13 Biggest Legal Mistakes Startups Make

Published on 16 Mar 2017 by Team

Setting up your start up involves a lot of work and effort. Many things need attention, including developing a proof of concept, finding product/market fit, and hiring the first set of employees. A multitude of situations must be handled, hence slips are bound to happen. One of the most common areas where most start-ups make a wrong choice is establishing a solid legal foundation.

For start-ups, particularly in the sectors like e-commerce, payments, food or health care, it becomes all the more important to focus on the legal aspect. You don’t want to make the same mistakes as someone else, rather learn from it, isn’t it?

Legal issues are often at the back of an entrepreneur's mind in the excitement of launching a start-up. But just because you are small doesn't mean that people are going to let things slide when you infringe upon their trademark or don't tell the full truth to investors. We are going to introduce you to the most common legal mistakes early start-ups make and how to keep the personal injury lawyers away-

1. Wrong Legal Entity

Choosing the right legal entity right at the outset is important. Some structures to choose from include a Registered Company (Public/Private Limited), LLP, proprietorship, and partnership. The more widely accepted one is a registered company, especially for any deals with foreign clients. Go for a Limited Liability Partnership or a Private Limited Company if you do not want personal liability for the losses/liabilities of your startup. Choose the right form of legal entity to avoid any legal hassles and payment of higher taxes.

2. Not tracking expenses

Another mistake commonly made by start-ups is not keeping track of their expenses, however big or small it maybe, throughout the year. Many try and gather all receipts only when tax returns have to be filed! What is not documented is not deducted, and therefore, it is like leaving money in the open. There are many options available to record and manage expenses. Entities can also hire accountants to manage these records if volumes are high.

3. Lack of documentation

Each and every interaction, be it meeting minutes or anything else, must be on the record. It is important to have all documents in order at all times. Legal due diligence can make or break an investment deal.

4. Missing Co-Founders’ agreement

Every startup may or may not run or be essentially successful. It is therefore important to have a solid founders' agreement in place because it is worth thinking about how you and your co-founders might deal with failure. The founders' agreement should contain all essential clauses such as ownership, vesting rights, and the roles and responsibilities of each founder, including salaries and terms of employment.

5. Mixing capital and revenue expenses

One of the major confusions for first-time business filers is about expenses. What expenses are considered assets /capital expenditure and which ones are called revenue expenses deductible in the P&L A/c. Higher-value items that will last significantly longer than one year are called Capital Expenditure/Assets/Equipment. For example, the expenses on laptop purchases are not deductible as revenue expenses in the P&L A/c, but only the depreciation/amortisation on them is deductible over a period of time.

Things that are consumed over the course of a year come under revenue expenditure. If the equipment or capital items are by accident deducted as revenue expense, the tax department can determine that the expense has been improperly characterised and a deduction does not apply. Hence, be careful in accounting all such expenses.

6. Missing personal and business expenses

Time and money are the biggest investments in a start-up, and often the personal and business expenses become indistinguishable. This can be a source of confusion when taxes are being filed, and in some cases, can lead to deductions being disallowed on an ad-hoc basis by the revenue authorities and higher tax outgo as a result. The company should therefore have a financial account at the onset and separate records as well.

7. Not protecting Intellectual Property

Intellectual property (IP) is a start-up’s most valuable asset. Trademarks, patents, and copyrights are the three essential components of IP. It is essential to not let anyone claim a right to your IP. Non-disclosure agreements are a way of ensuring this. Start-ups often neglect the protection of IP and suffer later.

8. Stepping on someone’s IP toes

You have a world-changing idea, a name for your business that will stick in customers’ minds like glue, and an eye-catching logo. Before you invest your blood, sweat, tears, and dollars on any of those, you need to make sure that you are not infringing on someone else’s intellectual property like Trademark, Copyright or Design. You or your intellectual property lawyer should conduct thorough searches and other due diligence to ensure that your company’s business and branding don’t expose you to infringement claims or force you to make costly and disruptive changes down the road.

9. Non-Compliance with securities laws

Start-up founders commonly issue stocks to angel investors, family, and friends. However, stocks issued without complying with specific disclosure and filing requirements under securities law can lead to serious legal issues at a later stage.

10. Missing regular tax payments

Businesses, be it sole proprietors or otherwise, are required to pay taxes in advance. This means they need to determine their taxes for the year in advance and pay as prescribed instalments. They can get into trouble for not paying the taxes on time. It is therefore important to take regular stock of the profit/loss statement at each quarter and pay the advance taxes.

11. Not ensuring professional help for tax related issues

A start-up must appoint a tax consultant to ensure all regulations are being followed. This will also give you more time to focus on building your company, forming strategic relationships, and other things. It’s essential to make sure all regulations are being followed to the tee. Taxes are also not something that a company should revisit only once in a year.

12. No exit strategy

Just like you may not be thinking about divorce on your wedding day, how you or your partners would go about leaving your business behind may be the furthest thing from your mind as you start your new venture. But business partners can grow apart or have different visions and goals as the years go by and may ultimately want to say goodbye or cash in their chips. Knowing how and when owners can sell their stake in the business, how much they should be paid for their shares, and who can buy an interest in the company is crucial. Have your attorney prepare a buy-sell agreement that addresses these back-end issues up front to provide for smooth transitions in the future.

13. Legal DIY

As an entrepreneur, you’re one of those folks who takes things into their own hands; if there’s something that needs to be done for your new business, you’ll take care of it. Combine that can-do attitude with the seeming ease and affordability of do-it-yourself legal websites and forms and it can be tempting to see your laptop as your lawyer. But saving a few dollars upfront by not working with an experienced small business attorney can cost you significantly more in the long run. Filling in some blanks on pre-printed forms that don’t address your specific needs, goals, and issues can leave you exposed to a number of problems that an attorney could have helped you avoid. With so much to do and so many other things to worry about as you try to get things off the ground, get someone on your team who can bring you peace of mind and ensure that you are positioned for success.

Not Hiring A Lawyer

If all this legal speak has you feeling overwhelmed, don’t worry because you’re not alone. Dealing with all the legal issues of starting a business is overwhelming at times. But the solution is not to avoid the issues and plan on dealing with them down the road. Avoidance really is the biggest legal mistake a start-up can make.

If you don’t take care of your legal matters upfront, it will only make things worse. The best thing you can do is find an experienced startup lawyer in India to help guide you through all the legal aspects of the start-up process.

Many start-up founders fear the high cost of working with a lawyer, but it will cost significantly more money to straighten things out in the future if you make a mistake.  It’s actually not always as expensive as you might think, and it will definitely cut back on the stresses that come with trying to figure everything out on your own.

Hire a startup advocate in India and make sure all your legal issues are taken care of as early as possible. It’s one of the most important steps you can take to get your start-up on track for success and avoid costly lawsuits or penalties from the government in the future.  You can thank us later when your start-up hits it big time.

Legistify connects you with the best lawyers in India and top Chartered Accountants in India with simple telephonic conversation or email. Call us at 846-883-3013 or send us an email at [email protected] to get started.



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