Top 7 most common legal mistakes made by startups

Legal mistakes made by startup founders can embroil the company in serious lawsuits. Sometimes, negligence of legal compliance or meeting legal standards can restrict the startup from raising funds for their business acceleration.
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Starting a company is not a cakewalk. It requires extensive effort and resources to develop a winning business idea and kick-start its operation. There are several tasks that require attention mainly to launch a product and operate safely in the market.

With many things in mind to make a market-fit product, founders often neglect the legal requirements of their startup in the initial stage. This leads to problematic legal mistakes that prevent the founders in establishing a strong legal foundation for their startup.

The legal mistakes made by startup founders can embroil the company in serious lawsuits. In some cases, negligence of legal compliance or meeting legal standards can restrict the startup from raising funds for their business acceleration. The most common legal mistakes made by startups are:

Choosing the business entity

When forming a new business, choosing the right business entity plays a critical role in making your startup legally viable. There are different structures that are available to choose from – Registered Company (Public or Private) and Sole Proprietorship or Partnership. Startup owners who rush into the registration process without spending ample time in researching the right option can have a negative impact on the performance of the business.

The most important factors that a newbie founder should consider while making the decision are tax treatment, liability, legal expenses, and growth plans.

Founders’ agreement

The only constant thing in this world is change. Startup founders work in a dynamic environment where things can change unpredictably. Therefore, it is important to have a properly drafted founders’ agreement in place in order to avoid ambiguity, hassle, and wastage of time.

A well-drafted founders’ agreement outlines the key roles and responsibilities of co-founders that avoids the chances of serious conflicts among them in future.

The most important aspects to look for in a founders’ agreement are operational responsibilities, decision making authority, equity breakdown, intellectual property right, remuneration, and exit clauses.

Protection of intellectual property

Intellectual property is very valuable for every startup. Due to widespread technological adoption, infringement becomes easy whether it the company’s name, domain name, or product. Securing of IP allows startups to protect their innovation and compete against large players in the industry after patenting the invention.

For instance, if a startup has an unpatented invention, industry giants can easily copy or use their invention to stay ahead in the market. For the best protection of strategy, it is important to hire a competent attorney.

Non-compliance with security laws

This is one of the most common legal mistakes that startup founders make. Early-stage startups often raise capital from angel investors, friends, and family without worrying about security laws. Complying with the relevant security laws requires disclosure, filing, and form compliances.

Stocks issued without complying with law may lead to serious consequences including heavy financial penalties for startup founders as well as the company.

Not taking tax issues under consideration

Every business owner has to pay a variety of taxes in order to operate safely. Without professional help, the founders may find themselves liable for certain fines and penalties. There are many factors impacting tax consideration, including choice of entity, stock options, tax incentives, etc., depending upon the nature of the business.

Thus, startups must appoint a professional tax consultant to ensure that all tax-related matters are dealt with properly and all regulations are being followed.

Not hiring a professional legal counsel

Since startups run on a low budget in the early stage, the founders try to make every effort to cut down expenses. Consequently, they appoint inexperienced legal counsel or bring in friends or family to save the cost. However, this leads to more legal troubles as they inadequately draft documents or make mistakes as per their lack of understanding and experience.

On the other hand, many founders also indulge in do-it-yourself approach and attempt to carry out all legal processes on their own. To avoid unnecessary troubles, founders must hire professional and experienced legal counsel to avoid heavy penalties or shutting down of businesses.

Lack of licenses and permits

No business can run without obtaining relevant licenses and permits or subscribe to budget friendly verified legal toolkits to facilitate the DIY approach. The necessary permits depends on the nature of the business and include – industry-specific permit, state qualification, sales tax, homebased business permit, city, county, zoning and seller permits, health department permit and federal or state tax ID.

Any form of non-compliance in obtaining licenses and permits may lead to hefty penalties and fines. Avoiding legal pitfalls for startups is easy if they appoint a professional legal consultant from an early stage.

It is also essential for founders to focus on meeting all regulations similar to focusing on building the company or a revolutionary product.

Avoiding these mistakes ensures a seamless business journey with better chances of growth and a positive company reputation.

Edited by Megha Reddy

(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)