This is a guest post by startup lawyer Jennifer Berrent
When launching a startup, legal issues often get brushed aside in order for founders to focus on building the product. But making the wrong legal decision early on in the process of starting your company may lead to thorny problems in the future. Frequently, issues can be avoided by taking action in three key areas: choose the right entity, allocate equity and protect your intellectual property.
Choose the right entity
Once you are ready to move forward with an idea, you should formally form your startup as an entity. One important benefit of setting up an entity is that you can protect yourself from liability, since, in general, only the assets of the entity (rather than your personal assets) would be at risk. Depending on your business, either a C-corporation or a limited liability company (LLC) would likely make most sense. Almost all companies that are going to seek venture capital financing elect to be C-corp.
However, more and more companies that expect to have early and significant cash flow are electing to start out as LLCs. You should discuss which entity is right for you with your tax and legal advisers.
Startups often have more than one founder or associate who contributes early on to the success of the enterprise. It is critical to have a clear understanding among founders, other early contributors and key employees regarding how the ownership of the entity will be allocated. This not only prevents misunderstandings that can erupt into messy legal battles, but also assures investors that claims of ownership from early business partners will not impact the value if their investment.
Not only does a frank and early understanding of the ownership of the entity avoid future problems, but if done correctly, vesting and other mechanisms can provide incentives to achieve critical desired goals.
Ideally, you should form your company and issue shares to founders, key contributors and employees as soon as possible to steer clear of any costly taxes or payments involved in acquiring the stock later when valuations may be higher.
Protect your intellectual property
Make sure that all intellectual property is owned by the company. Obtain licenses of any property obtained from third parties, such as a university. Have all founders, collaborators and future employees sign an assignment of invention agreement and a non-disclosure agreement, assigning any IP related to the business — whether developed before or after formation — to the company. You want to avoid disputes over ownership, as well as a potential competitor from a disgruntled employee or consultant down the road.
In order to make sure these agreements are enforceable, you must provide some consideration in the form of cash or equity. An important and sometimes overlooked step is to document any and all agreements, and properly issue equity.
By taking care of these critical legal matters now, you free yourself and your business partners to concentrate on turning your startup into the thriving company you envision.
Jennifer Berrent is a partner at WilmerHale in the Corporate Practice Group and Emerging Company Group.
She has been working with emerging companies in particular for more than 15 years and is focused on serving as trusted advisor to entrepreneurs and the NYC entrepreneurial community.
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