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Legal Issues for Start-Ups to Avoid

February 3, 2013

If you scour the web for information on "tips for start-ups" you will find an endless number of bullet points, lists, and helpful summaries. Interestingly, in the majority cases the items most often messed up, done poorly, or forgotten about relate to legal matters. For example, as a Venture Beat post discussed recently, many different legal matters are continually botched by those with great ideas and the best of intentions.

Perhaps it should not be surprising that many start-ups make legal mistakes, because most focus is on the product or service about which they are passionate. Many of the administrative and organizational details get short shrift. Add the fact that many startups seek to cut corners and avoid paying for professional help, and it is easy to see how so many legal errors are made. But it remains critical for all those hoping to make it in the long-term to get serious about avoiding the most common legal pitfalls. For example, some of the obvious ones discussed in the VB post include...

Lean About "Due Diligence"

Even something as simple as picking a name may come with legal ramifications. For example, many a business has chosen an identity only to discover later that ***oops*** its already taken. If any steps had already been made with the names, this errors requires starting over and potentially wasting time and money. In the worst cases-when the problem is not identified until later-it may actually result in a lawsuit.

The lesson: do your due diligence and research ahead of time. There are online databases to examine this information and ensure you get off on the right foot.

Choosing the Wrong Entity Structure

Besides a name, one of the most important early decisions is figuring out the entity structure to operate as. Mountains have been written about the different options and the reasons to chose one or the other. But the decision is so important that it is worth reiterating. As previously mentioned, there are several common entity structures, including sole proprietorships, partnerships, Limited Liability Corporations and C-Corporations.

Each entity has strengths and weaknesses, but in most cases it comes down to taxation and liability protection. Sole proprietorships and partnerships come with single taxation but little liability protection. If there is a risk of any sort of liability-and in virtually all cases there is-then it might be worthwhile to give serious thought to more sophisticated arrangements.

The C-corporation, which is the most common corporate entity, is the old-fashioned structure for the largest entities. While it comes with liability protection, it also means that the income is taxed twice-once on the corporate level and once on the individual level.

The Limited Liability Corporation (LLC) is a hybrid of the Corporation and partnership, and the seemingly "best of both worlds" that it offers makes it attractive to many. LLCs are relatively new, and as such, there is less certainty with some of the more complex legal issues involved. However, the fact that they may offer single taxation as well as liability protection means all startups should at least speak with a legal professional and determine if it makes sense for them.

Mixing Funds

If your start up moves beyond the sole proprietorship or partnership phase, then it is critical to understand the basic protocols to ensure the "entity" and your person are separate. Most notably, do not co-mingle business assets with your own. "Co-mingling" may lead to claims that the business entity protection does not apply. Usually you only discover this when you are actually facing liability-the exact moment when you have much to lose.

Playing Fast and Loose with Intellectual Property

Copyrighting, trademarking, or patenting your work is not something only for those in a select few business. These legal principles apply to many different start ups, even those who might not assume so from the outset. It is impossible to get into too much detail about intellectual property rules here, but the bottom line is: talk to a professional about it. Leaving it to chance or pushing it off the deal with later is a recipe for disaster.

The above list is just the tip of the iceberg as it relates to basic start up mistakes. Don't let your ideas and enthusiasm wither because of legal malfunctions. In our area, contact a Sacramento start-up attorney today to learn more.

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