1. Choosing the Right Legal Structure
One of the first decisions startups are faced with is the type of legal structure to choose. To incorporate or not to incorporate? That is the question.
Many entrepreneurs will postpone incorporating their business to avoid the costs associated with incorporation. Putting off incorporating may save you money in the short term, but invariably, the delay creates legal risk because running a business as a general partnership (or a sole proprietor if you’re flying solo) leaves you open to unlimited personal liability.
Incorporating also offers significant advantages for founders and subsequent investors. A corporate entity provides significant liability protection and offers tax savings through benefits and deductions that are not available to sole proprietorships or partnerships. In addition, an incorporated business is much more attractive to investors given the limited liability and the transferability of shares. Venture capitalists and angel investors often prefer working with corporations because they allow for a share structure with different classes of shares.
On the other hand, some entrepreneurs choose to save some money by braving the incorporation procedure on their own. Once again, this may save you money in the short term, but often leads to cookie-cutter share structures that are not appropriate for the unique needs of your company and its investors. So, chances are, when you’re ready to raise investment capital, you will need to consult a lawyer to fix your share structure to make it founder- and investor-ready. This will inevitably cost you more in the long run because reactive legal work is always more expensive than proactive legal work.
2. Naming Your Company
Finding a company name is one of the most challenging items on the list of first tasks for a startup. A Google search will provide you with a long list of resources on branding to help you in this creative process. But branding isn’t the only thing at stake when you’re looking for a company name. Before you start printing those business cards, you should consider some important legal issues.
Unless you are operating as a sole proprietorship under your personal name, you will need to register your business name in the province in which you are operating. To register a business name for a corporation, the proposed name must meet several requirements. First, the name must include a distinctive element, which is used to differentiate your proposed name from the names of other businesses that carry on the same activities. Second, the name must include a descriptive element, which is used to describe the nature of the business and can also be used to allow identical or similar distinctive elements. Finally, the last word in the name of an incorporated company must be the corporate designation (such as “Ltd.” or “Inc.”).
In addition to these requirements, you must ensure that your name is not too similar to an existing company’s name or trade-mark in the country in which you carry on business. The last thing you want is to spend significant time and resources on developing your brand, only to end up spending even more time and resources changing your brand or defending a trade-mark infringement lawsuit.
On a practical note, as part of your branding process, you should give some thought to your online presence. Is the domain name available for your chosen business name? If not, are you willing to settle for .ca over .com? There is no sense in spending the time and money to develop a brand if your customers can’t find you online.
3. Founder Issues
Often, a great idea is born out of a night of random banter over drinks with your good buddy. Before you know it, you have a brilliant concept and are on your way to creating your very own startup. But before you go too far down that road, you’ll want to make sure you’ve taken the necessary steps to protect yourself and your business.
Even if you are getting into business with your best friend of 20 years, it is important to have a solid understanding with your co-founder or co-founders about the business terms of your arrangement. Does the Zuckerberg/Winkelvoss twins Facebook litigation ring a bell? If you don’t stay up late at night reading US judicial court orders like I do, think back to the movie The Social Network and you’ll understand the problems that can arise between founders as the business evolves.
Most founder disputes can be avoided through founder control documents such as shareholders’ agreements and founder vesting agreements.
A shareholders’ agreement is a contract between some or all of the shareholders of a company that addresses certain key issues such as the management and operation of the company, shareholders’ rights, and restrictions related to the shares of the company. It should also include dispute resolution provisions to deal with any disagreement between the parties. Think of it like a pre-nuptial agreement—you hope you won’t need it, but if you ever do, you’ll be happy you have it.
A founder vesting agreement (sometimes referred to as a reverse vesting agreement) puts in place a vesting schedule that requires founders to “earn” their shares based on a performance commitment or continued participation in the business. It also gives the company the right to buy back the shares of a founder upon certain triggering events, such as the founder leaving. There are few situations worse than an ex-founder who keeps his hand in the pot and, with it, maintains his right to access your company’s non-public financial and other business information.
4. IP Ownership and Assignment
A technology startup’s most valuable asset is… well, its technology. It is important to ensure that your company has full ownership of any intellectual property that is necessary for the operation and success of your business. To do this, all founders should be required to assign their intellectual property to the company and waive all moral rights for the period both before and after the incorporation of the company. This protects the value of the company, which is a critical issue for investors.
But, to have an effective IP assignment, you first have to have rights to the IP. Founders of a startup are sometimes surprised to find out that their IP is actually owned by one of the founders’ current or previous employers. This situation may come about when a founder was “moonlighting” for the startup while still employed at his day job. Accordingly, it is important for each founder to review the employment agreement with his previous or current employer to ensure that he actually has ownership over any IP that was created for the new venture and to ensure that he is not in violation of any non-competition provisions.
5. Looking for Strategic Investment
When you’re ready to raise investment capital, it is important to carefully consider the kinds of investors you want to bring on. You don’t just want money, you want smart money. Investors that come with industry experience and customer connections will add value to your company far beyond the cash they put in. It’s time to leverage your connections to these sources from your peers, customers, suppliers, and advisors.
A new business venture can be exciting. But remember to step back from all the hype and think through these legal issues before jumping in with both feet. Better yet, work with a lawyer to think through these legal issues before jumping in with both feet. The right lawyer can add significant value and save you time and money in the long run.
When choosing a lawyer to work with, consider whether the lawyer has expertise reaching beyond general corporate law. You want a lawyer who understands the industry and the unique challenges facing technology startups, such as the need for multiple rounds of financing in early stages and the goal to exit the company (if that’s what you want). Finding a lawyer who understands the specific needs and the growth cycle of startups will help you protect your company and maximize the success of your business.
Author: Ava Aslani
This information is general in nature only. You should consult a lawyer before acting on any of this information. This information should not be considered as legal advice. To learn more about your corporate law and technology law needs, please contact our office at (250)448-2637
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