For over a decade I have worked with thousands of startups and entrepreneurs across a broad spectrum of industries and markets. I’ve seen them succeed. I’ve seen them fail. I’ve seen some overcome adversity, and others come to the realization that they needed to pivot and try something else. Many of these young companies faced similar challenges.
At the Entrepreneurship Law Center at the University at Buffalo School of Law, we strive to prepare and position clients to focus on growth. By being aware of – and avoiding – the following top five legal mistakes startups make, entrepreneurs can increase their chances of building a successful business.
1. Mislabeling independent contractors
By far, the most common pitfall for early-stage startups is labor and employment matters. In fact, three out of the five mistakes listed here stem from mishandling employees.
The first is related to contract employees. Just because someone is called an independent contractor does not necessarily mean they are legally an independent contractor. Several factors legally determine whether someone is indeed a contractor, and the title you give them is not one of them. Furthermore, there are different classifications between the federal government and state governments. Misclassifying employees as contractors can have significant regulatory and financial consequences, with fines often reaching tens of thousands of dollars in penalties and interest before the company even realizes there is an issue.
2. Not paying interns
Calling someone an intern does not mean companies can avoid paying them; interns should be paid. While there are some exceptions to this general rule, most companies not paying interns are doing so with a large degree of legal and financial risk, potentially creating wage and hour issues with regulators that could result in significant penalties or fines. Unpaid interns also open up personal liability to owners for unpaid wages.
If an intern is creating intellectual property (IP), companies could end up with an ownership claim over the IP. And finally, interns working for free could result in an accidental co-founder situation, where the intern can make a claim to equity.
3. Misusing equity incentive plans
Equity incentive plans, such as incentive stock options or restricted stock, can be great tools for a young, high-growth startup to attract and retain talent. They are, however, more complex than early-stage founders tend to appreciate and can have significant tax and regulatory consequences for both the recipient and the company.
It is critical to ensure that a plan is structured and managed properly. Moreover, stock options cannot, and should not, be used in lieu of paying employee wages. They can be used as an incentive, but that does not mean you can sidestep minimum wage and hour/exempt employee laws.
4. Not owning intellectual property
You would probably expect this one to be about filing a patent, trademark, copyright or even protecting trade secrets, but one of the most common issues I find with young startups is even more fundamental than that – making sure the company owns its IP. To the extent the company is relying on valuable technology, the company needs to own and/or control that IP.
This may mean making sure assignments are executed by the founders, but it also means ensuring that designers and technical members of your team (including interns) also assign the IP to the company – and that there is consideration for doing so. You do not want to be in the middle of due diligence with an investor when you realize the company does not actually own its IP.
5. Poor planning
Poor planning may seem like less of a legal issue and more of a business issue, but it can very quickly turn into a legal issue as the founders become consumed in conflict management, litigation and even dissolution. Poor communication and management of the team relationship and dynamics can result in an erosion of trust between founders.
Like most relationships, once trust is lost, it is extremely difficult to rebuild. A lack of business planning, vision and values can also result in misalignment between founders and friction as the company grows. When you are starting a business – and are focused on customers and raising money – these may seem like inconsequential matters, but ignoring proper planning can result in a weak foundation for the company. As the company grows, these mistakes become disruptive and can consume a company.
Unfortunately, no amount of planning can guarantee that a company will succeed. In fact, it’s almost a guarantee that most companies will fail. But by avoiding common mistakes and learning from others, founders can mitigate unnecessary risks and focus their energy on growing their businesses and succeeding.
Looking for more startup tips or support to launch your venture? Entrepreneurs gain access to strategic guidance, mentorship, connections and more when working with the University at Buffalo. Learn more about startup support at UB and inquire today.
Disclaimer: This article is meant for informational purposes only and does not constitute legal advice or create an attorney client relationship. Should you or your company be facing legal issues, make sure to consult with an attorney about the facts and circumstances unique to your situation.