A good idea is the cornerstone of a successful start-up. In practical terms, however, it is often not enough. Here is an overview of legal mistakes founders of start-ups often make but that can be easily avoided on the way to the next step towards success.
1. Set up rules for founders & investors
In the early days of a new business, the founders believe that they will always agree on everything. Often this feeling persists even when they decide to invite the first investors into their company. While it is of course possible that some lucky shareholders will not be confronted by any problems, relying on absolute agreement throughout the life of the company is rather naive.
It should always be kept in mind that start-ups usually begin and grow differently than traditional companies. Start-ups tend to grow rapidly, with intensive involvement by their (often more than one) investors, individuals and entities that are often not interconnected and that join the company gradually in individual investment rounds. A start-up, therefore, needs to be established professionally and with an eye to how the company will develop in the future.
Hence, it is essential to have a well-thought-out shareholders agreement that regulates not only the shares of individual shareholders in the company, but also the method of taking fundamental decisions, daily management of the company, division of the roles of founders and investors, as well as the procedure in case of disagreements between individual shareholders who are unable to agree on the further functioning of the company.
The shareholders agreement should be drawn up as soon as possible, at the latest when the first investor comes on board. It is advisable to remember that the life of a start-up is fast-paced, and companies that are unable to make internal decisions quickly and efficiently have no chance of long-term survival. Similarly, it is important to keep in mind the fate of companies where internal disputes between founders or disputes with investors have rendered the start-up toxic for any further investment.
2. Draw up bulletproof contracts
The first and foremost endeavour of any start-up is to develop its own product or service. However, by the time it is possible to launch this product for sale to customers, good contracts must already be in place.
A primary purpose of contracts is to protect the company from potential problems. But they can also be seen as a kind of instruction manual that describes the company's relationship with its customers. Many start-ups think of contracts only in the former sense, and often end up finding and using the longest and strictest terms and conditions used by a competing company. Every company is different, and copying terms and conditions from another company simply doesn't work. Contracts, terms and conditions that are too strict, unbalanced and possibly unreadable due to technical language also tend to put customers off.
Good business conditions should protect the start-up and allow it to grow without being overwhelmed by bureaucracy. They should also convey to customers that the start-up plans to deal fairly with them.
3. Comply with the law
Laws govern everything we do. That's why every new idea and business must comply with the law. Often there is no easier way to lose an investor or even an entire business than to fail to operate in accordance with the law.
Before launching a start-up, founders must always check carefully whether they have all the necessary permits, licences and registrations required for its activities.
It is also necessary to keep in mind the day-to-day management and its compliance with the law. Depending on how companies (and that includes start-ups) do business, they have to comply with obligations arising from data protection (GDPR) law, employment law, health and safety regulations and anti-money laundering (AML) regulations, just to name a few.
One of the things every potential investor examines is just how the start-up operates on a day-to-day basis and how it complies with applicable law. Failure to do so is a red flag for investors, telling them that something is wrong with the start-up.
4. Protect knowhow and high-quality employees
Start-ups must protect their trade secrets and know-how. Competition is fierce, and there are few situations worse than finding out that you've spent years developing a product and building a team, only to have your competitors literally destroy your business overnight by poaching key knowhow or team members.
So for key employees, it is important to consider at an early stage entering into confidentiality agreements and keeping sensitive information confidential. Such an agreement will ensure that the employee does not disclose sensitive information to anyone for an agreed period of time, even after the employment ends.
It is also advisable to negotiate a non-compete clause for even greater protection. Its purpose is to ensure that the employee is not allowed to work for a competitor for an agreed period of time after the employment ends.
Last but not least, it is also advisable to think about a non-solicitation arrangement. This agreement places employees (especially those in management positions) under obligation not to actively entice other members of the team to leave and start their own company or move to a competitor.
5. Do not neglect intellectual property rights
Most start-ups are built on a new, creative and important idea. It's quite surprising that some start-ups idea from a legal perspective.
First of all, it is advisable to find out whether the idea is really new or if someone else already has exclusive rights to the idea in the form of a patent, design, trademark, etc. If not, and the idea is genuinely new and revolutionary, it is important to protect it. This protection can include registration in the above-mentioned forms.
However, it is also important to think about ensuring that the idea and its further evolution really belong to the company. If the start-up already has employees working on the idea, for example in the form of software programming, it is important to think about their contracts and add clear clauses stating that the intellectual property created by them is the property of the company.
Another IP issue to clarify up front is choosing an appropriate company name, brand or project name, logo or domain name that will not conflict with the rights of others. If the name of the start-up or its product is identical to the name of another company or its products, the start-up may be required to reimburse the other company for the resulting damage and rename itself or its product. A good name is essential in business, and avoiding these mistakes, which is quite easy with good preparation, can prevent a start-up and the whole business from being ruined.
By Michal Janicek, Senior Associate, Matej Korduliak, Legal Advisor, Noerr