7 Legal Mistakes Startups Should Avoid

28 October 2021

So, you’re the proud owner of a brand-new startup. Whether you’re still bickering over the perfect logo with your co-founders or have just signed your first office lease, you should be aware of the most common pitfalls that catch many companies unaware in their early years. Startups come with unique legal issues, specific legal constraints and often require tailored legal assistance. 

7 Legal mistakes startups should avoid

Keep your startup on the right side of the law and firmly in the green by avoiding these common problems. 

1. Choosing the wrong structure (sole proprietor vs. partnership vs. incorporating)

The three most common business structures are a sole proprietorship, a partnership, and an incorporated company. If you’re a startup intending to scale, and especially if co-founders are involved, it’s important to incorporate as a company immediately. This structure comes with liability protections for founders, but make sure that you’re clear on the corporation’s legal obligations. When incorporating, always involve a legal professional to conduct the set-up and distribution of shares. Failing to do this can result in messy financial issues down the road.

2. Not writing a binding contract with co-founders

We know, we know – you have a great relationship with your co-founders – what could go wrong? Without a binding contract that defines boundaries and procedures around share distribution, voting rights, buyouts and exit agreements, the answer is…a lot. Shifting personal priorities and differing opinions on the company’s direction can wreak havoc on the success of a business. By ensuring all founders have mutually understood, binding agreements drawn up by a lawyer, the company is protected for the future, regardless of whether a founder chooses to depart.

3. Misunderstanding your tax, data, or regulatory obligations

Operating a company comes with a raft of tax, data, and regulatory obligations; the breach of any of these regulations can bring legal issues knocking on your door. Startups should be well informed of the legal constraints for a business. Professional legal advice is recommended. The multitude of legislative regulations can vary depending on where your startup operates and what industry it functions in. Failing to budget for corporate tax can become a financial predicament in the early years; breach of data regulations can bring hefty fines, and failing to adhere to regulatory obligations may bring legal consequences. 

4. Using leaky employment contracts 

We understand that working for a startup often means wearing multiple hats. To get a company off the ground, everyone has to pitch in across different areas. However, if you don’t draw up clear employment contracts with defined job roles and responsibilities, you may be leaving yourself open to legal action and employment complaints. If you’d like to avoid the fair work commission, we recommend robust legal documents such as employment agreements from day 1. To protect the company, we also suggest you engage legal assistance to include confidentiality clauses within any employment contracts.

5. Offering badly set up  sweat equity or share option schemes

It’s common practice for startups to offer sweat equity (or employee share option schemes) in lieu of, or in supplement to, market value salaries. While we understand this can effectively scale your workforce within financial constraints, there are serious risks in a poorly set up employee share scheme. Without legal documents and professional advice, you risk giving up significant company value for very little in return. An employee share scheme must be carefully crafted with vesting timelines, exit agreements, and much more. Avoid this common startup legal issue and engage professional advice.

6. Failing to protect IP and not using non-disclosure agreements

As a startup, your intellectual property (IP) is one of your most valuable assets. Ensure you protect this appropriately by understanding the different types of protections such as patents, trademarks, copyright, and contractual protections through NDA, assignment deed and other contract.  Legal assistance for startups is available and heavily recommended in this area. In addition, your company should be using non-disclosure agreements when engaging with suppliers, potential suppliers, customers, investors, and more. Essentially, anyone who may become privy to internal IP should be signing a legally binding non-disclosure agreement before this occurs.

7. Using boilerplate contracts, or worse – none at all

Many fruitful business and investor relationships begin from a casual conversation, but once things start to progress, casual needs to be replaced with an actual, legal, on-paper contract. Failing to use a contract, or even defaulting to a standard template found online, can open up your company to many risks. When you get a standard template from online, you really have no idea if it’s a good contract in the first place or whether it applies to your particular scenario at all. Take it from us – each situation is different and every time a contract is prepared for a client, a lot of customisation is needed. By failing to get a contract that caters to your specific needs, you are increasing your risk to legal issues and costly legal disputes. 

Startups that avoid these common legal mistakes from the beginning are more likely to find success in their early years and will certainly avoid costly legal fees that stem from fixing the issues arising from these errors. Engaging a legal professional that is well-versed in startup culture and the specific needs of these companies is an invaluable investment for the ongoing growth of your business. 

At UX Law, we specialise in supporting startups with their legal needs. We provide startups and entrepreneurs with practical legal solutions to protect and empower their business. Reach out for a free consultation to learn more.