Entrepreneurs face a multitude of legal issues as they create, launch, and build a new venture, and the failure to anticipate and understand these issues can often mean the demise of a new venture. In the Master of Science in Law (MSL) program at Northwestern Pritzker School of Law, entrepreneurs and business professionals learn how to navigate the legal issues facing startups and businesses of all sizes. One of the experts who teaches MSL students is Professor Esther Barron, Director of the Donald Pritzker Entrepreneurship Law Center (DPELC). Professor Barron recently shared with us the five most consequential issues founders face in starting a new business.
1. Setting Up The Entity
One of the first issues a founder must decide is how they want to structure their business – will it be a partnership, an LLC, a non-profit, a corporation? Each of these entity types has its own legal and business implications and can impact a founder’s legal and tax liability in a company. At the very earliest stage, founders should be considering which entity type will give them the best protection and the best tax advantages. If founders don’t consider these issues, or if they opt not to set up a legal entity or don’t file the proper legal documents with the state, their company may default to an entity they didn’t intend, potentially putting them at a higher legal and financial risk. The DPELC has seen the failure to properly consider and solidify the choice of business entity come up with its clients again and again. In one recent situation, a client did not set up an entity at the beginning of the venture, which caused the business to default to a general partnership; the rules of general partnership allowed a founder who had left the business to unexpectedly retain a large chunk of ownership.
2. Founders’ Agreements – Put It In Writing!
Relatedly, it is important to create a founders’ agreement at the earliest stages of the business – and to put the agreement in writing! Often, a business idea is developed among friends, and they might not think it is necessary to establish a formal agreement until the business takes off, or maybe they find it awkward to discuss negative scenarios that could happen down the road. But it is crucial to flesh out these things at the very outset of an endeavor. And even when founders agree verbally on their business deal, it is always best to put the deal in writing. As time goes on, memories fade, and even honest people with good intentions may have different recollections of what was agreed upon. The DPELC has seen more than one business stumble or even fail because the founders claimed to have different understandings on essential issues, such as how to split profits or make key decisions.
3. Protecting Intellectual Property
As an intangible asset, intellectual property is often overlooked but can be extremely valuable for both large and small companies. Founders should make sure that they own the intellectual property that their business is based on and that the IP is protected – this might be in the form of a patent, or patent rights, such as a license to use or sell a product. Additionally, it is important for startups to consider their brand and associated trademarks. The DPELC has worked with many companies that didn’t protect their trademark, only to find out that someone else had rights to their name and they needed to change their branding at a really inopportune time for the business, often after they already had some brand recognition or were on the verge of getting a big VC investment.
4. Raising Capital
Unfortunately, many entrepreneurs fail to grasp the magnitude of the expenses they will incur in launching their business; everything costs money, and usually more than expected. Although entrepreneurs can find different sources for capital and there is more than one pathway to success, entrepreneurs should carefully consider each round of capital and the investors and potential consequences when deciding how to finance a business. Whether they choose to take out a loan, use a convertible instrument, crowdsource, and/or secure a venture capital round of funding, founders should consider how each of these investments could impact the structure and course of their business.
5. Employment Issues
When it comes to hiring workers and building a team, a new venture can make a lot of costly mistakes if it doesn’t pay close attention to the law. By understanding some of the rules surrounding worker classification (employees vs. independent contractors, for example), an entrepreneur is much better positioned to make good decisions and comply with important requirements. Additionally, an entrepreneur should be thoughtful about when and how they leave their own employer to start a new venture. If not careful, they run the risk of violating a non-compete agreement, or worse, losing ownership of the intellectual property. For an entrepreneur, there are countless considerations when starting a new business, and legal issues are not always top of mind. But an entrepreneur who understands what these issues are and how they arise (even without necessarily knowing how to solve them), is much more likely to address these issues before they become major problems. Staying on top of these issues and knowing when to involve a lawyer can play a significant role in the ultimate success of the business.
