Starting your own business is exciting!
And it's not just about the money.
You get to follow your passion, control your schedule, achieve financial independence, and share your unique product or service with the world.
Whether you start your business on a shoestring or have millions in venture capital behind you, one thing is certain.
The success of your business depends on you and the actions you take, and sometimes the actions you fail to take.
Below are the seven most common legal mistakes made by startups and how to avoid them.
#1 - Not Having A Well-Drafted Founders' Agreement
Many startups have co-founders to give them a jump start with funding, experience, expertise, and more.
But the number one mistake made by startups using co-founders is not having a clear, well-drafted founders' agreement from the beginning.
With the excitement of starting the company and the rush to get things done, the founders often rely on verbal agreements and put off the written agreement to a later date, if at all. This is a recipe for disaster. Memories are not exact, and soon there are disagreements about the most basic terms like who is responsible for certain obligations, how much are the parties getting paid and when, and what happens when there is a disagreement?
You only have to look at the beginning of Facebook, now Meta, to see how badly things can go between founders when they disagree.
You can avoid those future problems with a well-drafted founders' agreement from the beginning.
This agreement should cover equity, operational responsibilities, decision making and authority, IP rights, remuneration, exit terms and conditions, and more.
#2 - Choosing a Company Name with Legal Issues
Choosing the right name for marketing purposes is difficult enough.
A great name can be invaluable for marketing and branding purposes. A poor choice can be costly. For example, Mercedes Benz entered the Chinese market under the brand name “Bensi” which translated into “rush to die.” Pepsi's slogan “Pepsi Brings You Back to Life” stumbled also when it debuted in China and was translated int “Pepsi Brings You Back from the Grave.”
But to avoid future legal issues, you need to do your research to make sure the name you want is available and has no trademark infringement or domain name problems.
Sometimes, recognizing trademark issues is difficult. You might unintentionally infringe on someone's trademark if your name or mark is likely to confuse the public about the source of the goods or services. A famous example is when Mead Corporation, the owners of Lexis-Nexis the legal services company, sued Toyota for trademark infringement for naming their luxury car “Lexus.” Mead won the first round of the trademark infringement lawsuit. But they were soon overturned by the 2nd Circuit Court of Appeals that ruled, “The differences in the marks and in the products covered by the marks, the sophistication of Mead's consumers, the absence of predatory intent, and the limited renown of the LEXIS mark all indicate that blurring is unlikely.”
Here are some steps to help avoid legal issues with your companies:
Is the name already in use? Do a Google search and see if another company is already using the name or a very similar name.
Search the Secretary of State records in your state to see if the name, or a very similar name, has already been registered, either as a state trademark or as a business name.
Search the U.S. Patent and Trademark Office site for any federal trademark applications or registrations for the name or a very similar name.
Do a domain name search. If the ".com", “.io”, “.net”, or other top level domain versions of the domain name is taken, you might have an issue.
Have an experienced trademark attorney do a comprehensive trademark search for the countries in which you plan to use the name.
#3 Not Protecting All Your Intellectual Property
Your company's intellectual property will likely become one of its most valuable assets. Not having the IP legally protected can be a costly mistake, leaving you open to theft, claims of infringement, and more.
The four main areas are:
People think of Trademarks and service marks as brand names. A trademark is the symbol, phrase, word, or insignia that we recognize and it lets us know that the product belongs to a specific company that owns that brand.
If you see a product with the golden arches, you think of McDonald's. If you see logos from Amazon, Apple, or Microsoft, you instantly recognize the source of the product. If you see clothing with "Just Do It," you know it is from Nike.
When you register your mark, you get the security that you have the exclusive right to use your mark. If someone tries to use your mark without your permission, you have a much easier time convincing them to stop if it is registered. The registration gives you legal rights including the ability to obtain statutory damages from someone making "knock-offs" of your product and, in some cases, the ability to recover your attorneys' fees from the infringer.
Additionally, your brand value will grow as the company grows. Famous examples of valuable brands are McDonald's - $33 Billion, Amazon - $254 Billion, Apple - $263 Billion, Microsoft - $140 Billion, and Nike - $30 Billion. These companies fiercely protect and defend their brand. You should do the same.
Patents can be extremely valuable assets for startup companies. Not only do you get protection and a limited monopoly for your product or technology, but investors often put a higher valuation on companies with patents.
And when it comes time to implement your exit strategy, a patent is a unique and valuable asset that makes your position more advantageous in a buy-out or merger. And failing to secure patent rights makes the sale of your business more difficult.
A small investment in patent rights today might lead to a vast return later.
Companies often fail to protect their work with copyright registration.
Most people know that copyrights protect artistic or creative works, like books, movies, music, and art.
But many business owners do not know that copyright laws also include protection for software code, technical documents, white papers, and other corporate literature.
There is no requirement that you must register your copyright with the federal government. But without federal registration, you don't have the right to sue someone for infringing on your copyright. Additionally, registration gives you the right to recover statutory damages (rather than having to prove actual damages) and attorneys' fees if someone infringes your copyrighted works after you register.
Trade secrets may be the most misunderstood and least protected of a company's intellectual property.
Many business owners don't know what defines a trade secret, and they don't know the simple steps needed for its protection.
The Uniform Trade Secrets Act ("UTSA") defines a trade secret as "information, including a formula, pattern, compilation, program, device, method, technique, or process" that has economic value and is subject to reasonable efforts to keep it secret.
Trade secrets include manufacturing processes, chemical formulas, industrial or manufacturing secrets, production methods, distribution or sales methods, client and marketing information, advertising strategies, client or supplier lists, and other types of proprietary information.
# 4 Choosing the Wrong Legal Entity
Should your new company be formed as a general partnership, a limited partnership, a C-Corp, an S-Corp, an LLC, or something else?
There are advantages and disadvantages to all of these entity types.
One of the biggest mistakes startup owners make in forming their company is not considering which entity will work now and in the future?
Sole proprietorships are easy to form but fail to provide limited liability to their owners. S-Corps have some tax advantages but have limitations on types of shareholders. Partnerships have some ulinique tax shifting advantages but may have liability issues for the partners.
Before choosing which entity will work best, you need to ask yourself what kind of business you want.
Will you be raising capital by taking on venture capital? Are you concerned about future lawsuits? What is your exit strategy? What is the entity that gives you the best tax outcomes?
Company formation and ensuing tax consequences can be complex. Get advice from a qualified business attorney before choosing your business entity.
#5 Not Having Great Contracts
Companies live or die by the contracts they use.
Whether you sell a service or a product, you will most likely do so with a written contract or agreement. A poorly drafted contract will not have the proper protection for you and your business. A long, complex, and overly harsh contract will turn off potential clients. An unconscionable, one-sided consumer contract may draw the scrutiny of regulators.
Unfortunately, many new businesses draft their own contracts by finding a competitor's contract online, modifying it, and creating their own contract without understanding the legality or enforceability of the contract. This is not a great idea.
Contracts should be transparent and easy to understand for you and your clients. But contracts need to follow certain formalities to be enforceable and protect you.
And you have to decide specific terms and conditions before the sale. What are your rights if the client stops paying? If the client sues you, are you going to court or arbitration? Can you cap your liability? What state law are you following? What if they want to return the product after two months?
Well drafted contracts make clients feel comfortable while giving you the protection you want.
#6 Mishandling HR Issues
Whether you have one employee or hundreds, employees have rights and obligations under state and federal laws. Not knowing your obligations as an employer can be costly.
The number one mantra for all HR issues is to follow legal procedures and document everything.
Here are just a few HR issues that startups often mishandle.
Many small businesses have a poorly worded employee handbook or no handbook at all. Your employee handbook formalizes the employee relationship and outlines your company employment policies and procedures that align with state and federal law.
Offer Letter or Hiring Agreement
Oral agreements can lead to problems later. A well-worded hiring agreement will be written confirmation of the details of the hiring agreement and include things like job, title, role, responsibility, salary, benefits, ground for termination, and more. And in most states like Oregon, it includes language explaining the employment is "at will."
Firing an Employee
Companies need to take great care in terminating employees, even in an "at-will" state.
Specific procedures must be adhered to before termination. And state and federal laws prohibit termination based on color, national origin, ancestry, gender, race, age, disability, marital status, religious preference, sexual orientation, absenteeism due to jury duty or military service, retaliation for sexual harassment, discrimination, or other allegations by the employee, and many other factors.
Hostile Workplace and Sexual Harassment Claims
These claims are becoming more prevalent, and every company must take them seriously and follow state and federal law with these issues. You should have these policies and procedures detailed before you hire any employee.
#7 Not Hiring the Right Attorney
To save money, many startups delay hiring an attorney until they run into a legal problem. Or they find their legal forms online and cut and paste documents together. Often, a friend-of-the-family-attorney might offer some advice.
There is no requirement that you must hire an attorney to help with your startup.
But the risk of having no qualified legal advice for your startup is enormous.
Most successful startups engage a qualified intellectual property and business attorney.
And the best time to talk to a qualified business attorney is before you form your business. As you plan your business, you need expert information on raising capital, business entities, taxes, intellectual property protections, employee issues, exit strategies, and more.
Your Next Best Steps for Your Startup
Whether you are just beginning or are a few years into your startup, we can help you determine your next best steps.
Res Nova is a boutique intellectual property and business law firm based in Camas, Washington and Portland, Oregon, with experience serving innovative companies and entrepreneurs in the Pacific Northwest and beyond.
We represent small and mid-sized businesses, including creative agencies, startups and more mature companies.
Call Res Nova and let us help you with the next best steps for your startup.