As an entrepreneur on a mission to launch a new startup company, your days likely involve charging through a never-ending to-do list and working to overcome unpredictable obstacles without dropping any critical deliverables.
There are countless decisions to make and steps to take to help you de-risk and grow your company from the ground up. To position both yourself — as a founder — and the business for success, seek experienced legal support to guide you through this early evolution.
Imagine having to rely solely on WebMD as a diagnostic and prescriptive tool any time you experience a health concern, as opposed to speaking directly with a doctor. The same can be said for attempting to establish a new business venture without any direct legal counsel. It makes a world of a difference to have a true professional who can give accurate and factual information and guidance. It may also save you tremendous time and money as you eliminate the likelihood of having to react quickly and course-correct down the road — particularly when it comes to a few key early decisions.
Choosing an entity
When you’re just getting started, an entity is the first thing you must choose: Should you opt for a C-corporation or a limited liability company (LLC), and in which jurisdiction does it make the most sense to put that entity? Founders often default to registering their business as an LLC in their local jurisdiction.
Because so many organizations are formed in Delaware, the legal precedence and regulations are very sophisticated, well-defined and predictable. It’s a business-friendly state, and you can expect very rapid turnaround or response time for critical filings, such as a certificate of amendment. Most investors strongly prefer to invest in a Delaware entity since their investment documents and most of their portfolio companies are based there.
Investors want to avoid the pass-through tax treatment they would experience if investing in an LLC, so they often require startups to establish themselves as a C-corporation in Delaware before investing.
Both C-corporations and LLCs have different tax benefits that are fact- and circumstance-driven and your attorney can guide you through this analysis.
Identifying, recruiting and classifying cofounders
As you move forward with the launch, are there others involved in the founding process? What are their contributions in coming up with the idea? How much time and money are these people committing relative to each other? These are key factors to consider in deciding how to allocate percentages of ownership.
Founders should structure their ownership so that they vest into ownership over several years, so if a founding individual leaves for any reason, they can only take with them the shares that have vested. From an investor’s perspective, there’s great comfort in knowing a team of founders is committed for the long term if the investor puts money into the company.
Building a team of employees and contractors
As you grow your team and vet potential advisors, employees and consultants, make sure you’re classifying each one correctly, ensuring you have all of the documentation in place to bring them on board. This could include an advisory agreement, restrictive covenant contract and consulting agreement or employment offer letter — all of which protect the company, including confidentiality, intellectual property and non-solicitation.
Legal counsel will provide clarity and structure as you grow your team. If you’re adding numerous employees, for example, you’ll be advised to put an Equity Incentive Plan into place, giving each of them stock options which offer a stake in the growth of the company. There are various advantages and disadvantages for employee stock options, particularly when it comes to taxes, depending on the entity you choose, so make sure you weigh all of the options with your attorney.
While growing your team is exciting, you’ll want to avoid several pitfalls that can add significant costs to correct down the road and may even impact your ability to raise capital in the future.
Protect all of your intellectual property
When safeguarding your IP, you have two very important obligations: 1) Make sure a Proprietary Information and Inventions Assignment Agreement (PIIAA) is signed by all members of the organization, and 2) Get a trademark for the brand. The PIIAA ensures that all intellectual property of the founders related to the business, and all work any team member does for the company as a consultant or an employee, belongs to the company and not the individual.
From an investor perspective, if there is a departed cofounder or early employee who may, at some point, challenge the IP ownership, that presents a risk that may impact their decision on whether or not to invest.
We’re just scratching the surface, but even amongst these early action items, the waters can be murky and difficult to navigate without the guidance of a legal professional experienced in working with startup companies. Make the investment, protect yourself and your company and avoid any future stress, roadblocks, expenses or investor resistance moving forward.
Knowledge is power!
Subscribe for free today and stay up to date with news and tips you need to grow your career and connect with our vibrant tech community.