March 4, 2024

Top 4 Legal Mistakes Startups Should Avoid

Startups are typically developed through trial and error. Founders create, test, and change course. Building innovative products requires this technique. But from a legal standpoint, it’s not the ideal strategy. The cost of trial and error in legal proceedings can be very high.

The top five legal blunders made by startups are listed here, along with some advice on how to prevent them.

1. Divvying Up the Equity Right Away

 Divvying Up the Equity Right Away

Many founding teams divide the equity equally up front without a vesting schedule in order to avoid having the difficult talk about individual contributions and obligations. This can cause a lot of issues and is how “Zombie Founders”—owners of a sizable amount of ownership in your firm who make no valuable contributions—appear.

Have the difficult conversation with your co-founders up front and ensure that everyone is on the same page to prevent this. Establish the levels of contribution and dedication that each founder is capable of offering, and make certain that the vesting schedule for all founder shares includes a cliff of at least a year. This implies you can fire a co-founder without having to buy out their stake, dilute the equity by issuing a tonne of new shares, or create a new business if they are unable to deliver value, are unable to renounce earlier obligations, or simply lose interest before the end of the year.

2. Absence of Intellectual Property Assignment

Founders are frequently too busy building their business to keep track of who developed what code or came up with a concept or a plan of action. This puts your startup at risk of significant legal problems.

Any intellectual property (IP) is automatically the property of its author. The IP must be assigned by the creator to the business in order for it to become corporate property. An early contributor who left your startup without providing assignments of IPs could return years later and seize a sizable chunk of your company.

Use a tech assignment agreement, also called a Confidential Information and Inventions Assignment or a Proprietary Information and Invention Agreement, to safeguard against this. All members of your company, including the founders, employees, and contractors, should sign this document. It declares that the corporation owns all inventions and intellectual property contributions made by anyone involved in the project.

An early-stage donor could inflict considerable harm by claiming ownership of a crucial component of your product or operational model when your firm becomes a large enterprise, costing the business millions of dollars. An agreement for a tech assignment will mitigate this risk.

3. Using employee equity improperly

Using employee equity improperly

It is tremendously difficult to build a solid team with the restricted resources of a firm in its early stages. Top talent will need to receive equity compensation from you as it’s possible that you won’t be able to pay market rates for them.

Some founders fail to account for this and divide the equity equally among themselves. They must rely on inexperienced professionals or contractors without creating an equity pool for employees, which slows the growth of the business.

Create an employee equity pool as soon as the company is incorporated. When early-stage employees mistakenly believe they own a piece of the company only to discover there is no stock for them, high-potential startups are easily brought down. They are let down and depart. People that are driven and skilled who want to create something amazing need to own a piece of the business.

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Lack of clarity on the grant’s terms may cause entrepreneurs to experience additional problems with employee equity. Although equity should be vesting, there are additional crucial factors. You can provide your staff with either stock grants or stock options as equity. Employees who receive grants receive a portion of the business; those who receive options can purchase that portion at a significant discount.

Make the choice regarding who receives stock grants and who receives options early to avoid unpleasant shocks or wounded feelings. Make sure your staff members understand the exact form of equity they are receiving. You want to prevent receiving an unexpected tax bill because this could have substantial financial repercussions for the employee as well.

4. Sending out non-disclosure agreements in bulk to everyone

A lot of new entrepreneurs bombard everyone they speak to with non-disclosure agreements (NDA). They zealously defend their idea since they believe it to be truly original. This is rarely the case in practise. The most crucial element of a startup’s success is execution, not idea.

They frequently don’t get the protection they require from this, and it could even scare off potential investors and partners. A deal can be killed before it even gets started if you refuse to meet with venture capitalists because they won’t sign an NDA. This shows that you are a novice.

Find a way to describe your product or service without getting too technical rather than hiding behind an NDA. Don’t divulge specifics about your algorithm or proprietary technology, but do provide a basic description of how your product functions, how it adds value, how it differs from the competition, and how you anticipate it will affect the market.

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