Twelve legal mistakes founders make

Two or three people agree to build something. Everyone knows the split. Nobody documents it, because documenting it feels like distrust at the exact moment everyone is enthusiastic.

Then one founder does less than expected, or leaves, or gets a job offer, and there is no agreement about what happens to their share. The conversation that was awkward at the start is now a dispute — and it is usually a dispute about the most valuable thing anyone owns.

Shares issued outright on day one belong to that founder permanently, whether they stay two decades or two months. A founder who leaves early with a large unvested-in-name-only stake is the single most common reason a promising company becomes unfundable.

Vesting is not a sign of distrust between founders. It is the mechanism that protects the ones who stay, and every serious investor will expect to see it. Putting it in later means asking someone to give something back, which is a much harder conversation.

If you receive equity subject to vesting, you may be able to elect to be taxed on its value at the time of transfer rather than as it vests. When the company is worth almost nothing, that value is almost nothing.

The deadline is short, it is statutory, and it does not forgive people who did not know about it:

“An election under paragraph (1) with respect to any transfer of property shall be made in such manner as the Secretary prescribes and shall be made not later than 30 days after the date of such transfer.”

Whether the election makes sense is a tax question specific to your circumstances. Whether you still have time to make it is a calendar question, and the calendar is unsympathetic.

People assume that work done for a company belongs to the company. Often it does not. A contractor who writes code generally owns that code unless there is a written assignment. A founder who built a prototype before the entity existed owns it personally until it is transferred in.

This surfaces in diligence, at the worst possible moment, and the leverage at that point sits entirely with the person who was never asked to sign anything.

Invention assignment clauses, confidentiality obligations, and non-solicitation terms from a previous employer follow people into their new company. So does the question of what was built on whose time and equipment.

This matters especially where a founder has come out of a large local employer into a company in the same field. It is a question worth answering early and in private, rather than during an acquirer’s diligence.

An LLC is often the right answer for a business that will distribute profits to a small group. It is frequently the wrong answer for a company that intends to raise institutional venture capital, issue options, and be acquired.

Converting later is possible and routine, but it is not free, and it tends to be needed at the busiest moment. The question is not which entity is better — it is which one matches the plan you actually have.

“We’ll take care of you” and “you’ll have a piece of this” are heard as commitments and remembered precisely, sometimes more precisely than they were said.

Undocumented equity promises to early employees, advisors and friends surface later as claims against the cap table, and they are difficult to disprove. Either grant it properly or say clearly that you are not.

Treating someone as a contractor because it is simpler does not make them one. The classification depends on the working relationship, not the label on the invoice — and getting it wrong creates exposure for back taxes and penalties that compounds quietly over time.

Options priced below fair market value create tax problems for the very people you are trying to reward, and the consequences fall on the recipient. Companies granting options need a supportable basis for the exercise price — which is a valuation question, not a guess, and one worth settling before grants go out rather than after.

Shares issued in a spreadsheet, a SAFE agreed by email, a convertible note someone remembers differently, an advisor grant nobody recorded. By the time a real financing arrives, reconstructing who owns what can take weeks and cost more than maintaining it would have. Investors read a messy cap table as a signal about everything else.

Accepting cheques from friends and acquaintances is still selling securities. The exemption you rely on has conditions, and some of them are lost by things done before anyone thought to ask — including talking about the raise publicly.

How the private placement exemptions actually work →

No minutes, no written consents, no record of who approved what. It feels like paperwork for its own sake right up until an acquirer’s counsel asks for the board approvals authorising every share ever issued. Records are cheap to keep contemporaneously and genuinely difficult to reconstruct years later.