Top 7 Legal Mistakes by Startups You Should Know & Learn What To Do

Updated: Apr 19

If you are looking to start a startup and are uncertain of all the legal considerations to expect for startups, then you have come to the right place.

The startup scene in Malaysia may have been nascent in the past few years. However, there were a few success stories in Malaysia.

For example, Grab, Piktochart, MindValley, and more. These are the several names that became known globally in the past decade.

Many fledgeling entrepreneurs become more motivated to grow their ideas with various organizations through incubation, accelerator programs, and micro-funding.

But what is considered a startup?

Startups are ventures or teams focused on a product or service that typically do not have a developed business model or lack adequate funds to move onto the next phase.

However, the key differentiator is that a startup has a high potential for exponential growth, if not overnight, at least overtime. And they are not limited to the typical bricks and mortar structure.

Key Success Factors

Founders often focus on these three critical factors to a startup’s success.

  • The viability of their products or services

  • Their business models and sales streams

  • The people, especially the pioneer team

However, founders may often overlook one crucial factor. That is the legal side of the business.

Legalities revolving around a startup may lead to complications, at best.

But the worst is with financial implications and failure to grow as planned. And eventually, fall during the startup’s infamous valley of death, as shown below.

Startups' Valley of Death - Legal Mistakes by Startups

(Source: https://www.greentechmedia.com/articles/read/into-the-valley-of-death#gs.Fwbd0aI, accessed 27.10.2017)

Some of the essential legal considerations may include:

  • Protection of intellectual property, especially for tech startups

  • The copyright protection of your work

  • The legal process revolving around equity investors like due diligence and contract drafting

  • Founders’ agreement and legal obligations

  • Employee’s working agreement

  • Other related aspects.

These areas could potentially lead to a company’s failure despite having great products, a great team, or loads of fundings, among other possible reasons.

Therefore, we have listed 7 legal mistakes by startups just for you. Know what to expect if you are thinking of starting or have already started your business venture.

7 Common Legal Mistakes by Startups You Should Know

1. Not Making the Deal Clear With Co-Founders

Ideally, all founders should invest their time, resources, and money equally to reduce conflicts at later stages.

Therefore, it is critical to define the get-go details to ensure everyone is pulling their weight accordingly.

It is common, though, that founders do verbal or informal agreements.

It is often overlooked because they would rather focus on product development. Some may excuse that if the whole idea doesn’t work, the money on legalities would be wasted.

As a result, founders have an unclear definition of responsibilities and returns. If there ever were a fallout, there would be no repercussions.

Hence, if one is serious about realising their ideas with their patterns, it is important to be clear with the deal and formalize it with a contract.

Here are some of the things you should work out with your founders.

  • How will you split the equity among founders?

  • What are the roles and responsibilities of the founders?

  • Are the ownership percentage of founders subject to vesting based on continued partnership in the company?

  • Do the founders get the option of buying back shares of the founder that left the company? If so, at what price?

  • What is the time commitment expected of each founder?

  • What are the limitations to outside responsibilities or commitments?

  • Will there be any salary entitlements for the founders, and how will it change over time?

  • Who and how will the key and daily decisions be made?

  • Who and how will any founders be removed from the company?

  • What happens if a founder is not living up to the expectations? What actions are they legally bound to be given?

  • How will the sale of the business be decided?

  • What is the business goal and vision?

2. Not Registering Your Business Formally

Often, founders start their startup venture without consulting their lawyers.

Some of the consequence may include

  • Higher taxes

  • Subject to significant liabilities

  • Resources wasted on the conversion of entities.

These could be avoided if you plan right.

Usually, for startups expecting funding injections in the future, a private limited company structure may be the best option.

You can strategically distribute your dilutable shares with the right investors and build a strong pioneer team.

Generally, there are 5 types of legal entities for you to operate your business in Malaysia.

Here’s the list for a summary.

  • Sole Proprietorship

  • Solely owned by an individual.

  • Simplest and cheapest legal form

  • Not required to submit audit or annual filing

  • Only pay annual fees.

  • Risky if you are going big because your liability is unlimited (means personal income, personal assets, and employment income are liable)

  • Partnership

  • Similar to Sole Proprietorship but with more than one owner (up to a maximum of 20)

  • Most suitable for professional firms like auditors and lawyers

  • Also bound by unlimited liability.

  • Limited Liability Partnership (LLP)

  • Similar to conventional Partnership with the advantage of Private Limited structure

  • It is a separate legal entity from the partners with limited liability.

  • Can sue, being sued, acquire, own, hold and develop or dispose of property

  • There is less compliance than Sdn Bhd and a more affordable business vehicle, i.e., no annual accounts audit is required.

  • Private Limited Company or Sendirian Berhad (Sdn Bhd)

  • A separate legal entity from the owners

  • Founders can separate their personal finances and assets from the business.

  • Shareholders are only responsible for the debts of the business, separated from their own wealth.

  • Can sue, being sued, acquire, own, hold and develop or dispose of property

  • Annual accounts audit, filing, and board meetings are required.

  • Public Limited Company or Berhad (Bhd)

  • Similar to Sdn Bhd, but the shares are offered to the public.

  • Minimum two shareholders and 50 members and more

  • Berhad requires your business to be listed and governed under the Securities Commissions of Malaysia.

  • Best suited for large corporations.

3. Not Protecting Your Intellectual Property

If you or your team have created a unique product, technology, or service, you should consider taking proper steps to protect your hard work and efforts.

As the founder, it is your responsibility to ensure the following.

  • Avoid infringing on the intellectual property rights of other parties.

  • Protect your intellectual property

Here are common types of IP protective measures.

Patents

A patent gives you the right to prevent others from making, using, or selling the invention you patented. This works both ways. Meaning, you cannot sell a patented product.

Patents generally can be filed when your invention doesn’t belong to any category of non-patentable inventions as prescribed by the Malaysian Patents Act. Meaning, it must be novel, inventive (not required for utility innovation), and susceptible to industrial application.

Copyrights

Under the Copyright Act 1987, Malaysia’s copyright law may be slightly different. And unlike trademarks, designs, and patents, there is no system for registration.

This means the copyright exists as soon as your original work is created. It belongs to you automatically.

The bad news is that it is difficult to establish the ownership of copyright.

Therefore, you may want to claim ownership by way of a Statutory Declaration or by filing a Voluntary Notification at the Intellectual Property Corporation of Malaysia (MyIPO).

Confidentiality Agreements

Commonly known to Malaysians as NDA—Non-Disclosure Agreement.

This agreement gives you the protection from having your secret product or business idea being leaked out earlier than planned or to the wrong party.

Confidentiality and Invention Assignment Agreements for Employees

The above should be added as a clause to the employment contract employees sign during employment.

The reason is fairly simple.

  1. Ensures the employee keeps your business’ confidential, proprietary information during and after employment.

  2. Ensures all inventions, ideas, products, and services developed by the employee during the employment or contract period belongs to the company and not the employee.

4. Not Having a Good Terms of Use Agreement and Privacy Policy for Your Website

Most people ignore the privacy policy and terms of use of a website. However, they are important both to your customers and your business.

Areas of Terms of Use to consider are

  • How the site can be used and the limits imposed on users

  • Disclaimers on warranties

  • Limits on the liability of the site owner and its employees, officers, affiliates, and directors

  • How disputes will be resolved (e.g., through confidential binding arbitration precluding class actions)

  • Representations and warranties of the site user and indemnification to the site owner

  • Rights to refunds and returns if products are sold

  • Intellectual property rights (e.g., copyrights)

Areas of Privacy Policy to consider

  • What information the site collects

  • How the site uses the information collected

  • How the information may be shared or sold to third parties

  • How the site deals with children under 13

  • How the site can be accessed through third-party services such as Facebook and Twitter

  • A description of the use of cookies and other technologies on the site

  • The steps to take by the site owner to protect the confidentiality and security of the information collected

  • How changes to the privacy policy may be put into effect

Do not copy these from any sites. You will need to customize your own with local privacy law taken into consideration.

5. Not Taking the Proper Steps Before Dismissing an Employee

I’m sure as a business owner, you’d know this. If you don’t fire properly, you will be under fire.

Well, it simply means that an employee may choose to sue the company for wrongful dismissal.

Unlike many countries, in Malaysia, you cannot employ and fire at will. This is a form of protection for workers.

You can only terminate your employee’s service if

  • It is justified

  • Done in good faith

  • Is procedurally fair

To avoid any unfair dismissal claim, you must know what potentially counts as just cause and excuse.

Since there is no specific just cause and excuse defined in the act, we could generally surmise the following based on experience.

  • Major misconduct, i.e., fighting at the workplace, sexual harassment, failure to follow safety protocols, theft, drunkenness, always being late

  • Any acts by the employee that adversely affects their duties towards their employers

  • Misconducts that are related to the employee’s duties or responsibilities entrusted to them

  • Negligence in performing their duties

  • Poor performance as defined in an employment contract or employee review

  • Private misconduct jeopardized the employer's legitimate interest, i.e., sabotaging share price for personal gain, etc.

  • Redundancy and closing of the business

6. Not Complying With Securities Laws When Issuing Stock to Angels, Family, or Friends

For limited liability partnership companies that perform sales of stock and issuance of interests to the founders and investors they are all subject to Malaysia's Securities Laws.

For instance, the sales must comply with certain disclosure, filing, and form requirements unless the sales are exempt.

The consequence of failing to comply may result in

  • Financial penalties

  • Force to repurchase all shares sold

  • Civil and criminal penalties

To avoid such damaging backlash, you should hire knowledgeable lawyers to process the documents according to the law.

7. Not Doing Your Due Diligence When Financing Your Business

Getting funds injected into your business can be a boon and a bane concurrently.

However, regardless of the pros and cons, it is a fact that your startup needs money.

The best way to protect yourself from any unwanted liability and consequences is that due diligence is critical to getting investors on board.

Though the investors of startups typically do it, you should know who you are inviting to get on board with.

You’d want to avoid having.

  • Your brand name being drag along with the investor's bad reputation.

  • To bear the liability of the investor.

  • Unable to maximise the investment

  • Being used by the investor for their own gain and more.

What is due diligence, then?

  • A deep background check of a business or person

  • Done before signing a contract, appointing a vendor

  • Or when you are evaluating a target company or its assets for an acquisition or funding.

  • It helps you in informed decision making with the enhanced amount and quality information.

In Conclusion

Starting a startup is not easy. Running a successful startup that thrives is even harder.

Focusing on the three key areas is important—product, people, and plan.

But it could all be for nothing if a company fails to comply with certain legalities.

All your hard work will go to waste.

We hope knowing these common legal mistakes by startups will help you make your business a success legally and protected.

If you find the entire process too taxing for you or your team, you can always talk to us.

Click on the contact us to find out how we can help you.



Note: This article does not constitute legal advice to any specific case. The facts and circumstances of each case will differ and, therefore, will require specific legal advice. Feel free to contact us for complimentary legal consultation.

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