Having an innovative idea does not automatically translate to the success of a startup. A startup’s success or failure is dependent on quite a lot of factors.
First time founders often overlook the legal structure of their business, they focus on getting their product or service to the market first. While launching quickly isn’t necessarily a bad thing, the risk of neglecting the legal aspect is that you might commit to obligations that aren’t in your best interest, and some of these commitments may be irreversible.
Imagine you’re a founder on the brink of success, with everything falling into place. But then, an unexpected issue with your developers surfaces—you realize you don’t have clear ownership of the intellectual property, like code, that they created. Yes, even if your Developers are employed in-house you need to make sure everything they work on actually legally belongs to your company.
You can start or operate a business in its infancy without regulatory barriers or concerns, but you can never scale that business if you are not compliant. Regulations will slow, hinder or shut you down.
Below are 15 Regulatory Mistakes Founders Should Avoid Making
1. Not having a Co-Founder Agreement: American academic Noam Wasserman, in his book “The Founder’s Dilemma” analyzed 10,000 founders and concluded that 65% of high-potential startups fail due to conflicts among founders.
How can this conflict be avoided? This conflict can be avoided by having a legal binding co-founder agreement.
A co-founder agreement is a legal contract that outlines the terms of a partnership between co-founders before a company is incorporated. It can help prevent misunderstandings and conflicts between co-founders, and can be essential for a startup’s success. This agreement outlines the roles, responsibilities, and rights of each founder, addressing critical scenarios that might arise during the business journey. From equity distribution to handling disputes and addressing exits, a well-crafted
Founders Agreement serves as a crucial document that outlines the operational framework and ensures clarity and fairness among co-founders.
What happens when a co-founder decides to walk away from the company shortly after launch?
If a co-founder departs from the company, can they walk away with their associated intellectual property?
What is each person’s contribution to the company?
What is the specific role that each person will play in the Company? What are their responsibilities?
These are just some of the very important questions that co-founders should come to an agreement on.
2. Ignoring Intellectual Property Rights Protection: IP refers to creations of the mind–ideas, inventions, and brand elements–that are legally protected.
Types of Intellectual Property
- Patents (inventions) – Patents protect innovations
- Trademarks (brand name, logo, and other brand identities) – trademarks secure brands
- Copyrights (creative works) – copyrights safeguard software
- Trade secrets (confidential business info) – trade secrets are protected through NDAs.
Neglecting IP protection can be detrimental to startups, making it crucial to seek the expertise of a legal professional or law firm. These experts can handle patent and agreement drafting, IP filings, and any related infringement or prosecution issues that may arise.
As a startup founder, if you do not have an IP Transfer Agreement with your Developers you are setting yourself up for trouble.
3. Picking The Wrong Name: For a startup to have the best chance of getting noticed, a memorable, appropriate and appealing name is essential. The business name chosen should remain relevant as the company, along with its products, brand and reputation, develops over time.
Much has been discussed about the significance of a business name, but getting it right on the first try isn’t always easy. For instance, Google was originally called BackRub, and Amazon was known as Cadabra.
Here are 5 common mistakes to avoid when choosing your business name;
- Avoid a name that is identical to an existing name.
- Avoid picking a name that is limiting and does not accommodate growth and expansion.
- Avoid names that are too long, hard to pronounce, spell and understand. Never choose a business name that is confusing.
Before finalizing on which name to use, it’s essential to check its availability with the Corporate Affairs Commission (CAC). Additionally, perform a search on domain name registrars like Namecheap, GoDaddy, etc to ensure your desired domain is available.
4. Choosing The Wrong Legal Structure When Registering Your Startup: When building a startup, one of the first steps is to register your company, and it’s crucial to select the right legal structure
Registering your business as a business name (enterprise) when you should be registering it as a Ltd liability Company that you can easily grow and scale.
How your business is registered determines your liabilities rights and privileges as a business owner.
5. Randomly issuing equity and not vesting the shares: Not vesting the shares issued to your founding team is a huge mistake. There’s a common story in the ecosystem about a founder whose co-founder worked for only 3 months before exiting, yet still owns 30% of the company. Brings on a co-founder or a founding team member – no matter how promising they seem, or the level of friendship that exists between you two – make sure everyone is on a vesting schedule,
The founding members’ shares should ideally be vested over a four-year period with a one-year cliff period so as to protect the Company in case they leave the Company before the end of the vesting schedule
6. Not following requirements while issuing Equity: Issuing equity is a common way for startups to attract talent and raise capital, but it’s a complex process that involves several legal requirements. Mistakes in this area can lead to significant problems such as:
- Legal and Compliance Issues: Each country has its own set of laws and regulations governing the issuance of equity. For example, in the U.S., startups must comply with securities laws, such as those enforced by the Securities and Exchange Commission (SEC). Failing to follow these rules can result in penalties, fines, or even legal action against the company.
- Cap Table Confusion: A cap table, or capitalization table, is a document that tracks the ownership stakes in a company. If equity is not issued properly, it can create confusion on the cap table, leading to disputes over who owns what percentage of the company.
- Tax Implications: Issuing equity without understanding the tax implications can create unexpected tax liabilities for both the company and the recipients of the equity, which can lead to financial strain.
- Dilution Issues: If equity is issued without careful consideration, it can lead to unintended dilution of ownership for existing shareholders, reducing their control and share of the company’s value.
- Investor Relations: Mistakes in issuing equity can damage relationships with investors, who may lose confidence in the company’s ability to manage its financial and legal responsibilities.
7. Not adhering to Data Privacy Regulations: A privacy policy is a legal document detailing a startup’s practices for data collection, protection, security, and usage. It’s essential not only to meet legal obligations but also to foster customer trust. Familiarize yourself with Data Privacy Laws of the countries you operate in.
Although most users won’t take the time to read your terms and conditions or privacy policy, having them on your website and app safeguards you from potential liabilities.
Create a Terms of Use that is peculiar to your business & your relationship with customers.
8. Poorly Drafted Employment Contracts or Agreement: An employment contract is more than just a formality; it’s a vital document that sets the foundation for a clear and legally binding relationship between the company and its employees. It covers essential details such as job responsibilities, compensation, benefits, working hours, confidentiality, intellectual property rights, and conditions for termination.
Lack of a clearly drafted employment contract can lead to:
- Intellectual Property Issues: Without clear ownership clauses, disputes over the intellectual property created by employees can arise, threatening the core of your business.
- Compliance Risks: A poorly constructed contract might fail to meet labor law requirements, leading to potential legal penalties.
9. Tax Evasion: All businesses irrespective of the size are required to pay tax. Payment of tax is an important obligation. Tax is incurred on the profit of the business. It is easier to pay tax when due to prevent payment of penalty, and the crime of tax evasion.
Remember, Tax avoidance is not illegal, Tax evasion is illegal.
10. Not involving an experienced lawyer early enough in your Startup: Perhaps this ought to be number 1. It is a fatal mistake to think you can build a scalable startup without covering your legal bases. Where there is a Startup, there ought to be a Lawyer. Especially a Startup Lawyer. This can prevent legal issues from arising. Your lawyer helps to proffer legal Solutions, conduct due diligence, review contracts and negotiate the best terms for your startup.
In conclusion, startup founders should give legal considerations the same priority as product development to prevent irreversible mistakes. Neglecting legal requirements can result in serious repercussions, including challenges with funding, damage to reputation, and even the potential failure of the business.
