How to launch a startup and avoid ending up in jail

(Editor’s note: Scott Edward Walker is the founder and CEO of Walker Corporate Law Group, PLLC, a law firm specializing in the representation of entrepreneurs. He submitted this column to VentureBeat.)

One of the most enjoyable (and sometimes complicated) part of working with startups is protecting founders and watching their backs.  Not only are there key contractual issues that must be buttoned-down (like vesting and IP assignments), but there are also a minefield of laws and regulations that must be complied with. 

In a world of easy access to online documents, this legal compliance is often overlooked or marginalized by founders, as they attempt to stay “lean” and “scrappy” (and sometimes even handle the legal work themselves or through a web service).  Certain violations of law, however, could lead to founders’ criminal liability.  Here are four sets of laws to watch-out for:

Employment laws.  The most common employment law violations are misclassifying an employee as an independent contractor and/or failing to pay an employee the minimum wage.  Both violations could lead to the same result: criminal liability for the failure to properly pay wages.

The key issue with respect to classification is control – the more control and supervision the startup exercises over the worker, the more likely he or she is to be deemed an employee. For example, if a worker is required to show-up to the company offices at a certain time and work a certain number of hours every day under the supervision of the same officer/manager, it is unlikely the worker is an independent contractor.  And simply calling a worker a “consultant” or an “independent contractor” in an agreement is irrelevant.

Also, as I have previously discussed, startups may not give employees “sweat equity” in lieu of any ongoing cash payment/salary; nor may startups completely defer wages and other compensation.  In short, employees must be paid at least the applicable minimum wage (and typically, at least semi-monthly).

Privacy laws.  Violation of privacy laws could also lead to criminal liability.  Accordingly, it is imperative that startups have proper privacy policies in place and carefully adhere to them.  Needless to say, privacy has become a huge issue both internationally and at the federal and state levels. Pandora, for instance, disclosed in its recent IPO filing that it received a criminal subpoena in April “in connection with a federal grand jury…convened to investigate the information sharing processes of certain popular [smartphone] applications….”

Last year, three Google executives were held criminally liable in Italy for an online video of an autistic teenager being bullied – and they were given six-month suspended sentences.

Moreover, certain states have criminal libel laws for web defamation, which generally means posting false information about someone that defames them (such as marital infidelity or criminal activity)  Colorado state law, for example, makes criminal libel a felony carrying up to 18 months in prison and a fine up to $100,000 for the first offense.

Tax laws.  One of the most common violations of tax laws by startups that could lead to criminal liability is the willful failure to “pay over” payroll taxes withheld from employees.  For example, in January 2010, the U.S. Court of Appeals for the 10th Circuit affirmed the conviction and 37-month prison sentence of a business owner who failed to deposit withheld payroll taxes with the IRS.

Similarly, if a startup collects sales taxes from its customers and then fails to remit them to the applicable state taxing authority, founders could be charged with theft of state funds.

Obviously, the failure to pay applicable federal and/or state income taxes could also lead to criminal liability.

Securities laws.  Finally, as I have previously discussed, a violation of applicable securities laws could trigger criminal liability.  Some of the most common securities laws violations by startups are making materially false or misleading statements in connection with the offer or sale of securities; and retaining unregistered finders (commonly referred to consultants, financial advisors or investment bankers) that offer and/or sell securities on a startup’s behalf. Other common violations include advertising, or improperly soliciting investors in connection with, the offer or sale of securities, including e-mail or other electronic transmission; and improperly offering and/or selling securities to “friends and family” who are not “accredited investors.”

Startup owners: Got a legal question about your business? Submit it in the comments below or email Scott directly. It could end up in an upcoming “Ask the Attorney” column.

Disclaimer: This “Ask the Attorney” post discusses general legal issues, but it does not constitute legal advice in any respect.  No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  VentureBeat, the author and the author’s firm expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post.

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