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Five Common Legal Mistakes for Startups to Avoid

Think you have all your bases covered? Think again.

Anyone launching a startup has no idea if it will survive a few months—much less succeed—so it isn’t surprising that many end up ignoring potential legal pitfalls.

However, with just a little forethought, you can spare yourself some unnecessary grief–particularly when it comes to these five common legal mistakes.

1. No Formal Agreement Between Founders

Let me guess: You and your co-founder have been best friends since pre-school. Why on earth would you need to reduce your special relationship to a legal agreement?

Well, you only need to look at Snapchat or Facebook to understand how much damage a fight between co-founders can cause.

While it may feel awkward, you need to make sure everyone agrees at the outset exactly who owns what, how the company will be run and how key decisions will be made. This is best addressed by incorporating the company and putting in place bylaws or an operating agreement (depending on the type of legal entity you pick). If you don’t, expect the following questions to loom large:

  • If a founder leaves, does the company or other founders have the right to buy back those shares?
  • Can a founder be removed as an employee? How is this done?
  • How are both strategic and day-to-day decisions made? Are there certain decisions that require unanimous signoff?

Also make sure that the founders are required to transfer to the company any ownership they have (or think they have) in any IP related to the business as a prerequisite for receiving their ownership share. That will reduce the chance that one founder can later claim that he or she alone created, and should own, the company’s secret sauce.

2. Failing to Protect Your Name

After hours of brainstorming, you finally decide on a name for your new company. Before you get too attached, make sure that someone hasn’t already trademarked it. You don’t want your fledgling business to gain name recognition only to discover you didn’t have the right to use the name in the first place. At that point your choices are either to change the name or try to buy the name from its current holder. Either way, it’s going to be an expensive process—one that could have been avoided.

Also, don’t forget about protecting your name in other countries. In 2012, Pinterest ran into this problem when, after two years of operating in the U.S., it applied to trademark its name in the E.U. Unfortunately for Pinterest, a U.K. company applied for the same mark earlier that year. Pinterest initially lost the right to use its name in the EU and was forced to spend years fighting to regain control of its name.

3. Not Following Proper Employment Practices

A unique trait of startups is how quickly they can go from two unpaid founders to dozens of real employees with a relatively high turnover rate. For that reason, it’s important to have proper written employment agreements in place.

Don’t forget to include arbitration clauses, which can save you a lot of money and keep you out of court, as well as confidentiality provisions to protect the company’s trade secrets. Finally, even though you may be small, you’re still required to comply with employment laws. This includes paying federal payroll taxes, having unemployment and workers’ compensation insurance and, in some states, offering paid family and sick leave.

4. Ignoring the Regulatory Landscape

There are a mindboggling number of regulations which can potentially impact your business—and it’s easier than you think to violate them.

For example, what if, instead of emailing potential customers, you decide to text them about sales and offers? Whoops! You may have violated the Telephone Consumer Protection Act.

For all startups, one common regulatory mistake involves early investments. While you may not view the money Uncle Bob invested in your business as a “real investment,” the Securities and Exchange Commission certainly will. The failure to either register the securities or comply with the requirements for an exemption from registration can result in substantial penalties—and additional headaches when you do eventually have “real investors.”

And before you think about relying on ignorance of the law as an excuse, consider what a Federal Appeals Court said on the topic: “No one with half a brain can offer ‘an opportunity to invest in our company’ without knowing that there is a regulatory jungle out there.”

5. Putting Off Legal Problems for Later

It’s easy to put off addressing potential legal issues—especially if they haven’t yet become legal problems. This is incredibly shortsighted. Most of the problems listed above only become hard to fix because they were ignored at the outset. While it may cost a few dollars early on, take the time to set your business up correctly. It will almost always cost you less to get it right at the beginning than trying to fix it somewhere down the line.

Most legal issues, including those discussed above, usually arise because someone needed to spend a few extra minutes thinking further ahead. Take the time to avoid these common mistakes so that you and your team can focus on what really matters: building your company for the future.

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