TEN MOST COMMON LEGAL MISTAKES MADE BY START-UPS AND HOW TO AVOID THESE MISTAKES

Business Jun 13, 2021 0 Add to Reading List

INTRODUCTION

Most Start-ups usually begin with an innovative concept to renovate the existing business ideas in order to stand out from the more prominent and established businesses present in the market. When entrepreneurs take their innovative ideas and give them substance in order to build their business, quite often, they tend to miss out on certain critical legal aspects of establishing and running a successful business. These legal matters could cost a lot to a budding entity such as a Start-up, if not taken care of. Let's look at some of these common mistakes:

Not having a Founders’ Agreement

A founders' agreement is an agreement between the Founders of any Start-up or company which comprises certain clauses that determine each founder’s role, rights, and duties in the business. It is essential to have a Founders’ Agreement while starting one’s business as, in most cases, it can avoid any future disputes that may occur between the founders. Typically, a founders’ agreement should specify the following:

The extent of ownership – Determining the share of each partner in the ownership.
Role and responsibilities of each founder
Division of equity amongst the Founders
Whether the exit of one founder opens up for grabs his/her shares for the other founders?
Non-compete clauses in case one Founder leaves
Salaries of the founders
Ways in which business-related decisions shall be made
Grounds for removal from a particular Role or from the entire venture
Capital investment by each founder
Dispute Redressal – How would the disputes between founders be resolved

No Documentation of Corporate and HR Affairs

Proper documentation of every activity that goes on in a company is of significance, especially the ones related to corporate affairs such as browsing for finances, purposes of mergers & acquisitions, and Human Resources affairs involving employees and other regulatory authorities. Following are examples of activities for which all start-ups shall maintain documentation:

Minutes from the meetings of Board and shareholders
Signed contracts
Record of job applicants, their resumes, and minutes of interviews conducted with them
Agreements with employees
Policies on workplace ethics such as anti-harassment, discrimination, etc.
Record of all disciplinary complaints, proceedings, and their redressals.
All details of Employees and their activities
Termination notices and severance agreements with dismissed employees
Non-compete and non-disclosure agreements

Not Having Competent Legal Consultancy & Representation

In order to save on expenses, start-ups often don’t pay much heed to competent legal consultants and representatives and end up taking advice from lawyers whom they know or who offer discounts on their fees. There are many legal issues involved in running a business, like drafting proper contracts, filing of taxes, drafting merger agreements, contracts of employment, non-compete & non-disclosure agreements, licensing, intellectual property protection & infringement, privacy policies, cyber laws, legal representation in disputes, and the list goes on. Compromising the quality of legal advice can put a business into some serious trouble. To locate competent legal counsel, the founders should:

Seek suggestions from business acquaintances
Take into consideration referral services provided by the State Bars
Browse through various legal websites

It is also advisable to have a permanent In-House counsel who although, might not have expertise in all the required legal fields but knows your business and can work with other professionals who specialize in various legal matters of the business.

Not Procuring all Essential Licenses and Permits or Procuring them in Illegal Ways

Many times, the entrepreneurs do not research enough about the licenses or permits that they might need in their business and how they would obtain them. The requirement of such permits/licenses is different for different businesses depending upon the activities they engage in. Some of the basic permits required are:

Industry-specific licenses for regulated businesses (aviation, agriculture, alcohol, etc.)
Threshold permits
National or State qualification to do business
Sales tax license
City business licenses
Zoning permits
Seller’s permits
Health standard licensing
Safety standard licensing
IPR licenses
Licensing for other operations (transportation, production, etc.)

In order to avoid being subjected to suspension or penalties from the regulatory authorities and to avoid any other legal disputes, it is essential to obtain the required licenses in legitimate ways.

Overlooking the Protection of Intellectual Property

The most crucial and valuable asset of a start-up is its Intellectual Property, which includes identification marks of the business, creative and artistic works, and inventions. These intellectual properties give an edge to the start-ups to survive the competition posed by the incumbent market players as well as gain a competitive advantage over others. Therefore, it is of immense importance that a Start-up not only protects its own work from infringement but also does not infringe upon the works of others. Here are some of the standard protective measures undertaken by start-ups:

Applying for the correct IP protection - There are various IP protections, and each IP must be appropriately protected. For instance, one should get: a patent to protect novel products and processes that have industrial application; copyright to protect exclusive rights of producing copies and derivate works of original works of authorship like books, music, software, photographs, films, etc.; a trademark to protect the identification marks, such as names, symbols, words/phrases, related to the business; trade secrets to protect the confidential information essential to the business which is not known in the public domain.
Non-disclosure Agreements - A non-disclosure agreement is an agreement between two parties wherein one party agrees to share some confidential information with the other party on the condition that the other party cannot share that information with any other person. This is especially useful in the protection of trade secrets or some other information used in creating other intellectual properties.
Agreements with Employees – These agreements with employees can enable the Start-ups to claim ownership over the work created by an employee during the course of and in the scope of his/her employment. The agreements can also impose non-disclosure obligations on the employees, legally binding them to keep the proprietary information of the start-up confidential during and after the end of his/her employment.

Not taking Taxes into Consideration

For Start-ups, it is essential to take into account the taxation of their businesses, which includes calculating the total amount that is required to be paid and timely apply for exemptions for which the start-up may be eligible. Regular documentation of gain and loss statements, income, and expenditure can prove helpful to start-ups, in being able to pay their taxes well in time and avoid any fines or penalties that could be imposed in case of default in tax payments. Having a full-time tax consultant is also quite beneficial for a business since it can receive regular updates on the new policies that could save taxes and also receive professional services for filing their taxes. Some of the taxes that start-ups should take into consideration include:

Corporate taxes
Goods and service tax
Income Tax

Not having Standard Form Contracts

Standard form contracts are the most effective way to safeguard one’s contractual and commercial interests and avoid unnecessary legal issues. Start-ups that do not draft their own standard form contracts face a lot of issues while negotiating agreements with other parties, such as:

Third-party contracts don’t consider all the aspects of the start-ups
Reviewing different contracts for different negotiations takes up a lot of time
Amending third party contracts is not easy
Each contract is different; thus, no assurance whether it will be suitable for the respective negotiation.

Lacking Terms of Use and Privacy Policy for Website

In the present times, a website is a must for any Start-up; however, what the Start-ups don’t pay much heed to is the fact that having legitimate terms of use and an assuring privacy policy can play a huge role in determining the popularity of the website among the customers. The terms of use agreements lay down the terms and conditions for people using the website, while the privacy policy tells the people how will their personal data be used, sold, or released to third parties. Another important thing that must be considered is that these terms should not be blatantly copied from other websites; rather, they must be very carefully drafted to suit the requirements of one’s business and must also be in consonance with Consumer and Data Laws.

Not having Confidentiality Agreements with Employees

While building a business, gaining the confidence of people is essential, and in order to achieve that, the Start-ups might have to share some valuable, confidential information about their business with their partners, employees, and other parties. In such situations, the entrepreneurs might miss out on taking certain measures to secure the confidentiality of the shared information, especially in the case of employees, who might disclose that information once they change their jobs. One such measure is entering into confidentiality/non-disclosure agreements to protect the proprietary business information.

Not following the Corporate Decision-Making Protocol

Making Business decisions is not as easy as making other decisions. The companies are supposed to follow a certain corporate protocol while finalizing such decisions, which the Start-ups frequently miss out on. The corporate procedures are generally mentioned in the laws (Companies Act, 2013), or notifications/ ordinances passed by the parliament, or in the agreements of the start-up, such as a founder’s agreement and not complying with these procedures could nullify the outcome of the decision and also impact the reputation of the start-up as well. This procedure may include obtaining permissions for taking certain decisions, convene meetings to discuss the decisions and obtaining the permissions, provide a time-period for other parties to raise objections.

References:

By Vareesha Irfan