5 Common and Costly Legal Mistakes that Australian Founders Make in Year 1

Introduction

The first year of starting a business is often overwhelming, fast-moving and reactive. This is usually coupled with resource constraints and limited cash flow that means every decision is weighed as a need versus a want.

As a result of the above, legal considerations often tend to fall down the priority list. However, the risk here is that early missteps create long term exposure for a business that is far more expensive to fix later on.

This article will explore the most common and costly legal mistakes that we see Australian founders make in year one and what Australian founders should do instead.

Choosing the Wrong Business Structure

It is common for founders to start operating their business as a sole trader. This is often the default as it is a quick structure to set up and is relatively inexpensive compared to setting up a company.

While operating as a sole trader may be appropriate for some, particularly for low-risk businesses, it can expose business founders to significant personal liability.

As such, it is incredibly important to consider whether a company structure is more appropriate, particularly when considering the consequences that may arise for a sole trader if the business incurs debt, enters into disputes or faces claims from other parties.

To mitigate this mistake, founders should assess the risk profile, growth plans and revenue expectations of their business early and seek professional legal and accounting advice as to what structure suits their needs. While registering a company with the Australian Securities and Investments Commission (ASIC) may involve higher upfront costs, it can provide greater protection (both financial and non-financial) in the future.

Using DIY or Generic Contracts

While it may seem easier and more convenient to use free templates or copy agreements / contracts from the internet or using artificial intelligence to create them, using this shortcut can be incredibly costly.

The templates that are available online or that artificial intelligence generates are rarely tailored to Australian law or your specific commercial circumstances.

Using poorly drafted contracts based on unsuitable templates can lead to a variety of issues including:

• Unclear payment terms;
• Inadequate limitation of your liability;
• Weak or unenforceable intellectual property provisions;
• Inadequate confidentiality provisions; and
• General ambiguity around the contractual relationship and the obligations of each party.

These issues can often lead to costly disputes or incurring costs to rectify them.

We recommend that from the outset, founders invest in properly drafted agreements. We understand that cash flow may limit the number of documents that can be prepared but accurately documenting your key contractual relationships such as with clients, contractors and suppliers is incredibly important.

At a minimum, founders should ensure that any agreements and contracts used clearly allocate risk, define deliverables, have clear payment terms and address how disputes are to be resolved.

Failing to Properly Protect Intellectual Property

A common mistake made by founders is assuming that they automatically own everything that they have created for the business.

However, this is not always the case and becomes a considerable issue when third parties such as contractors are used.

It is essential that there are clear contractual terms regarding intellectual property in place to ensure that any intellectual property created belongs to the business and not the contractor.

Founders should ensure that all agreements, particularly with contractors and employees, contain robust intellectual property assignment clauses. Founders should also consider whether trade mark registrations or other protections are appropriate for the business.

Misclassifying Workers

A key aspect of growing a business is engaging workers to assist you.

Engaging workers as “contractors” instead of employees can seem like a flexible and cost-effective option. However, misclassification is a high-risk area under Australian law.

Employment law is a heavily regulated area with authorities such as the Fair Work Ombudsman actively pursuing businesses who engage in sham contracting arrangements. Sham contracting arrangements refer to where a business misrepresents an employment relationship as an independent contracting arrangement to avoid paying employee entitlements.

Founders should also be aware that they can still be penalised for sham contracting arrangements, even if there was no intention of misrepresenting the relationship.

To avoid penalties, back payments and reputational damage, founders should carefully assess the true nature of the working relationship they have with their workers. Founders should consider the level of control and independence their workers have and how the work is performed, irrespective of what the contract says.

We recommend that founders obtain legal advice from the outset to ensure they have the right contracts in place and to ensure they are not misclassifying their workers.

Not Having Insurance or the Right Insurance in Place

When setting up and operating a new business, insurance is often considered to be an optional expense that can be dealt with at a later date.

However, obtaining and maintaining appropriate insurance is a critical part of risk management for any business.

Even where founders have well drafted contracts and indemnity clauses to provide protection, founders may still face:

• Negligence claims;
• Property damage claims; and
• Disputes that require costly legal defence.

Insurance can provide certainty in relation to the above and assist with cash flow in circumstances where founders need to pursue another party under an indemnity clause. Insurance provides a financial safety net that contracts cannot do alone. Insurance should be used to complement any well drafted contract and indemnity clauses.

From the outset, founders should consider what policies are appropriate for their business, such as professional indemnity insurance, public liability insurance or cyber insurance.

Conclusion

The first year of your business is all about growth and building momentum. However, this does not mean that founders should overlook legal fundamentals as doing so can undermine everything that follows.

What founders don’t often realise is that the cost of fixing problems later is almost always higher than getting it right from the outset.

By taking a proactive approach to structure, contracts, compliance and risk management, founders can avoid common pitfalls and focus on what matters most, growing a sustainable and successful business.

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