8 Common Legal Pitfalls Encountered by Early Stage Companies
Entrepreneurs and emerging business owners are typically focused on finding financing for their business and developing and marketing their products and services and may not be as familiar with the various legal issues that can impact the success of their company. This list describes some of the most common pitfalls emerging business owners face, and provides information about ways to avoid them. This list is by no means exhaustive and it is important to approach these areas thoughtfully and to seek proper advice on these issues when necessary.
1. Failure to Have Proper Corporate Governance Documents – Just as important as choosing the correct entity for your venture (e.g., corporation, partnership or LLC), it is important to make sure that your corporate governance documents properly reflect key terms as understood by the owners; including terms relating to ownership, management and signing authority, protections for minority investors, issuance of employee incentive equity, and expectations regarding the allocation of profits and losses and the distribution of cash to its owners. The failure to have properly drafted corporate governance documents can lead to future disputes.
2. Choosing an Infringing or Weak Trademark – You begin building valuable goodwill in a trademark from the minute you start using it in connection with your products/services. You will lose all such goodwill and potentially face significant re-branding and legal costs if you later discover your trademark is infringing on a third-party's rights. Trademark law is complicated and a trademark does not have to be identical to another mark to infringe upon it. Many people mistakenly assume that they have trademark rights because they have been able to obtain a domain name and/or a corporate name. It is valuable and important to discuss any potential trademarks you may want to use (including your company name) with a trademark attorney who can provide you with a "trademark clearance opinion," an opinion as to the strength of a trademark, and can discuss with you the possible benefits of obtaining a trademark registration for one or more of your trademarks.
4. Entering into Onerous or Incorrect Contracts with Third Parties/Employees – You need to carefully understand the key terms in your documents with third parties, which includes the important Limitation of Liability, Indemnity, Warranty, Termination and Assignment language in your agreements. In particular, you must make sure that any third party who develops anything for you that might include intellectual property, such as a trademark, design, website and/or software, has properly assigned the rights in such intellectual property to the company. In addition, employment contracts should include proper work for hire and intellectual property assignment clauses.
5. Loss of Rights Because of the Disclosure of Confidential Information Without a Non-Disclosure Agreement – You can lose key rights and your proprietary ideas by disclosing information about your company without first having the receiving party enter into a properly drafted Non-Disclosure Agreement. In particular, you can lose potential patent rights in inventions if they are improperly disclosed to third parties. Make sure all potential investors you meet have signed a Non-Disclosure Agreement before you provide them with any potentially confidential information.
6. Not Understanding and Properly Protecting Your Intellectual Property – There are four broad categories of intellectual property: patents, trademarks, copyrights and trade secrets. Each of these types of intellectual property are distinct and have their own rules relating to the use, protection and enforcement. Actions that a company takes at an early stage can provide protection for your key intellectual property or could lead to the loss of your company's most valuable intellectual property assets. Make sure you understand the different types of intellectual property and take the proper steps to develop and protect your intellectual property.
7. Failing to Comply with Securities Laws – Navigating securities laws when trying to raise capital to finance growth can be a challenge, but non-compliance with securities laws can have serious consequences for you and your company. Speak to an attorney and before you begin fundraising make sure you understand the rules regarding crowdfunding, Regulation D offerings, shareholder limits before SEC registration is triggered and other important rules related to the raising of capital.
8. Poor Record Keeping - In addition to keeping good financial records, you must maintain easily accessible and up to date copies of all key contracts and related correspondences and must be able to keep track of all intellectual property owned by your company. In addition to the risk of not being able to locate your key contracts in the case of a dispute, future investors will want to see and review such documents. If you are unable to provide such documents, it can reduce a potential investor’s interest in your company and/or reduce the valuation they are willing to provide.