When it comes to business law, it pays to know your stuff from the moment you launch your startup. Read on to avoid the most common legal pitfalls founders make.
By Annie Fernandez Webber (Founder & CEO, Legal Hero)
As a founder in the legal tech space, other founders often open up to me about their experiences with legal issues, from forming their business on day one to dealing with lawyers during an exit. Two themes come up all the time: a) law is intimidating and b) it’s easy to make mistakes.
Here are four common mistakes and ways to avoid them:
1. Embracing the Dreaded Equity Split Conversation
These days, most founders know they should create a corporate entity for their business. But, lots of founders seem to lose sight of the importance of thoughtfully splitting the equity pie with co-founders to avoid messy situations down the road.
For example, imagine you start a company with a co-founder and split the equity 50/50, because “it seems fair.” Now, two years later, you’re working 80 hours a week, and your co-founder is out of the picture. 50/50 doesn’t seem so fair anymore.
Talking about how to split the pie is an uncomfortable conversation, but not as uncomfortable as the tension that will arise if you don’t have the conversation up-front. The equity split should be determined by a number of factors: Who came up with the idea, how much capital or other property is being contributed and how responsibilities will be divided, among others.
And no matter what you decide, put it in writing! If you don’t, memories have a way of changing… just check out this co-founder horror story.
2. Vesting Isn’t Just for Employees
Founders are incredibly attached to their creations. Companies are like children, conceived as ideas, molded into working business models and developed into full-fledged businesses. So, it’s not surprising that many founders balk at the suggestion that their stock should vest. That is, they balk right up until the day a co-founder walks out the door with a huge chunk of equity, because she wasn’t subject to a vesting schedule.
For many reasons, co-founding relationships sometimes don’t work out. Maybe the co-founders don’t get along, or maybe a family crisis means somebody needs to step away.
Vesting schedules provide an incentive for co-founders to keep working hard and reward those co-founders who are committed over the long-term.
3. Beware DIY: Great for Craft Projects but Not-so-Great in Law
There are numerous DIY tools out there for founders to use. These tools can be invaluable when researching and addressing legal issues. But beware of using DIY tools exclusively without the help of a lawyer.
An experienced lawyer can tailor even routine documents (such as employee documents, vendor agreements and customer contracts) in a way that’s advantageous to your business. On the other hand, doing it (all) yourself often leads to costly mistakes that need to be corrected down the road.
4. Start out Thinking Like a Big Business
When you’re a promising startup, it rains lawyers. They show up at your school or at your incubator, promising free services right up until you raise some money. Once you’ve raised money, these free services disappear.
But you only know one set of great lawyers — the folks who did your financing — so you keep going back to them, even though it might not make sense for certain types of legal work. And that leads to big bills. I can’t tell you how many times founders have reached out to me with stories of how much they spent on simple legal projects, like having a $20,000 contract reviewed for $3,000 (that’s 15 percent of the contract value!)
Instead, founders should take their cue from big companies. Big companies divide their legal work among different law firms and attorneys, ranging from less expensive attorneys for more routine work to extremely expensive lawyers for bet-the-farm transactions.
To make your capital go further, think carefully about how you allocate your legal dollars. And when you do need a lawyer for a legal project, choose carefully. You should never skimp on quality. Learning about a lawyer’s practice areas, experience and industry expertise is key to making the right choice for your business.