Top 5 Legal Mistakes by Startups

Starting a startup company without creating basic legal protections for the product that it is going to sell is like opening a store and saying I’ll get the door lock installed later. Many a startup has failed because it ignored the legal realities of protecting the big idea from a disgruntled founder, a dissatisfied employee, or a shady competitor. Here are the top five legal mistakes that startups make that often cause them to fall apart or get bogged down in a legal dispute way before they start making money:

1. Not defining the ownership structure (who owns how much).  Leaving this question for later, will inevitably cause a dispute among the founders and impede funding.  Look at it this way – if you can’t agree on the ownership structure, how will you be able to agree on any business-related decisions down the road? 
2. Failing to create a legal entity (like corporation or LLC).  Formation of a legal entity will help protect the owners from liability, allow for business tax deductions, and help with obtaining funding down the road. 
3. Failing to have everyone who works for the startup, including founders, assign their intellectual property to the startup entity.  The history is riddled with stories of falling outs between startup owners, where one of them leaves and takes his code/product/idea with him or her.  Having the right assignment agreement in place can prevent that from happening. 
4. Failing to protect the idea or product with a rock-solid non-disclosure agreement. Any startup must have a non-disclosure agreement (NDA) to hand to anyone with whom it shares any confidential information.   Nothing illustrates the importance of an NDA like the recent ZeniMax v. Occulus/Facebook lawsuit where the court awarded ZeniMax $500,000,000 for breach of its NDA. 
5. Failing to properly set up and document employment relationships.  The startups often cut costs by hiring independent contractors, when, in reality those individuals should be classified as employees.  While this might cut costs in the short term, in the long term, it can result in tax liability, fines and litigation from said employees.

Leiza Dolghih is the founder of Dolghih Law Group PLLC.  She is board certified in labor and employment law and has 16+ years of experience in commercial and employment litigation, including trade secrets and non-compete disputes. You can contact her directly at leiza@dlg-legal.com or (214) 531-2403.