The legal facets of a startup are frequently overlooked when founders concentrate on getting their product or service ready for the market. This ignorance can accumulate over time and may even result in situations that are irreversible.
To avoid getting into any kind of trouble, you must set aside some time and ensure that all legal requirements are met before embarking on your venture.
The process of forming a company is typically straightforward at the outset, but as the company grows, legal expertise becomes essential. You will likely require guidance on issues such as equity compensation strategies, contracts, term sheet negotiation, licensing and intellectual property strategy, regulatory matters, international considerations, and much more. Even your investors would expect you to be represented by legal counsel who is experienced in venture capital financing.
Hiring a full-time lawyer is not an appropriate option for startups, especially those that have not even received their pre-seed funding. For the simple reason that building an in-house legal team for startups is a costly affair, the ideal solution is to choose a law firm that has the kinds of experts in place to help with the matter startups have to routinely deal with.
The requirements of a startup who does not need an in-house lawyer are simple and can vary from trademark registration to copyright filing. However, if a startup is developing a unique idea, it may require the assistance of a dedicated IP lawyer who can assist the founder with both patent requirements and building an appropriate IP strategy.
Even if your requirements are not complex, having one or more lawyers you can call when you need help can be a good way to avoid legal troubles. If you have a lot of legal work but do not have the money to hire a full-time lawyer, having a lawyer on retainer will work best for you.
Legal mistakes can have a negative impact on your startup and can make it hard for you to raise money. It can be a reason behind legal suits filed against you by your team members, clients, prospects, investors, partners, competitors. Legal mistakes can also cost you money for regulatory violations. In the worst case, it may lead to business failure.
This article will introduce you to the mistakes you should avoid as a startup founder.
Many times, startup founders make a huge mistake by not creating a co-founder agreement. They think they started on good terms. Everybody was excited. They thought that nothing could go wrong between them as they are all good people.
However, with time, they eventually find that things could have been much better if everything were made clear in a written document. This doc is called co-founder agreement.
Co-founder's agreement is important because the amount at stake is big and minor differences can go in crores. One of the reasons that co-founders fail to anticipate the situation and underestimate the need for a written agreement is because they have known each other for a long time.
However, it should be noted that the previous relationship consisted of colleagues, friends, peers, team members, and so on. These relationships are very different from those of co-founders. A decision or mistake made by one co-founder can have a big impact on every other co-founder.
Another reason is that it is a tough discussion, which first time founders want to avoid because it requires decisions around times when things go wrong: like a departing co-founder, death of co-founder, decision making, etc.
Remember that the co-founder agreement was made for bad times, not good times, so keep that in mind. Most of the time, when things don't go as planned, you'll need to look at your co-founder agreement. When disagreements arise and negatively impact the company, it is crucial to refer to the co-founder agreement to resolve disputes.
A Co-founder Agreement is a legally binding contract that each co-founder signs that highlights their ownership in the company, contribution of capital, and what their duties and responsibilities will be. This agreement plays a vital role in the events of disputes or at times when one of the co-founders does not live up to the standards set by the agreement.
Another reason to have co-founders' agreements is because it is a prerequisite for fundraising. It reduces the risk for investors. For example, the vesting clause motivates the co-founders to stay and work for a longer period in the startup.
If a co-founder leaves in the middle, they don't get their full equity in the company and this equity can be used to bring another person who can take the responsibilities.
The most important things to look for in a founders' agreement are the company's vision, operational obligations, decision-making powers, equity distribution, restriction on transfer of shares, intellectual property rights, remuneration, buy back rights, founder’s salaries, conditions of removal, exit clauses, and dispute resolution.
It is advisable not to commence business operations with an unregistered trademark only to later discover that the trademark has already been taken, leading to potential trademark infringement suits.
Instead, it is highly recommended to conduct comprehensive research on your trademark and the class in which you intend to register it well in advance of filing the trademark application. This proactive approach can help you avoid legal complications and protect your brand. Registering your trademark provides various benefits, including legal ownership, public notice of your rights, and the ability to bring a lawsuit concerning the trademark in federal court
Trademark research is essential before registering a trademark, as it can save you time and money in the long run. By conducting thorough research, you can avoid registering a trademark that has already been registered by someone else, which would result in rejection. This research process can also help you identify potential issues with your chosen trademark, such as infringement on existing trademarks, and prevent costly mistakes.
Only after the trademark has been registered should you begin using it for business purposes. By getting trademark protection for your brand, you can prevent other businesses from copying and misusing your brand name.
Since trademark rights are country-specific, if you wish to conduct business in multiple countries, you will need to file for trademark protection in each of the countries in which you wish to operate.
If the startup founders do not seek professional assistance, they may be subject to fines and penalties.
Tax considerations are influenced by several factors, including the choice of entity, stock options, payroll taxes, sales taxes, tax incentives, and other factors that can vary depending on the nature of your business and where it is located.
If you are a founder who does not have a grip on these matters then it is ideal to consult a CA or a lawyer who can assist you in better managing unforeseen tax liabilities, penalties, and fines.
Early-stage startups commonly receive funding from angel investors, friends, and family. There may come instances where a founder may not follow the legalities that come with issuing a stock due to not being aware of the regulations.
During stock issuance, founders have to exercise caution. Despite the many advantages of issuing stock, doing so incorrectly might result in significant problems, and in such situations, Securities & Capital Markets counsel can be of considerable assistance.
The issuing of stock must be documented. You might not have thought this through, but it can be problematic during mergers and acquisitions and liquidation if you've sold stocks to friends and family without a proper negotiation.
The issuance of stock should be documented. When venture capitalists or strategic investors are involved, a more thorough Stock Purchase Agreement is required.
Following the issuance of shares, startups should issue a Stock Certificate to the investors and create a copy of each Stock Certificate to keep track of the company's finances.
A startup's equity structure is critical when it comes to keeping track of all of its shares. As a result, founders will know where the stock is located, who owns how many shares, and how much dilution is caused by an issuance. Having no clear information on their equity, startups may wind up issuing shares without knowing how much ownership they are giving away, which can gradually lead to stock dilution if not correctly managed and looked into.
In order to keep track of, manage, and record all of a startup's equity, Qapita's Qapmap serves as an equity management tool for the startup founders. All transactions and modifications to cap tables and ESOPs are recorded in real-time. Allowing founders to share the cap table with their lawyers and accountants for assistance while keeping everyone updated on their share.
No business can operate without the proper licenses and permits. Depending on the nature of the business, a variety of permits are required, including industry-specific licenses, sales tax permits, home-based business permits, seller permits, and health department permits, to name a few. Failure to adhere to licensing and permit requirements could result in heavy fines.
Some registrations that are required by Indian startups based on their nature of business are:
Startups in the food industry require an FSSAI license, and those involved in import/export require Import Export Code, to name a few.
A license to operate certain types of businesses, such as those that deal with insurance, financial services, broadcasting services, etc., require approval from regulatory bodies such as the Reserve Bank of India, the IRDAI, and other similar organizations in India.
Depending on the nature of business, additional permits may be required by the fire department, the environmental board, or even the local health care system. Where it is best to consult with a legal and regulatory expertise to learn about the applicable laws and regulations.
Another mistake that a startup can make is overlooking their intellectual property or IP protection. When it comes to protecting a startup's IP, the founders and investors must take the necessary steps.
A wide range of factors is taken into account when starting a business, from branding and marketing to growth and expansion. Among other things, IP is one asset that plays a crucial role not only in a startup's growth but also in its success throughout.
Innovations are protected using patents, brands through trademark, software using copyrights, trade secrets via NDAs, infringement of IP using IP agreements, and the rest using other kinds of contracts, depending upon what you seek protection for.
It can be damaging for startups to ignore the protection of their IP and for this purpose, it is essential to take help of a technical legal expert or a law firm, that can take care of patent and agreement drafting, and also matters relating to IP filings, their infringement and prosecution as and when required.
Another mistake a founder can make is to have poorly written contracts or agreements in place. Failing to see how these contracts could affect them in the future. There are a lot of contractual requirements to run any business, and it is no different for any startup.
Before going into any business with customers, vendors, stakeholders, or employees, it is ideal to have agreed terms set that will save you from future troubles, and only get into business once the paperwork is done.
Consultancy service agreement, non-disclosure agreement, co-founder’s agreement, vendors agreement, shareholders agreement, software license agreement, appointment letters, employment agreement, leave policies, insolvency, and bankruptcy agreements, are among different types of agreements required by all the startups to have in place.
Having a knowledgeable lawyer to draft your contracts can prove to be an investment in the long run. Additionally, having a lawyer will also help you uncover things you haven't even thought of covering previously.
Two things you should keep in consideration with contracts are: avoiding making contracts too lengthy and keeping the language as simple as possible. Doing so will encourage the other party to go through the contracts easily.
Keeping proper corporate and HR documentation up to date is something many startup founders struggle to do well. Startup founders either outsource HR or do not even consider having one, and the documentation responsibility often falls on the shoulders of an accountant.
However, there are many things that are taken by HR, keeping proper documents is one while other is adherence to labour laws. There are some relaxations for startups, but a violation can result in penalties.
Founders are frequently preoccupied with other aspects of their business that they do not get the time to think about having proper documentation in place. However, this can result in a startup being held liable during regulatory inspections, employee lawsuits, and due diligence performed during mergers and acquisitions.
It is advisable to seek legal advice in order to examine the rules that apply to your startup and ensure that your startup is in compliance with all the applicable labour laws and regulations.
Some of the documents that startups should keep in place are documents related to stock options, offer letters, employment agreements and responses to employee complaints, so that in times of conflict, these can be used as evidence.
Not adhering to data privacy regulations is one of the costliest legal mistakes that a startup can make. The existing legal framework for data privacy is a mix of country-specific and international laws and regulations, as well as industry standards.
Privacy laws have a big impact on how data is kept private. In fact, the reason most websites have a privacy policy in the first place is that they are required by the laws of the country they operate in.
A revised Personal Data Protection Bill by the Indian government has given a 24-month window for the implementation of the Act's provisions so that organizations have enough time to implement the changes to their policies, infrastructure, and processes. The bill combines personal and non-personal data under the same umbrella and has provisions for data localization, DPO, managing social media platforms, and more.
Indian startups having international customers and employees need to worry about international data privacy rules such as GDPR, CCPA, HIPAA etc., depending on the country they operate in or seeking to cover.
Non-secure data can result in cybersecurity incidents that are often the precursor to investigations and possible enforcement actions.
The damage to a company's reputation that can occur as a result of a data breach is far more severe than any legal ramifications. Startups have a hard time recovering the loss after a legal suit that follows a data breach incident.
As privacy and security regulations tighten and fines are on the rise, it's imperative that startups incorporate privacy by default and design into all of their processes. Some measures that just can’t be overlooked are the implementation of a zero-trust model, least privileged access, password policies, encryption, as well as timely audits.
The importance of a solid legal foundation cannot be overstated. It is just as important as having a passion for innovation and a laser-like focus on consumers and the market. Startups need to put effort into complying with all the regulations as they do into creating a new product or service. Furthermore, by avoiding legal mistakes early on, startups can save their long-term viability and reputation with significantly less difficulty.
In conclusion, startup founders must prioritize legal considerations alongside product development to avoid irreversible mistakes. Failing to meet legal requirements can lead to severe consequences, impacting funding, reputation, and even business failure.
Key legal mistakes, such as neglecting co-founders' agreements, trademark infringements, and non-compliance with tax and data privacy regulations, can have far-reaching implications.
Establishing a solid legal foundation, seeking professional assistance, and engaging legal expertise early on are crucial steps to ensure a startup's long-term viability and success in the dynamic business landscape.
