19 July 2023

Companies in the STEM sector often start out life as a hot bed of creativity and optimism regarding how to solve a new problem or engineer a new product. This creative and optimistic starting point can also lead to certain errors that can be hard to unwind, but which could have been avoided. Below is a list of early stage company mistakes to try to avoid:

1. Failing to make a clear deal with fellow founders

To avoid disputes, it is necessary for everybody to understand the relationship with each other and with the company. This understanding should expand beyond simply the shareholding percentage and include agreement on the roles and responsibilities of founders, expected time commitment and what happens if someone leaves, including leaving for a rival. These issues are an incredibly common source of disputes.

2. Improper or unwise issue of shares

In the early stages, it can be tempting to take cash investment from anyone willing to invest in your company and instantly move on to using the money to grow the business. Firstly, there is a proper process that should be followed when issuing shares. The issue should be recorded in an internal share register called the “Statutory Registers” and Companies House should be updated. If the company is ever to receive significant investment, or to be sold, then the Statutory Registers are the first thing that will be inspected.

Secondly, you are creating a relationship with your shareholders, so may need to consider if there any are terms to the deal. For example, you cannot force a shareholder to sell shares unless you have a contractual mechanism to do so, it would be common to provide in the company’s constitution that the majority of shareholder can “drag” a minority into a sale. This means that 100% of the shares in a company can be sold on the same terms if the majority agree to the proposed sale. Likewise, if the shareholder is an employee, you may wish to have a mechanism to get the shares back if they leave the company so you can incentivise future employees.

3. Over-promising to institutional investors

Entrepreneurs by nature are optimists and institutional investors are usually realists driven by figures and performance. Providing an investor with an aspirational or overly optimistic business plan will, at best, lose credibility and, at worst, set the benchmark for how the company is going to be assessed by the investor leading to potentially disappointing performance.

4. Failing to protect Intellectual property appropriately

Often in this sector Intellectual property is the primary value creating asset. If you have developed a unique product, technology, or service, you need to consider the appropriate steps to protect the intellectual property and therefore harness the value of the asset.

5. Not considering who is creating intellectual property and who owns the rights

This issue can either be misunderstood or dealt with carelessly, and it can create significant legal issues that affect the value of the company. Simply put, all employees, contractors, consultants (or in some cases friends and family) should sign something that assigns the intellectual property created in their role to the company. If this is not done, then the person that develops the intellectual property will own the intellectual property.

6. Inappropriate disclosure of confidential information

In the early stages of a business, you may be required to disclose the key idea or concept that makes your business unique or innovative, or you may require to disclose other information that you consider key and confidential. When disclosing such information internally, employees should understand the nature of the information and their contract of employment should have confidentiality provisions. Additional care is required when disclosing information externally and confidentiality agreements or non-disclosure agreements should be used to protect the information. The smart entrepreneur decides what is disclosed, when it is disclosed and to whom, and otherwise ensures that information is not disclosed. Leaks in confidential information can cause leaks in company value.

7. A lack of written agreements

Again, due to the nature of starting an enterprise, lots of mini deals can be made on the basis of a handshake with nothing formal backing it up. This uncertainty can lead to misunderstandings, which can grow to disputes which will be expensive to resolve. Create a written agreement, ideally with the benefit of professional advice if the matter is of significance.

8. Record keeping

This is not glamorous and is often not a priority. If a company gets to the stage of taking on external investment or a full share sale. then an extensive due diligence will be conducted on the company. If records are not in good order or incomplete, then the shareholders will often have to accept any associated risk, will lose credibility or the of the sale proceeds will be “chipped” to reflect the deficiency. Records, particularly relating to key value concepts like shares, intellectual property, physical property and tax, should be well maintained.

Operating an early stage company is undeniably hard. You’ve probably not done this before. You are excited by the future prospects. You are aware of the risks of failure. If it would be helpful to discuss any unique risks that your company is facing, feel free to contact a member of our corporate team.

Michael Cox, Senior Associate: mxc@bto.co.uk / 0131 222 2939