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What are the Legal Mistakes That a Startup May Possibly Make?

Narendra Kumar

| Updated: Jun 20, 2018 | Category: Legal Law

Legal Mistakes

What are the Legal Mistakes That a Startup May Possibly Make?

It is the world of innovative ideas, their creative implementation, and expansion to the maximum markets. In short, it is the rise of Startups. Establishing your own startup involves a lot of attention, hard-work, and efforts. With so many things at hand at once, some slips are bound to happen.  Some of the common legal mistakes that a startup may make have been listed below. You don’t want to make the same legal mistakes as someone else.

  1. Wrong legal entity

After deciding your unique idea, choosing the right legal mistakes structure is the next important step. You can choose from a Private Limited company, Public Company, Limited Liability Partnership, Traditional partnership, or even proprietorship. The most preferred one is company registration due to its various benefits. My legal and tax hassles can be dealt with by deciding upon the right type of structure for your business. A professional should be consulted to understand the pros and cons of each structure and deciding which shall be best for you.

  1. Not tracking expenses

Not keeping track of their expenses is another common legal mistake that startups commit. Throughout the year, the expenses and their nature with the description must be maintained. This practice is useful in long-term and especially during those financial close times. A professional’s assistance in maintaining such accounts goes a long way for a startup.

  1. Not hiring an experienced legal counsel

Any legal mistakes counsel hired or being consulted must be experienced in dealing with entrepreneurs and venture capitalists. Such lawyers shall be more focused on recognizing the little potential legal traps that look nothing to a layman’s eye. It also helps the startup’s gain reputation and approvals of many venture capitalists who often judge the startups from their choice of a legal counsel. Thus it is advisable to hire a professional who knows the standards, potential risks and games of the market.

  1. Lack of documentation

What is not documented is lost! Every startup must follow this rule. One should try to document every interaction and bring them on the record. It is important to have all documents in order at all times for the purpose of Legal mistakes Due Diligence.

  1. A detailed Founders’ agreement

It helps with easy management and smooth functioning of the startup. When the terms on which the startup shall function are certain and unambiguous, more attention can be paid on expansion and growth instead of petty issues that can be dealt with at the beginning itself. Also, nobody wants to think, but every startup may not essentially be successful.
Thus to stay prepared for the worst to come, it is important to have a solid Founders’ Agreement in place. It will provide outlines on how the startup shall operate, how will the management be conducted and also how the founders will have to deal with the various aspects in case of the failure of the startup. The Founders’ Agreement shall contain clauses such as ownership, vesting rights, particulars of the capital raised by both founders and investors, the roles and responsibilities of each founder, including salaries and terms of employment, details of exit formality for founders, dispute resolution etc.

  1. Mixing personal and business expenses

Time and money are the biggest investments in a startup. Hence, the personal and business expenses of the founders often become indistinguishable causing confusion when taxes are being filed. It is thus, always advisable that a financial account of the startup must be prepared and maintained at the onset and kept separated from the personal expenses.

  1. Not protecting intellectual property

Intellectual property (IP) is the most valuable asset of a startup. Patents, copyright and trademark registrations form major components of IP and a startup must ensure that they are protected from every kind of illegal claim in the future. Confidentiality Agreements in form of Non-Disclosure Agreements (NDA) have been the way of ensuring it. It has been observing that startups often neglect the need for IP protection which brings them significant losses later.

  1. Non-compliance with securities laws

Startups issue stocks to friends, family and angel investors. However, it must be noted that stocks which are issues without due compliance with specific disclosure and filing requirements under securities law have the potential to cause serious legal issues in the future.

  1. Mixing capital and revenue expenses

For the first-time business filers, confusion may arise as to the expenses and its varied forms. This may cause anomalies in the accounts of the startup which does not reflect well with the investors and during due diligence. It may even land the startups in trouble. The determination of the type of expenditure must be done carefully.
Higher-value items that shall last significantly longer than one year are called Capital Expenditure/Assets/Equipment.
Expenses on items that are consumed over the course of a year are termed as revenue expenditure.

  1. Irregular tax payments

Every business has to pay taxes. The determination of taxes depends on the type of entity it functions as- LLP, company etc. The business can get into trouble for not paying the required taxes on time. Thus a startup must appoint or seek assistance from a tax consultant to ensure all the regulations are being followed well within time. It is therefore important to let the Tax professional look into the details of the tax cycles such as income tax return filing or GST return filing and the compliances therein which will give the founders more time to focus on building the business, building connections, forming strategic alliances, and expansion.

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Narendra Kumar

Experienced Finance and Legal Professional with 12+ Years of Experience in Legal, Finance, Fintech, Blockchain, and Revenue Management.

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