Top 5 Legal Issues Many Startups Face
Starting a company is an exciting endeavour; however, it can be a daunting task no matter what industry an entrepreneur chooses to operate in. While entrepreneurs tend to focus their efforts on the development and growth of their startups, they typically overlook the legal risks that their organization may face. Failing to address these issues can be detrimental to the success of the business. Below, in no particular order, we examine some of the more common legal issues faced by business startups so that entrepreneurs can make themselves aware of these risks.
Failing to Choose the Most Appropriate Business Structure
Entrepreneurs often fail to select the most appropriate business structure and thus open themselves up to liability that could be avoided. While sole proprietorships and partnerships as business structures allow for low setup and registration costs, they do not insulate the entrepreneur or his or her partners, if any, from being personally liable for the debts and liabilities of the business. Choosing to not incorporate based on a belief that the incorporation process is too expensive or confusing leaves entrepreneurs open to potential personal liability. However, the cost to incorporate could be considered a small price to pay to avoid such a large risk.
Businesses that are incorporated tend to also be more attractive investment opportunities due to their limited liability protection and thus, can more easily attract capital investment. Also, a corporation that is organized correctly and with the appropriate share structure will more clearly establish the ownership rights to the business startup between the current owners as well as any future investors.
Executing Agreements Without Adequate Legal Advice
Unfortunately, startup businesses may execute contracts without receiving adequate legal advice. This oftentimes leads to many issues down the road that could have been initially avoided with proper legal counsel, and which incur greater legal costs to remedy. Startups commonly work with a limited budget and on a sensitive time schedule, therefore they believe that hiring a lawyer will both delay their operational efforts and be costly due to the traditional hourly legal billing structure by lawyers. Entrepreneurs will even sometimes believe that they have no choice but to take a risk and execute documents without legal guidance. In these situations, many terms of the agreements are either unfavourable to the entrepreneur or misunderstood. One solution for startups that face this issue is to seek out a business lawyer who is willing to work within the startup’s budget on some sort of flexible fee model that makes sense for everyone.
Working with Partners Without a Written Agreement in Place
Business startups are often a collaborative effort among the founding partners. However, disputes occur over many issues such as roles and commitments, and sometimes if not resolved, these disputes can lead to many unfortunate consequences such as interrupting or halting the progress of the business, and costing many times more in legal fees than what may have been initially required. A well thought-out partnership or shareholder agreement allows partners to map out in advance fundamental terms for which the partners must abide by in relation to the business regarding among other things, buyouts, parties exiting the business, the ownership structure, banking matters, voting control, etc. Further, going through this process provides the partners an opportunity to thoroughly and honestly evaluate their roles and commitments to each other and to the business itself.
Failing to Protect Intellectual Property Rights
When a business startup develops its project, the intellectual property rights (whether copyright, trademark, patent, confidential information and trade secrets, or industrial designs) are often major assets that need to be protected. However, startups are often unaware of the steps required to protect these IP rights, and fail to take even the minimum precautions, such as registering copyrights, filing trademark applications or having parties sign confidentiality agreements. Furthermore, sometimes IP rights are not properly transferred or acquired under properly crafted agreements that establish the legal ownership of the IP, which can lead to devastating effects on the business startup.
Relying on Handshake Deals and Oral Agreements
Business startups commonly make the mistake of relying on handshake deals and oral agreements because they typically believe there is a strong working relationship between the parties they work with and that there is some amount of “trust” that they can rely upon. However, issues, confusions, and disputes arise even among the most friendly of business associates, clients, suppliers, and colleagues. Although an oral agreement may be legally binding, this approach is fraught with difficulties. This is generally because when an issue or dispute arises, each party’s recollection of what the “oral terms” of the agreement tend to differ, and if the terms are unclear or vague, enforcing such agreements becomes extremely complicated, if not impossible.
This article was written by Jindra Rajwans, a business lawyer based in Toronto, Canada. The information in this article is not intended to be legal advice and is of a general nature. Consult a lawyer for advice for any specific situation.