What are some common legal mistakes made by startups?
Takeaway: The most devastating legal mistakes are almost always made in a startup's first few months; they are unforced errors in formation, IP, and equity that create foundational cracks that can destroy a company years later.
As a startup lawyer, I see the same, entirely avoidable mistakes made by founders over and over again. These errors are rarely complex or nuanced; they are almost always failures to handle the foundational "blocking and tackling" of corporate law correctly. The tragedy is that these early missteps can create profound, and sometimes fatal, problems that only become apparent years later during the due diligence for a major financing or acquisition.
Here are five of the most common and damaging legal mistakes that early-stage founders make.
Choosing the Wrong Legal Entity. Founders sometimes form an LLC or S-Corporation, believing it will be simpler or more tax-efficient. This is a classic error for any company that plans to raise venture capital. VCs invest in C-Corps. This mistake inevitably leads to a costly and time-consuming legal conversion to a Delaware C-Corp down the road and can mean you don’t get the benefit of the QSBS tax break.
Failing to Handle Founder Stock Correctly. This is a multi-part mistake. Founders often don't formally issue their stock through a Stock Purchase Agreement, or they fail to file their critical 83(b) election within the strict 30-day deadline. Missing the 83(b) deadline can result in a catastrophic personal tax bill for the founders as their stock vests.
Neglecting IP Assignment Agreements. The default rule is that an individual owns the IP they create. A startup must have every single founder, employee, and contractor sign a Proprietary Information and Inventions Agreement (PIIA) that formally assigns ownership of their work to the company. A company with a "cloudy" IP title due to a missing PIIA is often considered unfundable by sophisticated investors.
Misclassifying Employees as Contractors. In an effort to save money on payroll taxes and benefits, cash-strapped founders will often classify their early employees as "independent contractors". This is a major compliance risk. If a government agency determines that you misclassified an employee, you can be liable for significant back taxes, wage claims, and penalties.
Promising Percentages of the Company. A founder will tell a key hire, "I'll give you one percent of the company." This promise is legally ambiguous and a recipe for a future dispute. As the company's capitalization changes, that "one percent" becomes a moving target. All equity grants must be for a specific, fixed number of shares, not a floating percentage.
All of these mistakes are avoidable. They simply require discipline, attention to detail, and a commitment to building your company on a clean and compliant legal foundation from day one.
Disclaimer: This post is for general informational purposes only and does not constitute legal, tax, or financial advice. Reading or relying on this content does not create an attorney–client relationship. Every startup’s situation is unique, and you should consult qualified legal or tax professionals before making decisions that may affect your business.