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Three Legal Pitfalls Every Tech Startup Should Avoid!

Last Wednesday I was lucky enough to be invited to speak at Edinburgh’s monthly tech meetup, held at Skyscanner HQ. I have attended the event a number of times and am always delighted to meet a number of tech entrepreneurs, start-ups, programmers and general tech enthusiasts from around the capital, as well as enjoying the top quality beer and pizza on offer.

Since there is always a good amount of tech startups in attendance, I decided to talk about the three most common legal mistakes that I have seen tech start-ups make while I have been working in MBM Commercials Dispute Resolution Team. The title of my talk was: Three Legal pitfalls every tech start-up should avoid!

This blog post outlines and summaries the main points of my talk. The video of the full talk can be found below:

1. Choosing the Wrong Business Structure.

The first pitfall that I addressed was choosing the wrong business structure.

There are a number of business entities a tech start-up can choose; however for my money the most sensible is that of a limited company. Limited companies offer several distinct and money-saving advantages over other types of entities, the two most crucial being Limited liability and investment potential.

Limited liability - A limited company has its own legal identity. This means third parties contract with the ‘company’ and not the individual directors and shareholders. Not only does this allow a company to survive the death of the owners, but it also makes it possible for the directors and shareholders involved with the company to change over time. It also means that the company is liable for any debts that it takes on, and the owner’s personal finances are protected. This is unlike a sole trader, or a partnership were the personal assets (i.e. House, Car, etc.) of the business owners are at risk if things go wrong. Since starting up a new business is a risky venture limited liability is a key asset.

Investment - While sole traders and partnerships generally have to raise new capital from their own resources, companies are able to raise capital at any time by issuing new shares. Many investors will only invest in limited companies and certainly most crowdfunding platforms require that any business seeking investment must be a limited company. Since an integral part of most tech start-ups success is seeking good funding, when they need it, the limited company structure ideally suits.

In summary, the limited company is the preferred choice for most startups as it limits the owners risk and makes life easy for getting investment and growing the business.

2. Not Protecting Your Intellectual Property!

The second pitfall that my talk touched on concerns startups not protecting their intellectual property. For most tech startups, the IP can be their most valuable asset whether it is their brand identity or the very software that makes their business work. Computer code is subject to copyright which means soon as the person writes a piece of code it is automatically protected, and that person owns the copyright. If someone infringes copyright, they can be sued for copyright infringement.

However, most tech start-ups become unstuck when they enlist the help of a freelancer to help them with a bit of programming or design work. Technically the work that the freelance produces belongs to them and not the start-up. The problem usually doesn’t arise until a startup seeks investment and checks are done to unearth who owns the IP. This can lead to costly delay in investment deals and even full-on collapse. An easy way to avoid this is to make sure appropriate contracts are signed and crucially to make sure the contract contains the following clause:

“...Contractor hereby assigns to the Customer all intellectual property rights...”

Once the contract is in place, all IP rights will be assigned to the startup, and there will be no nasty surprise come investment time.

3. Not Getting Agreements in Writing or Making Up Your Own Contracts!

The third and perhaps most prolific mistake that new business make are not giving enough attention to the agreements they make. Under Scots Law, there is no formal form that a contract or agreement should take. It can be a 40-page formal contract drawn up by solicitors, a series of email exchanges, an exchange of Facebook messages or even just a verbal agreement. The problem with the more informal types of contract is that not all terms of the contract are clear, or even included and can often lead to misunderstanding between the parties. This misunderstanding is what leads to a dispute. In my talked discussed an example of a client who had entered into a contract failing to specify the exact timing of deliveries, this lead to a misunderstanding between the two parties and an eventual breakdown in the relationship. A year later my client was being sued for £16,000. Eventually, the matter settled out of court; however this expense and waste of time could have been avoided if more thought was given to the contract. The take home message from the example was that if the contract involves a considerable amount of money or forms an integral part of your business, then it’s defiantly advisable to get professional help with it. The initial cost of getting advice will usually be minimal in comparison to the cost of a dispute that could arise as a result of a badly written contract.

If you would like any advice relating to setting up a startup, please do not hesitate to contact us via our online contact form.

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