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Insights Paper | 5 Common Legal Mistakes Startups Make

May 2021 | Tas Wylie

The South Australian start-up and innovation sector has seen exciting growth recently, evidenced by a 14% increase in patent filings, notwithstanding an overall fall in filings nationwide, and a 15% increase in trade mark filings in SA for 2019-20201 .

Great ideas are, however, only one piece of the puzzle and a failure to plan the commercialisation of that idea is where many startups struggle.

To help you avoid making mistakes, here are 5 common legal problems we often see when assisting startups, and useful tips on how to avoid them.

1. Business structuring and your relationship with co-founders

The number one reason startups need legal advice is not getting their business structure and ‘business pre-nup’ in place before they commercialise their idea.

If you launch your startup with partners, the management of this relationship is critical to success, not only when things go wrong, but if you are successful as well.

How are you going to structure your business? Will you use companies? Trusts? Unit Trusts? Partnerships?

Governance of the relationship should start with analyzing your business and working out what structure would best suit. Consider the pressure points of your relationship with your partners. Matters to consider include:

- equity shares and entitlements (such as voting rights);

- founder contributions;

- how decisions are to be made;

- exit strategies (both if you want out, or if you want to force your partner out);

- ‘drag-along’ and ‘tag-along’ rights (the right to force a sale to involve another shareholder’s shares); and

- management of disagreements.

Remember just because you get along now does not mean that cannot change in the future. If a shareholder needs to leave, it is important to have a strategy in writing, otherwise your limited funds may instead be used up on a prolonged legal dispute.

2. Choice and protection of branding

Choosing a business or product name is an early decision which can have serious long-term consequences if not given proper consideration.

Whilst deciding upon your branding, it is important to do your homework and ensure you are not infringing upon someone else’s trade mark or name, particularly if you trade in similar products.

Start by:

- Googling your prospective brand names including variations of the spelling;

- Searching existing trade marks through (https://search.ipaustralia.gov.au/trademarks/search/quick); and

- checking domain name availability.

If you have international ambitions, you may need to ensure that your search includes foreign markets as well, as trade marks are country-by-country based.

When it comes to protecting your brand via trade mark registration, which we strongly recommend, the Trade Marks Act 1995 requires the mark to be distinctive. You will not be granted protection in descriptive terms that indicate a kind, quality, quantity intended purpose, value or geographical origin. For instance an app developer in Adelaide cannot register the trade mark ‘Adelaide App Developers’.

Although it may be tempting to choose a name which informs your customers what it is you sell, more often than not, the most iconic brands are inventive and will through their acquired reputation, have far greater value long-term.

To avoid the expensive exercise in re-branding or worse yet, trade mark infringement litigation, you may wish to speak to a lawyer about your branding before you have invested significant funds and development of it.

3. Not properly protecting the confidentiality of IP

Upon coming up with a great idea, it’s a natural instinct to want to tell everyone, but you may be putting your IP rights at risk.

If you think your idea might be patentable, be aware that if you discuss your invention in public before filing, you may no longer be eligible for a patent. If you need to discuss the idea with employees, investors or suppliers, you should have them sign a confidentiality agreement first.

Even if your idea is not patentable, your business may be damaged if a competitor has access to your IP, so again, a good confidentiality agreement is important.

Whilst there is a trend in the startup community against non-disclosure agreements (and the old saying ‘an idea is worthless, it’s all about execution’), the value of your business can suffer significantly if you don’t cover yourself appropriately.

4. Engaging people to work in or with your business

When you are growing your startup, you often need an extra pairs of hands. You may decide to hire  contractors (either onshore or offshore) to do work you don’t have the time, or skills to do. If you need long-term assistance hiring employees may be the most effective strategy.

One of the biggest steps in a new venture is your first employee. Employment law is one of the most heavily regulated areas of law and the consequences can be significant if you get it wrong. Having an appropriate contract is a great way to minimize some of the risk, but so often overlooked.

The first step is correctly classifying the type of engagement, is your employee casual, part time, full time or a contractor? Each type of employment or engagement has different entitlements, and there can be serious penalties for getting it wrong. Just calling someone a contractor or casual does not make them so!

When it comes to the contract, although it may be tempting to download one off the internet, many precedent contracts you can purchase online may not be specific for the Australian jurisdiction, or compliant with applicable industry laws and awards.

If you are going to use contractors instead of employees, be aware of some key traps:

1. Contractors who are hired for their labour (including mental labour) are entitled to superannuation payments even though they aren’t ‘employees’; and

2. If you hire a contractor, unless there is something in writing that says otherwise, the contractor owns the IP in everything you pay them to create!

Employees and contractors are going to be one of your biggest expenses, therefore it is advisable to engage legal or HR support to get it right.

5. Reviewing investment agreements

Finding someone willing to invest is exciting and also critical to the commercialisation process, but at what cost? It is paramount to read any investment agreement closely, whether a simple loan, equity raising, incubator or raft of other options available.

We regularly see entrepreneurs giving up far more than they thought and risk losing control of their business by simply not reading (or having a lawyer review) the fine print.

Get some help – Free Phone Advice Line

We completely understand that when you are bootstrapping your startup spending money on professional advice can seem like a luxury you can’t afford. Unfortunately, failing to get proper advice upfront can cost you a lot more in the long run.

Wallmans Lawyers is proudly South Australian and a key partner to Startup Adelaide, with experience in advising and supporting a significant number of Adelaide’s startup, new venture and entrepreneurial community.

Wallmans Lawyers offer a free phone advice service where you can get pointers on whether or not you have legal issues. We offer all Startup Adelaide members a free 15 minute phone call. Please contact Commercial Partner, Paul Gordon on 8235 3052 or paul.gordon@wallmans.com.au

More about Wallmans Lawyers Legal Support for Members here

1IP Australia, Australian Intellectual property Report 2021: https://www.ipaustralia.gov.au/ip-report-2021

Disclaimer

The content of this newsletter is for general information purposes only and should in no way be treated as formal legal advice.