Legal Mistakes Every Startup Company Should Avoid Making
It can be easy to overlook legal matters that seem unnecessary while developing your business. More importantly, hiring lawyers and filing paperwork may seem like a financial luxury you can’t yet afford. However, avoiding legal matters could lead to issues with compliance, contracts, or stolen intellectual property down the road.
Not hiring lawyers because of financial concerns is one of the most common legal mistakes that startup founders make. In addition, some business owners also neglect to sign well-defined shareholder contracts for fear of driving potential investors away.
These issues may not seem imminently important, but not handling them early in the process can lead to expensive litigation. Accounting for these legal factors is necessary for a successful business.
A Suitable Legal Entity
One of the first decisions a startup founder should make is selecting the type of business entity. This step is vital because you need to match the business structure with the vision and goals of your startup.
The type you choose will affect your ability to grow and attract investment. It also has repercussions for taxes, regulatory compliance, licensing, registration, and the day-to-day governance of your business.
There are four main types of business entities for startups.
- A sole proprietorship is best if you want to run and control the business by yourself. The main drawback, however, is that this structure does not allow you to separate your business and personal finances.
- A partnership involves an agreement between two or more people to share the profits, expenses, and risks associated with running the business. This structure requires a clear agreement that defines contributions, duties, and benefits for each member.
- A limited liability company (LLC) provides the simplicity of a sole proprietorship or partnership for organization and taxation. However, it also comes with liability protections that allow owners to separate personal and business finances.
- A corporation is an organized entity that allows shareholders to have ownership of portions of the company. This structure is ideal for startups that want to attract and retain investors and potentially sell the business for a profit in the future.
Choosing the correct legal entity is just the first step in establishing your business.
The Company Name
The company name provides a legal identity for your startup. You need to choose a unique name to register your business and file the necessary paperwork. It can also help distinguish you from your competitors and define your identity for customers and clients.
Startups need to register a unique business name with the appropriate state agency (usually the Secretary of State or Department of Commerce) after checking that the chosen title isn’t already in use. You can also search the United States Patent and Trademark Office (USPTO) to check the name nationally.
Validating the unique nature of your company name is an essential step to avoid confusion among customers, vendors, and investors. Furthermore, someone else can use an unregistered name and force you to change your title or sue you for infringement if they choose to do so.
Trademark Creation and Renewal
Filing a trademark gives you legal protection if someone else uses your brand name for business purposes. According to the USPTO, you need to file paperwork at regular intervals to prove you are still using the name. You start the trademark process by searching the USPTO website for your chosen name. If your name is unique, you can file paperwork for creating a trademark and pay the filing fee.
You can hire a legal firm to handle the application process. This step can be valuable if there are any complications related to the trademark. A legal advisor can also help you maintain and renew the trademark at five-or ten-year intervals. Without timely renewal, someone else could legally claim your trademark and start to use it.
You may also want to consider the valuation of your trademark. The value of a trademark is the attorney and filing fees plus the cost of rebranding after a failed application. You also need to factor in marketability and any other costs or delays associated with having to change your company’s name.
With all this in mind, hiring an attorney to handle the trademark application can ensure everything progresses smoothly.
Tax planning may be burdensome, but neglect can typically lead to an escalation in legal matters. This involves evaluating your business plans and operations to limit your tax liability. For example, you may be able to limit taxes by changing the size and timing of inventory purchases, debt payments, and limiting other expenses.
With the help of an accountant, you can also define and plan for tax exemptions or deductions offered by your state and the federal government.
By not being fully aware of how the tax code affects your company, you risk exposing yourself to higher tax payments. Furthermore, as your company grows, you could have to deal with an unexpected tax increase which you should anticipate to stimulate your company’s growth.
Agreements Among Founders and Shareholders
Startups often lack defined roles for employees, and clear expectations with investors or stakeholders. Disagreements regarding individual functions within a business can cause conflicts, change plans, and limit the productivity of certain employees.
Likewise, having clearly defined expectations for shareholders ensures they know the level of input they can have in operations and how they obtain their share of realized profits. In a worst-case scenario, not having shareholder agreements could lead to legal action.
Intellectual Property Rights
Intellectual Property (IP) considerations vary from industry to industry. A startup may need to consider copyrights, trademarks, or patents to protect its ideas. Obtaining legal ownership of your intellectual property is the first step in the process.
You also need to clearly define and document guidelines related to sharing information and using protected ideas and methods. These expectations should be a part of the contracts for employees and contractors.
If you do not protect your intellectual property, other businesses can use the same or similar ideas and methods without fearing any legal repercussions.
You are not legally required to have written contracts with employees or contractors. However, putting everything in writing can bring advantages and protections to startups.
A contract can require an employee to give a specific amount of notice before they leave their position.
A contract can also set performance and attendance standards, establish non-disclosure rules, and define terms and procedures for termination. Contracts can also establish benefits, such as a retirement plan, vacation days and sick leave, and health and life insurance.
A contract gives the employee a well-defined set of expectations, and it allows the startup to take action if an employee does not meet those expectations.
Complying With Specific Laws
Government regulations apply to plenty of industries. For example, if your startup is involved in healthcare, food production, or transport, you must abide by specific laws that protect consumers and the general public. Furthermore, every business with employees needs to meet health and safety standards for the workplace.
With these standards in mind, startups need to be aware of both general employment laws and the specific requirements of their industries to avoid any further legal repercussions.
Legal experts can help a startup keep up to date with the latest regulations in their industry and ensure that all operations comply with these rules. In some sectors, such as finance, detailed record-keeping and reporting are required. Failure to comply with regulations could lead to fines, legal action, or other penalties that could disrupt or even ruin your business.
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