The Entrepreneur’s Seven Sins
Common Legal Mistakes Can End Your Business Before it Starts
By Gretta Spendlove
July 10, 2009
Lust, envy, gluttony, sloth, greed, anger and pride—those were the seven deadly sins to medieval men hoping to enter heaven. What are the serious mistakes that prevent today’s entrepreneurs from reaching their goals?
1. Creating the business entity too late or incorrectly
Entrepreneurs sometimes jump the gun by entering into contracts before they’ve created their company. Sometimes they act in their own name and sometimes in the name of a company that doesn’t yet exist. A limited liability company (LLC) or corporation is not created until articles of organization (for an LLC) or articles of incorporation (for a corporation) have been filed with the proper state entity and accepted. If entrepreneurs act in the name of the company without it being correctly created, the results can be harsh. As the Utah LLC Act states, “All persons who assume to act as a company without complying with this chapter are jointly and severally liable for all debts and liabilities so incurred…”
2. Being ambiguous over what’s expected from company investments
True story: Bob provides $50,000 to Company B and receives a 40 percent interest in the company. Later, Bob claims that the $50,000 was really a loan and must be paid back, but that he will still own his 40 percent interest even after the “loan” is repaid. What he gave for his 40 percent interest, Bob claims, was the availability of financing, not the money itself. Subscription agreements and other company documents should clearly specify the consideration which is being given for ownership interests. Some people give cash; others give real estate, intellectual property, guarantees, time or expertise. Huge fights can arise from disagreements over what was promised by founders and investors.
3. Failing to include vesting or buy-out provisions
What happens if a founder promises to provide services or cash, but fails to do it? What happens if a founder gets tired of the business grind and wanders off? Subscription agreements or other contracts with founders should include remedies if a founder fails to stay with the company or fails to perform. Membership interests or stock might not “vest” until several years after an individual receives them, and might be contingent on performance. The primary founder, or the company, might have the right to buy out owners for nominal amounts if they disappear or fail to perform within a certain period of time.
4. Accepting money from investors without considering securities laws
When investors lose money, their lawyers routinely check to see if disclosures were properly given and if filings were made or exemptions documented under the securities laws. If not, the investors may seek not just damages, but treble damages. “There was no stock issued. The investor gave me money and I gave him a promissory note,” the entrepreneur protests. That’s not a good excuse—many promissory notes are considered to be securities. The securities laws are complicated. Entrepreneurs should get capable advice when dealing with investors.
5. Failing to check noncompete agreements
Entrepreneurs should check their own contracts with prior employers, and the contracts of key people they hire, to make sure that new business relationships will not violate the terms of old relationships. Lawsuits over “no competes” can be brutally expensive—$20,000 or more in legal fees for defending against injunctions—even if the entrepreneur ultimately wins.
6. Not securing patents, trademarks and other intellectual property
The most valuable possession a new company owns may be intangible—an invention, a name, an idea. A first priority for entrepreneurs is to inventory the company intellectual property (IP) and make sure it is protected under the patent, trademark, copyright and trade secret laws. There are strict deadlines for filing patents—for example, within one year after an invention is publicly disclosed in the U.S. (ex. offered for sale), or before it is publicly disclosed abroad. If a company gives its product a name it cannot trademark, it may have to change the name and loose thousands of dollars in marketing costs. Anyone who creates company IP, whether as an employee or independent contractor, should sign a “work for hire” agreement, so the IP clearly belongs to the company. Nondisclosure agreements should be used with anyone who shares or reviews company IP.
This classic “deadly sin” affects today’s entrepreneurs, as well. Entrepreneurs are wise to recognize their own limitations and find skilled legal advisors, despite the expense and hassle, regardless of whether or not they anticipate the need for them.