Many entrepreneurs make costly legal errors when launching a startup. Based on my observations of startups from the view of an outside counsel and an occasional angel investor, I will highlight the most frequent legal errors made by startups. These mistakes can prove fatal in certain cases and may prevent entrepreneurs raising capital necessary to build their businesses.

Common legal mistakes by startups include:

  1. Neglecting to properly document agreements: Startups often neglect to properly document agreements, such as employment agreements, which can lead to disputes and legal issues down the road.
  2. Failing to properly structure the company: Startups often fail to properly structure the company, such as by failing to properly document equity ownership, which can lead to disputes among founders and make it difficult to raise funding.
  3. Not having proper agreements in place: Startups often make the mistake of not having proper agreements in place with partners, vendors, and customers, which can lead to disputes and legal issues.
  4. Failure to properly protect intellectual property: Startups often fail to properly protect their intellectual property, such as trademarks, patents, and copyrights, which can lead to disputes with competitors and make it difficult to secure funding or partnerships.
  5. Failing to address potential legal risks: Startups often fail to address potential legal risks, such as liability for product defects or intellectual property infringement, which can lead to costly lawsuits.
  6. Neglecting to protect trade secrets: Startups often neglect to protect trade secrets, which can lead to theft of proprietary information by employees or competitors.
  7. Neglecting compliance issues: Startups often neglect compliance issues, such as data privacy and security regulations, which can lead to costly fines and penalties.
  8. Neglecting to consider the long-term: Startups often focus on short-term goals and neglect to consider the long-term implications of their decisions, such as potential legal and business risks.

It’s important for startups to be aware of these common mistakes and take steps to avoid them. This could include consulting with legal and business experts, having regular legal and business review, and establishing and enforcing internal policies and procedures.

Next we highlight certain legal errors startups make. These problems usually arise during the initial formation of a business, at the beginning of the company’s growth or when dealing directly with employees.

Mistake 1A – No Formal Written Agreement with Co-Founders

Entrepreneurs are optimists. They are creative, motivated, passionate and ready to believe in the impossible. Smart entrepreneurs are careful to not make unrealistic or untrue statements, projections, and promises. Optimistic views, aspirations, or stretch goals should always be stated as such. These statements could be considered fraud and cause potential investors to lose credibility. Smart entrepreneurs should not assume that investors are experienced enough to know which statements are true and which are lofty. A well-vetted business plan, with solid projections, and honesty about the risks you face is the best way for your business to succeed – and to avoid legal problems.

Startups are dynamic structures that can change rapidly. Startup founders operate in an environment that is constantly changing and are subject to unexpected changes. The only constant in the startup ecosystem is change. This is often repeated. It is therefore essential to have a well-drafted agreement. It will prevent unnecessary chaos later. This agreement should outline the roles and responsibilities for co-founders, as well as the rights to make decisions, intellectual property rights, equity breakdown and remuneration.

Mistake 1B – No Formal Written Agreement with consultants or employees

If you hire contractors/consultants without an assignment, you may not own the resulting work, but merely have a license to the work.  Your company wants to maximize the value of the services provided by the consultant. You should own all intellectual property and software rights. This covers not only the source and object of the code, but also the concepts contained in the code that might be used elsewhere.

Developer contracts usually refer to the various intellectual property rights that the software contains: copyrights and patent rights, trade secrets, and so forth. Copyrights refer to tangible components of the system such as the code and documentation. The majority of development contracts grant clients exclusive ownership of any copyrights to their system. This means that the consultant cannot duplicate the code it has created for the client or deliver it to another client.

Copyright ownership does not cover the ideas and concepts that underpin the software. Trade secrets and patents are relevant. Patents are a 20-year monopoly that grants the right to use, make, or sell the patent invention. You should be the sole beneficiary of any consultant’s creative ideas if the software they receive is patentable in its entirety. Development contracts usually grant the client exclusive patent rights.

Trade secrets protect the software’s ideas, but they are only valuable if the information is not widely distributed. Therefore, most development contracts prohibit the consultant’s disclosure to any parts of the software that, if only used by the client, could give the client a competitive edge.  Having a signed agreement with each contractor or consultant will remove this potential red flag during investor due diligence. Similarly, you should have employment agreements with employees that spell out their assent to assigning all intellectual property rights to the company, and each patent filed should have its own assignment that is recorded with the USPTO to perfect your rights in the employee’s IP contribution to the business.

Mistake 2 – Starting a Business without C-Corp Protection

As a entrepreneur, one of the most important decisions you will make is which entity to use for your startup. Entrepreneurs who start businesses without consulting a lawyer on financial and legal issues can incur significant taxes and be subject to substantial liabilities that could have been avoided if the entity was a C Corporation.

Most investors won’t invest in sole proprietorships or limited- liability companies (LLCs) as there are higher risks. It can be difficult and costly to convert to a C Corp after the company has started operating. Startups that have not been registered as C Corps since day one cannot claim the Qualified Small Business Stock (QSBS) exemption.

Section 1202 of the IRC is commonly referred to as the QSBS exemption. If you are a founder, angel investor, or an employee of a successful early stage company, you need to be aware of certain qualifications that could help you protect up to $10 million (or 10 times your cost basis, whichever is greater) from federal taxes. To benefit from the QSBS exemption, you must have held your stock in a Qualified Small Business for at least five years. The Qualified Small Business is defined as:

  • A domestic C Corporation
  • An entity with cash and other assets totaling $50 million or less, on an adjusted basis
  • Any business other than: (a) services firms such as health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial or brokerage services, (b) banking, insurance, financing, leasing, investing and similar businesses, (c) farming, (d) mining and other natural resource businesses (e) operation of hotel, motel, restaurant or similar business.
  • An entity that is actively running a business. In other words, at least 80% of the assets of the firm must be used to actively run the business, not for investment purposes.

Mistake 3 – Ignoring Trademarks, Copyrights, or Patents

In the initial stages of a startup, it is crucial to protect the company’s IP. This includes its trademarks, patents, copyrights and trade secrets. It is important to develop a strategy to protect IP. This includes registering in countries where you intend to do business and documenting agreements. You should also draft solid NDAs with employees and suppliers.

A trademark registration is an essential step in any business venture. It should not be ignored. You can protect the name of your company, products, and services by registering a trademark. This will ensure that no one else can use trademarked words and designs.

Your trademark is an asset that can increase in value and be licensed or sold to other people once you have secured its rights. Registering a federal trademark is essential for any business or wealth-building strategy. Depending on the product and business you are involved in, copyright and patent protection might also be of interest to you.

You can lose your ideas if you don’t secure them, and if you publicize your ideas on your website or on crowd-funding sites, you have lost patent rights in many countries. In the US you have one year from the first disclosure to patent your idea.

An example of startups who do not patent, see what happened to startup Unlockd who filed legal proceedings in the United States against Google claiming it collapsed because of the tech giant’s anti-competitive behavior. The once high-flying Australian founded startup claimed it was forced into bankruptcy as a direct result of Google banning Unlockd’s apps from its services after Google invested in its competitor. Another example, see how Phhhoto Inc., a defunct social media app featuring short looped videos, accused Facebook Inc.  founder Mark Zuckerberg of personally engineering a fraudulent “scheme to crush” the once-popular startup and slavishly copied its software. 

Patents could have put second thoughts into competitors who clone your product.  Remember, He who has rights, and sleeps upon them, justly loses them.—Miller v. Bridgeport Brass Co., 104 U.S. 350 U.S. (1881).

Business Mistakes

Next we discuss how the legal mistakes can be amplified with business mistakes. You’ll have likely spent many hours researching the most important aspect of your idea being realized: funding. You’ll also have met the major players in company funding, the venture capitalists.

You should be prepared before you try to get into meetings with VCs. You can’t just show up with a pitch and expect to get your $5M check on the spot.  It’s a process coupled with art, and it will take planning.

Mistake 4. Not having an A team

If you show up as a solo entrepreneur, investors may think that you can’t convince others to your cause and that may show a lack of traction as to people. The team can include your co-founder and early stage consultants or employees, as well as those of your advisors, mentors, and investors. In essence, VCs invest in teams .Your team is your greatest point of difference.

Mistake 5. Not knowing your business metrics

Solid evidence will be required to back up the details of your pitch. You must be able show them how you arrived at your prediction of fifty percent growth within twelve months. You should be able to show them real metrics that support any claims you make.  It is more powerful if you can show real traction numbers as validation of your business idea.

VCs will need different information depending on the industry. Look at a competitor or comparable company to determine the key elements they measure. You won’t be able to find the key elements that make or break a deal if you are in FinTech.

Mistake 6. Not showing them the uses of the cash investment

Although it may seem obvious, every VC will want to know in detail what you plan to do with your cash. This can be done with a cashflow statement or a ball-park estimate of expected expenses.

In the software space, you are lucky that your cost of good will be very low, between 10-20%.  However, your marketing expenses may be very high due to get your high traction.  Advertising expenses can include TV, Sky-writing, Google Ads, Social Media, TV, etc.  Other typical expenses include R&D/Engineering and office expenses, for example. You will need to plan the budget and show the results. You should also project how they can help you make a lot of money.

Mistake 7. Research is key to finding the right VC

While you may be tempted to seek out delicious funding, it is important to understand who your potential partners are in your business. Venture capitalists have different interests. One firm might be focused on apps and software while another may have a primary portfolio that includes medical technology.

It is advantageous to choose someone with a direct interest in your business. However, this can be a disadvantage. They will not “get it”, but are very well-versed in all aspects of the landscape, including competition, growth potential, and common pitfalls. Prepare to be grilled.

Mistake 8. Over or Under Enthusiasm

It is difficult to balance passion and energy with outright brilliance. Although VCs love to see entrepreneurs who are enthusiastic, they also don’t like being stalked by emails, calls, and a constant stream of documents.

They are excited about your journey and will look for you to bring that enthusiasm to others. They will also be looking for your communication and listening skills.

Don’t overdo it with technical jargon. Keep your materials simple. Make sure you get to the core of your business and future plans. Then, sum up how you plan to get there. Your time with them should be spent wisely.


It is difficult to start a startup. You need to plan everything, from the business structure to the confirmation of a patent-free domain name to legal advice. According to the most recent data, 70% of startups close within the first three years. With the right people, resource, and IP protection, you should be able to make it into the 30% of successful startups.