Mistake # 5 – Not having a clear founders’ agreement
You don’t need to look far to find an example of a successful start-up that fell into this common trap. Facebook dealt with a costly and lengthy legal battle between Mark Zuckerberg and his former classmates, including the Winklevoss twins. Zuckerberg’s former classmates claimed that Zuckerberg stole the idea for Facebook. A contract governing the relationship between the owners, commonly known as a founders’ agreement or buy-sell agreement, may have prevented this lawsuit. A founders’ agreement should answer all of the questions that could cause problems later on. Some of these questions include: What are the roles and responsibilities of each founder? How much of the company does each founder own? Is the percent of each founders’ ownership subject to vesting based on continued participation in the business? Will all founders contribute equally with start-up capital? What will each founder receive as compensation and when will such compensation be paid? How can a founder be removed? If one co-founder leaves, what are the remedies available to the remaining founders? These questions and others should be addressed and answered up front in order to prevent nasty legal battles in the future.
Mistake # 4 – Not having a formal business entity
Businesses can take many forms: sole proprietorships, partnerships, limited liability companies, C corporations, S corporations, in addition to several others. Selecting the form for your business is an important and complicated legal decision. Organizing your business as a limited liability company (LLC) or corporation can prevent a number of common start-up issues. For example, the issue of percentage ownership, noted above, can also be resolved by incorporating the business and issuing shares to co-founders. A formal business may also help shield you from personal liability in the event the business is ever involved a lawsuit or bankruptcy action.
Mistake #3 – Not complying with securities laws
It is crucial for every business that sells stock to abide by applicable federal and state securities laws. Normally that means registering the securities but for most start-ups it means not only meeting the requirements for an exemption, but also subsequently filing the exemption with Securities Exchange Commission (SEC). Founders are responsible for compliance with securities regulations regardless of their level of understanding of the legal framework. Ignorance of the law is no excuse for non-compliance. In Mueller v. Sullivan, 141 F.3d 1232 (7th Cir. 1998), the Court of Appeals affirmed the business owners’ criminal convictions for securities violations, stating, “[f]ailure to comply with [securities law] requirements can result in significant financial penalties for the founders and the startup company including requiring the startup company to repurchase all the shares at the original issuance price even if the company has lost most, if not all, of its money.”
Mistake # 2 – Not taking the appropriate steps to protect intellectual property
The company itself and a product it provides could potentially require intellectual property protection. If your start-up has developed a method, technology, product, or service, you may want to file a patent. In the United States, patent law is governed by 35 U.S.C. 101, which sets forth that patentability hinges on novelty and usefulness of the “process, machine, manufacture, or composition of matter, or any new and useful improvement thereof,” as well as several additional factors. Under U.S. patent law, there is a yearlong grace period to file a patent application after an invention is sold or made public. However, that is not the case internationally; therefore, if the invention is disclosed outside of the US without a patent application in that country, the business will lose the ability to patent the invention there.
Copyrights protect original and creative works of authorship. While copyright comes about at the moment of creation, companies should register its copyrights in proprietary creations (such as website content and arrangement, software code, photographic images, videos, literary works, designs, drawings, and sound recordings, amongst other items) with the U.S. Copyright Office. Regardless of whether a copyright is formally registered, a company should always take care to display a copyright notice on all original works. At a bare minimum, proper notice format is comprised of “Copyright © [YEAR OF CREATION] [NAME OF COPYRIGHT OWNER]” (e.g. Copyright © 2014 The Harbor Law Group).
Trademarks protect the unique identifiers that businesses use to distinguish their goods and services from those of others. In order to obtain federal trademark protection for the mark as used in connection with the goods and/services provided by your business, your company must use the mark in interstate commerce. Although it is not necessary to register a trademark with the U.S. Patent and Trademark Office in order to assert trademark rights, federal registration offers a number of advantages, including, but not limited to, a basis for filing for trademark registration in other countries and possible incontestability.
Mistake #1 – Not hiring experienced legal counsel
Trying to save on expenses by failing to hire appropriate legal counsel will often backfire in the form of large litigation fees and possibly even criminal charges due to failure to comply with a complicated legal landscape. Hiring competent and experienced legal counsel can prevent costly legal fees from problems that can be stemmed early on in your entrepreneurial journey. It always pays to do things correctly from the start!
