Four legal issues that could kill your startup

In my quest to start my own company, I made mistakes that would make every lawyer cringe with disgust. Luckily all my early startup ideas died during inception, so there were no legal repercussions to worry about!

As I started my latest company (Zensurance), I did speak with several lawyer friends about how to manage my risks properly. I also spoke with many startups (in Canada and the US) about the advice they would give to other startups. Finally, I spoke with our own lawyers about the most problematic legal issues.

Summarized below are the top four tips I got through my conversations.

1. Not making the co-founder terms explicit

The shareholder and founder agreements should be thought of as prenuptial agreements. Though difficult to discuss when the company is still in its formative stages, it is critical to ensure complete that there is clarity on roles, responsibilities and ownership. In a recent Harvard Business Review article, the equity split is cited as the most common sticking point, though there are a number of elements to consider early on:

  • Ownership stake and vesting period
  • Financial contributions required to start the company and salaries (if any)
  • Time commitments and responsibilities
  • How key decisions are to be made

There are different opinions on the right time to align on these points. Some choose to do so extremely early, while others wait to get to know each other and understand the likely contributions of each founder. Some go through detailed calculations and discussions, while others opt for the simplest ‘equal split’ approach. Other articles discuss the merits of these approaches. Whatever approach you choose, it is important to have the discussion and come to a written agreement.

2. Not being diligent about intellectual property ownership

It is quite normal for founders to get excited about new ideas and to just start building the company. Along the journey, one may ask friends for input, and even try to get some free work by asking someone to write some code in their spare time. While all of these seem like very innocent requests for help, they can come back to haunt you in the future. The most famous such example is Facebook, as portrayed in the move The Social Network, but the same thing happens countless times at a smaller scale.

It is important to ensure all IP is owned by the company. Whether you call in a favour, bring on a contractor or hire an employee, always have in place an IP Assignment and Confidentiality Agreement. This ensures that all output is owned by the company and is kept confidential by the worker. Without this, someone could come after you in the future to claim a stake in the company and drag you into a protracted legal battle. This will undoubtedly scare away potential investors and customers.

The legitimate grey zone is when a friend gives you ideas over a few drinks. It may seem weird to pull out a contract after the fourth beer and have your friend assign the IP over to you. If you do give this a try, let us know how it goes!

3. Leveraging “unpaid” interns

In the early days of a company, it is very tempting to find “free help” wherever possible. Many people may also be willing to work for no pay just to get the experience and an extra row on their resume. However, even if both parties agree, the unpaid internship may not be legal. There are very specific cases in which an unpaid intern is permitted (e.g., the intern is not replacing a permanent position, it is a true learning opportunity and not actually benefiting the company).

There is a big risk for companies bringing on employees without paying at least minimum wages. Such employees could claim for unpaid wags, which could result in a liability against the directors and officers of the company, in addition to negative publicity. In many cases, even stock options are not sufficient: compensation must be paid in cash. HootSuite ended their unpaid internship program and actually provided back-pay for the interns.

If you are considering going down this route, make sure to consult your lawyer to ensure you are meeting all the necessary requirements.

4. Putting in place overly restrictive non-compete agreements

Entrepreneurs are competitive and driven by nature, and want to protect their company’s interests. We are very protective of our intellectual property and use every opportunity to stay ahead of the competition. This feeling often drives us to want the most restrictive non-compete clauses possible so that exiting employees can’t take the company’s secrets and know-how to competitors. However, having an overly restrictive non-compete clause can actually back-fire.

There are many examples of courts overturning non-competes clauses as they see that as interfering with individual liberty and restricting open competition. Furthermore, courts do not look to adjust the contract or specific provisions to make it more reasonable, they tend to throw the entire thing out, leaving you with no protection. It is far better to be pragmatic in the structure of the non-compete, and even consider a non-solicitation clause instead.

Do these resonate with you? Do you have examples you would like to share with others? Send them our way (info@zensurance.ca) and we can include them in future material.

About Zensurance

Zensurance, Canada’s leading online commercial insurance broker. We offer a full range of insurance products to small businesses, with a particular focus on startups. We understand what it is to be a startup, and know the most common risks of which you should be aware. Based on that (and a lot of analytics), we recommend the ideal insurance coverage for your business.

If you have specific questions about insurance, please visit us as www.zensurance.ca or email us at info@zensurance.ca and we will find the answers for you.

This article is not meant to provide legal advice. This is just some friendly tips from one founder to the another. Consult with your lawyer for actual legal advice.