Founder Guide: Avoid 10 Rookie Legal Startup Mistakes

As a founder you wear every hat, and nobody expects you to be a lawyer too. But we've been doing this since 2008, and we see the same handful of problems again and again, usually when a company is raising its first priced round or getting acquired and a diligence team starts asking for paperwork. The good news is that none of these mistakes is exotic. This guide walks through the ten we see most, in roughly the order you'll run into them, and links to the FAQ that goes deeper on each one.

Mistake 1: Issuing founder stock that doesn't vest

Splitting equity between co-founders is a hard, honest conversation about what each person brings: time, expertise, capital, relationships, existing work. There are benchmarks, but much of it is judgment, and our founder equity FAQ walks through how to have that conversation.

The bigger mistake is what happens after the split. Nobody can predict how a founding team will work together, and it's common for a co-founder to leave in the first year or two because of team dynamics or a change in personal priorities. If their stock isn't vesting, they walk away owning a large slice of a company they no longer help build, and the people who stay are working for them.

Our default setup is simple. The company authorizes 10,000,000 shares at $0.00001 par. Founders buy restricted stock at par, which is its fair market value at formation, under a restricted stock purchase agreement. The stock vests over four years with a one-year cliff, and each founder files an 83(b) election.

Do this at incorporation, not later. Right after formation the stock is worth almost nothing, so paying par is generally treated as paying fair market value. If you wait until you have traction or a term sheet, the value goes up, which means paying more for the same shares or facing taxable income on the difference. A handshake split, or a founder agreement signed before incorporating, leaves vesting and IP unresolved.

Here is how that plays out. Two co-founders each buy 4,000,000 shares for $40. Nothing vests for the first 12 months. At the one-year cliff, 1,000,000 shares (25%) vest for each founder, and the rest vest monthly over the next three years. If one founder leaves at month nine, the company can buy back all of their unvested shares at the price they paid, $0.00001 per share, or $40 for all 4,000,000. If they leave at month 18, they keep 1,500,000 shares and the company can buy back the other 2,500,000 for $25. Our vesting schedule FAQ covers the variations.

Founders who worked on the idea before incorporating can get vesting credit for that time, and many founder agreements add double-trigger acceleration on a sale. Be careful with acceleration on any termination without cause: a co-founder who isn't working out, but did nothing that counts as cause, could leave with most of their stock. See Single Trigger vs Double Trigger Acceleration.

Mistake 2: Missing the 83(b) deadline

When you receive stock that is subject to vesting, the default tax rule looks at the stock as it vests, not when you receive it. An 83(b) election tells the IRS you want to be taxed on the stock when you receive it instead. For founders who pay fair market value at formation, the income recognized at filing is generally zero, and the election means later increases in value aren't measured at each vesting date.

The election applies to restricted stock, including founder stock and restricted stock awards, and to options that are exercised early. It does not apply to ordinary stock options that haven't been exercised. The deadline is 30 days from the date the stock is issued, and there is no extension. You can file on IRS Form 15620, online or by mail.

The company doesn't file the election for anyone, but it should make it easy: tell every recipient of restricted stock about the deadline the day the stock is issued, give them the form, and ask for proof of filing for the company records. Whether to file is a tax decision for each recipient, so they should talk to a tax advisor. If a deadline has already passed, talk to your lawyer and tax advisor. Our 83(b) FAQ explains how the election works.

Mistake 3: Not owning your own IP

For most startups the code, designs, product and know-how are the company. If the company doesn't own them, investors and acquirers will find out in diligence, and fixing it then means tracking down a former co-founder or contractor and asking them to sign, sometimes when they have leverage.

The fix is a Confidential Information and Invention Assignment Agreement (CIIAA) signed by everyone who builds anything for the company: employees, advisors and the founders themselves. Founders should also assign anything they built before incorporation that relates to the business. Contractors need the same assignment language in their contractor agreement (see Mistake 6). Our CIIAA FAQ explains what the agreement covers, and Who Owns Startup IP? walks through the founder, employee and contractor rules. If your team builds with AI tools, note that ownership of AI-generated code is a new area of law likely to shift.

Where do NDAs fit? An NDA protects confidential information you share with someone outside the company, like a potential partner or vendor. It's a useful tool, but it isn't a substitute for an IP assignment, and most investors won't sign one before a pitch meeting. Asking can make you look inexperienced. Save NDAs for situations where you're handing over genuinely sensitive information, and read our NDA FAQ for when they make sense.

Mistake 4: Promising equity you never issue

A founder writes "you'll get 1% of the company" in an email or offer letter, and the board never approves a grant. Months later the company has raised money, the stock is worth more, and nobody is quite sure what was promised, at what price or on what vesting schedule.

Equity exists only when the board approves it in writing and the paperwork is signed. Promise equity in exact share numbers, not percentages, and get board approval promptly. If you've already made promises, the fix is to have the board approve the grants now at today's fair market value, with vesting credit back to each person's start date. Our promising vs issuing equity FAQ explains the fix, and Why Use Exact Share Numbers explains why percentages cause trouble.

Two timing rules trip founders up. An option generally can't be granted to someone who hasn't started work yet, and the board can't date a grant back to when it was promised, so the exercise price is the fair market value on the day the board acts. Approve grants on a regular schedule, monthly or quarterly, and put any special terms, like acceleration, in the board approval itself.

Mistake 5: Skipping the equity plan and pool, or granting the wrong equity

You'll almost certainly pay early hires and advisors partly in equity, so you need shares set aside and a plan that governs how they're granted. We recommend adopting the equity plan and option pool at incorporation (the Option Plan is a separate project), typically 1,000,000 of the 10,000,000 authorized shares. Pools are usually sized at about 10%, 15% or 20% depending on the hiring plan. See our option pool FAQ and employee stock option plan FAQ.

The type of equity matters too. Before the company has a 409A valuation, the first hires and advisors usually receive restricted stock awards. Once the company has a 409A valuation, new grants are typically stock options: ISOs for US employees and NSOs for everyone else, including advisors and contractors. A stock option is the right to buy shares later at a fixed exercise price, and that price must be at least the fair market value on the grant date. The 409A valuation is how you establish that value. Granting options below fair market value can expose the recipient to an additional 20% tax, which is why you never pick an exercise price out of the air. Our startup equity compensation hub compares the options side by side.

To set it up right from the start, see our Founder Guide: Equity and Hiring.

Mistake 6: Treating contractors casually

Contractors are a great way to get help on a project basis and to test whether someone fits the team. They also create three risks founders often miss.

First, IP. Under copyright law, a contractor generally owns what they create unless a written agreement assigns it to you. Without that assignment, your codebase or brand may partly belong to someone else. Second, confidentiality. Contractors often see customer data and internal processes, so the agreement should protect that information. Third, classification. Calling someone a contractor doesn't make them one. If you control when, where and how they work, they may legally be an employee, and misclassification can bring back wages, taxes and penalties. Some states, including California, apply strict tests.

Use a written contractor agreement with IP assignment and confidentiality terms, and check classification before you bring someone on. Our contractor agreement FAQ covers the agreement, and Independent Contractor vs Employee covers classification.

Mistake 7: Copying someone else's privacy policy

Most founders know privacy matters but find the rules confusing, so they copy a policy from a company they admire. The problem is that a privacy policy is a public promise about what you collect and how you use it. If it doesn't match your actual practices, you've made a statement that regulators and plaintiffs can hold you to.

The rules have multiplied. Nearly 20 states now have comprehensive consumer privacy laws in effect, including California, Colorado, Connecticut, Texas and Virginia, and Oklahoma, Alabama and Louisiana take effect in 2027, with Vermont in 2028. Many of these laws apply only above certain size or data thresholds, but your obligations also depend on who your users are. Health data can bring in HIPAA, data from children under 13 brings in COPPA, and EU users bring in the GDPR. Our privacy policy FAQ, Can't My Startup Just Copy Someone Else's Terms? and US Data Privacy Laws explain what applies.

Mistake 8: Skipping board approvals

Even a two-person startup has a board of directors, and the board has to approve the company's major decisions. That includes adopting bylaws, appointing officers, issuing every share of stock and every option grant, adopting the equity plan, and approving financings such as SAFEs and convertible notes. Missing approvals can leave those decisions open to challenge, and cleaning them up during a financing costs time and money.

The board doesn't need to hold formal meetings for most of this. In Delaware, the board can act by unanimous written consent, which is how most early-stage companies document decisions. When you do hold a meeting, keep minutes. Delaware also expects an annual meeting of stockholders to elect directors, which stockholders can often handle by written consent instead. Quarterly board meetings are good practice once you have outside investors, but they aren't a legal requirement. Our FAQs on what the board needs to approve, board consents and board meeting minutes go deeper. Keep the signed consents with the rest of your corporate records in one organized folder, set up the way an investor's diligence list is. See How Do I Keep My Startup Legal Documents Organized?

Mistake 9: Ignoring annual Delaware filings, or panicking over the franchise tax

Every Delaware corporation must file an annual report and pay franchise tax by March 1 each year. The annual report fee is $50. Miss the deadline and Delaware adds a $200 penalty plus 1.5% interest per month, and if you keep missing it the company can lose its good standing, which will surface in any financing or sale.

The rookie panic comes from the franchise tax notice. Delaware's default calculation, the authorized shares method, can produce an alarming number for a startup with 10,000,000 authorized shares, about $85,000. Most startups instead use the assumed par value capital method, which usually brings the bill down to the $400 minimum for an early company. Our franchise tax FAQ walks through the calculation.

One piece of good news: since March 2025, companies formed in the US haven't had to file beneficial ownership (BOI) reports with FinCEN, and a final rule in August 2026 made that exemption permanent. Only foreign companies registered to do business in the US still file. You may still need to register in the state where you operate, and our I Just Incorporated FAQ lists the other post-formation steps. Also open a company bank account and run every company dollar through it. Paying company bills from a personal account, or moving money back and forth, blurs the line between you and the company that limited liability depends on.

Mistake 10: Stacking SAFEs without modeling dilution

Most early funding is raised on SAFEs, which are fast and inexpensive. The downside is that it's easy to keep signing them without tracking what they add up to, and some founders are shocked by their ownership when the SAFEs convert in the Series A.

With a post-money SAFE, each investor's ownership is roughly the amount invested divided by the post-money valuation cap, and the SAFEs add up. Suppose you raise $500,000 on a $5,000,000 cap, then $750,000 on a $7,500,000 cap, then $1,000,000 on a $10,000,000 cap. Each SAFE could convert into up to about 10% of the company, so together the SAFE holders could hold up to about 30% before the Series A investors buy their shares and the option pool is topped up. Each new round then dilutes everyone, founders included.

None of this is a reason to avoid SAFEs. It's a reason to update your cap table after every SAFE and model what conversion looks like at a few Series A valuations. Our SAFE FAQ and equity dilution FAQ explain the mechanics, and our Founder Guide to the SAFE goes deeper.

Where to go next

If you're forming your company, start with our Founder Guide: Incorporating Your Startup. If you're raising, our Founder Guides cover each stage in depth: the SAFE, convertible notes, the seed round and the Series A. If you're considering a mission-driven structure, see our guide to the public benefit corporation.

Westaway is a flat-fee startup law firm, and our General Counsel plans are built to keep these ten mistakes from happening in the first place: incorporation, founder stock, equity grants, contractor and employee agreements, board consents and fundraising. If you'd like help with any of them, contact us.