The most common mistakes startups make
// February 28, 2019
When we come up with an idea, we always believe that it is the best idea we can ever come up with. However, is it or not, to become a real game-changer, you, your team and your startup shall be prepared that from the idea to its implementation – there is much to be done. Most of the mistakes the startups make are widely known, though everybody keeps making the same mistakes again and again. Here in this article, you will find the most common legal mistakes startups make and the solutions on how to solve it.
It is important for any startup to have the necessary legal documentation in place as early in the company as possible. It is easy for startups to fall into the trap of not having legal documentation in place, either because they are unaware that it is mandatory, or because they are not willing to spend the money for these issues. Most startups do not believe or have not experienced how it makes significantly easier to track things within the company and organize its daily activities.
One of the most common mistakes a business owner/entrepreneur can make when starting a business is the failure to sign agreements. If an agreement has been signed in writing, this would prevent a lot of hassle and avoid ‘he said she said’ scenarios. One of the best examples of this mistake is the dispute between Winklevoss brothers and Mark Zuckerberg, the former classmates and business partners of Facebook. Mark Zuckerberg was accused by Winklevoss brothers of stealing their idea, technology, design, and business plan while they were students at Harvard for the social networking site from a company called ConnectU. The lawsuit ended then Facebook paid 65m dollars. This example shows that no matter how good relationships may be, they can always be threatened when agreements are not put in place. Being legally secure will prevent further implications in the future.
To avoid such mistakes, here are the key deal terms and questions you need to address in a written founder/shareholders agreement:
- Distribution of the shares of the company. The founders have to remember that just because you came up with the idea you don’t deserve 90% of the company. Though, do not give 15% of the shares of the company to your cousin just because he contributed EUR 2 000.
- How much involved all of the founders will be in business? What are the roles and responsibilities of the founders? Usually founders never really agree on who is in and who is out, roles in the company, who makes decisions, expectations for time, side projects, budgeting, and expenses. More of a leadership problem than a legal one, but the legal process, properly followed, helps ensure people understand and agree before getting started.
- What is the exit strategy? If one founder leaves, does the company or the other founders have the right to buy back that founder’s shares? If yes, at what price? Answers to these questions help to ensure the fluent and continuous business of the company, to avoid the situations where shareholder’s shares are sold to the third party which might disorganize the existing course of business.
- How shall key decisions and day-to-day decisions of the business be made? By majority vote, unanimous vote? Will the company have the board? If yes, what decisions and rights shall it have?
- How shall a sale of the business be decided? In case a startup becomes very successful, or maybe even a “unicorn”, that is the question you must had thought through in a very beginning.
- What are the consequences if one of the founders breaches the agreement?
- What is the plan to retain or replace key talent? Option Agreement with the employees is one of the solutions to retain key employees.
At the very beginning, co-founders have to agree on what the deal is among you and in the long run, it would be cheaper for all the parties involved to put their agreements into writing. This would mean almost no risks of litigation or court visits.
Lack of employment documentation and intellectual property protection
Startups often encounter problems when they do not maintain adequate employment documentation. The core group of employment documents, including the confidential information and intellectual property protection documents, shall be signed by all employees.
The parties of the employment contract may agree that the employee will not use and not disclose to another person (during the performance of the employment and after the termination of the employment) certain information indicated in the confidentiality agreement, which is received from the employer or obtained due to performance of the work function. However, confidential information cannot be considered as data that is publicly accessible, nor data which, by law or according to its purpose, the employer does not take reasonable protection measures.
The agreement on the protection of confidential information must specify the data constituting the confidential information, the expiration date of the agreement, and the employer’s obligations on how it assists the employee in maintaining the confidentiality of the information.
If you are developing a unique product, technology, or service, it is even more important to consider the appropriate steps to protect the intellectual property you are developing. If the potential investor during the legal due diligence process finds that the intellectual property of the startup company has not been protected carefully, it is very likely to be “a deal breaker” for the investor. Both the company’s founders and its investors have a stake in ensuring that the company protects its intellectual property, it belongs to the company and the company avoids infringing the intellectual property rights of third parties.
One more safeguard which can be used to protect your ideas and products is non-compete agreements. Though, it requires payment of minimal compensation in the amount of 40% of employee’s salary and which must be paid both, during the term of the employment contract and after the termination of the employment.
The non-compete agreement can specify the prohibited work or professional activity of the employee in a certain territory. However, it is only allowed to conclude a non-compete agreement with employees who have special knowledge or skills that can be adapted to a competing employer or to competing for self-employment activity, thereby causing damage to the employer. The maximum term of such agreement is 2 years after termination of the employment contract.
Lack of legal guidence
This final mistake is actually often the cause of the other mistakes above. When you’re starting out, money is no doubt tight, therefore startups will often try to save money in the legal department. Not investing in the right legal counsel will lead to inadequately drafted documents, mistakes, and an unsatisfactory and incomplete understanding of what is needed for the company to operate safely within the boundaries of the law.
Another option that startups often go for – is trying to do it by themselves. However, unless the founders are educated in the legal sector and have the necessary experience to draft and deal with important documents, it is not particularly advisable to use this approach. However, it does not mean you need to work with a lawyer on every minor legal issue that comes up, but, for key areas – especially those discussed above – experienced advice can make all the difference.
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