Startup Law 101: Key legal issues an early-stage entrepreneur must be aware of
Why do I need legal assistance at the early stage? What legal issues should I address at this stage keeping in mind the future? How can I identify the right legal advisor or law firm for my business? These are three key questions early-stage entrepreneurs must ask themselves.
By Team Smart CEO Media Labs
Often, in the quest for growth and scalability of a business idea, founders (of startups) miss out on researching, forming and implementing key legal documents, which ensure a smooth journey for a startup in the long run. We can quote one too many instances where the absence of a legal framework has created a dent in the business or slowed its pace of growth. A classic example (popularized by the movie The Social Network) is the Winklevoss Twins vs. Facebook case, where Mark Zuckerberg entered into a verbal agreement with the twins to help create HarvardConnection in return for equity, while parallelly setting up TheFacebook.com. Closer to home, we often hear of disagreements between co-founders, because of lack of clear legal documents detailing the agreement between a startups’ founders or even with early-stage employees.
Keeping such case studies in mind, in our first blog, we take a peek into the nuances of having a clear legal framework and strategy right from the early days.
The first step, quiet obviously, after you decide to startup is to figure out how you want to incorporate your company.
As a startup, you can register your company as a private limited company, a sole proprietorship, a limited liability partnership (LLP), or a partnership. The co-founders must collectively decide the type of entity they want to form, keeping in mind the venture’s long-term plans. Right from the incorporation stage, we’d recommend you to work with a lawyer to get the documents in place. Each type of entity has its own advantages and disadvantages – in terms of tax, personal liabilities, future fund raising factors and so on. Even the location where you incorporate your company matters, and expert opinion becomes crucial in all these matters.
The co-founder agreement
The second, crucial step lies in creating a comprehensible shareholder agreement with your co-founder or business partner. Today, more than ever, a lot of startups are founded with multiple co-founders on board. And, typically, a conflict between the founders arises when the business is either taking off or is on a downward spiral. In such circumstances, a co-founder agreement will come in handy. It should cover critical aspects such as the common goal of the company, the roles and responsibilities of each founder, the ownership percentage, the salaries that each founder is entitled to, the dilution strategy; who will dilute, when, the extent of dilution and more.
An IP strategy
The third aspect lies in the protection of core intellectual property. If you have a unique product, technology, platform or process, or if you are outsourcing part of the development to an independent developer or external service provider, it is vital to come to a clear agreement on who owns the code and content. In fact, it is advisable to create an agreement, which states clearly that the ownership lies with the company and not with the service provider you have engaged.
The role of intellectual property, especially in technology-oriented businesses, is turning out to be extremely crucial in today’s world. It is important to work with the right IP experts to file copyrights, trademarks and other forms of IP and even plan your future IP strategy. It is also crucial not only to create IP, but also to monetize and protect ones IP rights, and the right legal partner can make a huge difference in all these areas.
Having a contract
The world of entrepreneurship has changed remarkably in the last decade or so. Companies are relying a lot more not only on full-time employees but also on part-time talent and even a network of partners. For example, large startups like Ola Cabs operate with a network for drivers, none of whom are full-time employees. Companies like Snapdeal rely on online seller-partners, who’re small businesses.
In most of these situations, problems can potentially arise due to disagreements. The role of a watertight contract becomes all the more crucial. We’d strongly recommend having contract with all key relationships your business has – with employees, partners, vendors and clients.
While the actual nature of the contract will obviously vary, a good contract will be drafted by thinking through all possible scenarios and corner cases, over the long-term. Often, contracts tend to miss out on timelines. For example, if a client says you cannot work for a competitor, as a startup protecting your own interests, you should add a timeline to it and say you will not work with a competitor for 3 months after the current project ends.
Identifying the right lawyer/law firm
With the advent of Internet and digital platforms, to search and identify legal firms/advisors may seem like a breeze. However, it is essential that you work with a firm or individual who understands your business and has prior expertise in the sector you operate in. In fact, the best strategy to identify the right firm or individual is to go through word-of-mouth or referrals. That way, you can avoid a future mismatch between what was committed, what was delivered and what is protected.
Startup founders often avoid going to a law firm to save some cash in the early days. However, a better strategy would be to identify a law firm or lawyer through your entrepreneur peers and go with a firm that has a transparent and fair fee structure.
While in the early days it is advisable to work on a project-based fee model, and as the startup scales up, one can move into hourly billing or retainer model.
At a macro level, the need for legal assistance at any startup must be linked with key business milestones. The milestones can be in the form of revenue generated, the number of customers you have secured, the regions you have expanded into, and more.
Over time, as the business expands, you may need to onboard a full-time legal officer and then even setup a full-time team.
Till then, do not ignore your legal needs; work with the right law firm to ensure all key legal documents are in place. It can make a critical difference in important junctures – while you’re fund raising, trying to exit your business or even while you ramp up your team.
Happy starting up!