Six Big Legal Mistakes Startups Make
By Scott Edward Walker, “Ask the Attorney,” VentureBeat
A reader asks: My buddy and I are coding up a new site and we will be ready to launch the beta in about a month. We have a couple of angel investors who are interested, and we don’t want to screw anything up. What are the biggest mistakes that you’ve seen that guys like us make?
Answer: Here are six quick ones:
IP Ownership. Some entrepreneurs make the mistake of creating IP for their new venture while they are still working for someone else. They then quit and launch their startup, not realizing that the IP is actually owned by their prior employer. This is a tricky issue, and you should carefully review all employment-related agreements to determine if there are any provisions that may inhibit your new venture.
Choice of Entity. Choose your entity formation carefully. Investors generally only put their money in corporations – not LLC’s or partnerships. So it’s usually best to stick with a corporation when you’re getting started. Consult with an accountant as to whether you should make an S corporation election (and then convert to a C corporation down the road).
Place of Incorporation. Many startup owners incorporate their company in the wrong state. As a rule, Delaware is where you want to do it – that’s what investors generally require = then qualify the company to do business in California and/or any other state in which it is “doing business.”
Vesting Restrictions. Never issue stock to co-founders without imposing vesting restrictions. If you do, you’ll regret it if/when one of the founders ends-up leaving in a few months and keeps all of his or her equity. Make sure you and your co-founder(s) execute a restricted stock purchase agreement with a reasonable vesting schedules (typically four years) upon the issuance of the company’s stock.
Securities Law Issues. Too many entrepreneurs make the mistake of not complying with securities laws. For example, they issues shares to “friends and family” who are not “accredited investors” without proper disclosure documents or they retain a consultant who is not a registered “broker-dealer” to sell company stock for a commission. Be very careful when issuing any kind of securities. Non-compliance could cause severe consequences, including a right for the security holders to get their money back, plus interest, injunctive relief, fines and penalties – and possible criminal prosecution.
LegalZoom. Finally, think twice – then twice more – before using LegalZoom or other sites to prepare legal documentation. While they’re a cheaper alternative, these sites are not law firms and do not render legal advice, nor are they able to create the kind of sophisticated documents you may need to protect yourself and to demonstrate credibility with your prospective investors. Admittedly, I’m a bit biased on this one, but bite the bullet and retain an experienced corporate lawyer to help you from the legal side.
Scott Edward Walker is the founder and CEO of Walker Corporate Law Group, PLLC, a law firm specializing in the representation of entrepreneurs. This “Ask the Attorney” post discusses general legal issues, but it does not constitute legal advice in any respect. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.