12 Legal Mistakes Startups Make (and how to avoid them)

Starting a new business is a hugely exciting time, but it also brings a degree of uncertainty. Many start-ups make legal mistakes that end up costing a considerable amount of money, time, and stress to put right. Fledgling businesses are more vulnerable to a lack of knowledge around specific legal issues ranging from the protection of intellectual property to contracts.

Many new business owners overlook these matters when launching their venture, choosing instead to deal with problems as they arise. Whilst at the outset it may seem like the most efficient route, it can end up costing the business significantly more money.

So, what are the most common legal mistakes you need to be aware of before starting a business?

1. Neglecting the basics

Many startups fall at the first hurdle by neglecting to have legal agreements in place from the outset to ensure they are fulfilling their obligations. Usually, this is because they are not fully aware of their responsibilities, or they may not wish to incur the costs of getting documents in order. Unfortunately, failure to have the basics in place can carry some serious consequences and these could harm the future of the business. 

Our tip: Be aware of which documents your business needs from the outset and if you’re unsure, get impartial legal advice. You may trust the people you started the business with, but boardroom disputes can happen at any time and things can escalate quickly.

2. Non-compliance with data regulations

Despite changes to data protection laws within recent years, many small businesses are still not fully compliant when handling data. A recent study suggested that only 1 in 3 businesses are compliant. Since the introduction of the General Data Protection Regulation (GDPR) laws, if a business is collecting or processing data, it must be handled in accordance with GDPR guidelines. This includes the business's marketing activity and storage of any customer data, as well as their terms, conditions and privacy policies.

Our tip: Ensure you are fully up to speed on exactly what is required to meet GDPR laws and make sure your business is acting accordingly. If you are unsure then get advice to avoid any hefty fines or complaints further down the line.

For tech startups, the way you handle data is likely to be a pivotal part of your product.

3. Not registering the proper business structure

A key step when forming a new business is deciding how the company will be structured. Setting out the structure at the start lays the foundations for developing and growing the business.

For example, deciding whether it will be a limited liability company, or set up as a sole trader basis, will determine how the business operates going forward.

Clarifying these points when registering the business will benefit the business's performance in the long run.

The Founders’ Agreement, the Articles of Association, the Shareholders’ Agreement are examples of legal documents that co-founders use to agree the structure of a business. Laying out this information in the form of a written document illustrates clearly how things will function within the business.

Our tip: Making sure this is done in the early stages of formation will ensure better performance in the future. This will help to reduce risk if your business structure changes or is forced to change further down the line.   

4. Not protecting their intellectual property

In the excitement of starting a new venture it is understandable to feel the urge to share the big news with the world. However, disclosing information to anyone before obtaining a patent or copyright protection for any ideas could mean someone else is free to take the startup’s intellectual property and use it themselves.  It is in the best interest of the business to keep all projects or proposed ventures confidential until they are protected. 

Our tip: Until you can protect your creation, it's a good idea to look into non-disclosure agreements for any employees or co-founders to ensure information cannot be leaked by anyone within the business.

5. Not limiting their liability

Understandably, many startups don’t want to consider the things that could go wrong when planning a new venture, but preparing for all eventualities and any problems that could occur in the future protects the venture from serious consequences. By having correct procedures in place, should any complications arise, it is possible to limit the damage. However not having established plans in place could result in little protection from any legal issues in future. This could mean the venture will face liability, even for problems that they think are not their own fault.

Our tip: Ensure terms and conditions are established that will limit your liability as and when these situations arise. It's better to be prepared by having these measures in place even if you rarely use them than not to have them and find yourself in a tricky situation later down the line. This can cover you from anything ranging from advice you give to clients, to legal issues around employees and accidents at work.

6. Not having correct employment agreements in place

As the business becomes successful, there will come a time where more staff are needed to support the functioning of the venture. At this point, it is necessary to have the correct agreements in place to protect not only the interests of your business but also the interests of any employees.

Our tip: Make sure these agreements  are set-up before you start hiring to ensure cover for all parties' rights as and when it comes to needing staff. Waiting until there is a pressing need for staff could mean agreements are neglected which could cause issues for any party involved.

Great employment contracts can help build a great culture.

7. Lack of legal counsel

The legal advice received at the point of forming a business could significantly impact the future of the venture. The lawyer chosen will be responsible for drafting documents as well as using their commercial advice to help guide you. By being aware of potential legal pitfalls, you could save time and money down the line.

Another common mistake made by many startups is choosing to draft documents themselves as opposed to seeking professional legal input. Whilst this may initially be attractive due to saving on costs, most co-founders of a startup are unlikely to possess the expertise required to draft such documents adequately. Again, by not having the correct legal advice, incorrect documents could be created which will cause more problems in the future. Online templates can only get you so far.

Our tip: Seek appropriate legal advice from an experienced lawyer with knowledge of your business sector. With legal experience, as well as business expertise, a commercial lawyer can prove a valuable part of your team.

8. Not putting their agreements into writing

Most agreements are reached informally through conversations, whether in person or over email. Although these agreements can be legally binding, if they don’t appear in writing, there is a risk that conflicts may arise over what was agreed and court proceedings may be necessary in order to resolve such a dispute. This process is likely to be costly, time-consuming and damaging to the company’s prospects.

Our tip: Ensure all agreements made verbally or electronically are adequately placed in writing to hold all parties to account and remove the possibility of any dispute.

9. Inadequate document and filing systems

If a startup fails to maintain accurate records it can make it challenging to keep track of business activity. This can be risky when it comes to assessing whether the venture is functioning appropriately.

Keeping accurate records will allow co-founders to observe clearly how the business is performing and to plan ahead for the future.

Our tip: Keep a record of all of your paperwork in an organised system or a secure cloud system. This will make it significantly easier to keep track of the business.

10. Issuing founder shares without vesting

Starting a new business requires a lot of hard work and will rely on a committed team of co-founders who will devote their time and effort to making the new business a success. It's vital that those chosen to receive founder shares are not given the responsibility too soon. 

Consistency, hard work and reliability are key to a successful startup and issuing founder shares too quickly could result in co-founders who are not as invested in the business and may not stay with the venture if challenges arise.

Our tip: Ensure that the founder shares are issued only to those who have invested their time, money and expertise into the business.

11. Failing to comply with business tax laws

New ventures may not be aware of the implications of taxes on their business, meaning they misunderstand their responsibilities and may not deal with tax and VAT correctly.

It's vital to have a complete understanding of how and when you will need to pay your taxes and set up clear procedures for doing so. Failure to do so could see a business face serious repercussions, such as legal action.

Our tip: Hire an accountant to assist with your tax and VAT policies and ensure you are fully compliant.

12. Thinking legal problems can wait until a later date

No doubt, starting a new business can throw up some unavoidable legal challenges. It is possible to avoid these problems from spiralling into larger issues by tackling them directly. Whilst it might seem more appealing to bury your head in the sand, by not dealing with these issues promptly, they are only likely to worsen and become harder to deal with as time goes on. 

Our tip: Tackle legal issues as soon as they arise. If unsure, get impartial legal advice. Some of these issues will be time-sensitive and ignoring them could make things more difficult for your new business. Dealing with any challenges head on gives you the best chance at overcoming them and ensuring the best possible success for your new venture.

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