The One Mistake Startup Entrepreneurs Always Make - A Legal Perspective...

by JD Supra Perspectives
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Incentivize your team like crazy and really get everyone rowing in the same direction. That’s what creates a culture and an environment for radical success... - Michael Esquivel at Fenwick & West

In your experience working with startup entrepreneurs, what's the one mistake they make time and again?

The answer to that question of course varies greatly, depending on whom you ask - and, for a legal perspective, we put it to startup attorneys writing on JD Supra.

Yes, the myriad concerns (legal and otherwise) of business formation are complicated, more so than what can be summed up in a single line item. Even so, there's much to consider in the diversity of responses when we ask attorneys well-versed in startup life to commit to just one idea. Here is what we heard back:

They Sign Contracts Too Quickly

From Nancy A. Park, of counsel in the business services practice group of Best Best & Krieger LLP: "Entrepreneurs are often so anxious to seal the deal due to the unequal bargaining positions that they tend to sign contracts too quickly, without reading them or considering all of the possibilities. They may check the economic terms, although even sometimes that is not checked carefully, and think that the fine print is unimportant. First timers are often leery to expose their lack of knowledge, mistaking careful attention to detail in contracts for busywork or boilerplate. Costly errors, which are hindrances to business success like expense, prepayment penalties, division of duties and other important requirements, are often hidden deep in the fine print. This is especially true for loan documents and leases, which entrepreneurs sign often and early. They should read the contracts, ask questions if it doesn’t make sense, and think about the what-ifs of extreme success as well as the possibility of failure, and ask what might happen in each instance, which can be done without triggering alarms. Such careful attention to detail is the mark of a prudent business person rather than an inexperienced pessimist."

They Fail to Properly Document Deal Terms

From Joy Dixon and Chris Hennen, members of the Startup Group at Chambliss, Bahner, & Stophel, P.C.: "Without a doubt, one mistake that we see startup entrepreneurs make repeatedly is failing to properly document, or failing to document at all, the terms of a deal. The failure to properly document deal terms does not necessarily refer to documenting prices and deadlines, but can refer to a wide variety of aspects of the business deal. While it is always a good idea to focus on crucial deal terms such as pricing and deadlines, it is important to pay attention to other vital deal terms which can often be overlooked, such as who owns rights to certain intellectual property (e.g. logos, websites, programs and other content) and the specific rights and obligations of the various parties involved in the deal (e.g. management rights or obligations, equity interest or independent contractor status).

Startup entrepreneurs are often so overwhelmed in the initial planning and development stages and so focused on the product or business idea itself that they can inadvertently neglect to document important details that will help them avoid conflict, and preserve the value of their idea, later on. Thus, it is important for startup entrepreneurs to make sure they document in writing all aspects of their agreements with other people. While a written document signed by all parties involved is preferable, at the very least entrepreneurs should practice following up with a simple summary email setting forth the key terms."

They Don't Put Together That Business Pre-nup, the Shareholders Agreement

From Keli Whitlock, partner at Duane Morris: "Entrepreneurs are extremely passionate about their ideas. When they embark on a new venture with their co-founders, they often get caught up in the moment and forget that things change. People run out of money, get distracted by another idea, have marital problems, develop drug or alcohol problems, get sick, die or simply change their minds about what they want to do with their time. When those things happen, if the entrepreneur has not put together the business form of a prenuptial agreement in advance, it can cause a drag on the company in terms of time resources and capital resources. It can also sometimes call into question the ownership of the company’s intellectual property and create various problems that make it less attractive for investors. These issues often delay the forward progress of the company and sometimes lead to its demise. A simple shareholders agreement detailing what happens when a founder leaves, whether or not by choice, is critical to keeping the company on the right path when the things that inevitably will change actually do."

From Ashley Dobbs at Bean, Kinney & Korman: "Too often, entrepreneurs start out doing business on a handshake, rather than getting important agreements detailed in writing. For example, offering a friend 'a stake' in the business in exchange for 'sweat equity' contributions of marketing, programming, web design, etc. Or simply paying a web designer or marketing professional to create content, without ensuring there is a written 'work for hire' agreement in place before the work begins.

Verbal agreements not only open the entrepreneur up to disputes over what 'a stake' means … a share of the company? Membership and voting rights?  … but also loss of control of the intellectual property inherent in such materials. Unless the person is an employee of the business, the copyrights in the materials vest in the creator, not the company, unless appropriate written agreements are in place. This puts the entrepreneur at risk for the person to resell, reuse, or otherwise compete with the entrepreneur using the very materials created for their venture.

They Fail to Secure Intellectual Property

From Trent Dykes, Chair of the Northwest Emerging Growth and Venture Capital Practice for DLA Piper: "Everyone knows that it is critical to protect your company’s intellectual property, but the first step is making sure your company actually owns the intellectual property. In the flurry of activity surrounding company formation, an often overlooked step is to make sure all founders and consultants assign their work product (both initial and going forward work product) to the company before they begin work. Attempting to obtain retroactive assignments of intellectual property can be difficult and expensive.

I recall one situation where two founders developed some technology and then formed a company to commercialize the same. Fast forward a year later, and while the technology was gaining significant customer traction, the relationship between the two founders was becoming increasingly contentious and the founders (not-so-amicably) decided to part ways (one founder left the company and the other stayed put). Neither founder had properly assigned their ownership in the underlying intellectual property to the company. The founder who left the company then licensed the intellectual property to a competitor."

It's Not Always a Legal Issue: Focus on Technology and People

And a good, parting reminder from attorney Michael Esquivel at Fenwick & West. It's not always a matter of focusing on legal issues: "I have two suggested guiding principles that help to solve 90% of the various legal challenges startup entrepreneurs frequently encounter.  First: The right place to be aggressive and to take risks is on the game-changing technology and disruptive go-to-market strategy at the core of your company. That’s where you can experiment, get creative and really push the envelope. It’s tempting to translate that same mentality into other areas of the business, but when it comes to legal you’ve got to keep it simple. Be plain – be vanilla whenever possible – a startup generally isn’t the right place to break new ground in the law. That’s just a recipe for frustration and additional expense and unnecessary complication. Second:  Within the bounds of reason, be generous to your team. Incentivize your team like crazy and really get everyone rowing in the same direction. That’s what creates a culture and an environment for radical success."

What's your view on this? Send a note to news@jdsupra.com and we may add it in an update to the post, with credit to you.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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