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5 Legal Pitfalls Every Start-Up Should Avoid

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Last week, the dispute resolution team at MBM Commercial gave a seminar which highlighted 5 of the key legal pitfalls that every start-up should avoid. This blog is a summary of the main points covered at the seminar.

  1. Choosing the wrong business structure

Having an appropriate business structure in place is important as it determines matters such as how decisions are made and the extent of liability for any debts – and choosing the wrong structure could negatively impact your business. Below is an outline of the main structures that start-ups can opt for.

Sole traders

The biggest benefit of operating as a sole trader is autonomy – you can make all the decisions without having to reach an agreement with others. The main downside is that there is unlimited personal liability, meaning that personal funds are not protected if the company gets into any debts.

Business partnership

In partnerships, a group of individuals collaborate in order to run a business together. In an ordinary partnership there will be joint and several liability for any debts. However, an increasingly popular form of partnership is the limited liability partnership, which limits the liability of the partner to an agreed amount. This can protect individual partners from facing unlimited personally liable for the debts of the partnership.

Limited company

The most common form of limited company is a company limited by shares, where shareholders own the business. Liability is limited to the amount of share capital that you have put into the business. A limited company can make it easier to raise new capital through the issuing of new shares. It also has a separate legal personality. A disadvantage of the limited company is there are more onerous reporting and governance requirements.

  1. Not protecting your intellectual property

Generating intellectual property is often a hugely important part of a start-up’s business and assets. Therefore, one thing to make sure that you do is protect these intellectual property rights in order to guarantee that you are able to make use of them. This means for instance registering any trademarks or patents and thereby your interest in them is protected. It is also important to make sure that what you think that you own is in fact yours. As well as providing clarity as to what your property is, effectively protecting your intellectual property can help you to avoid potential disputes that may arise over ownership. 

  1. Not getting your agreements in writing or making up your own contracts

Under Scots law, most types of contracts do not need to be in writing and in such circumstances a verbal agreement will suffice. However, not having an agreement in writing is a potential pitfall because it is much harder to prove what was agreed in the event of any disputes than it would be if the agreement was clearly laid out on paper. You should also be wary of writing your own contracts, because experience has shown that while two parties may think that they have reached a mutual agreement, the actual written contract that they have produced may potentially not reflect what they thought the agreement was. For this reason it is important to instruct lawyers who have experience in drafting contracts and who will know how to write in an unambiguous way, ensuring there is minimal scope for misunderstanding.

  1. Not having a founder’s agreement

When there are multiple people involved in founding a start-up it is essential that a founder’s agreement is put in place so that each person understands their responsibilities in the business. There are certain key details that a founder’s agreement should contain, including how and by whom important decisions will be made, what happens to shares if one of the founders wants to leave the business, and the relationship between majority and minority shareholders.

  1. Not managing disputes properly

Disputes are often costly, time consuming, and are something that start-ups in particular should wish to avoid as best they can. Despite all best intentions however, disputes can and do arise. For this reason it is important that a system is in place to see that they are managed properly and are dealt with as quickly and early on as possible. One way this could be done is by including a dispute resolution clause in any agreement that your business enters into, setting out the procedure to be followed in the event of a dispute. For cost effective dispute resolution it is helpful if the agreement stipulates that methods of alternative dispute resolution, such as mediation, should be the first port of call. This is important because it means that the parties are contractually bound to sit around the table and discuss the dispute at the first instance, instead of immediately launching costly litigation proceedings. 

It is important to avoid the pitfall of burying your head in the sand and simply hoping that the problem will go away – the chances are that it will not. The best approach is to be realistic of the best and worst case scenarios that you are faced with, and from there decide on the appropriate course of action.

I am setting up a company or have a dispute. What should I do?

 If you have any questions then please contact our Dispute Resolution team on 0131 226 8200.

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