Five common legal mistakes startup founders make

Launching a startup is exciting, particularly given New Zealand’s thriving and innovative startup ecosystem. However, the journey can be a steep learning curve and present numerous challenges, especially for first-time founders. This article explores five of the most common mistakes startup founders make and how you can steer clear of them.

1. Choosing the Wrong Structure

When launching your startup, one of the first decisions founders must make is determining an appropriate business structure. Choosing a structure that is not suitable to your startup or circumstances can cause a range of issues in the future, including:

• Tax implications;
• legal obligations and compliance requirements; and
• unanticipated financial implications.

Some of the most common business structures used by early-stage startups in NZ include:

• Sole trader: This is the most basic form, offering simplicity in setup and management. However, operating as a sole trader provides no distinction between personal and business assets, exposing the founder’s personal assets to risk if your business has financial difficulties.
• Partnership: A partnership allows you to share the business’ responsibilities with one or more partners. While very flexible in structuring, there is no distinction between personal and business liabilities, and each partner is jointly liable for the business’ debts.
• Company: Startups typically prefer a company structure due to the ease of raising capital and the benefits of limited liability. This means shareholders are only responsible for paying any remaining amount on their shares and not for the business’s debts or obligations. While a corporate structure does impose certain ongoing reporting and maintenance obligations, these are not cumbersome from a time or cost perspective.
• Trust: Trusts can provide some asset protection and tax benefits. However, they come with onerous reporting requirements and are often not considered for high-growth startups looking to raise capital (which a company structure is better suited for). They can, however, be a good option for founders as a vehicle to hold shares in their company.

Working with both a legal and a financial advisor who understands NZ’s startup landscape will help you determine the best structure for your startup.

2. Issues with Employment Law

It is common for founders to underestimate how hard it can be to appropriately onboard and manage employees, particularly when most founders are looking to scale quickly. Founders may not comprehensively understand employment law, leading to costly legal disputes and potentially harming your startup’s reputation.

Some key employment considerations to keep in mind include:

• Classify personnel correctly: Wrongly classifying employees as independent contractors is a standard error that can lead to claims against the company for a range of statutory entitlements. There may also be tax implications for your business.
• Employment agreements: Under the law, all employees must have a written employment agreement detailing the key terms and conditions of their employment.
• Comply with required standards: New Zealand has strict minimum employment standards regarding pay, working hours, and leave entitlements. Breaching these standards can result in financial penalties and reputational damage.

3. Having the Wrong Contracts

Contracts are the foundation of any business as they govern and formalise business relationships. Failure to have appropriate contracts (or no contracts at all) will likely lead to disputes, which can cause significant financial losses. Some key contracts are outlined below.

Shareholder Agreements: These are among the most essential documents if you are not the only shareholder of your company. This confidential agreement governs the relationship between shareholders and the company and between the shareholders themselves. It seeks to protect shareholder rights, establish clear processes, and ensure certainty regarding key matters relating to the governance and management of the company.

Supplier and Customer Contracts: These contracts define the commercial relationship between your company and key external stakeholders. Ensuring robust, clear legal documentation is put in place ensures clarity on crucial matters such as the quality of the service/product, payment terms, subcontracting, and how to resolve disputes, as well as agreeing upfront on appropriate risk allocation between parties.

Confidentiality Agreements: These agreements allow you to share and use commercially sensitive information for clearly defined business purposes and provide protection from information misuse by either party; and Employment contracts: as discussed above, having robust template employment documentation and processes in place as you grow your team is critical.

4. Forgetting Website Essentials

Having an online presence is essential for any modern business. However, many founders fail to consider the legal requirements of running a website, which can impact customer trust.

Some website essentials that should not be overlooked include:

• Website terms of use: Your website’s terms of use govern how visitors use your website. They also help protect your intellectual property and limit your liability concerning third-party links, service outages and unintended use and loss due to reliance on information.
• Privacy policy: If you collect personal information, you should have a clear and accessible privacy policy that details what information is collected, how it is used, and how it is protected.
• Data Protection: If your website uses cookies or otherwise tracks user data, you must inform your users and obtain their consent in compliance with data protection regulations.

5. Failing to Protect Your Intellectual Property

Your intellectual property is likely one of your most valuable assets, so protecting it is critical for long-term success. Unfortunately, many startup founders neglect IP protection, which can lead to a loss of market share.

• Trade mark registration: This prevents competitors from using names or logos similar to your startup’s. This avoids diluting your brand and confusing your customers.
• Protecting your domain name: Purchasing domain names early in your country and other regions is inexpensive and will save you costs later if other startups have purchased the same domain names. Think global early!
• Developing a comprehensive intellectual property strategy: This should cover all aspects of your brand. Depending on the nature of your startup, patent or design registrations may be necessary.
• Ongoing monitoring: You should actively monitor for potential IP infringement to protect your rights and take appropriate action.

Key Takeaways

Avoiding these common mistakes early will help establish a solid foundation for success. Some of the most common mistakes startup founders make include:

• Choosing an inappropriate business structure;
• Having issues with employment law compliance;
• Lack of appropriate contracts;
• Neglecting website essentials; and
• Failing to protect intellectual property.

To help your startup succeed, download our free Startup Manual: A Legal Handbook For Founders . You might also like to register for our free September webinar on Essential Legal Compliance for Businesses: From Conduct to Contracts . For legal advice to support your startup’s goals, call us today on 0800 005 570 or visit our membership page .

Georgina Toomey is NZ General Manager and Practice Group Leader at LegalVision

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