Biggest Legal Mistakes New Businesses Make

Despite the pandemic having a severe impact on the global economic activity, it has triggered a surge in business start-ups across major economies including the UK with substantial increases in new company registrations. This is down to various factors from changing needs and even laid-off workers launching their own ventures.

Starting your own business (especially if it’s your first one) is no walk in the park. You’re bound to come across hurdles and learn along the way. But avoiding common mistakes where possible can help prevent major setbacks.

Karen Holden, founder of A City Law Firm has represented hundreds of businesses – from start-ups to big businesses – and has found that time and time again the same issues crop up. Here are some of the biggest businesses mistakes to watch out for.

Weak Shareholders Agreements 

Choosing the wrong business partners can be problematic if your work ethics and long-term motivations are out of sync. Businesses should be careful to choose the right partners and clearly document roles, responsibilities, goals and objectives in a shareholder’s agreement to ensure alignment. This means as founders you can build upon the platform you have created together, but if it goes wrong (which from time to time it unfortunately does) you have a pre-agreed means to address the problem. The key is choosing the right partners in the first place, talking candidly and asking the tough questions at the beginning.

Poor Contracts And Cashflow

Understanding your marketplace, your competitors and what you need financially to be able to grow is key.

It’s important to be realistic with budgets and prices and ensure your contracts protect you – not only with clients but with employees, suppliers and contractors. It is fundamental payment timescales with clients are closely monitored, especially if you are working on large projects. Corporate clients may expect 60 – 90-day payment terms but your sub-contractors will not.

Also don’t forget to pay yourself a reasonable salary, especially when you are seeking investment, otherwise, if the founder is distracted, the business is not going to progress. Any investor will want to see this factored into any business plans and financial models.

Bad Staff Contracts And Lack Of Incentives

Most businesses can’t run without people. Therefore, it’s no surprise a large part of any company’s budget will be put towards recruitment, training and retention of its employees. Despite this, there is a real risk that those key people could walk out of the door leaving you without the requisite skill pool you need. There is also a real possibility that they may take all of their knowledge of your business and pass it to a competitor.

Many businesses neglect to focus on staff retention and protection against them stealing your business. From a legal standpoint, it is important to:

• Have well-drafted employment, contractor, consultancy and sub-contractor contracts in order to protect your IP and confidentiality. It is also important to have suitable restrictive covenants to avoid staff taking your know-how, client databases, IP or other members of staff to a competitor or setting up on their own in competition with you.

• Find ways to incentivise and look after your team; you want to inspire loyalty and dedication. Consider EMI options as they can give staff the feeling of being part of the fabric of the business and as you succeed so do they in terms of profit-sharing without significant costs in the short term to you. This also can attract more specialist experts or more qualified personnel to the team where cash is not readily available.

Not Having Intellectual Property Ownership In Writing

IP ownership can only be granted or transferred (“assigned”) in writing. As such, if your freelance coder or developer has no contract with your business then they could actually own the IP that they have helped design, not you.

If there is a dispute, then they could hold this to ransom causing a costly dispute or loss of your code or design. You need to ensure that you have checked these contracts carefully and that you actually have one carefully drafted in your favour. Many companies work with friends and often make arrangements based on goodwill, but when a dispute arises without a contract you are at the mercy of the designer.

Also, many businesses fail to check that their proposed company name and/or branding is free to trademark. This should be carefully checked before a large budget is set aside for branding and marketing as otherwise, you may find yourself having to start all over again.

Rushing Investment 

If you are seeking investment, which is often a necessity when companies are scaling up, it is vital that you carry out your due diligence on what’s available, what the risks are and who the investor actually is.

  • Do they understand your sector?
  • Have they got the resources to add more money at a later date if that’s what you need?
  • Can you approach them if things go wrong?
  • Do they have competing interests in the marketplace?
  • What is your exit plan for them?
  • Have you also explored grants available for your industry, innovation offerings, R & D credits and other means of funding?

Many people are often dazzled by the cheque and sign a contract… but that’s just the start of the journey. It is important that you consider whether you want to get involved unless you are certain you have aligned goals, an agreed exit plan and can handle a crisis together.

Not Being Prepared For Investors 

When start-ups do find the right investor, a common pitfall is they are not ‘investor ready’ because they haven’t got their house in order. For example, they have not allocated and issued shares correctly or their articles may not properly reflect the workings of the company. If an investor picks up on things like this it can reflect badly on the founders potentially risking scaring off investors.

More broadly other things that may put an investor off include inaccurate/bold statements that have been put in writing such as:

  • “This is unique to the market, no one else is doing this”. If you say this it needs to be upheld.
  • “I don’t need a salary for 1-2 years; I can use 100% investment on the business”; wrong! No one will invest in someone who can’t eat and pay their bills!
  • “My business is valued at £10 million because it’s going to be worth that in two years when we build our technology”. Can you support that with figures and market research? Be realistic and able to evidence all assertions.

Not Understanding Market Regulations

Many businesses, especially those in disruptive markets, need to be regulated or may be covered by additional regulations or laws.  In particular, various Fintech InsurTech, LawTech companies and those handling large scale data need to be regulated.  Choosing to risk investment or token raises prior to taking proper advice or considering the proper process may expose you to an FCA or other regulatory investigation.

This is not an issue which only affects those in financial markets but includes among many others those in advertising, legal services/legal tech, recruitment, packaged holidays etc. Knowing your marketplace, sector and taking advice is essential prior to any public offering.

Not Getting Professional Advice

Not everyone is necessarily cut out to be a financial director or HR manager, but when running a business these roles become fundamental and often fall to the founder to deal with in the early days. It’s important to acknowledge you can’t do everything. Not getting good advisors on board early enough is a common mistake. A good lawyer, accountant and tax advisor saves you money (and pain!) later on, especially if they can secure you EIS or another favourable structuring. A good FD helps secure investment and cash flow by managing the budgets and financial forecasts, they also add the commercial know-how into your passionate pitch deck.

Downloading templates and googling legal advice happens because of the costs involved, but if you want your business to succeed then tailored, personal advice and legal support is fundamental.

From a personal perspective, I have benefited from this advice greatly myself as I have brought in various consultants and advisors to help me and train me in my areas of weakness. Admitting these gaps in my knowledge and bringing experts in has helped me scale up.

Not Investing Yourself And Not Asking For Enough 

If you are seeking investment for your business, you need to start with securing some capital yourself or through your contacts. This shows investors you have faith in your offering, which then means they are more likely to match. This is something I hear frequently from equity investors, so try friends and family first. Another common mistake is asking for too little which cannot be sustained and then you have to go back to the platform or investor for money which could result in them losing faith in your financial model. You need to forecast and present realistic figures, so you don’t ask for too much or too little.

Saying Too Much Without Proper Protections

If you have to discuss the details of your tech, design or offering to secure an investor or client then where possible secure an NDA to protect your confidential trade secrets or ideas or Patents. They may be hard to enforce, which is often a concern of many, so they don’t bother, but it’s a deterrent. If you don’t have a signed NDA and for example, you discuss a potential or pending patent, you could even lose the rights. It’s also a good starting point for an injunction if someone tries to reproduce your business. You should always however exercise caution and limit what you say to someone about your business and ideas, the less you disclose the lower the risk of it being taken.