Startup founders often make these legal mistakes

Early-stage founders face many challenges. Some of the trickiest and most foreign are legal because the legal world is unfamiliar and ever changing. What are some of the impactful legal mistakes founders make, what are the implications, and how can they avoid them or mitigate risk?

As a partner at Grellas Shah, I have done sophisticated legal work in transactional and litigation matters. As a startup and venture lawyer with extensive experience in handling a broad range of corporate, transactional, and intellectual property matters, including work on multi-million-dollar financings and acquisitions, I have deep expertise in handling complex corporate and intellectual property transactions, as well as in counseling startups and investors on avoiding and navigating litigation.

Ill-defined relationships

In imprecise language, founders discuss issues around equity, other compensation, and roles and they make promises to each other and early employees before relationships are documented.

Often, the intent is not nefarious. Instead, imprecision results from founders not being lawyers and not thinking about how an oral statement or casual email might be interpreted.

For example, a founder might promise early employees equity in percentages without clarifying what vesting terms apply or what type of stock will be issued. Employees receiving paperwork months later when a lawyer is hired may say no to signing. Where does that leave the company? That earlier vague promise could potentially be considered a binding contract with unsettled terms, leaving a cloud on the company’s capitalization that can be hard to clear without litigation.

Founders or early employees frequently claim that promises were made orally or by email.

These aren’t theoretical problems. Founders or early employees frequently claim that promises were made orally or by email. Fixing these problems dwarfs the cost of avoiding them in the first place. Sometimes, though, these problems don’t quite get fixed. Instead, the early employees might wait to see if the company grows and then file a lawsuit.

The recent lawsuit brought by early employees of Consensys against its founder/former CEO, Joseph Lubin, and the company demonstrates the real-world danger of ill-documented relationships and their impact as the company grows.

As the early employee plaintiffs describe it, Consensys, like many early-stage companies, couldn’t offer much of a cash salary. So, to attract talent, Lubin made specific equity-related promises to employees that were allegedly made in a mixture of oral statements, internal memoranda, and other nonlegal documents.

The first such promise dealt with Consensys’ structure. The company was to be built on a hub-and-spoke model, per the plaintiffs. The hub would own and develop specific IP, with that IP being spun out into spokes that would be their own companies. The “hub” company would own equity in all spokes, though they would not be wholly owned subsidiaries.

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