Avoiding Legal Pitfalls: 10 Critical Mistakes Startups Must Dodge | Legal Lesson Deep Dive 107

"One problem that people run into is co-mingling their business and personal assets"
-Andy Contiguglia

Episode Title: Avoiding Legal Pitfalls: 10 Critical Mistakes Startups Must Dodge

Description: In this episode, Andy Contiguglia, a seasoned corporate attorney, dives deep into the legal landscape for startups. He discusses the top 10 legal mistakes that startups often make and provides insightful strategies to avoid them. From intellectual property protection to hiring practices, Andy covers it all, offering valuable advice to keep your business legally sound and thriving.

Key Takeaways:

• Understanding the importance of separating personal and business funds to avoid "piercing the corporate veil."
• Choosing the right business structure and its impact on liability and operations.
• Navigating securities laws when seeking investments and avoiding conflicts with shareholders.
• The significance of founders' agreements in establishing equity divisions and conflict resolution.
• The critical role of legally binding agreements and contracts in protecting intellectual property.
• Compliance with data privacy laws, including GDPR and California Consumer Protection Act.
• Avoiding common mistakes in hiring practices and maintaining compliance with employment laws.
• Fiduciary duties owed to investors and shareholders in a startup.
• Detailed insights into shareholder agreements and strategies for avoiding legal conflicts.
• The ultimate importance of involving a lawyer in every stage of your startup journey.

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Disclaimer:

Please note that the legal information shared in this podcast is for general informational and entertainment purposes only. It is not a substitute for consulting with a licensed attorney for specific legal matters. Past performance does not indicate future results; every legal case is unique. Consult your own attorney for personalized legal advice.

Transcript

00;00;01;13 - 00;00;33;07
Andrew J. Contiguglia
This is Andy Contiguglia, your corporate casual Denver-based business attorney bringing you the Don't Skip the Legal podcast where you can listen in on the real stories, the real stakes, and the real legal lessons from real business owners just like you. These behind the door conversations about business are instrumental to your success. This is where the deals are made, negotiations are discussed, and company problems are identified, leading you to overcome the challenges we all face in our business.

00;00;33;07 - 00;00;56;11
Andrew J. Contiguglia
This podcast is your invitation to where the real business happens and also where the best ideas take place. So let's get behind the doors and business and break down this legal lesson in overall. Remember, don't skip the legal in this deep dove. I'm hoping to give you ten things that you can take with you. They will help you avoid legal mistakes in your business because it's something that you're going to face, something that you're going to experience.

00;00;56;12 - 00;01;17;03
Andrew J. Contiguglia
So bringing these to your attention now will hopefully help you put in perspective the things that you need to avoid later on down the line. As a startup company, you are vulnerable to setbacks because you are in a precarious position. Financially, it's hard to afford a lawyer, it's hard to put things in contracts, and it's hard to buy and invest in the things that you need to protect yourself.

00;01;17;08 - 00;01;37;04
Andrew J. Contiguglia
So here's an overview of the legal mistakes that startups often make, which can cost them dearly down the line. So where do we begin? You're in the beginning phase of opening your new startup. It's an awesome time for you. Congratulations. You're going through an exciting and challenging time, but it's important to understand that all new business owners are going to make mistakes from time to time.

00;01;37;07 - 00;01;54;27
Andrew J. Contiguglia
It's part of the learning curve. It's part of the experience that you have to go through. So having your business set up properly at the outset will help you avoid costly legal mistakes. A primary number one here is mixing your personal and business funds. There's a business principle called piercing the corporate veil. Perhaps you've heard of it.

00;01;54;28 - 00;02;14;29
Andrew J. Contiguglia
This happens when business owners can become personally liable for the actions of the business. Now, this defeats the whole purpose of having a separate business entity in the first place. The whole reason we start businesses, the whole reason we start LLCs is to start our corporations is to avoid this piercing the corporate veil component. This is what we call limited liability.

00;02;14;29 - 00;02;44;10
Andrew J. Contiguglia
You cannot be held personally accountable for the acts of your business. One problem that people run into is co-mingling their business and personal assets, and it is one of the factors that a court will look at in determining whether a business is an alter ego of its owner. That person then masquerading as a separate business is this person running their business completely as an alter ego, not really managing their business in the appropriate ways, following the key components that keep their businesses separate.

00;02;44;14 - 00;03;04;26
Andrew J. Contiguglia
So keeping your business and personal assets separated can help you avoid this mistake. This means you have a business account. This means you have your own personal accounts. When you pay yourself, you pay yourself from your business account and you transfer it into your personal account. You don't buy your groceries from your business and you don't pay your Zelle bill for your business from your personal account.

00;03;05;02 - 00;03;31;23
Andrew J. Contiguglia
These are things that you need to keep track of and things that you need to keep separate. So keeping your business and personal funds separate paves the path away from hassles, also from your accountants, as well as potentially nightmare scenarios that can't be fixed later on down the line. So choosing the proper business structure for your startup also creating boundaries between personal and business funds can make everything super clear for your business partners, your accountants and people who might want to come after you.

00;03;31;23 - 00;04;05;23
Andrew J. Contiguglia
Number two, not having a formal business structure, every startup will benefit from establishing a legal business structure initially. Now, keep in mind, you can always change this later on down the line. Just because you start as an LLC, that doesn't mean you can't later change it to a corporation. Or if you start from a corporation that you later want to change it to an LLC, each of these business structures needs to be formed and operated differently, but lacking the formal business structure is going to put you in a difficult position if you just run in as a sole proprietor that has no business structure, that could open you up to liability.

00;04;05;24 - 00;04;27;25
Andrew J. Contiguglia
Creating the right business structure limits your liability. So whether you're looking at a partnership, an LLC, a corporation or something else, there are many details that you have to work through. Doing this at the very start of your business will help everyone, including your accountant, including your other business partners, helping everybody stay on track. When it comes to taxes and operations of your business, it also helps keep your founders in line.

00;04;28;05 - 00;04;51;24
Andrew J. Contiguglia
Number three, ignoring securities laws. This comes into play when people are looking at, Hey, I want to bring investors into my company. I want to go to people and ask for money. This is something that people come to me with all the time and raising capital for your startup, I understand it can be very, very challenging. It's also a very tempting thing to do to ask your friends and family to invest informally into your business.

00;04;51;24 - 00;05;14;05
Andrew J. Contiguglia
But what you need to understand is whenever you accept money from someone as a quote-unquote investment, that person no longer has control over their money. They are handing it over to you. This, my friend, is the sale of a security, and the sale of a security triggers automatically a very complex area of law that you really need special attention to.

00;05;14;07 - 00;05;36;27
Andrew J. Contiguglia
So when you are looking at bringing on investors or looking at bringing on venture capital or looking at bringing on anybody who's going to be investing into your company, you need to take into consideration the securities laws, making sure you have a business lawyer or a securities attorney. Somebody who is specialized in securities laws to help you navigate through these regulations is absolutely, absolutely important.

00;05;37;06 - 00;05;58;29
Andrew J. Contiguglia
Issuing stock, you need to take this seriously. You can't just go out and start offering people investment into your business and giving them stock in your company. These things are going to create problems. One of the main ones is avoiding conflicts with shareholders. The last thing you want to do is start taking money from people and understanding what relationships you're building with them and creating these responsibilities for them.

00;05;58;29 - 00;06;25;03
Andrew J. Contiguglia
The moment you take over their money, you create a fiduciary responsibility to them between you and the shareholders. The moment you accept money from them and not following the securities laws is going to create additional problems for you. You must take this seriously for a number of reasons. The main one here is avoiding conflicts with shareholders. You don't want to end up in a situation where the people who are investing in your company aren't properly identified and aren't properly apprized as to what you are doing.

00;06;25;08 - 00;06;46;12
Andrew J. Contiguglia
You also want to avoid conflicts with the co-founders. The last thing you want to do is start accepting money from one person, diluting interest in another one. Stay in compliance with securities laws because if you don't, there are huge penalties that you may face. Also, stay strategic in your process. Does investment opportunity really follow the objective, of what you're hoping to accomplish with your business later on down the line?

00;06;46;15 - 00;07;03;22
Andrew J. Contiguglia
Doing this wrong, you'll end up getting penalties, doing it the right way. You're going to avoid these penalties. You're also going to avoid litigation down the line. Make sure that if you are doing these, you speak with a securities attorney, someone who focuses and specializes in securities laws to make sure that your filings and forms are done correctly.

00;07;03;23 - 00;07;22;29
Andrew J. Contiguglia
Just because these laws are triggered, it doesn't mean you can't do it. But there is a very special and isolated process that you must follow to do it correctly. At the end, you also want to create shareholder buyout agreements to make sure that once investments are maintained and once certain milestones are met, that you have opportunities to buy out these other shareholders or pay back investors.

00;07;23;02 - 00;07;47;11
Andrew J. Contiguglia
The problem with securities laws here is if you don't do this right, you are facing hefty fines and penalties and in some instances even prison. If you mess this up, securities fraud is a crime. It can be a crime from a civil standpoint where you can face civil penalties for not following the laws. And if you misrepresent things to people who are investing and it turns out that you're trying to defraud them, you're looking at prison.

00;07;47;20 - 00;08;09;02
Andrew J. Contiguglia
Now, I know you're saying here, wait a minute, I'm not trying to defraud anybody. Of course not. But the reality here is failing to disclose pieces of information about your company that a reasonable investor would want to know creates securities fraud. That is the key here. You have to over-disclose information, not to mention the people who are investing in your company have to meet certain financial requirements.

00;08;09;05 - 00;08;31;00
Andrew J. Contiguglia
The importance here is to talk to a business lawyer before issuing any stock, doing any disclosure filings, and any forms that you make before you make these severe legal mistakes because it could be the end of your business. The next one here is not creating founders' agreements. Starting a business is exciting for entrepreneurs or highly productive people who want to move forward as quickly as possible.

00;08;31;02 - 00;08;49;19
Andrew J. Contiguglia
And in the process of doing this, in the midst of all of this excitement, what do they end up doing? They end up cutting corners. And you've heard of the saying, you cut one corner, you create two more. So it's time to make sure that everything that you do when it comes to your business is covered and make sure that everything is discussed with your startup co-founders.

00;08;49;22 - 00;09;06;12
Andrew J. Contiguglia
These types of dilemmas are important to identify and to address early on in your business adventure ideas here, like how should the Division of Equity be made among the founders. Is it going to be 5050? Is it going to be 6040? Do we have more than one person and we're going to divide it over a number of different people?

00;09;06;12 - 00;09;22;28
Andrew J. Contiguglia
What happens when we want to bring in more money? What happens if somebody else has to put in more money? What happens if you don't have money? These are the types of things that you need to think about that should be addressed in a founders agreement. Also, should the person investing the most money get the most equity? Because without these funds, the startup would be zero.

00;09;23;01 - 00;09;39;06
Andrew J. Contiguglia
Does money create value in the company or does the experience or the services or what you are providing the brain behind the business? Does that create the most value for the company? Because money without an idea is nothing. So it's important that you sit down with your founders and discuss what are these breakups going to be.

00;09;39;06 - 00;09;56;13
Andrew J. Contiguglia
What is this breakdown going to be, and what is the contribution of value? Whether it is experienced, whether it services, whether it is money? Should the main founder get more equity than everybody else? Hey, it's my idea. Shouldn't I get the most equity out of this? That is also a very important question. Where are you going to divide the lines here?

00;09;56;16 - 00;10;21;25
Andrew J. Contiguglia
Then what happens when your honeymoon is over and you're at one another's throats about how the business should be operated? That also is a very key question I've been involved in many business disillusioned business divorces where people who started businesses together, were best friends growing up. They went to college together. They went to graduate school together. And now all of a sudden, their insight as to how they want their business to be run and developed later on down the line, they don't see eye to eye.

00;10;21;29 - 00;10;39;02
Andrew J. Contiguglia
How are you going to avoid these conflicts? What are you going to do to resolve these conflicts? How do you manage this moving forward? And in the end, what happens when you no longer want to be in business with each other? These founder agreements will help figure out what you are going to do later on down the line.

00;10;39;05 - 00;11;08;18
Andrew J. Contiguglia
Think of these founder agreements like a prenuptial agreement in a marriage drying up. These legally sound founders' agreements can help you avoid conflicts and legal mistakes down the line. Now, contracts are essential for any business, including startups, and that leads us to our next item lack of legally binding agreements and contracts. Even if you feel like you trust your partners and have everything under control, do not, under any circumstances skip this critical step or believe that informal agreements like handshakes will be enough.

00;11;08;28 - 00;11;38;08
Andrew J. Contiguglia
Examples of legally binding agreements and contracts include IP assignment agreements. How are you going to manage your intellectual property? Articles of Incorporation Founders Agreements. See number four above non-disclosure agreements. What's going to happen with your trade secrets? Bringing people in, talking to people about your business, shareholder agreements, buying each other out, employee contracts and supplier contracts, and taking care of these binding agreements and contracts are essential for your startup success, and it's important that you have them in place.

00;11;38;11 - 00;11;57;29
Andrew J. Contiguglia
Remember, without these agreements, you can't define the duties and responsible parties between the parties to really figure out who's in breach and who is it? Are people doing what they're supposed to do when they enter into these agreements, failing to have binding agreements, and failing to have valid contracts will be a pitfall for your business to overcome. So put those agreements in place.

00;11;58;17 - 00;12;18;19
Andrew J. Contiguglia
There's an old saying In business you hire slowly and you fire fast. And that brings us to number six poor hiring practices. When a startup has poor hiring and employment practices, it is ultimately going to backfire on them in some form or fashion. And since most of us aren't our experts, it's not hard to slip up and make what you consider to be a small mistake.

00;12;18;21 - 00;12;36;26
Andrew J. Contiguglia
But that gets you in a lot of hot water with a candidate or employee. So legal mistakes in hiring simply are not worth it. Make sure you comply with all the necessary laws and regulations by consulting with a lawyer or an h.r. Professional who can help guide you through employment practices. You can also check out one of our blogs on hiring advice for startups.

00;12;36;26 - 00;12;59;00
Andrew J. Contiguglia
The link is in the show notes. Number seven Neglecting shareholder Orders. Owners of a startup referred to as a fiduciary duty to investors and shareholders. When you give up a portion of your business to an investor or another shareholder or a member of your LLC, you're opening yourself up to obligations owed to those people. I have many people coming into me who own their businesses outright.

00;12;59;00 - 00;13;19;06
Andrew J. Contiguglia
They're the sole member in their LLC or the sole shareholder in their corporation looking to bring on another business shareholder who's going to put money in like an investor. The moment they do that, they create a fiduciary duty between themselves and these other people. They are managing the company. They owe these people a fiduciary duty. When it's just you owning your business, it's what you do for yourself.

00;13;19;11 - 00;13;43;28
Andrew J. Contiguglia
You don't owe yourself a fiduciary duty, but when you bring in other people, guess what? You have to be accountable to them. So there are two primary fiduciary duties every owner owes to the business and its shareholders. These are the duty of care and the duty of responsibility of loyalty. You have a duty to make sure that you take care of your owners, to take care of the shareholders, to make sure that you are loyal to them, truthful to them, and open to them.

00;13;44;04 - 00;14;13;19
Andrew J. Contiguglia
Open avenues of communication are paramount when care and loyalty are on the line. So don't neglect your shareholders. Number eight Failing to protect your intellectual property creates problems in and of itself. Nothing can ruin your startup faster than confrontation over who owns its intellectual property. Every contractor or employee of your business, anybody involved in producing content or products for your business should be required to assign any intellectual property rights that here he has over to the company.

00;14;13;25 - 00;14;42;01
Andrew J. Contiguglia
Even in situations where you have work-for-hire agreements and you're hiring people out. The important thing here is making sure that your company owns all the intellectual property it creates. Now there's a provision in the law that people who work for your company, who are producing content for your company, are automatically owned by your company. But in some circumstances, in your employment contracts with those people, see the above your hiring practices, making sure that anything that people within your organization create remains your intellectual property.

00;14;42;05 - 00;15;06;13
Andrew J. Contiguglia
But what constitutes intellectual property in your startup? Well, this varies from business to business days now where everything or many things are done online, social media, content, marketing, content, blog post, podcasts, things like that, all of that creates value. All of this is intellectual property. All of these digital assets. If you're an influencer, if you are an online business owner, all of these things are created and they benefit your company.

00;15;06;13 - 00;15;28;02
Andrew J. Contiguglia
This form of intellectual property must be protected. The last thing you want is one of your employees who creates an amazing blog post for you or some great artistry for your business to then run off and try and take this intellectual property with them. So a lawyer can help confirm intellectual property and develop contracts such as confidentiality, and non-compete agreements to ensure that everything is adequately protected.

00;15;28;05 - 00;15;53;24
Andrew J. Contiguglia
Detailed documentation related to intellectual property is particularly important for tech companies. The last thing you want is somebody stealing your formula or stealing your software or anything behind the scenes for the operations of your apps. Nowadays, with the GDPR, California Consumer Protection Act, and Colorado pick a state. Now, these laws that are coming into place related to data privacy and security are paramount and in the forefront of our faces as business owners.

00;15;54;01 - 00;16;16;10
Andrew J. Contiguglia
So from your website's terms of use policy to the GDPR in the European Union or as I mentioned, any of the other Consumer Protection Act confidentiality laws that are in place throughout the United States, every startup needs to practice due diligence regarding privacy and security as companies that control large amounts of data need to be especially mindful of security breaches and the possibility of legal violations.

00;16;16;12 - 00;16;37;18
Andrew J. Contiguglia
I tell companies all the time if you are gathering data from your users, anybody who is coming on to your website, or anybody who you're asking for an email from, make sure you only gather the data that you need in order to facilitate the deal. So if somebody is coming on to your website and they want to sign up for a white paper or they want to sign up for your newsletter, do you need where they live?

00;16;37;18 - 00;17;02;24
Andrew J. Contiguglia
Do you need all of their address, all of that personal information, or do you really only need an email address to facilitate this deal? Now, in some business transactions when you're purchasing items and you're actually engaging in a financial transaction and you might be storing somebody's financial data that is going to require deeper amounts of security. And not having those security protocols in effect can really affect your business because if you end up with a breach, you're looking at severe, severe penalties.

00;17;03;05 - 00;17;29;26
Andrew J. Contiguglia
And number ten, last but not least, starting your business without a lawyer. You knew that one was coming, right? Of course, everybody knows that you should not be going through and adventuring down any of these paths without having a lawyer by your side or one that you can call and be available to you. So whether you're a startup entrepreneur, whether you're acquiring a new business, starting a sole proprietorship, or starting something from scratch, having a trusted business lawyer on your side is invaluable.

00;17;29;27 - 00;17;49;13
Andrew J. Contiguglia
Again, these have been the ten legal issues that I have identified, and of course there are always possibly more. But what I have identified being the ten big legal mistakes made by startups, I hope you found it informative. Looking forward to talking to you more if you have any ideas. Other topics that you'd like me to cover here on these deeper dives look forward to hearing from you.

00;17;49;21 - 00;17;55;28
Andrew J. Contiguglia
This is Andy Contiguglia reminding you don't skip the legal. Good luck.

00;18;01;21 - 00;18;20;04
Andrew J. Contiguglia
Thank you for listening to the Don't Skip the Legal podcast. I'm your host, Andy Cantabile. I hope you enjoyed our time together in this great opportunity to peek behind the business door and examine the legal lessons in business. If you're keen to hear how these lessons can be applied in the real world, well, join us next week for another episode where you can listen in to another business success story.

00;18;20;05 - 00;18;36;14
Andrew J. Contiguglia
As always, you can head over to contemplate Wacom forward slash podcast to sign up to our email list as well as check out all the links and resources in our shownotes. If you enjoyed this episode and you'd like to help support the podcast, please share it with others, post about it on social media, or leave a rating and review to catch all the latest for me.

00;18;36;14 - 00;19;02;11
Andrew J. Contiguglia
You can follow me on Instagram, Twitter and TikTok at AJC. Eskew Thanks again. This is Andy. Julia reminding you to don't skip the legal good luck. The legal information contained in this podcast is intended for general informational and entertainment purposes only. It should only be used as a starting point for addressing your specific legal issue. The legal information I talk about does not create an attorney client relationship between you and me.

00;19;02;11 - 00;19;22;18
Andrew J. Contiguglia
This podcast is not a substitute for an in-person or telephonic consultation with a lawyer whose license to practice in your jurisdiction about your specific legal issue. And you should not rely on this legal information for those purposes. You understand that questions and answers or other information contained in this podcast are not confidential and are not subject to attorney-client privilege.

00;19;22;18 - 00;19;38;26
Andrew J. Contiguglia
I am not providing you with a legal service. Every legal case is different and past performance is not indicative of future results. Please consult your own attorney.