Posted on April 19th, 2010The life of a start up can be precarious and a wrong turn will lead to a point of no return. According to Harvard Business School Professor; Constantce Bagley, “While the language of the law can be intimidating, the concepts are usually quite straightforward.”. She also further states that, “Lawyers tend to be risk averse, and if you delegate to them you will usually stay out of legal trouble but can often compromise your business objectives.”
In other words, legal problems should not be postponed. It should be given equal priority and should be handled by both you and your legal counsel. You, as an entrepreneur should be aware of every step that needs to be taken in order to steer your business in the right direction.
Now to give you an early heads up, these are the 10 most common mistakes made by your group! Avoid them!
Mistake Number 10: Failing to incorporate early enough
An acronym for this problem is called- “Forgotten Founder”. In this problem, a partner who initially was a part of the venture drops out and when the company is ready to get a funding from a venture capitalist or from public- the partner suddenly appears to claim his stake. How to avoid this? Incorporate early enough!
In layman terms, issue shares to the founders, subject to vesting. In a nutshell, for the shares they get, they assign all of the Intellectual Property to the company and work for the company. This further averts yet another problem- “cheap stock”. By doing this exercise early enough, you have an idea of the value of share and can get the IRS of your back. If you issue the stock too cheap to your founders and the expensive ones to your investors you will be on IRS radar since they will consider that you profited from the difference from stock price.
Mistake Number 9: Issuing shares without vesting
Vesting is like signing up a bond with your employer. This is basically done to keep your team intact and productive. If the member leaves, then you can reassign the stock to the replacement!
Mistake Number 8: Hiring the wrong lawyer
If you are going to get divorced, get a lawyer who specializes in divorce- no one will opt for a criminal lawyer because it is not his niche field. Moreover, there might be potential trap where the lawyer might get entrapped or miss golden opportunities. Similarly, there is a sect of lawyers who specialize in start up legal affairs- hire them! Here is an inside news- Most VCs rate the entrepreneurs on their choice of legal counsel. First impressions last, so you better make a good one.
Mistake Number 7: Opting for Section 83(b)
This is a way to get rid of your monster called IRS. Well, you could get rid of it if you avoid the Mistake number 9. IRS does not consider a stock deal is closed until the risk of forfeiture evaporates. Once the deal is closed as per IRS, it then calculates the ordinary income which is price paid at the time of purchase and value at the fair market on a later date. This difference is taxed as it is considered as income! So by opting for Section 83(b) you can get IRS to make tax computation to be based on value of stock at the time of issue which are just pennies compared to dollars.
Mistake Number 6: Negotiating with VC based solely on valuation
It is a common misconception that valuation is the only parameter that a VC considers! There are many other factors that influence a VC decision. VCs have many ways to get compensated if the shares are of high price. These include high cumulative dividend, redemption cumulative dividend, redemption rights exercisable after only several years, and ratchet anti-dilution protection with no cap.
More importantly, before you reach there the VC asks the following question in their own mind!
What is the reputation of the firm? The credibility of the entrepreneur? Do they have a good network in the industry? Are they known among big players? If you can get these questions right, then you will end up getting a high valuation!
Mistake Number 5: Intellectual Property Consideration
This is your business. This is your soul! If you wait too long to consider this, you might end up loosing your idea after all. You must understand, patents are given country by country basis. In the US, there is one year grace period to patent an application after making public. In other countries, it is the other way around. If you go public, then you cannot patent it.
Trademarks is a whole another issue. If you have a brand in US and market it internationally, you might be stepping on some toes. Then it is a violation, legally punishable. So spend money early and get your brand insured in your target markets.
Mistake Number 4: Working on Non-Disclosure Agreement
What if you cannot wait till your whole patent process is over? Then here is how you maintain you trade secret- Non-Disclosure Agreement. This way you can secure your product from your competition.
Moreover, it is always safe to get VCs to sign the NDA before getting them on board. Yes, we agree that it is big negative point and most won’t. In today’s world reputation and integrity matter the most. Hence, whoever you deal with get them to sign to NDA before you get them on board. It should simply state that you will not disclose any information to anyone without permission. This should also take a precedence in your Business plan in order to protect it.
Mistake Number 3: Violation of employee of contracts
This is probably the most common and often thought of the unimportant matter. If you still employed and start your entrepreneurship journey, you must be understand that all the IP generated in the course belongs to your employer. If you are employing a person who is still on contract, then you are again violating contracts. So, ensure that you are not violating these petty legal mistakes.
Mistake Number 2: Failing to comply with Federal Securities Law & Business plan integrity
Do not promise more than you can deliver. That not only affects your integrity and your reputation, it also gets you in to legal trouble. Your business plan must be an honest appraisal of your goals so that the VC will be able to understand if your goals are realistic. If you try to promise more, you will find it difficult to get funding int the subsequent rounds.
If anyone is selling your company stock or other forms of securities must comply with both federal and state securities law which can be done by registering the securities or meeting the requirements for an applicable exemption. This is often neglected which is a violation of both federal and state law. Avoid this Judgment: “No one with half a brain can offer ‘an opportunity to invest in our company’ without knowing that there is a regulatory jungle out there.”
Mistake Number 1: Legal matters can be solved LATER!
Postponing any legal matter or for that matter any job will only accumulate and become too big to handle. Handle legal matter then and there! The thought : “ Let me get started. Let me get funding. Let me go public. Then let me get a lawyer” In most chances you won’t reach the stage! Moreover, legal matter if solved then and there will prove to easy and cheap in your pockets!
shoot amazing info man.