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Five common legal errors of start-ups

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By Sakina Babwani, ET Bureau | 17 Feb, 2014, 08.00AM IST

Setting up a business is a complex procedure and every aspect needs to be worked out in
detail. However, often the legal aspect gets ignored. "When a novice sets up a venture, he
may not be aware of seemingly minor errors that can have a significant impact on the
business," says Mumbai-based lawyer Geetanjali Dutta. One sure way of avoiding such
mistakes is to hire a qualified, experienced lawyer to help you with paperwork. Startups
tend to make the mistake of cutting corners and hiring inexperienced lawyers or asking
their chartered accountants to give them legal advice. This can lead to patchy information.
It is best to take the help of an expert even if it means shelling out a larger sum.
1) Choosing the wrong organisation structure
Slipping up on the legal front can land your business in a

The first thing that you need to do is choose an organisation structure. You may set up a

soup. ET Wealth identifies the five common legal mistakes of

start-ups.

proprietorship or form a partnership, or even choose a more sophisticated structure like a

company. In fact, once the new Companies Act comes into place, you will also be able to
set up a One Person Company. Each business structure comes with its benefits and bugs.

ET SPECIAL: Save precious time tracking your

For instance, a proprietorship is very easy to set up. Apart from business-specific

investments

approvals, the formalities involved are close to nil. But at the same time, a proprietorship
exposes the business owner to a number of risks as he is personally responsible for everything.
Therefore, in case of a default, creditors can be paid by selling your personal assets. On the other hand, setting up a company is a
costly affair and the costs can run into a few lakh of rupees depending on the lawyer you hire. But a company is legally recognised as a
separate entity from that of its owners. This has several advantages since creditors cannot proceed against your personal assets in the
event of a credit default. The working of a partnership firm is closer to that of a proprietorship in the sense that its identity is not separate
from that of its owners.
However, for those who want the flexibility of partnership, as well as the limited liability feature of a company, a limited liability partnership
(LLP) can be explored. Like a company, an LLP's identity is separate from that of its owners, but is taxed like a partnership. Before you
finalise an organisation structure, go through its features carefully and select the one that best suits your requirements.
2) No clear deal with the co-founders
While forming an enterprise with friends, the deal between co-founders is often not spelt out clearly. This ambiguity can prove
detrimental to the business. In the beginning, all co-founders may be involved in several aspects of the business. But once it is up and
running, each member's role must be clearly defined. You will also need to figure out how key decisions as well as those regarding
day-to-day matters will be taken. The rights and duties of each co-founder must be clearly sorted before the enterprise becomes
functional. Do not hesitate to discuss uncomfortable matters like the circumstances under which a member can be removed from his
position and how the organisation should deal with members not living up to the expectations. Don't forget to incorporate the deal you
work out in the form of a formal agreement that is signed by all co-founders.

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Five common legal errors of start-ups - The Economic Times

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3) No clear documentation with employees

Hiring people without proper documentation is another common mistake. Ideally, you should make your employees sign a contract that
contains terms and conditions of their employment, including payment and nonmonetary benefits like insurance. This must also include
a standard no-compete agreement, which bars the employee from taking up employment with rivals. The agreement must also contain a
clause, which prevents a former or current employee from divulging trade secrets. Additionally, if you are in a creative field, your contract
must be clear on the status or rights of the employee on matters of intellectual property. For example, if you own a content writing
business and hire professional writers, ensure that the employee contract clearly states that copyright vests with you or the company, not
the individual employee.
4) Not protecting intellectual property
Intellectual property is one area that is the least understood, given that it is a slightly technical subject. Basically, businesses need to
deal with three types of intellectual property issuestrademark, copyright and patents. A trademark is nothing but a name or symbol
that is used to represent your products in the market. Registering your trademark with the Trademark Registry prevents others from
using your brand name.
On the other hand, copyright helps to protect your creations, such as writings or designs, from being copied by others. Like a trademark,
you can register your work with the Registry to prevent others from using it without your prior permission. Your rights over your work are
clearly established even if you don't register it, but registration offers certain advantages as it is easier to prove that the matter in
question actually belongs to you.
Besides, if someone else registers your trademark or work as his, you'll be hard pressed to prove your point. A patent, however, must be
registered for you to claim exclusive ownership.
Basically, a patent is a licence to exclusively use your invention or a particular process, which does not include anything covered by
copyright laws. But you can't patent an idea, scientific principles or algorithms. In case, your invention is not complete, you can choose
to file a provisional application and complete the application within a year.
5) Not having an exit policy in place
In your enthusiasm to run a successful business, do not forget to have an exit document in place. This document would contain the
terms and conditions under which the business can be wound up. The structure of the business defines how it is to be shut. For
instance, closing down a proprietorship does not require any formalities, while a company is more complicated to wind up as you have to
file a petition in court to initiate the process.
A partnership firm comes to an end on the death, insolvency or lunacy of a partner. In addition to this, the partners can agree on the
conditions under which the firm will stand dissolved. If you are operating a franchise, then the grounds for terminating the franchise
would be mentioned in the agreement with the franchiser. Alternatively, you can sell the franchise to a third person if your contract with
the franchiser permits you to do so.

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