Six out of ten startups fail. At least that’s what the American firm Cambridge Associates, which analyzed the performance of nearly 30,000 startups, assured us and came up with this disturbing result.
While it is true that the data is positive about others that have been handled in the sector, it is no less so the fact that this high failure rate is, on many occasions, avoidable.
This is avoidable because the error is often attributable to inexperience or poor advice, like choosing wrong pay for a paper service the startup and the entrepreneurs receive.
Advice is a key element in developing an entrepreneurial project in the legal field. Legal advice is vital in the startup of projects, but no less so in the processes of investment, sale, or even dissolution of the project itself. Each phase a startup goes through, pre-seed, seed, growth, series A, B, exit, etc., has a key moment in the success or failure of the project. A wrong choice of the corporate formula, an ill-advised incentive plan, insufficient asset protection, a bad partners’ agreement, or a wrongly configured drag-along or accompanying right can turn a viable project into a nightmare for the entrepreneur.
The following is a list of the most frequent legal errors in the life cycle of a startup:
1. Lack of professional legal advice
The sources of law are those listed in the Civil Code -or equivalent norm in the respective legal systems- and, unfortunately, Google is not among them. We observe how the entrepreneurs ignore any type of professional advice and choose to use models downloaded from the Internet and be advised in a self-taught way, resorting to readings that are available on the net. Experience tells us that the results are not as expected and, on occasions, lead to the rejection of investors to enter into businesses configured in an inadequate manner or with serious contingencies.
2. Choice of inadequate corporate formulas and governing bodies
The choice of corporate vehicle and the governing body is another key element to consider by the entrepreneur. We have come across unpleasant situations where a third party has directly approached the entrepreneur (and not a limited liability company) claiming the breach of obligations or the payment of economic amounts for different concepts, for having made the wrong decision at the time to go to the market operating as an individual and not using a limited liability company to safeguard his assets. A poor choice of the governing body is also a cause of dissatisfaction and disputes among the partners.
3. Error in the choice of the territory in which to operate the economic activity
The entrepreneur will have one nationality, but this should not determine when choosing one place or another to operate a particular business. For this purpose, elements such as the legal viability of the business in the territory in question, the applicable tax regime, the possibility of raising funds in the territory, etc., must be considered. This decision, like many others, admits future modifications. Still, we have seen many cases where a bad choice leads to significant economic losses or directly to the impossibility of operating the business because the country’s regulations in question do not cover it.
4. Not signing a shareholders’ agreement
A shareholders’ agreement is something like planning a “good divorce.” The partners’ agreement is the document regulating the relationship between the startup partners. A bad configuration can mean that the company cannot be sold, despite the desire of the majority of its partners, that it cannot pivot to another activity, or that the company is in a situation of blockage that makes it inoperative.
5. Disregarding the importance of intangibles
If we look at the large corporate and investment operations in recent years, some of them in the millions, we can see that the assets acquired by the buyers are mostly intangible. It is no longer the purchase of the real estate, machinery, or similar, but intangible assets, such as databases, software, trademarks, algorithms, patents, know-how, industrial secrets, etc. International intellectual and industrial property regulations protect these intangible assets. Still, practice shows that proper advice in this field ensures that the assets are in the company and not in its members, that the registrations have been carried out properly, that the confidentiality of the company’s sensitive information has been duly protected etc. Poor management of these assets can frustrate due diligence in an investment or sale process.
6. Ignoring the importance of privacy
Europe has lived and dragged the rest of the world into a race to protect the privacy of individuals. Respecting the privacy of startup users by default and by design are obligations that no entrepreneur or startup should ignore. Non-compliance leads to astronomical penalties.
7. Poor choice of the labor regime of the staff or managers
We get fed up every day reading in the media about how certain startups find themselves in check due to having chosen to hire their collaborators as independent professionals and not as company employees. Not only that, in the hiring of collaborators and even in the configuration of the labor or mercantile regime of the entrepreneurs, it is relevant to clearly define the ownership of rights over their contributions and creations and the obligation of confidentiality over the information to which they have access due to their relationship.
Having said all this, it is quite possible that, even taking into account all of the above, the failure rate of startups will not have improved in ten or twenty years. If this is the case, it may not be for not taking the right steps in the legal, regulatory and normative fields.