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6 Big Legal Mistakes Commonly Made By High Growth Startups

6 Big Legal Mistakes Commonly Made By High Growth Startups

There is no better time to start a business than the present. After all, we are living in the entrepreneurial boom, and there are more than 500,000 new businesses started in the U.S. every month. But as counsel for entrepreneurs and startups in Gainesville and all over the U.S., we have found there are also several “legal” traps that may catch founders off-guard. In an effort to prepare new companies for the legal journey ahead of them, which can actually be a smooth process if the proper precautions are taken, we outline six common traps below:

1.              Failing to Consult the Right Lawyer. Indeed, most entrepreneurs will give you the exact same advice. A competent technology or startup lawyer can quickly answer most of the mistakes outlined in this article. Most lawyers will provide a free consultation to entrepreneurs or startups, so do not hesitate to take advantage of this.

2.              Failing to Clearly Explain Equity Terms With Other Co-Founders. It is extremely important to negotiate and finalize terms with co-founders (think of the Facebook and Snapchat litigation, where ousted co-founders have come back to sue the company). Most legal complications can be avoided with a founder stock purchase agreement (for a corporation) or a well-written operating agreement (for an LLC). If you don’t have the money to hire a lawyer to write these documents, we recommend using the online service Clerky.com (“Clerky”). Clerky uses widely accepted forms with the latest market standard terms. Using Clerky, you can set up a Delaware C-Corp and founder stock purchase agreements. However, we still recommend consulting an attorney to review the documents and ensure they accomplish the co-founder’s goals. Below are some issues that you should discuss with your co-founders:

(a)           What percentage will each co-founder receive?

(b)           What vesting restrictions will each co-founder be subject to?

(c)           Outline roles and responsibilities of co-founders.

(d)           Clarify how important decisions will be made.

3.              Failing to Comply With Federal or State Securities Laws When Issuing Stock. The sale of stock or partnership interests is subject to state and federal securities laws. If a company issues stock or partnerships interest without ensuring compliance with state and federal securities laws, serious issues can arise. Most securities sales require specific disclosures, and there are filing requirements. It is important to hire a competent securities or startup attorney to document the sale and transfer of shares.

4.              Ignoring Tax Implications When Issuing Stock or Options To Employees. Issuing stock incentives to employees is an important way to recruit key hires and ensure that employees will stay with the company. Startups regularly make the mistake of issuing or selling stock or options to employees without considering the appropriate tax consequences. It is very important to consult with an experienced startup or tax lawyer so that these transactions can be appropriately structured. While we realize that tax consequences do not contribute to revenue growth and are not particularly interesting, they are something that co-founders and key employees should understand. You may ask yourself, “Why should I care about tax consequences?” In sum, failure to consider the tax issues can create negative tax consequences for you and your employees. And as we all know, the team is the lifeblood of the company, so make sure that you take care of them by ensuring that they will not be surprised with unforeseen consequences.

5.              Failing to Have Your Company’s Legal Documentation in Order. Many startups make the mistake of not having their legal documents together. This is important because legal due diligence can make or break an investment deal. Not having your organizational documents in order will probably not kill a deal; however, it can lead to a cheaper and smoother due diligence process when implementing a liquidity event.

6.              Failing to Lock-Down IP Ownership. It is extremely important for all of your employees to have solid invention assignment and confidentiality agreements. This is important because it clears up any ambiguity as to who owns the intellectual property.

See Also

Given all of these legal traps, one of the best ways to add value to your startup is to get a qualified startup or a corporate lawyer to become part of your team. For any legal questions or for a free consultation, feel free to call us at 352-327-3976.

This article was written by attorneys John Montague and Peter Reinert with Lowndes, Drosdick, Doster Kantor & Reed, P.A. The firm’s Gainesville office is located at 308 W University Ave., Gainesville, FL 32601. For more info, please visit: www.lowndes-law.com.Montague

With a passion for technology companies, John Montague is a corporate attorney in the Capital Markets & Technology Group at Lowndes, Drosdick, Doster, Kantor & Reed, P.A., a DECA sponsor. John advises startups and mid-size companies on corporate, commercial and securities issues, and he represents entrepreneurs and venture capitalists who have emerged from either private or university-generated research.

Reinert

Peter Reinert is the chair of the Capital Markets & Technology Group at Lowndes, Drosdick, Doster, Kantor & Reed. Peter is a board member of the Florida Venture Forum, the Chairman of the Smart Awards for the Association for Corporate Growth (Orlando Chapter) and is the founding member of bioOrlando, the local affiliate for bioFlorida.

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