Why Do Startups Fail? 3 legal reasons for startup destruction

Why Do Startups Fail

Why Do Startups Fail? Half of the startups shut down within the first five years. They die young. It is not so hard to realize why since entrepreneurs face a reality of insecurity, chaos, and scarcity of resources.

Legally, startups could fail when founders do not have the knowledge to comply with the rules. Let’s talk about three reasons for failure because of the lack of legal compliance.

3 legal reasons for startup destruction

Entrepreneurs are learners. They are making of their business, willing to survive. They should avoid risks that could wreck their business. That is why they need an attorney. Legal guidance is a way to teach them how to prevent those threats. Lawyers and entrepreneurs must work in harmony for business’ sake. Accordingly to Bagley and Dauchy, in The Entrepreneur’s Guide to Law and Strategy:

Legal astuteness is a valuable dynamic capability that enables the top management team to work effectively with counsel to solve complex problems and to protect, leverage, and transform firm resources.

However, what happens when they don’t have a chance of legal guidance?

1. Entity Formation Failure

Founders can easily choose the wrong entity for his/her needs. For instance, working as partners when the business has ingrained risks that make an LLC advisable because of the limitation of liability clause.

Moreover, let’s say a startup is seeking venture capital. In that case, it is unwise to choose an LLC because venture capitalists do not feel comfortable to invest in a business with this entity formation.

LLCs have pass-through taxation, which means they are not taxed as an entity, and capitalists do not want to be personally involved in business taxation. Also, LLCs do not provide a simple flow of capital as a C Corporation, where capitalists can invest buying stocks, being easy to enter and exit.

A smart lawyer can help to bootstrap the business, choosing an entity that fits on the business model.

2. Raising Capital Failure

Founders usually face hard times to raise capital. Now and then, an enterprise may have a marvelous model, but the founders do not have networking skills or strive to convey ideas. An attorney can present founders to sources of capital and prepare them to deal with investors.

3. Employment Law Failure

People usually think the United States does not regulate labor. That is not true. Each American State has its employment law. An entrepreneur needs to comply with it, or they will undoubtedly have issues with employees.

Startup lawyers can help founders to organize better the work environment. For instance, they can prevent founders from treating a worker who is legally an employee as an independent contractor, which can lead to litigations.

Believe it or not, a startup lawyer can save your business from closing.

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