It is often said that young entrepreneurs are the future industry leaders. It is the new ones who are enthusiastic, full of energy and has all that takes to make a difference. But building a business is not an easy task. It can be a hectic rollercoaster ride full of trial and error. Part of this ride is dealing with the legal matters.Being a corporate lawyer I have been involved with many startups, and my experience from over six years of practice has revealed some of the basic legal mistakes new entrepreneurs makes. Lack of legal knowledge or focus towards making the business click, whatever the reason is, new entrepreneurs often ignores the legal basics which subsequently, lead to closure of their business. Today I am focusing on some of the common mistakes which new entrepreneurs often make.
Keeping It Straight With Co-founders
It is important to be on the same page with your co-founders from the very beginning. The agreement amongst you should be clear. Not doing so can cause enormous problems later (the Zuckerberg/Winklevoss Facebook litigation will give you all a heads up). Some of the key deal terms needs to be addressed in a Memorandum of Understanding amongst you:
- Who gets what percentage of the company?
- Is the percentage ownership subject to vesting based on continued participation in the business?
- What are the roles and responsibilities of the founders?
- If one founder leaves, does the company or the other founder have the right to buy back that founder’s shares? At what price?
- How much time commitment to the business is expected of each founder?
- What salaries (if any), are the founders entitled to? How can that be changed?
- How are key decisions and day-to-day decisions of the business to be made? (Majority vote, unanimous vote, or certain decisions solely in the hands of the MD/CEO?)
- Under what circumstances can a founder be removed as an employee of the business? (usually, this would be a Board decision)
- What assets or cash into the business does each founder contribute or invest?
- How will a sale of the business be decided?
- What happens if one founder isn’t living up to expectations under the Memorandum of Understanding? How is it resolved?
- What is the overall goal and vision for the business?
Starting The Business By Forming The Wrong Entity
Deciding on what legal form the business will be operated is one of the first decisions for the founders to make. But since entrepreneurs in our country have a tendency to start a business without consulting a lawyer, they end up with facing various obstacles and sometimes opt out from numerous benefits available for companies.The types of business forms that are ideal for a startup business are as follows:
Sole Proprietorships:Generally speaking, a sole proprietorship requires no legal documentation, fees, or filings other than state and local business permits. On the other hand, there are disadvantages to operating in the form of a sole proprietorship: (1) it only has one owner and if additional capital is required from another investor, the form is not available and a partnership or other entity form is required and (2) a sole proprietorship provides no protection for the founder against creditors of the business (in other words, creditors can directly sue the founder), in contrast to private limited companies where, generally speaking, the creditors of the business cannot successfully sue the founders and other investors.
Partnerships: If there is more than one founder, a general partnership is often chosen as the legal form of business entity. Preferably, the founders will agree on a partnership agreement to “set the rules” among the founders. The income of a partnership is taxed directly to the partners generally on a pro rata basis. Finally, each partner of a partnership is generally liable for the debts of the business and thus exposes the personal assets of each partner to the business’ creditors.
Limited Company: These are formed under Companies Act, 1994 and has to be registered with the Registrar of Joint Stock of Companies and Firms. This option is the most ideal for startups. The costs for forming and operating this entities are often greater than for partnerships and sole proprietorships due to legal, tax, and accounting issues. However, Limited Companies generally offer significant advantages for founders (and subsequent investors) including, significant liability protection from business creditors, tax savings through deductions and other treatment only available to limited companies, and ease in raising capital in contrast to sole proprietorships and partnerships.
Protecting Intellectual Property! What is that?
This is a very uncommon practice in Bangladesh. People simply don’t understand the need for IP protection. Generally when you have developed a unique product, technology, or service, you need to consider the appropriate steps to protect the intellectual property you have developed in order ensure that other don’t claim your product and to avoid infringing the intellectual property rights of third parties. Here are some of the common protective measures that should be undertaken by start-ups:
Patents: Patents are the best protection you can get for a new product. A gives its inventor the right to prevent others from making, using, or selling the patented subjected matter described in words in the patent’s claims. The key issues in determining whether you can get a patent are: (1) Only the concrete embodiment of an idea, formula, and so on is patentable, (2) the invention must be new, (3) the invention must not have been patented or described in a printed publication previously, and (4) the invention must have some useful purpose. You obtain a patent from the Department of Patents, Design and Trademarks, Ministry of Industries, and this process can take several years and be complicated. You typically need a patent lawyer to draw up the patent application for you.
Copyrights: Copyrights cover original works of authorship, such as art,copy, books, articles, music, movies, software, etc. A copyright gives the owner the exclusive right to make copies of the work and to prepare derivative works (such as sequels or revisions) based on the work. You obtain a copyright from the Copyright Office of the Ministry of Cultural Affairs.
Trademarks: A trademark right protects the symbolic value of a word, name, symbol, or device that the trademark owner used to identify or distinguish its good from those of others. You obtain a trademark from the Department of Patents, Design and Trademarks, Ministry of Industries, and this process can take several years and be complicated. You typically need a trademark lawyer to draw up the patent application for you.
Trade Secrets: A trade secret right allows the owner of the right to take action against anyone who breaches an agreement or confidential relationship or who steals or uses other improper means to obtain secret information. Trade secrets can range from computer programs to customer lists.
Confidentiality Agreements: These are also referred to as Non-Disclosure Agreements or NDAs. The purpose of the agreement is to allow the holder of confidential information (such as a product or business idea) to share it with a third party. But then the third party is obligated to keep the information confidential and not use it whatsoever, unless allowed by the holder of the information. There are usually standard exceptions to the confidentially obligations (such as if the information is already in the public domain).
Confidentiality and Assignment Agreement for Employees: Every employee should be required to sign such an agreement. It accomplishes several purposes. First, it obligates the employee to keep confidential the proprietary information of the business, both during employment and after employment. Second, it ensures any inventions, ideas, products, or services developed by the employee during the term of employment and related to the business belong to the company and not the employee.
Not realizing the role of a lawyer in your company
It is a common scenario in Bangladesh that entrepreneurs don’t realize the need of a lawyer in their company. In a misguided effort to save on expenses, start-up businesses often proceed without a legal counsel. Rather than spending the money necessary to hire competent legal counsel, founders will often do the work themselves. In doing so, the founders deny themselves the advice of experienced legal counsel who can help the founders avoid many legal problems. Even if the ones who realize the need of a lawyer, they often end up with an inexperienced lawyer in an attempt to cut cost. Founders should consider interviewing several lawyers or law firms and determine the competency and experience of a lawyer as opposed to just saving money.