Legal Issues Faced by Start-up Companies

It is common to see founders of start-up companies spend most of their time building their businesses. They spend the majority of their time trying to hire the best people, trying to get investors on board, and trying to convince customers that they have the best product to serve their needs. It is common for founders to not pay attention to the so-called “non-critical” matters in the early days of the firm.

Legal issues are often categorized as one such non-critical task. They are often thought of as being a formality, a form of paperwork that needs to be done. It is also common for start-up founders to avoid spending large sums of money on hiring the best lawyers. This is because they do not believe that legal matters are important, to begin with.

The failure to give due importance to legal functions often results in expensive and time-consuming lawsuits at later stages. In this article, we will have a closer look at why legal functions are important in a start-up company.

Choosing the Right Legal Entity

Any start-up company can be formed in multiple ways. A company can be started as a sole proprietorship, a partnership, a limited liability partnership, a joint venture, or a limited liability company.

A limited liability company can also be of various types. Each of these is considered to be different in the eyes of the law. All of them are governed by a different set of rules. Each set of rules has its own advantages and disadvantages.

For example, any kind of “limited” company has limited liability. This means that their liability towards the business is limited by the extent of money that they have invested in their shares. Their personal assets cannot be used to recover the dues owed by the company. This is not the case with partnerships and sole proprietorships. Hence, founders should engage specialist legal counsel who can help them choose between these entities depending on their specific situation and the pros and cons of each situation.

Agreements Amongst Co-Founders and Shareholders

Start-up companies are prone to conflicts between co-founders and shareholders. Even large companies such as Facebook witnessed extensive conflict between co-founders Mark Zuckerberg and Eduardo Saverin. These conflicts can degenerate into events that lead to the destruction of the entire company if they are not controlled at the outset. A good legal agreement that details the rights and responsibilities of all parties in different scenarios.

It is important to involve expert legal consultants and draft an agreement that clearly explains the rights, duties, capital contributions, roles, and status of all office bearers and shareholders. A well-drafted agreement can help in resolving disputes without arbitration or litigation. This can save the firm a lot of time and money in the future.

Intellectual Property Rights

We live in an era where most start-up businesses are operating in the information technology field. Hence, it is highly likely that a lot of these businesses will have some kind of proprietary algorithm or some other intellectual asset that gives them an edge over their competition.

Oftentimes, companies are not very careful about their intellectual property. This is particularly true if the start-up is not using investor funds. In many cases, the intellectual property is registered in the name of individual founders instead of being registered in the name of the company. Hence, at a later stage, if a founder wants to leave the company, the ownership of the intellectual property becomes the source of litigation.

Similarly, oftentimes start-ups do not mention the details of the ownership of any intellectual property created during the course of employment. In such cases, if the employees of the start-up create intellectual property during the course of their employment, lawsuits and other related disputes are bound to occur. All this can be avoided if the start-up founders appoint a legal team and pay attention to their suggestions. This is important since ambiguity regarding the ownership of intellectual property deters potential investors.

Exclusivity Provisions

It is common for firms to approach investors and investment bankers while trying to raise funds. There are several investment banking firms that claim to have a network of high-net-worth individuals. However, a lot of the time, these firms ask the start-up to sign contracts that have exclusivity provisions. This could mean that the start-up firm is not able to seek funding from other sources.

It is also common for certain investors to demand exclusive rights which exclude other investors from later rounds. These provisions can have a negative impact on the overall valuation of the firm. Hence, such provisions should be avoided. A trained legal team will be able to identify such predatory provisions and point out related issues to newbie investors.

The fact of the matter is that investing in a legal team is not really considered to be a priority by many investors and founders. However, it is important to ensure that an expert legal team has been formulated to ensure that the company is standing on a firm legal footing. The inability to do so can be detrimental to the firm’s future.


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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.


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