More and more people are entering the realm of working for themselves or starting their own business everyday. Because of the new experiences and level of stress that can be put on the principals of a startup, it can be hard to remember that everything has to be kept within certain legal guidelines as well. Below are some of the most common legal mistakes startups make, and ways to prevent them in the future.
Improper handling of intellectual property ownership issues.This one really has a number of subparts, but I see them all the time. If your startup is based based upon a patentable idea, you’ve got to make sure it’s done correctly or you risk losing your rights.
- Applying for patents in foreign markets. Yes, there are treaties between nations regarding the recognition of patents. For any number of reasons that are way outside the scope of this article, those international markets may not honor your patent. Patents are applied for on a nation-by-nation basis, excepting the EU where one application is available covering all member nations. It is important to intelligently determine your key markets as early as possible and be prepared to spend the money necessary to ensure that market is available for your product.
- Who owns the patent? If your patent was created while you worked with another company, it is often the case that the patent belongs to the former employer. Depending on the type of employment contract you entered into, this can even be true if the patent was developed on your own time (there are a number of exceptions ot this rule, however, depending on your state/nation of domicile). If you are managing a startup corporation, make sure that any patents on the products you intend to market are owned by the corporation, regardless of who came up with them.
- Prematurely disclosing inventions. Seeking investors, venture capital, or even just looking to hire employees? Unless any such parties sign a no-disclosure agreement, do not disclose any invention unless you’ve obtained patent protection. Otherwise the only protection available to you is that of trade secrets, for which you will be required to show certain steps were taken to maintain secrecy of the product.
Forming the wrong type of business entity.Generally speaking, I only recommend an LLC for holding companies, internet based business, and business without employees. Venture capitalists and other investors often don’t respect pass through organizations (those where the tax burden “passes through” the initial owner). You must further determine whether it is more beneficial to you to be taxed at the self-employment tax rate or the standard federal income tax rate as an employee. Through a careful analyzation of a variety of factors you should reach the right decision. All to often, however, an incorrect decision was made, usually due to bad or non-existent professional advice.
Attempting to obtain capital without an adequate idea of your startups worth.This is usually tied into the worth of a patent, but not always. If you’ve received a positive worth evaluation on your patented product, and begin shopping for venture capital based solely on this evaluation. You can be creative when making offers to venture capitalists, and those offers can and should be framed in such a ways as to least effect the potential profitability of the business and without devaluing your own interest in either the business or the patent.
Not having a clear agreement between the initial owners.With an LLC it’s an Operating Agreement. With a Corporation it’s typically the bylaws, though you can also have separate shareholder agreements. These are the documents that define everyone’s responsibility within the corporation. This includes the owners. Are they silent? Are they expected to perform certain day to day operations? What percentage of the company does each owner hold? How much capital is each investor expected to provide? What are the rules regarding an initial investor’s selling his or her portion of the company? What if you want to remove one of the initial investors? All of these things must be defined somewhere if you are trying to avoid a dispute. Maybe it’s a business with just husband and wife or two close friends who think they don’t need such an agreement because of their pre-existing relationship. How did that work out for the initial investors at Facebook?
Not having standard form contracts pre-drafted in your favor.The number of contracts you will find yourself entering into when starting a business is staggering. Having a number of solidly drafted for agreements on hand that you are already sure are drafted in your favor and don’t have any language written in that could screw you over in the long run can be a life saver. You don’t ever want to find yourself as the one receiving the contract to sign, and if the agreements are already in your possession that’s never going to be an issue. Consult with a business attorney ahead of time and make sure you have these ready and available at all times. Examples include non-disclosure agreements, non-compete agreements, employment contracts, subcontractor agreements, and purchase and sale agreements.