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The Top 3 Legal Mistakes Entrepreneurs Make and How to Avoid Them

Law and Order
image credit: iStock Photo

For newbie entrepreneurs, building a business can be a hectic period of trial and error. Part of the adventure is wading through daunting legal matters.

Jennifer Berrent, a partner at the New York office of legal firm WilmerHale, says the three most common mistakes 'treps make in the early stages are failing to adequately protect their intellectual property (IP), not formalizing the equity arrangements among founders and inaction or haste in choosing the right structure for their business.

Berrent held court on how to avoid common pitfalls. 

How can entrepreneurs protect their IP early on?
Before you form an entity, people are chatting; they might be at their current job, maybe they spend a couple of hours collaborating. And there's a question when you are going to develop a business around that: Who owns that idea?

Once you form an entity, that company doesn't own that IP unless you get it into the entity. You get it in by licensing it or by an Assignment of Invention agreement. All the founders--anyone with whom you collaborated, anyone who gave you a nugget of an idea--needs to get assigned into this company.

How can founders avoid disputes over equity arrangements?
It's sort of like a prenup. The way we propose it is, the company is going to have to exist when one of you leaves. So picture yourself as the founder who stays. Would you be OK with that other guy walking away with 50 percent of the company? If you wait [to formalize equity agreements] and things have gone sour, that's when you end up paying people a lot more than they would have gotten. One of the biggest reasons for failure we see is this [type of] founder fighting. If you don't have the equity sorted out, it becomes all-encompassing and nasty and personal.

What are some considerations when forming the company?
Making sure you are choosing an entity in a jurisdiction that makes sense for what you're doing. What happens is that there are so many choices that people choose the wrong one, or they push it off and don't actually form the company. There are a few types of entities (a corporation or a limited liability company) and there are different tax treatments (a C Corp or an S Corp). All the names are very scary to entrepreneurs.

How do you choose?
It would be a 60- to 90-minute discussion to talk about all these issues--the difference between an LLC and a C Corp, how you're going to split your equity, what everyone's titles are. You can get things done in a week or two, more quickly if needed. Our legal fees are about $4,000 and there's about $1,000 in filing fees.

The mistake is in not forming the entity, or just forming an entity that their buddy who's a real-estate lawyer told them to form without really thinking it through. There's this inertia and fear, then making the quickest decision as opposed to the right decision. It's helpful to talk it through with a lawyer.

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This article was originally published in the November 2012 print edition of Entrepreneur with the headline: Law and Order.

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