Top 8 legal mistakes by the startup community that contribute to its downfall

Picking the right business entity is important for a startup. This depends on the nature of the business and the number of people one is starting with.

Top 8 legal mistakes by the startup community that contribute to its downfall
A qualified legal counsel is absolutely necessary to understand all legalities concerning the startup especially when it comes to NDAs that disclose confidential information. (Pexels)

By Rahul Hingmire

Once an entrepreneur comes up with a business idea, there are several legalities to keep in mind to ensure that the startup goes through with manifesting its idea into reality. Startups often face business and legal issues, often because of not having a legal team in place to guide them.

Some legal mistakes made by the startup community that contributed to its eventual downfall include:

1. Not registering their business

Sounds like a simple task, but many overlook it. To realize revenues at some point in the future, startups have to get their business entity registered. To raise funds from private equity investors, the business has to be registered as a Private Limited Company, Limited Liability Partnership, or a Partnership Firm. In India, the startup owners need to fill out a form and submit documents under ‘Startup India’. Failing to register a company will result in not being able to obtain a business license as well as not being able to open a current account for revenue accumulation. 

2. Not picking the right business entity 

Picking the right business entity is important for a startup. This depends on the nature of the business and the number of people one is starting with. On the account that there is just one person, the business can start as a Proprietorship firm that has relatively fewer compliance and registration formalities. In the case that there are two people, the business can be registered as an LLP. Failing to choose the right business entity might create legal problems for the founders of the startup in the future, hindering growth.

3. Not protecting their intellectual property 

The startup could have a trademark that distinguishes other products/services from what it has to offer, this will secure the brand from being counterfeited. Failing to do so might result in other businesses coming up with similar ideas and marketing the same at a higher level, putting the startup out of business.

4. Failing to use a form of Employment Agreement or Offer letter when hiring employees

A carefully drafted offer letter should be used to hire an employee and he/she should be encouraged to read the terms and conditions. For senior executives, a detailed employee agreement proves beneficial. The company should ensure that the letter and any first-day paperwork are signed both by the employee and the company. Failing to do so, can create problems within the organization and the company may lose a considerable amount of money or even labor on the account of a conflict between the employee and the company.

5. Ignoring branding and marketing/IP considerations

Intellectual property rights require suitable guidance from qualified IP counsel. A “do-it-yourself” approach is often chosen by young professionals who do not have enough guidance. However, failing to keep company documents in order, ignoring standard IP practices, failing to create and implement an IP strategy, and failing to implement appropriate confidentiality controls may lead to the startup’s eventual downfall.

6. Lack of advice from an experienced professional

The startup should have in its team, a legal professional to advise on legal matters. Being involved with a legal professional is fruitful for a startup’s success. He/she may advise the startup on various issues on the legal front that may otherwise go unnoticed.

7. Not understanding clauses given by investors before signing

When entering into an agreement for funding by investors, it is important to understand clauses like clawback, ROFR, and ROFO. By not having a legal team in place, these terms may not be understood and can prove very dangerous in the future for the startup.

8. Failing to have its own legal team in place

A qualified legal counsel is absolutely necessary to understand all legalities concerning the startup especially when it comes to NDAs that disclose confidential information. A startup should have its own term sheet and shareholding agreements (SHAs) that can be created with the help of an in-house legal team. These documents will be used for all future investments and save them from being perplexed when approaching big VC funds.

(The author is Founding Partner at Vis Legis Law Practice, Advocates. Views expressed are personal.)

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