Top 10 Legal Mistakes of Entrepreneurs

July 12, 2011

A few weeks ago we shared this abbreviated version of the “10 Rules of Entrepreneurship” presented at a conference in Austin by a founder of LinkedIn.

We’ve come across a parallel list at Working Knowledge (from Harvard Business School):  “Top Ten Legal Mistakes Made by Entrepreneurs.”  We’ll excerpt it as we did with 10 Rules… while also encouraging you to read the entire piece.  Here are a money graf and 2 (of the 10) most directly relevant to this audience:

“While the language of the law can be intimidating, the concepts are usually quite straightforward,” she [professor Connie Bagley] says. “Lawyers tend to be risk averse, and if you delegate to them you will usually stay out of legal trouble but can often compromise your business objectives.  [The coaching] I give entrepreneurs is to give them sufficient comfort with the legal concepts to feel confident in driving the process, to understand the ways in which the law is a constraint, but also the ways in which it is a tool that can help you create and capture value.”

#6 –  Negotiating venture capital financing based solely on the valuation. Valuation is not the only thing one should consider when selecting a venture capitalist or when negotiating the deal. There are many other ways for venture capitalists to get compensated if they end up paying a high price for shares. These include requiring participating preferred with a high cumulative dividend, redemption rights exercisable after only several years, and ratchet anti-dilution protection with no cap.  One must ask, what’s the reputation of this firm? Do they have a history of standing by the entrepreneur if the entrepreneur stumbles? Do they have good contacts in the industry? In trying to build alliances, do they know the big players? A no-name firm offering the highest valuation is often not the best source of equity.

#8 – Hiring a lawyer not experienced in dealing with entrepreneurs and venture capitalists. Many venture capitalists say that they often rate the judgment of entrepreneurs by their choice of legal counsel. Lawyers who have no experience working with entrepreneurs and venture capitalists will most likely focus on the wrong things while failing to recognize some of the more subtle potential traps. It’s better to hire someone who has played the game, who knows what’s standard and what isn’t, and who will get the deal negotiated and closed promptly.

As with most aspects of building a business, choosing the right partners – including who represents your firm and its interests – is crucial.  The same rigor that is applied to building a sales force or augmenting an executive team should be utilized in selecting legal counsel.  Credible counsel will both protect your legal interests and facilitate a successful launch to the entrepreneur-venture capitalist marriage.

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