5 Legal Questions Every Startup Should Ask

Before your charge headlong into the frenzy of your baby company, ask yourself these important legal questions:

Founders

How will we protect us from ourselves?
The biggest risk inherent in starting up is in the fact that founders are human beings. As humans, we can be irrational, selfish, unpredictable and emotional. Conflict within the management team is one of the major causes of business failure. Awareness of the potential for interpersonal conflict is a key first step towards mitigating its potential negative impact on the company. A great second step is to integrate tools into the operational documents of the company that anticipate conflict among founders. Before jumping headlong into the frenzy of building a business, founders should take a careful look at:

• Equity division: Equal division is not always the fairest or best arrangement for the company
• Tie-breaking power: Consider assigning ultimate tie-breaking power to a particular shareholder, officer, advisor, or other third party.
• Shareholder protections: Certain provisions can save a minority shareholder from being hurt by majority decisions. Drag-along and tag-along rights ensure that a minority shareholder doesn’t get stuck with a random majority shareholder. Rights of first refusal or first offer can ensure that no shareholder (majority or minority) gets stuck with random co-owners.

Formation

How will we protect ourselves from others?
Different entity types offer different levels of protection from liability. Partnerships and sole proprietorships can leave founders at risk of losing their personal assets should the business be liable for damages. Common wisdom is to form a limited liability company (LLC) or corporation, each of which provide a layer of protection and prevent creditors from collecting the founders’ personal assets to satisfy business debts. There are significant tax and regulatory differences between LLCs and corporations, so founders should research and choose carefully. In addition, the state in which a business is formed can affect the outcome of business-related conflict. Delaware is a popular state for incorporation because it has a well-established body of corporate law, which makes court decisions more predictable. It also is significantly more expensive to file in Delaware than other states. Read more on choice of entity and state of incorporation.

Employees/Contractors

How will we protect ourselves from our people?
Employees can be a company’s biggest asset and their biggest source of exposure. Founders should take a good look at how they use employees: Does it make more sense to hire W-2 employees or use 1099 contractors? Are the employees privy to confidential information? Do the employees create intellectual property for the company?

Whatever the specifics with regard to employees/contractors may be, founders should make sure that they properly document the services they receive. Employees should typically sign an offer letter, where contractors should sign a Contractor or Non-Circumvention Agreement. All employees/contractors should execute agreements to keep corporate information confidential and assign all IP they create in their jobs to the company.

Intellectual Property

How will we protect our intellectual property?
For a lean startup, intellectual property is frequently the most valuable asset. Founders should examine the types of intellectual property they have and create a plan to protect it. Intellectual property can be a unique design or idea, software or code, media, a trademark or brand, or a proprietary recipe or method. Each of these type of IP requires a different type of protection – patent, copyright, trademark or a trade secret program. If intellectual property is the life blood of your startup, an important early step is to make sure it can’t be stolen or misappropriated.

It is equally important to make sure that ownership of the intellectual property is clear. The employee documentation discussed above can help. But, bootstrapping startup founders often begin building their companies while still holding down day jobs. It is important to take stock of when and how you are creating your company’s IP, and ensure that you take steps to reduce the risk that a current or past employer will claim some rights in the IP.

Legal Counsel

Who will help?
It is common knowledge that good legal counsel can help you analyze and navigate these typical legal minefields. But, contrary to popular perception, good legal advice doesn’t have to be expensive. Lean startup founders tend to be frugal with their company’s resources, and rightly so. Think of paying for reasonably-priced, reliable legal advice as an essential investment in your company. Otherwise, inevitable mistakes can be even more costly in the future. In addition to the issues above, a prudent startup founder might seek legal advice on:

• Website Terms of Use and Privacy Policy language
• Form customer agreements
• Securities regulations (which impact private companies, too)
• Contract review
• Corporate operational policies
• Corporate governance procedures and documentation
• Building due diligence portfolio

Each of these legal topics could be a series of articles in and of themselves. So, use this list as a starting point for organizing your startup’s legal inquiries. Find an attorney you trust. And, get cracking.