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This is a guest post by entrepreneur and startup lawyer Ryan Bowers
The law. It is just about the last thing you want to talk about when you are getting your startup off the ground. It probably ranks up there with whose turn it is to take out the garbage.
Trust me, I’m a lawyer who advised startups for a living, and even I had a hard time keeping focused on legal concerns with my own startup.
But remembering a few simple legal protections can save a lot of headache later on.
There are some good posts out there covering legal pitfalls for a startup on the business level, but this post is intended for individual startup founders.
Rule 1: Agree on Equity Terms
When you are first starting off it might be tempting to reach a handshake agreement regarding equity. Maybe your initial founders are friends and family and you are confident everyone will play nice. Memories get hazy, terms are misunderstood, and things get messy. Protect yourself by making sure your equity is clearly stated in writing.
Rule 2: Don’t Mingle Assets
This protection is simple. Make sure you have sufficient capital at the start, set up your business account, deposit all funds into that account and then only use it for your startup. In the early days it can be easy to ignore these basic corporate formalities. Don’t fall into the trap.
Why? If you co-mingle assets, it can be argued that your corporate form (and the limited liability you thought you had) should be disregarded as fictitious. You could then be sued personally.
Rule 3: Execute Assignment Agreements
If you are a technology startup, intellectual property is likely your most valuable asset. Therefore, protecting your IP becomes extremely important. In simple terms – have everything assigned to the company, and get it in writing. If a founder creates something before incorporation, make sure to have it assigned when the company is formed. After formation, have all founders (and all future employees) execute assignment agreements.
People often assume that if they pay a vendor or consultant to create something (logo, design, code), the IP rights in what is created are automatically property of the startup. Not so. Certain magic contract language (“work made for hire”) is required. (admittedly, even I was a little tricked up by this complex issue)
On a related note, and this is very often overlooked, if you start your new venture before leaving your “day job,” make sure your startup’s IP doesn’t become the property of your employer. This may sound silly, but employment agreements may contain provisions that assign all inventions created to the employer, even if invented “off the clock.” Thoroughly read your current employment agreements (and other employment related docs) as well as those of all co-founders.
Rule 4: Consider a vesting schedule
Building and launching a startup is an exciting time — no one wants to think about what happens when things don’t go as planned. In particular, co-founders often fail to agree on what happens when one of the co-founders leaves.
For example, I worked with a startup that was growing nicely but had yet to reach significant revenue. With a new baby on the way, one of the founders headed for greener (as in, steady paycheck) pastures. The transition was rocky, to say the least, as there was no plan in place.
You will want to consider vesting schedules, which grant certain percentages of stock to founders on a set schedule, as well as rights of first refusal or repurchase rights
Rule 5: Protect yourself
This one is crucial. And it becomes even more important when you get funding. Your interests are not always aligned with the startup’s interests (think Eduardo Saverin in The Social Network). Thus, having your own lawyer review what you sign will help ensure you are protected. Moreover, the legalese can get quite thick — your lawyer can explain it to you in plain English.
Nothing is more satisfying then seeing your startup succeed. I feel a sense of pride with every new user and a sense of satisfaction every time a client connects with a lawyer. Protect your success by remembering to protect yourself from the very beginning.
Ryan Bowers is the founder of RFPattorney.com, which provides cloud RFPs for legal departments and a cloud legal marketing platform for lawyers. He is also the General Counsel and VP Operations for a large construction company and previously practiced construction, antitrust and technology law. He blogs at blog.rfpattorney.com.
Court gavel on cash via zimmytws/Shutterstock