Entrepreneurs are known for thriving in uncertainty and proceeding despite risks, but with legal matters, proceeding with caution is the best idea.
Galon Mason, special counsel at Foley and Lardner, LLP in Chicago, has worked with startups for nearly five years, and says it’s absolutely heartbreaking when someone that’s “all in” on a great idea fails…or doesn’t reap the full rewards from their idea because of structural, tax, IP or other avoidable business issues.
Mason says cost may be a reason early-stage entrepreneurs forgo legal advice. “A new technology startup doesn’t need and can’t afford custom legal documents and may not be able to pay until the idea proves out, “ says Mason. But cost is much greater when legal issues are triggered. Firms, like Foley and Lardner, work with early-stage companies through fee-alignment plans.
Focusing on legal issues early is the key, and is especially helpful for new entrepreneurs, according to Mason. The increase in startups after the recession, coupled with cheaper costs in starting a business, led to a stronger attraction in entrepreneurship. And with many founders new to building a business, the need for legal advice has become even more pressing.
Emily Cieri, Managing Director of Wharton Entrepreneurship–a hotbed for early stage innovation, says enrollment has been up–especially for MBA students who are coming to Wharton specifically for Entrepreneurship. Cieri says Wharton addresses legal issues with course offering such as Legal Aspects of Entrepreneurship. But, Cieri also warns its also especially important that students learn early how to manage relationships with people, in addition to legal aspects. “If you end up in a lawsuit, then you are now in the business of managing a lawsuit,” says Cieri.
Within Wharton Entrepreneurship program and on campus, there are a number of opportunities for budding entrepreneurs to start asking questions and dealing with legal issues early on. Wharton’s Venture Initiation Program (VIP), for example, is an on-campus educational business incubator which helps students launch business ventures and mentors students in many areas, including legal.
Warby Parker, online eyewear success, is a product of VIP. Cieri says, Warby Parker is a great example of co-founders seeking advice early on and in doing so, managing their company in a way to keep the business whole even as situations changed internally.
Peter Fusco, partner at Lowenstein Sandler, LLP in New York, who represents tech companies and venture funds, says common mistakes in areas such as forming a company, and IP are hard to move on from. These mistakes can be “soul-crushing,” he says.
Fusco is also part of the Tech Group at Lowenstein Sandler, which runs the outreach initiative VentureCrush. The program offers invite only events for startups, growth company founders, investors and global tech companies. Fusco regularly speaks to startups on common legal mistakes to avoid. Fusco also provides startups with packets to help with necessary legal documents.
While there are many legal mines to steer clear of in the early stages, a few are common to entrepreneurs:
Allocation of company ownership is important says, Mason. “Aside from deciding how much each founder will own, it is equally important to address what happens if one founder departs,” he says. “Absent vesting provisions by which founders earn their right to ownership over time with the company, one founder can be left running a company she only owns half of,” says Mason. This puts founders on shaky turf with future investors.
Early tax elections.
Failure to make an 83(b) election when founders’ shares are subject to vesting, will result in being taxed at ordinary income rates instead of capital gains, according to Mason. “What’s worse is those tax obligations can come at a time when there is no cash to pay them.”
“Get the equity done as soon as the company is formed,” says Fusco. “Founders need to have these conversations from the very beginning.” Equity is what drives the company forward.
“If you don’t own what you’re building you can’t later sell it,” says Mason. Fusco adds that IP ownership is a huge concerns early on.
Employee v. Consultants.
“You can’t abuse wage and hour laws,” says Fusco. It’s important to know the difference between employee and consultants and pay them accordingly, he says.
Entrepeneurs who seek legal advice early can avoid these pitfalls. Mason says he has seen all of these issues arise. “They are always deal breakers or costly to fix.”
This article was written by Mamie Joeveer from Forbes and was legally licensed through the NewsCred publisher network.