5 legal mistakes most entrepreneurs make (and how to avoid them)

Contxto – We tend to get caught up in the excitement of starting new projects as entrepreneurs. Most of the time, though, we leave legal topics until the very end.

If we start having problems with our partners or landing investment deals, for example, sometimes we don’t have the proper legal protections in order. Since we wait too long to take action, the rush and disinformation can lead us to make bad decisions for our startup.

Don’t let the emotion and excitement distract you when you’re beginning a project. Pause and discuss the legal decisions with your team. This is key for success and will ensure investments later on down the road.

Here are some of the most common legal mistakes that entrepreneurs make with legal logistics:

Not incorporating at the right time

When is the right time to establish a company? As soon as you and your partners agree on the terms. Most of us delay the incorporation process as long as possible because we want to save money or maybe we’re not ready to commit. Believe me when I tell you, though, that incorporating as soon as you’ve gained your bearings is a smart decision.

Why?

Because when you have a real company (meaning it’s legally incorporated) and you’re not just meeting up with your partners to “work on a startup,” you’ll have a legally binding agreement to hold everybody accountable.

In this contract, you can specify the rules of the game, when to start playing, and even the logistics that go into constructing an empire. How can you build an empire without knowing how much of it belongs to you?

Legally creating an organization will prove to your partners, collaborators, employees, clients and future investors that you meant business right from the beginning. It’ll definitely make you even more attractive for investors because a good idea isn’t the only thing they evaluate.

Now, let’s say your startup experiences exponential growth and you’re seeking investments to fuel even more continual growth. Investors want transparency. They’ll ask to see your legal and financial structure as clearly and simply as possible. What will you show them if you’re not even a real enterprise?

To avoid this, I advise starting the incorporation process as soon as possible. Traditionally, the process in Mexico takes up to one month. But here’s a piece of advice: don’t be traditional. As a startup founder myself, I spotted the importance of digitizing this industry, too. Along with my partners, our startup EasyLex allows companies to legally incorporate in just seven days.

The second mistake directly connects with this last idea:

Not choosing the right company structure

The first decisions you must make is creating a company and then establishing game rules. If you already made that decision, congratulations! You officially avoided the number one mistake. But, are you sure you chose the best format?

There are various types of companies, each one with unique characteristics, and unique in every country. Not all of them have the necessary legal structure for a startup to earn investment and potentially become an empire. You must be informed on the legal restrictions and advantages for each one to make the best selection.

For startups, consider choosing a business format that’ll empower you to establish rules such as vesting, drag-along, tag-along, non-compete, employee stock option pool, among others. These features are essential for founders to receive investments and aren’t addressed in every corporate structure.

Here’s a quick tip if you are creating a company in Mexico: the type of firm you want is the SAPI de CV (Sociedad Anónima Promotora de Inversión de Capital Variable). SAPI is the most flexible arrangement in Mexico. It allows you to establish all the rules we mentioned and gives advantages to minority shareholders

Not having a shareholders agreement

The shareholders’ agreement is a private document where startup partners establish specifications of the company’s day-to-day operations. For example:

• How much time will they invest in the startup?
• What are the positions? Who is the CEO, CTO, CFO, COO?
• What are the founders’ salaries?
• Who has a vesting schedule and what is its specification?

This complementary document goes alongside the incorporation deed. Still, it’s fundamental for startups because it regulates how funds are distributed.

See it this way – the incorporation deed outlines startups’ activities. It specifies the type of company, identifies the shareholders and states the business’ location. Moreover, the shareholders’ agreement designates who is responsible for what, how partners are subject to vesting and receive their fair shares, etc.

Not establishing a vesting schedule

By now, I’ve mentioned the term “vesting schedule” a few times. Some of you might be asking yourself, “what is that?” Well, it’s pretty simple and straightforward. The vesting schedule subjects the shares of the founders (or employees) to a vesting period. This time table basically means that the founders must work with the startup for a certain number of years to be eligible to receive their shares.

It’s easier to understand with this example:

Co-founder Jane owns 50 percent of a startup while fellow co-founder John has the other half. They are both subject to a vesting period of four years with a monthly vesting schedule, meaning that we have to divide the 50 percent by the number of months over four years:

4 years = 48 months

50 percent / 48 months = 1.04 percent

What this equation means is that for every month the founder works with the startup, they will acquire 1.04 percent of the company. If the founder decides to abandon the project before the vesting period ends, they’ll forfeit the unvested percentage.

The purpose of this is to prove to investors and co-founders that each player is committed to the startup.

Imagine the case of Jane and John where they created a company but suddenly John abandons it to go on a six-month spiritual retreat. If he’s not subject to vesting, he’ll still own half of the venture, even though he’s not contributing anymore. If he’s subject to a vesting period, however, the unvested percentage will go back to the business.  

Not protecting your Intelectual Property (IP)

What makes a company great? Well, a few things: the team, the founders, what they do, not to mention what they create. This is the intellectual property and it’s integral for startups.

There are companies that receive investments with just an idea or an MVP (minimum viable product). To add value, the good or service must be protected. You ought to make sure that your company’s intellectual property doesn’t belong to anyone else. Also, guarantee that whoever accesses the IP is legally bounded to protect it as well.

How do you do that?

In order to accomplish this, you must do the following:

• Register your brand and name of the startup
• Have confidential and non-competitive agreements with whoever has access to your information.
• For suppliers, make sure you have an IP assignment clause in your services agreement. This clause states that suppliers must recognize that any IP created or derived from the services it provides to your startup is yours.

While these concepts may be a bit confusing at first, these steps are actually really easy to implement. Play your cards right and you’ll definitely be able to protect your startup and long-term value.

The legal structure of your company says a lot about your team, your management and your potential for success. If you apply these organizational and transparent tips from the beginning, you’ll surely be putting your best foot forward to build your startup empire.

Written by: Yaritza Rodelo from EasyLex