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Five legal mistakes you can't afford to make

on September 1, 2011 Source: Kauffman Foundation

The data shows that most startups fail within five years.

Of course, that doesn’t stop the train from rolling – the U.S. Department of Labor estimates that, on average, 600,000 new startups emerge every year in the United States.

A lot of those companies would last longer if they avoided some unfortunately common mistakes on the legal end of their businesses. does a good job of summing up the topic, but let’s cast a wider net and see if we can shed some more light on key legal mistakes that entrepreneurs make.

Shaking hands – Entrepreneur points out that one of the most common ways to get into a legal wrangle is not putting agreements in writing. That goes for deals with vendors, business partners, and especially customers. Any big contracts you enter into should be reviewed by a skilled attorney. He or she will be the first to tell you that handshakes are great – just not for business deals.

Intellectual Property – Newbie entrepreneurs make this mistake at their own peril. Often, startup owners create intellectual property rights while they’re working for someone else. That’s a big error. While the law is sketchy in this area, by and large, if you create an IP ownership while employed by someone else, your employer, by law, owns the IP rights.

Vesting Errors – Entrepreneurs want everyone to ride the gravy train when their company really takes off – and that’s a good thing. But don’t be too generous. For example, don’t issue stocks to partners or employees without first implementing some vesting restrictions. If the partner or employee leaves in six months, they have every right to maintain all of their equity – at your expense. Instead, craft a stock distribution plan that includes reasonable, multi-year vesting schedules. Check this web site out for some good stock vesting tips.

Not incorporating at the right time – Make sure you incorporate as soon as possible. Do that so you can nip any problems with partners in the bud. By incorporating early, you’ve set the parameters for when your business really gets rolling – well before any funding or financing deal falls into place. Go ahead and issue stock options – within the realm of that vesting issue discussed above. In return, each participant should sign over any ideas, inventions, or other “value added” benefits they bring to the company.

Hiring the wrong lawyer – Startup owners often make the mistake of giving their legal business to a college friend or another lawyer who doesn’t have the right experience. But that could be the wrong move if your lawyer doesn’t have a background in finance, especially working with venture capitalists. Make no mistake, venture funding firms are watching your lawyer closely. If they don’t like what they see, they could withhold your funding.

There are lots of mistakes you can make on the legal end of your business, and from time to time we’ll add to the list. But start with these five mistakes, and start learning from them.

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