Avoid these 10 legal startup mistakes

Last Updated at: Jan 22, 2021
Avoid these 10 legal startup mistakes

All startups must be smart in their approach towards expanding their business. Creating a distinct and practical legal entity for your venture is one of the most crucial steps for your progress. It is equally important that your IP rights and Copyrights over your inventions are secured at the earliest.

Startups are usually distinguished from other companies based on their lack of experience in the market and their limited operating history. They are mostly funded by their entrepreneurial founders to capitalize on developing a product or service being generated by the company. Any type of venture based from India is governed by the Companies Act 2013 that defines startups as “An entity that provides commercial goods and services and does not have a turnover exceeding 25 lakhs INR for the first five financial years”.

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Recently, with the development of e-commerce, many online startups have started to emerge. However, due to lack of experience, the fact that every startup needs to abide by certain legal procedures and has to be structured legally usually slips their minds. These mistakes could eventually put the venture in jeopardy. Some basic legal mistakes that every startup must avoid are:

Appropriate legal entity:

Choosing the right legal entity is one of the most fundamental steps that all startups need to concentrate on. Indian laws provide various options such as a partnership firm, a proprietorship firm, a limited liability partnership firm, a private limited company and a one-person company. It is always advisable for a startup to choose a limited liability partnership firm or a private limited company in order to protect the investors from converting the company’s liabilities into their personal liability. In case of a single founder, a LLP is preferred over a proprietorship firm.

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Protecting intellectual property:

Patents, Copyrights, and Trademarks are components of Intellectual Property laws that every startup must look into. Any symbol, image, logo, etc. has to be cross-checked to make sure it is not copied from any other source and prevent any kind of infringement of the intellectual property rights of others. It is also necessary to protect these IP entities from others who could claim rights for the IP used by the company. A non-disclosure agreement could be used to protect these valuable assets.

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Undocumented Founders’ agreement:

A co-founders agreement describes the definitive rights and duties of each co-founder to the startup and enunciates their responsibilities of being a member. The agreement is binding on the signatories and helps in resolving any kind of legal disputes that may arise in the future. But the founders often neglect signing the agreement due to their close acquaintances which leads to serious trouble if a dispute may arise. The agreement must essentially contain terms of ownership, roles, and responsibilities of founders, salaries, etc.

Abiding by tax and financial laws:

As the startup grows, their funds start to flow in and so the legal restraint increases. The co-founders must seek the advice of legal expert advice regarding the financial regulatory laws such as RBI, SEBI, etc. Taxes must be regulated periodically with the help of tax consultants. Each transaction must be carefully documented in order to prevent any mishaps in the future.

Documenting expenses:

The transactions made must be documented and every receipt must be stored properly to substantiate the spendings. However big or small the expense may be, the startups must keep track of it throughout the year. Every income and savings must also be properly consolidated to avoid any legal liability. Startups often do not preserve these documents and end up in a cash crunch situation.

Accounting for expenses:

The expenses that a startup makes could be minimal but however, each expenditure has validity or a period for its recurrence. It is distinguished as capital and revenue expenses. Capital expenses are valid for a longer period of time and revenue expenses are the cost of repairs, maintenance, etc. All such expenses must be recorded monotonously and distinctly maintained for tax exemptions.

Ignoring tax liabilities:

After the implementation of the GST bill, the compliances of the taxpayers have reduced. Startup owners can look forward to ease of doing business due to decreased indirect taxes. However, the tax liabilities of the startups have not been eliminated completely. So in order to file the returns, each profit or loss statement must be evaluated and paid in advance so as to escape the tax evasion liabilities.

Not availing professional help:

Co-founders are often tempted to discuss their business plans with friends and acquaintances rather than hiring a professional advisor in the field for guidance. This often leads to the disclosure of vital information about the startup giving rise to jeopardising situations. A non-disclosure or non-compete agreement must be signed to maintain the business interactions of the co-founders with others on a professional note rather than a personal one. The agreement enables the co-founder to legally prohibit the other person from disclosing the information.

Hiring employees

As a new company expands, the need for hiring people becomes necessary in order to meet the needs of the potential customers and to maintain the records, etc. While doing so, one needs to consider all the laws governing employee benefits and laws safeguarding the workers such as Employee provident fund act, Employee state insurance act, payment of gratuity act, payment of bonus act, labor laws etc.

The contract between the employing startup and the employees must be pro-employee to create a sense of fairness in them and must be drafted in such a way to protect the employer from litigation problems.

Being elaborate to clients

In order to gain more clients, every startup takes measures at the beginning of the business. Sometimes the result proves to be fruitful resulting in a good number of clients but most often the startups end up in a liquidity crunch due to uneven payments received from the clients. These issues could be overcome by signing a contract with the clients which binds them legally to pay for the goods and services by the startup. It is also the duty of the goods or service providers to be clear of the terms of use, privacy policy and disclaimers and disclose them to the customers priorly, to avoid legal problems.

Establishing a loyal and committed relationship with your clients and customers will always keep you in an excellent stead at all times. Hiring skilled and suitable employees when you expand your operations is equally crucial at all times. Experts can help startups in formulating effective strategies to deal with the changing trends.