·  Legal News, Analysis, & Commentary


Most Severe Legal Issues for Startups

— December 11, 2020

When starting a new business, most entrepreneurs are usually focused on things like available financing options for funding for their startup, building a business website, marketing and attracting their first few customers, and so on. At this point, many entrepreneurs don’t take the time to consider different legal aspects of their new business.

Failing to get your legal ducks in a row when setting up your startup can lead to lots of issues down the road, some of which could even lead to the failure of your business.

It is a good idea, therefore, to engage legal services when starting your business to avoid having any legal hazards derail your new company.

If you are an entrepreneur in the process of setting up a new business, here are 8 of the most severe legal risks that startups face, as well as how to avoid them.

  1. Not Using the Right Legal Structure for Your New Business

Before starting a new business, the first thing you need to do is to determine the legal structure under which your business will operate – either as a sole proprietorship, a LLC or a corporation.

Your chosen legal structure will affect things like your ability to get funding, the founders’ personal liability, as well the taxes the business is liable to.

To avoid finding yourself operating a business under a legal structure that leaves you subject to liabilities and requires you to pay higher taxes, always consult legal experts when setting up your business.

  1. Not Making a Clear Agreement with Your Co-Founders

It’s quite common for people to come together and start a business venture. Actually, some of the most successful companies today were started by two or more people.

In most cases, people starting a company together are usually friends, and therefore, at the beginning, they never see the need for a founder’s agreement. 

Unfortunately, this creates trouble down the line once the company has started making money, and could even lead to big lawsuits. The case of Zuckerberg and the Winklevoss twins is a good example.

Man screaming into telephone; image by Icons8 Team, via
Man screaming into telephone; image by Icons8 Team, via

To avoid this, make sure to create a well-defined partnership agreement with your cofounders. Define how much of the company each co-founder owns, the contributions of each co-founder, as well as their roles and responsibilities in the company. The agreement should also define how matters will be handled should one cofounder choose to pull out of the business.

  1. Lack of Knowledge About Your Tax Obligations

Every business has certain tax obligations that it needs to meet. These vary depending on the nature of the business, as well as the jurisdiction where the business is based.

Before starting your business, you need to be aware of the taxes that your business needs to pay, as well as the records that you need to maintain for tax purposes.

Ignorance of your business’ tax obligations will lead to non-compliance, which will in turn lead to huge, unanticipated fines and penalties.

  1. Lack of Proper Licenses

Before you start your business, you need to be aware of the permits and licenses that your business needs in order to operate legally. If you are not aware of the licenses that apply to your kind of business, both federal and state, seek the advice of a legal expert.

Failure to obtain the necessary licenses will often lead to huge fines that could easily run your business to the ground.

  1. Failure to Maintain Proper Employee Records

In the early stages, a lot of startups tend to be very casual when it comes to hiring employees. Employees are hired without any contracts or agreements, there are no clear descriptions of employees’ roles and responsibilities, and agreements about employees’ compensation are made verbally.

In addition, a lot of startups do not have an employee handbook that defines how the company will handle matters like employee benefits, employee leave days, and so on.

Unfortunately, failure to create these documents can have very huge ramifications for the company down the road. For instance, if the company gets involved in M&A activity, lack of proper documentation and records about its employees can cause huge problems and even lead to deals falling through.

At times, lack of proper employee documentation can even lead to lawsuits. For instance, in cases where an employee feels that they have been wrongly dismissed and sues, defending the company in the lawsuit can be a huge challenge without proper employee records.

  1. Failure to Consider Intellectual Property Issues

A lot of startups are very casual when it comes to Intellectual Property (IP) issues. However, if your company is found to be infringing on the IP rights of a third party, you could be subjected to huge fines and penalties. To avoid this, you should seek the advice of an IP law expert to ensure you’re in compliance with all copyright regulations.

In addition to avoiding infringing on the IP rights of others, you should also take adequate measures to protect your company’s IP assets.

If you have any unique product or technology, ensure that you have secured a patent to protect it from being copied. You should also seek protection for your trademarks (such as your brand name and logo) and your trade secrets.

  1. Not Using Proper Documentation When Selling Shares

As your new startup starts growing and expanding, you might need to sell some shares in order to raise the funds required to sustain your company’s growth. If you decide to sell some of your company’s stock, you should be very careful about how you go about it.

Selling shares is an activity that is covered by securities laws, and there are certain regulations that you need to adhere to when selling your stocks. Failure to adhere to these regulations can lead to huge fines that could have a huge impact on the health of the company.

To avoid finding yourself facing such penalties, you should always involve legal experts who are knowledgeable in matters concerning the sale of stocks.

  1. Lack of a Proper Privacy Policy on Your Website

If you’re starting an online business, or even a traditional brick and mortar business, you’ll need an online presence, and therefore, you will need to create a website for your startup. 

As part of your sales and marketing efforts, you will most likely need access to your visitors’ personal information. If this is the case, your website needs to have a privacy policy describing how you will use and keep your visitors’ personal information secure.

What a lot of startups do here is to get a generic privacy policy from the internet and copy paste it on their website. You should note, however, that these generic policies are not created for your specific type of business, and therefore, they might have loopholes that could leave your business susceptible to lawsuits.

To avoid this, you should engage legal experts and have them develop a privacy policy that is customized for your website based on the kind of personal information that your business collects, as well as how your business intends to use and protect this information.

Wrapping Up

While there are many other important matters to focus on when starting a new business, you should also make sure that your legal matters are in order to avoid facing legal risks that could easily run your business to the ground.

In this article, we have covered eight of the most severe legal issues faced by startups and how to avoid them. Fortunately, you can seek the help of online legal service providers and have them take care of these issues while you focus on growing your business.

Join the conversation!