Starting a business can be an exciting and challenging endeavor, but it is crucial for entrepreneurs to navigate the legal landscape with care. To shed light on this topic, Harvard Business School associate professor Connie Bagley shares her insights into the top ten legal mistakes often made by unsuspecting entrepreneurs. With her expertise in corporate governance and legal aspects of entrepreneurship, Bagley offers valuable advice to help entrepreneurs avoid potential pitfalls.
Failing to incorporate early enough
One of the common legal mistakes is failing to incorporate early in the business journey. Bagley emphasizes the importance of incorporating before substantial value has been created and well before any financing event. Incorporating early helps prevent potential tax problems associated with issuing inexpensive stock to founders when more expensive stock is sold to investors later on.
Issuing founder shares without vesting
Another critical mistake is issuing founder shares without vesting. Vesting protects the founding team members who contribute to the venture’s growth. It ensures that if team members leave before the vesting period is complete, their shares can be retrieved and given to replacements.
Hiring a lawyer without entrepreneurial experience
When seeking legal counsel, it is crucial to hire a lawyer experienced in dealing with entrepreneurs and venture capitalists. Lawyers knowledgeable in this area can provide valuable guidance and help entrepreneurs navigate potential legal traps. Venture capitalists often assess entrepreneurs’ judgment based on their choice of legal counsel.
Failing to make a timely Section 83(b) election
Entrepreneurs who issue shares subject to vesting need to make a timely Section 83(b) election. This election allows the tax computation to be made based on the value of the shares at the time of issuance, often at a low value per share. Failing to make this election can lead to tax problems when the IRS argues that the difference in stock price is considered income to the entrepreneur.
Negotiating venture capital financing solely based on valuation
Entrepreneurs should not focus solely on valuation when negotiating venture capital financing. Bagley advises entrepreneurs to consider the reputation and track record of the venture capital firm. Building alliances with a reputable firm that has industry connections and a history of supporting entrepreneurs can be more valuable than simply choosing the highest valuation.
Waiting to consider international intellectual property protection
Entrepreneurs often overlook the importance of considering international intellectual property protection early on. Patents and trademarks are granted on a country-by-country basis, and failure to file timely applications can result in loss of protection. Making intelligent choices about where to protect intellectual property and allocating funds accordingly are crucial for global expansion.
Disclosing inventions without a nondisclosure agreement
Protecting inventions is vital for entrepreneurs, especially before obtaining patent protection. Entrepreneurs should take reasonable steps to keep their inventions secret from competitors. While it may be challenging to obtain nondisclosure agreements from potential venture capitalists, entrepreneurs can require them to sign agreements acknowledging the confidential nature of disclosed information.
Starting a business while employed by a potential competitor
Entrepreneurs must be cautious when starting a business while still employed by a potential competitor. Current employees, particularly key employees, cannot operate a competing business simultaneously. Incorporating or pursuing investments while still employed may spark legal disputes. Open communication with the current employer or seeking their investment can help smoothly end the relationship.
Promising more in the business plan than can be delivered
Integrity and realistic projections are crucial when creating a business plan. Entrepreneurs should provide an honest appraisal of what can be achieved and set forth realistic assumptions. Promising more than can be delivered can damage credibility and expose entrepreneurs to potential lawsuits for fraud.
Thinking legal problems can be solved later
The most significant mistake entrepreneurs make is assuming that legal problems can be solved later. Bagley advises entrepreneurs not to delay hiring competent lawyers or addressing legal issues. It is essential to invest time, effort, and money into understanding and addressing legal matters early in the business journey. Resolving legal issues early is more cost-effective than attempting to correct them later on.
FAQs
Q: Can an entrepreneur issue shares without vesting?
A: Issuing shares without vesting can jeopardize the interests of the founding team. Vesting protects team members who leave before the vesting period, ensuring that their shares can be retrieved and transferred to replacements.
Q: Why is hiring a lawyer with entrepreneurial experience important?
A: Hiring a lawyer experienced in dealing with entrepreneurs and venture capitalists is crucial. They understand industry-specific challenges and can help entrepreneurs navigate potential legal traps more effectively.
Q: Why is it essential for entrepreneurs to consider international intellectual property protection early on?
A: Considering international intellectual property protection early helps entrepreneurs avoid losing patent and trademark rights in different countries. It ensures that their creations are safeguarded in global markets.
Q: Can entrepreneurs start a business while employed by a potential competitor?
A: Starting a business while employed by a potential competitor can lead to legal disputes. It is important to communicate openly with the current employer or seek their investment to avoid conflicts of interest.
Conclusion
Navigating the legal landscape is crucial for entrepreneurs to protect their interests and ensure the long-term success of their ventures. By avoiding common legal mistakes highlighted by Connie Bagley, entrepreneurs can set a strong foundation for their business and mitigate potential risks. Remember, addressing legal matters early on can save time, money, and effort in the long run.
