Setting up a new business can be an exhilarating time and the culmination of a dream. However, in most cases, this is a brave leap into the unknown…with unpredictable results. Without the correct legal structuring and preparation, many new businesses can find themselves making errors which require a considerable amount of time, money and effort (and stress) to fix. At the beginning, many owners are keen to get started which can leave businesses exposed to nasty surprises. Below is a (non-exhaustive!) list of common issues which are worth bearing in mind before starting a business.
1. Not implementing the optimal business structure
The structure of a business will be a key step for owners to consider. This will be very much dependant on the proposed activity of the business. For example, the business could be set up through a private limited company, a partnership or on a sole trader basis, etc. The legal structure will determine how the business operates and grows going forward and will have an impact on the responsibilities of interested parties.
Recommendation: Making sure this structuring is done in the early stages of formation will ensure better performance in the future. This will help to reduce risk if your business structure changes or is forced to change further down the line.
2. Failing to adequately cover the basics
Many start-ups begin business on shaky foundations by failing to have legal agreements in place which correctly map out the relationships and obligations between relevant parties. In many cases, parties are not fully aware of their responsibilities or do not want to incur additional costs in putting these affairs in order. Although there may be a large degree of trust between individuals going into business together, disputes can take place at any moment and things can easily escalate. Agreements reached informally (through conversations, email, whatsapp, etc) create a risk of conflict arising over what exactly was agreed. This can create messy situations which often lead to further costs when parties eventually seek to tidy up their affairs. Absent any resolution, costly court proceedings could be the logical endgame in order to resolve a dispute.
Accordingly, efforts should be made to formalise arrangements at the outset in written legal agreements. For example, it is important to correctly characterise any initial financing arrangements from founders (whether by means of capital injections or shareholder loans) or in mapping out the terms which are relevant to the operation of the business (such as agreements with suppliers or services agreements with consultants).
Further, when more than one party is involved (ie a joint venture), it is important that significant points are agreed in writing at the outset between founders. A Shareholders’ Agreement or Partnership Agreement are examples of legal documents that co-founders use to agree the structure of a business. This will regulate the relationship among owners and cover important matters such as the trajectory of the business, any dividend policies, restrictions on transfers of shares and further shareholder protections.
Recommendation: Be aware of the vital agreements which are material to your business and seek to formalise these in writing.
3. Not seeking appropriate legal advice
The future of a start-up can be significantly influenced by the legal advice received at the outset. Legal counsel will be responsible for advising on potential legal pitfalls and the relevant licencing/regulatory environment relevant to the business’s sector. Start-ups can save a lot of time and money down the line by ensuring that they engage appropriate legal counsel. A common issue involves start-ups seeking to cut corners by drafting their own legal agreements. Although online legal templates can be useful, they are rarely the finished product and in many cases are wholly inappropriate (often drafted under the laws of a different jurisdiction or applying legal concepts which do not function where the business operates).
Recommendation: Always seek appropriate legal advice. A commercial lawyer can become a valuable part of your team who is alive to the issues of the business and, where bespoke matters arise impacting a specific industry, they will often have a network of further experienced lawyers who are on hand to assist.
4. Being too quick to offer shares without vesting considerations
A new business requires hard work and commitment. Especially in the early stages, founders rely on dedicated team members who are required to live and breathe the business. There is often a temptation to offer shares to team members who are playing a key role in the success of the start-up. This is often an effective way of incentivising individuals and promoting loyalty. However, it also risks pre-maturely offering a portion of the business to individuals who do not prove to be invested in the long term success of the project. These arrangements can have long-lasting implications and can be difficult to unwind.
Recommendation: In light of the above, it is usually sensible to introduce specific vesting terms for any share offering to team members. These vesting terms mean that key team members earn entitlements to shares over time (rather than instantly owning a portion of the business) – these terms can linked to either the length of their employment, particular financial milestones or other relevant metrics over the lifetime of the business.
5. Ignoring data regulations
The last thing an entrepreneur is thinking about when setting up a business is often data protection – this can be a dry and boring subject! In the early stages, businesses need to survive and we therefore sympathise with those which initially pay more attention to their product and cash flows. However, the truth is that this is a subject which cannot be ignored. Since the introduction of GDPR, any personal data collected or processed by a business must be handled in accordance with GDPR law and applicable guidelines. Many small businesses are still not fully compliant when handling data (a recent study suggests that only around a third are compliant). In our experience, this is something which is usually not on the agenda at the outset.
Recommendation: It is important that you are fully up to speed on exactly what is required to comply with data protection laws and ensure the business is acting accordingly. This will involve consideration of how customer data is stored and consideration of the business’s T&Cs and privacy policies. Advice should be sought where individuals are not clear on the requirements – this can help to avoid hefty fines or complaints!
6. Not protecting their intellectual property
Intellectual property is a business asset which can set apart certain businesses from their competitors. Start-ups are often inclined to over-enthusiastically share big news and successes with the world which risks sharing sensitive information. In other cases, information can leak out through team members. Where information is disclosed without adequate protections being in place, someone else may go ahead and begin using the start-up’s intellectual property. Businesses with valuable intellectual property should consider the following actions in order to protect their position: (i) register copyrights, trademarks, and patents, (ii) register business names and domain names, (iii) put in place robust non-disclosure and confidentiality agreements, and (iv) implement security measures.
Recommendation: Prior to any relevant registrations taking place which can adequately protect creations, a business should enter into non-disclosure agreements with employees and co-founders to protect against information being leaked.
7. Delaying legal problems
Legal challenges arise in all businesses. Although there may be a temptation for heads to be buried in the sand when issues present themselves, avoiding issues are likely to magnify them in the long run. The longer that a problem is left to fester, the harder (and costlier) it is to tidy up.
Recommendation: Address legal issues as soon as they are discovered.