How 2 Avoid Top Startup Mistakes
Startups commonly make the same legal mistakes. Jack Steele, a lawyer at Pierce Atwood LLP, who works with new businesses, recently visited Babson and shared how to avoid these familiar problems. Presenting with him was Joanna Geisinger, MBA ’17 and founder of TORq Interface. TORq Interface is a platform that allows hospitals and medical device companies to share real-time data, improving the efficiency of surgeries involving devices. Joanna participated in last year’s Summer Venture Program, and as a solo entrepreneur, has a unique perspective on the mistakes Mr. Steele shared with us. After introducing themselves, the presenters launched into the most frequent oversights made by startups.
Dividing equity without a strategy
Although you may have hand-picked your business partners because they have the same goals and complementary skill sets, it is vital that you strategically determine your company’s division of equity. One way of doing this is by creating a vesting schedule. Joanna told the audience that she has utilized this tool when bringing on new members to the TORq Interface team. Maintaining the majority share in her company is important, so she is careful about the amount of equity she gives out, as well as its recipients.
Mr. Steele also mentioned that if you are a co-founder of a startup, and you have discussed splitting the equity 50/50, you also must determine how decision-making will go. Must each co-founder agree on every decision? If this sounds unrealistic, consider agreeing upon a “leader” and making them the majority shareholder.
Not understanding the equity
This problem exists in two parts. One is that you never memorialize the equity arrangement. It is difficult to regain equity held by someone who eventually decides to leave the business, so decide early-on whether the company has buyback rights and put it into writing. The other aspect to this issue is that you must understand how the type of equity differs depending on the form of entity that your business pursues (such as a corporation or LLC). For example, LLCs give out membership interests and phantom equity, each of which have different implications with regards to tax treatment and voting rights.
Raising initial capital from the wrong sources
Receiving an initial investment in your company is extremely difficult as the investor is taking a sizeable risk. However, in order to receive this capital you may accidentally make a “deal with the devil.” This happens when you take money from a strategic business partner in the industry, but later find that there are certain strings attached. Joanna recommends creating a positive relationship with big names in the industry while your business is growing. Ask them to invest when the business is more established because then there are fewer areas that the investor can request to change. The key takeaway here is that “all money is not created equal.” Take capital from where you can, but be conscious that there may be other implications that come along with it.
Not having ownership of the intellectual property
As the founder, be sure to assign all relevant IP rights to the company. Doing so will be reassuring to potential investors.
There are questionable origins of the intellectual property
If you work somewhere and come up with a product or business, your employer may claim the rights to the idea. Upon employment, it is likely that you signed a contract giving the IP rights of any business idea you have related to the company or industry are owned by your employer. However, if you are not ready to quit your day job just yet, you may want to go over the documents you signed to ensure that you will be able to maintain control of your startup.
For Massachusetts-based businesses: the use of independent contractors makes you susceptible to attack
Under Massachusetts law, if someone is performing a service for you, and it is related to what your company does, they are presumed to be your employee. If your business model is based on widespread use of independent contractors or the gig economy, rather than hiring employees, you may face significant issues in Massachusetts. Investors may see this as a source of heightened risk on their investment.
We would like to thank to Mr. Steele and Joanna for advising Babson students how to avoid legal problems commonly faced by startups!
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