What is the most common mistake startup founders make during early growth? Not establishing a strong legal structure off the bat. While it’s tempting to dig into the vision for your company and start making your idea a reality, it’s important that founders pause and cover their legal bases. Below, we’ve outlined the core seven legal documents that founders need to put into place to avoid costly legal battles down the road.
1. Articles of Incorporation
A common mistake startup founders make is failing to put the proper business structure in place. Setting up only a sole proprietorship can result in huge income tax bills and legal liabilities for which founders are personally responsible. By not filing with the Internal Revenue Service to form a distinct legal entity for their business, founders risk losing their personal savings and, in some extreme cases, their homes.
While all options have their pros and cons, for the most part, startups with multiple shareholders should form a C corporation. Businesses that want fewer tax obligations and want to avoid heavier fees during early growth should consider forming a limited liability company (LLC).
Related: What to Consider When Deciding Between Forming a Sole Proprietorship or LLC
2. Intellectual Property (IP) Assignment Agreement
An IP assignment agreement could be the key legal document that determines whether your startup can attract the investments it needs in order to grow. This is especially true for technology companies, because it’s often the value of your IP portfolio that investors and venture capital firms are evaluating.
Startup founders should have complete ownership of all IP assets in writing to avoid costly claims filed by patent trolls and companies trying to copy your business model, among others. During the formation of a new company, a best practice is to assign all relevant intellectual property to the company. There are two types of IP assignment agreements to consider:
Technology Assignment Agreements assign startups any intellectual property created before forming the company. Developers may in certain instances retain individual IP ownership rights, or they may sell their rights in exchange for equity or cash.
Invention Assignment Agreements assign the new company IP ownership of any relevant work product created by employees after the company’s formation. A confidentiality and invention assignment agreement is typically signed by founder(s) and employees. The company will own all rights to the IP portfolio.
3. Bylaws
In order to ensure that a startup operates with as little complications as possible, founders should formulate strong bylaws off the bat. Bylaws should establish the internal rules of the company like how to settle disputes, select leadership and determine the rights and powers of shareholders. Most importantly, bylaws should institute voting thresholds for approvals to certain actions by the corporation like electing new board members or entering into debt.
4. Operating Agreement (Founder’s Agreement)
To avoid any conflict among founding parties, all co-founders should sign a comprehensive operating agreement. The agreement should define the relationship of the founders, provide the expectation that all work will belong to some entity in the future and outline a basic communication and conflict-resolution clause that can help prevent disputes.
Related: The Rules and Regulations of Being a Franchisor
5. Non-Disclosure Agreements
Having a non-disclosure agreement (NDA) readily available is imperative before any business conversations take place between you and an outside party. From the moment a prospective employee or investor walks through your door, you need to have an NDA agreement waiting for them to sign. NDAs protect your startup by safeguarding your founder and employees’ ideas and your intellectual property. An NDA should specify the following:
What constitutes confidential information
How confidential information should be handled
Who owns that information (the company)
The time period that the information will be disclosed
The time period confidentiality will be maintained
6. Employee Contracts and Offer Letters
Startup CEOs and founders should draw up clear employment contracts and offer letters when hiring new employees. These legal documents are key to ensure employees understand what’s expected of them. They should clearly state the following.
Terms of employment (e.g., compensation, role responsibilities, working hours and grounds for termination)
Reporting structure
IP ownership of work
Expectations
Required commitments
Share vesting
Company policies (e.g., vacation days, paid time off structure, dress code)
7. Shareholder Agreements
Finally, when a startup is ready to take on private investments, CEOs should create a shareholder agreement that determines the rights of shareholders and defines when they can exercise those rights. Those rights can include shareholders’ right to transfer shares, right of first refusal, redemption upon death or disability and shareholders’ power to manage and run the startup. It’s also important that founders document the sale of any shares to avoid huge financial penalties under state and federal laws.
While time is a precious resource for any startup, founders should prioritize putting these agreements into place to secure their company’s future.
Posted By: branford rogers
Wednesday, January 13th 2016 at 10:14AM
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