Is your startup sitting on a legal landmine?
Entrepreneurs have their hands full trying to get their companies off the ground. With endless demands and “to dos” and limited time, legal matters often get moved to the “when I get to it” list.
Legal services are expensive, and finding an attorney takes time. Finding the right attorney for your company, rather than just any attorney, is important, but the need to invest time and resources can be off-putting. Time-starved founders often find it easier to just put legal on the back burner. Legal needs are addressed if and when they become critical or inescapable.
There are some basic legal areas founders need to address in the early days of their companies and not avoid. Taking care of tasks in these areas will go a long way toward averting legal landmines down the road.
If your company cannot afford to hire a lawyer, you will need to be sure that whatever legal resources you use instead are the right ones, have been designed with startups in mind, and do not reflect terms negotiated to fit someone else’s business needs.
The following are the basic legal areas your startup will want to cover. The list below is not exhaustive, but it provides particular areas in which mistakes or omissions are commonly seen.
If your company has not addressed one or more of these areas, it may be sitting on a legal landmine.
1) Entity Formation: This area involves choosing the correct entity form and jurisdiction (state) of formation for your business, filing the correct forms to establish the entity, filing any qualification documents (if needed) in states other than your entity’s state of organization, adopting the “rules of the road” for running your company (bylaws, operating agreement, partnership agreement, etc.), adopting organizational resolutions of the governing body and/or shareholders/members, making appropriate tax filings, and obtaining any local licenses needed to operate the business.
2) Business and Brand Names, Trademarks and Domain Names. Your company will want to be sure that any business, product, or service name that it wants to use as a trademark is actually available for use and not already being used by someone else. Equally important, subject matter on which your company wants to seek trademark protection must be determined to be eligible for trademark protection. When researching names for trademark, also be sure the top-level domain is available.
Do not set your heart or put any money behind names that you have not cleared for trademark and/or domain name registration. As well as determining eligibility for registration, your company wants to be sure it will not be infringing others’ marks when adopting any name for use.
3) Document All Founders’ Roles, Responsibilities and Ownership. Failure to document founder roles, responsibilities and ownership can cause significant trouble down the road, especially if the company becomes successful. This documentation is also important in case a founder resigns or is asked to leave the company. Do not leave this negotiation among founders until something arises that will affect the founders’ relationship. Crisis negotiations almost always leave the company and continuing founders with less leverage than they might otherwise have had.
4) Develop and Implement Programs to Acquire, Capture and Protect Intellectual Property. Your company’s IP acquisition begins with the transfer to the company of any core IP founders may developed prior to the establishment of the entity. As the company begins to do business, it may want to acquire IP from third parties, or it may itself develop IP. In each case, the company should have a process to acquire, capture, document and protect IP. The founders may also want to have an understanding of when the company will seek protection for IP through registration, such as with patents, trademarks or copyrights, and when it will use secrecy (trade secrets). The company’s IP strategy must extend to the company’s employees.
5) When Your Company Raises Money, Comply with Securities Laws. It is never advisable to assume that an issuance of company securities will fly under the radar or that it is automatically exempt from registration, even issuances to founders. If your company ever raises outside money from an institution, venture capitalist or other sophisticated investor, the company’s handling of issued securities will be one focus of the due diligence process. Neglect this task at your company’s peril. Unattended securities issues can cause serious financial or tax repercussions for your company – and may affect the company’s ability to raise outside money.
6) Comply with All Labor, Employment and Non-Discrimination Laws. Failure to comply with applicable labor, employment and non-discrimination laws can open up your company to fines, penalties, assessments and other financial risks. Do not assume that labor and employment compliance starts when your company hires its first employee. These laws may apply to founders working in the business as well as regular employees.
7) Plan for Executive and Employee Incentive Compensation. If your company will not have the means to pay market salaries to attract talent, you will want to think early on about setting up some type of equity compensation plan. There are legal, tax, and accounting considerations that attach to different types of equity compensation, and your company needs to understand the lay of the land with any equity compensation it issues. Some mistakes in this area cannot be rectified, and mistakes may affect the company’s future fund-raising.
With each of the above areas, it is often better to trade limited resources for expert help than to apply self-help and simply hope it’s right or assume you can fix errors later.
If your company does decide to go it alone, do your homework. Find the best resources you can, preferably those specifically designed for startups. Leverage any available legal advice you have access to, with the caveat that the person or service providing the advice actually knows the subject area. It doesn’t make a lot of sense to seek securities compliance advice from a lawyer who specializes in immigration or personal injury litigation, for example.
Startup companies have somewhat distinct legal needs, and the lawyer you trust to advise your company – even on an ad hoc basis – should be familiar with those needs.
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.