10 Legal Mistakes made by Startup Entrepreneurs
Setting up your startup involves a lot of work and effort. Many things need attention, including developing a proof of concept, finding product/market fit, and hiring the first set of employees. With these many things to be handled, slips are bound to happen. One of the most common areas where most startups make a wrong choice is establishing a solid legal foundation. Some of the most common legal mistakes made by startups:
- Wrong legal entity: Choosing the right legal entity right at the outset is important. Some structures to choose from include a Registered Company (Public/Private Limited), LLP, proprietorship, and partnership. The more widely accepted one is a registered company, especially for any deals with foreign clients.
- Not tracking expenses: Many try and gather all receipts only when tax returns have to be filed! What is not documented is not deducted, and therefore, it is like leaving money in the open.
- Lack of documentation: Each and every interaction, be it meeting minutes or anything else, must be on the record. It is important to have all documents in order at all times. Legal due diligence can make or break an investment deal.
- Missing founders agreement: The founders agreement should contain all essential clauses such as ownership, vesting rights, and the roles and responsibilities of each founder, including salaries and terms of employment.
- Mixing capital and revenue expenses: What expenses are considered assets /capital expenditure and which ones are called revenue expenses deductible in the P&L A/c. Higher-value items that will last significantly longer than one year are called Capital Expenditure/Assets/Equipment. Things that are consumed over the course of a year come under revenue expenditure. If the equipment or capital items are by accident deducted as revenue expense, the tax department can determine that the expense has been improperly characterized and a deduction does not apply. Hence, be careful in accounting all such expenses.
- Mixing personal and business expenses: This can be a source of confusion when taxes are being filed, and in some cases, can lead to deductions being disallowed on an ad-hoc basis by the revenue authorities and higher tax outgo as a result. The company should therefore have a financial account at the onset and separate records as well.
- Not protecting intellectual property: Intellectual property (IP) is a startup’s most valuable asset. Trademarks, patents, and copyrights are the three essential components of IP. It is essential to not let anyone claim a right to your IP. Non-disclosure agreements are a way of ensuring this. Startups often neglect the protection of IP and suffer later.
- Non-compliance with securities laws: Startup founders commonly issue stocks to angel investors, family, and friends. However, stocks issued without complying with specific disclosure and filing requirements under securities law can lead to serious legal issues at a later stage.
- Missing regular tax payments: Businesses, be it sole proprietors or otherwise, are required to pay taxes in advance. This means they need to determine their taxes for the year in advance and pay as prescribed installments.
- Not ensuring professional help for tax-related issues: A startup must appoint a tax consultant to ensure all regulations are being followed. This will also give you more time to focus on building your company, forming strategic relationships, and other things.
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