3 Most Common Legal Mistakes When Building a Startup
Launching a startup can be a very exciting yet hectic venture. While enthralled in building your company and generating ideas for a product, it’s easy to forget one of the most challenging components of the entire process: the legal side. This is often the trickiest part for entrepreneurs because navigating the multitude of complex laws and corresponding paperwork involved in starting and building your company can be quite difficult and time-consuming. As a result, it’s very easy for entrepreneurs to get caught in the middle of a heated lawsuit over a simple mistake, the consequences for which are often very severe. Here are three of the most common legal mistakes entrepreneurs make when building a startup.
1) Picking an Unoriginal or Semi-Original Name for Your Company
When creating a startup, it’s important to carefully choose the name of your company and consider its potential legal ramifications. Every entrepreneur knows that your company’s name needs to capture the purpose or function of your product so that potential consumers will know what your company is about. It’s also well known among entrepreneurs that what kind of entity you choose for your business must be factored into your company’s name. This matters because it affects how much personal responsibility you bear for your company and its financial obligations, such as unpaid debt and taxes. But there’s another component to naming your business: ensuring that your chosen name is entirely original. This part of the naming process is where many startups who find themselves in trouble regarding their chosen name go wrong. Entrepreneurs want the name of their company and product to be as catchy, clever, and intriguing as possible. However, if you do not do your research to confirm that your company and product’s names are completely original, larger incumbents may notice and drag you to court. Unfortunately for you as an entrepreneur, they are very likely to win simply because they are much larger and have better legal teams, even if they do not have a particularly strong case.
In 2010, Brian Hamachek developed an app called Who’s Near Me Live, which enables users to chat and call others based on their current location. However, Stephen Smith and his company, myRete, who developed Who’s Here back in 2008, did not like the name of Hamachek’s new app and made it known to him. In order to avoid a lawsuit, Hamachek decided to change the app’s name to WNM and make sure all references to his app called it WNM. This appeared to resolve things for about a year, until Smith filed a federal lawsuit against Hamachek for trademark infringement. He then gave Hamachek a choice: either shut down WNM or hand over all of your assets. Hamachek refused and litigation continued for several years while Hamachek continued to make offers to Smith in order to reach a settlement.
Although WNM was ultimately able to survive the lawsuit, Hamachek felt the heat of the entire ordeal. He lost out on tens of thousands of dollars in legal fees, which he otherwise could have put towards his product. Additionally, due to the length of the litigation surrounding trademark infringement, Hamachek had to spend hours on end every day for several months dealing with the lawsuit instead of spending it on further developing and improving the app. It is also worth noting that Hamachek consulted with Smith when developing Who’s Near Me Live to ensure that his app’s name was distinct and he still wound up in legal trouble. Therefore, when it comes to naming, complete originality is a must.
2) Not Being Fully Transparent with Investors and Shareholders
When starting a business, entrepreneurs often will set goals in terms of sales (in units and/or dollars), revenues, profits, and annual growth. Some startups find that sales are slower than expected, they have a serious cash flow problem, or maybe they just want to keep more of the revenue they earned. Many entrepreneurs who engage in this behavior did so under the belief that they and their company would be able to benefit by hiding certain information from third parties, such as investors and shareholders. However, more often than not, their lack of transparency catches up to them later on in the process. As hard it can be to admit you have a money problem, it is crucial that you are upfront with investors and shareholders about where your company stands because the consequences of withholding pertinent information are much more severe than being transparent about your money problem.
In 2016, Domo, Inc., a fast-growing computer software startup based in Utah, found themselves in hot water when Jay Biederman, a company shareholder from Delaware, requested financial documents in order to determine how much his shares of the company were worth. Domo was able to remain a private company and thus avoid mandatory disclosures. It looked like a lost cause for Biederman, until he found out that Delaware state law required full financial disclosure if the plaintiff could prove that they owned shares of the company. Since Biederman had proof he owned 64,000 shares, Domo was forced to open its books. Financial records revealed that after a $200 million investment by a private equity firm, the company was valued at $2 billion and the shares Biederman bought earlier for 32 cents each were now valued at $8.43 per share. Afterwards, Domo had to cough up the amount they had cheated Biederman out of when they withheld financial documents.
As the Biederman vs. Domo, Inc. case demonstrates, attempting to hide financial records and mislead shareholders and investors, either intentionally or unintentionally, is something to avoid at all costs, particularly as you seek a new round of funding. Having a pending lawsuit under your company’s belt serves as a giant red flag for potential investors. This is particularly true if the case involves a lack of transparency, as this may permanently destroy investors’ ability to trust you. Losing the trust of investors may also mean losing your ability to receive additional outside funding, which could prove fatal for your startup.
3) Copyright, Patent, and Trademark Infringement
When starting a business, you need to take the necessary steps to protect yourself from unfair and/or predatory competition as well as infringement. To do this, your company will require legal protection, such as copyrights and patents for your products or trademarks for your brand (logos, slogans, etc.). Securing legal protection for your company and its products can take months or even years to obtain and is quite expensive, especially for patents, which can cost as much as $15,000. On the other hand, it is very easy to unintentionally infringe upon a name or product already legally protected. Therefore, you need to ensure that all your company’s products as well as slogans, logos, and content on your company’s products and website are entirely original in order to avoid copyright or trademark infringement. If anything of yours is too similar to copyrighted, trademarked, or patented content, even just a couple phrases on your company’s website, you may quickly find yourself in the middle of an infringement lawsuit.
Michael Glanz, founder of HireAHelper, Inc. knows this to be the case. In 2008, U-Haul sued Glanz and his company, alleging trademark infringement. U-Haul pointed to two phrases used on HireAHelper’s website, “moving help” and “moving helpers” and claimed they were too similar to two registered trademarks of U-Haul. Despite Glanz’s attempts to settle with U-Haul, they refused and brought him to court. After three years, U-Haul finally agreed to settle the case for an undisclosed amount, though Glanz claims the terms were almost identical to the ones he proposed at the start of the ordeal. While HireAHelper was able to survive and later continue to grow, significant financial damage was inflicted upon Glanz and his family as well as co-founder Pete Johnson.
When all was said and done, Glanz owed $250,000 in legal fees, Johnson had to sell his home and move in with Glanz and his family, and Glanz’s parents had to push their retirement back by an entire decade. As damaging as the consequences were for Glanz, they could’ve been far worse. Had U-Haul taken them to court and won, Glanz and his family could have had their personal earnings wiped out, which would have resulted in Glanz losing his home just after having a newborn and would have all but certainly been the nail in the coffin for HireAHelper. Due to U-Haul’s size compared to HireAHelper’s, the former would almost certainly have won the case had a settlement not been reached.
When you’re creating a startup, the legal side will likely be the most challenging part to deal with. The three cases discussed in this post demonstrate just how perplexing business law can be, but also how easy it is to run afoul of it. In all three cases, the end results were heavily damaging for the entrepreneurs involved and a settlement of some sort was the only thing standing between the legal system and their entire business. Taking the time upfront to ensure that you know and understand all relevant business laws and that you and your company are in compliance with all of them is a necessity in order to avoid these expensive but preventable legal pitfalls. Avoiding these mistakes will allow you to focus your time and attention on the health of your business and will increase the likelihood of success and stability of your business in the long run. Are you a startup seeking funding during Seed or Series A? Check us out here!
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