Start-Up: Avoid common legal pitfalls for start-up companies

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No one wants to think about the “worst case scenario” in the heady days of a new business venture. But, before your start-up company does its first day of business, there are basic legal issues you should address to avoid complications down the road.

Taking the time to plan up front can save you headaches and hours of problem solving later. Based on my experience as a business lawyer working with hundreds of start-up companies, here is my list of common legal pitfalls to avoid as a start-up.

1. Read Before You Leave. Many employers require employees to sign agreements that protect the business and restrict an employee’s rights and activities even after the employee leaves the organization. Examples include assignment of invention agreements, non-compete and non-solicitation agreements, and confidentiality agreements that may contain time, geographic location, and type of activity restrictions. Carefully review all agreements you signed – ideally before you leave your place of employment - to ensure there aren’t restrictions that may put you or your new business at risk. Defending a breach of contract lawsuit against your former employer is not how you want to focus your energy.

2. Don’t Lose your Shirt. No matter the size of your fledgling business – a one-woman show or a 10-person partnership – taking the time to create a business entity will protect owners from liability by keeping your business assets separate from your personal assets. The most common types of entities for start-up businesses are corporations, including C corporations and S corporations, limited liability companies, and partnerships (limited or general). All of these entity options provide liability protection, but each has its own particular tax treatment, owner/investor requirements, methods of transfer of ownership, and other characteristics.

To choose the right business entity for your start-up, you need to consider your particular circumstances, current plans, and future goals. After the legal structure is set up, you must consistently utilize business practices appropriate for your business' legal structure, so you don't lose the liability protection you created. Properly operating your business to maintain liability protection includes creating and maintaining a separate bank account for your entity, using the entity name when entering into contracts and marketing the business, and following the rules created by Nevada law or your own organizational documents. These are all simple processes, but in the hectic start-up phase, it can be easy to take shortcuts thinking you will do it right later when you have more time. But beware, the consequences of failing to do business through an entity or not respecting the entity once formed, could be the difference between losing just your business assets and losing everything down to the shirt on your back.

3. Create Good Habits. Small business owners are constantly multi-tasking, stretched and pulled in so many directions that simple items can easily get pushed aside. As busy as you are performing every function from pitching investors to sending out packages, it is crucial that you create and maintain records that track your business operations. Best practices include creating and maintaining minutes and consents from business meetings, documenting any loans that you or other owners make to or from the company, and most importantly READING and organizing all contracts. Like your personal income taxes, taking the time to perform these tasks as you do them is much easier than recreating them after the fact, or organizing a year’s worth of records under the gun.

4. Don’t Be Vulnerable in a Business Divorce. If your business has more than one owner, all of the owners should enter into an agreement that outlines each person’s rights, responsibilities, and how the business will be operated and ended. You have likely heard of shareholder agreements, buy-sell agreements, operating agreements, partnership agreements, or transfer restriction agreements. Each type of agreement is tailored to the type of entity it governs, but they all share the common purpose of establishing owners’ rights and restrictions such as management and decision making powers, restriction on transferring the ownership of the business, and spelling out what will happen in the event of a death, bankruptcy, or divorce of an owner. The owners should discuss and agree on a framework and procedure to handle events if these circumstances arise. I have seen best friends, family members, spouses, and formerly close relationships ultimately destroyed because business owners did not take time at the outset to consider and record their common goals.

5. Protect your Intellectual Property Assets. All businesses have something unique, even if it is just the name. Taking the time to protect the unique aspects of your business could create more value for your company, and may prevent others from copying or stealing your ideas. Just as large employers restrict departing employees, your small business should require employees and owners to sign an agreement that (1) prohibits disclosure of company secrets; (2) assigns all rights to any unique items they create while working for the company to the company; and (3) prevents owners or employees from competing with your company or soliciting your clients, suppliers, or current employees during and after their employment or ownership.

6. Don’t Dodge the SEC. When a company issues evidence of ownership (e.g. stock, LLC membership units or interests, or partnership shares), the company is issuing a security. All “issuing” companies are subject to federal and state securities laws that have complex registration requirements. The good news is that various exemptions are available to start-up companies, provided certain requirements are met. So, whether you are raising money from family or friends, or you are courting investors, in all cases you should consult an attorney who understands securities laws to avoid unwittingly running afoul of filing and registration requirements.

In closing, my advice to new business owners is this: proactively manage your risk and avoid legal pitfalls with simple education, preparation, and attention to detail at the outset. Take advantage of resources and advice from other business owners, mentors, and professional advisors so you can focus your time and energy on growing your start-up venture.

Fritz Battcher is a partner in the Reno office of Holland & Hart. His practice focuses on helping start-up and emerging growth companies at all stages of their lifecycle.