10 Legal Mistakes Startups Make
Updated: Oct 8, 2019
I had an opportunity to speak on a startup panel with some great colleagues about mistakes startups make. Below are the legal missteps I touched on:
1. Overall Approach to Legal – Too Rich
Sometimes startups feel most comfortable using a big law firm whose name they recognize or because they have a relative or connection there who is a star attorney. While most big national firms (and smaller full-service firms) have a corporate department and will (usually) be happy to work with a promising startup, using counsel who is not familiar with startups and startup process and documents can be a mistake, resulting in ballooning legal costs much too early.
2. Overall Approach to Legal - Too Lean
Far more common than running too rich is running too lean on legal. For the most part, founders are founders because they are self-starters and risk tolerant. These are great qualities, but often they result in DIY legal. This usually doesn’t matter…until it does. I’ve seen hundreds of thousands of dollars spent trying to un-do what a founder did while shooting from the hip.
3. Capitalization – Founder Equity
When starting a company, founders are starry-eyed and ready to take on the world. When it comes to co-co-founders, that optimism often translates into an assumption that a lax handshake deal (or no deal at all) anchored only by some vague notion of a “fair split”. Far too frequently, this approach results in a disconnect between value, vision and ownership later. Any time there is more than one founder, it’s best to define roles and responsibilities upfront and implement vesting on initial equity.
4. Capitalization – Options
In many areas of a startup, fast trumps right, and often something done not quite right out of the gate can be fixed later. Legal doesn’t always work that way, and faulty option grants are one common screwup that can be difficult to fix. Failing to follow proper rules for valuing, approving and granting options can result in significant cleanup costs as well as a huge loss of value for the recipient.
5. Capitalization – Too Free with Early Equity
Equity is cheaper than cash for a young company, but if successful, the pendulum will soon swing the other direction. Treating your equity like monopoly money out of the gate can be empowering at the time, but handing out oversized checks to minor contributors at your Company’s exit is a painful way to learn.
6. Capitalization – Too Careful with Early Equity
For a successful startup company on the rise, its equity is its most valuable currency. While being too free with that equity is a mistake, being too tight-fisted with it can be as well. For a cash-strapped company, equity is often the only tool you have to punch above your weight when it comes to recruiting top talent and providing incentive for key advisors and contributors. Failing to do so may result in missed opportunities for key talent.
7. Intellectual Property (IP) – Founders
Intellectual property issues in startups are common. Failing to have founders assign IP rights to the company early on is all too common in a startup. In many cases, it’s no big deal and a cooperative founder can make that assignment later when required by an investor or acquirer. But with so many founder “marriages” ending in divorce, founders may find themselves in the troubling position of needing to go back to an estranged founder and ask them to assign their IP to your company.
8. IP - Consultants
As a default rule, a startup company owns the IP created by its employees within the scope of their employment. The opposite is true for consultants: unless they have agreed otherwise, consultants own what they create, even if the company has paid for it. Failure to have consultants assign IP to the Company calls into question the ownership of that IP, and chasing down those consultants years after the fact (and hoping they will cooperate) while your long-awaited acquisition hangs in the balance is nerve wracking.
9. IP – Contracts
At a scaling tech startup, inbound and outbound licenses fly around like fidget spinners in a middle school. But careful attention should be paid to license terms, ownership, infringement risk and indemnity provisions in these contracts because a misstep can prove costly, especially in the case of a lawsuit or data breach.
10. Tax – Don’t know what you don’t know
While much of getting a startup off the ground is common sense or can be quickly figured out by a savvy founder, taxes and the tax code are an exception. Running ahead without accounting and tax input is like running with the Bulls in Pamplona…blindfolded. The sooner you can get good tax and accounting support, the better.
This site and the content herein is the property of Triumph Advisors, PLLC ("Triumph"). It is made provided for educational purposes only, not to provide specific legal advice. By using this site, you understand that there is no attorney-client relationship between you and Triumph. The site should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.