially mitigate your risk of failure. Remember that if you’re able to avoid most legal problems, you’re more likely to raise the capital you need to launch and scale your startup successfully.
