By nature, founders are big-picture thinkers; we relish the opportunity to create novel ways of doing things. The issue is that sometimes we attempt to portray a wider picture before establishing the basics of really running a business. The legal aspect of starting a business is sometimes viewed as a time-consuming duty that is tossed aside until it becomes an urgent requirement. However, in order for your firm to operate freely, this must come first, before you consider acquiring clients, adding personnel, or finally presenting to investors.
A business’s legal structure ensures that your service or product is protected, that you are not operating unlawfully, and that you do not lose out if your team changes. The Winklevoss twins, who notably failed to properly document the early phases of their social media network, allowing Mark Zuckerberg to launch Facebook using some of the code he had built for them, are a classic example of not doing this correctly.
Despite their ease of avoidance, legal problems are a leading cause of startup failure. Founders who do not recognize their legal needs early on may discover a major issue with their business much later in the trip.
To ensure that you are legally protected, follow these steps to establish your legal framework, as taught by the experts.
As soon as possible, define your intellectual property.
This is the initial, and arguably most critical, legal step you should take with your business. If you do not design a complete intellectual property strategy early on (even before you begin constructing anything concrete), someone else may assert ownership of your ideas, patents, or trademarks. For example, a former employee may leave your startup and build their own utilizing your fundamental ideas, or a loose-tongued CEO boasting about your algorithm at a conference may see a competitor rapidly patent it ahead of you. Bear in mind that intellectual property rights are a first come, first served basis.
Additionally, if your product is not protected, you risk being accused of patent or copyright infringement by other businesses—possibly competitors with similar business models or previous employers alleging you stole an idea from them.
The individual responsible for identifying intellectual property is determined by the organizational structure of your business. While the CEO, CTO, or product lead typically takes the lead, it might be good to include other team members in the discussion to gain a different view on which aspects of your organization should be classified as intellectual property. For example, more businesses are choosing to secure data such as financial information, cloud-based materials, user profiles, and device information in the digital era.
Begin by registering trademarks and patents with the United States Patent and Trademark Office. A trademark filing typically costs between $400 and $600, depending on the breadth of products and services for which the mark is being used. Patents are expensive, costing several thousand dollars. This may seem like a significant fee for early-stage ventures, but it is a drop in the bucket compared to the cost of not filing and being later charged of infringement.
Jim Gatto, Sheppard Mullin’s open source team leader, states “Patenting is not a one-time event; founders should get legal assistance early on to determine what is and is not patentable, as well as any deadlines they must satisfy. This cycle must be repeated as products evolve and further features are added.”
Prepare a comprehensive co-founder and equity agreement.
If you’re co-founding a business with another individual, you absolutely must have a co-founder agreement. Often, founders embark on their journey with a great relationship, only to discover that it deteriorates as the going gets difficult. Legally establishing ownership and obligations, as well as what happens if things go wrong, may help assure your financial security in any situation—and can spare you a lot of difficult talks.
A co-founder agreement should clearly define who owns what percentage of the business and how stock is distributed. There is no hard and fast rule for how stock should be distributed; this should be determined on an individual basis depending on the contributions of each co-founder. It’s advisable to consult an accountant in advance to determine the value of current firm assets and to incorporate them into the agreement. Similarly, the agreement should include non-disclosure provisions that prohibit founders from using company information to work for or establish a rival business. Additionally, Gatto notes that “it is critical for all founders to agree in writing to assign the company’s intellectual property.” Without this, if a founder leaves, the company may not hold all of the founder’s intellectual property.”
According to Alan Gongora, managing partner of Langon Law Group LLC, “A co-founder agreement serves as your startup’s constitution. It’s the document that will serve as a reference for roles, ownership, and salaries—all of which are legally binding; and if someone departs, it’s the document that will explain their entitlements.”
While you and your co-founders can design a co-founder agreement, it should be reviewed by a lawyer and, once confirmed, a copy distributed to all parties involved.
Recognize your legal obligations as you mature.
No matter where your business is in its lifecycle, scaling should be a consideration in your legal framework. Every firm wants to expand, and the sooner you understand the legal requirements, the more quickly and efficiently you may do so.
If your firm intends to have an international team or customer base, you must understand the following: whether you must register a formal corporation in foreign countries, whether foreign partners can hold a portion of your company, and the tax implications of selling outside the United States. Not only are these points vital to avoid hefty fines, but they will also assist you in determining your profit margins.
Gongora suggests, “rather than beginning in another country, experiment with other formats that allow for greater flexibility.” For instance, companies are embracing offshore models—in which a component of their staff is based overseas—in order to reduce operational costs and leverage local knowledge into prospective international markets to disrupt. Remote supports offshoring models by acting as the employer of record, which eliminates the need to establish an international corporation in order to scale internationally.
Offshoring has a number of advantages, but it does necessitate engaging with an agency or establishing a distribution agreement with offshoring companies and employees. Similar to a co-founder agreement, this document should explain who is engaged, how much money is being exchanged, and how firm data is protected. Again, you should consult a lawyer to ensure that you are complying with both local and US rules while offshore.
While speaking with an attorney upfront is always more beneficial because the advice is customized for your business, if you’re on a tight budget, you can conduct your own study using online tools. Gatto recommends reading blogs from prominent law firms or subscribing to mobile alerts from regulatory and judicial agencies in your business (for example, the Food and Drug Administration) to stay informed about new rules and litigation affecting the locations you’re targeting.
However, investing a little time up front with an attorney can prove to be a priceless investment. In a short period of time, a competent attorney can advise you on a thorough intellectual property strategy and identify any regulatory difficulties that may affect your firm. Frequently, cutting-edge enterprises face hidden regulatory concerns.
Conduct due diligence prior to funding.
Having a brilliant idea alone is insufficient to attract substantial investment. Investors will always conduct due diligence to ensure that you own and protect your intellectual property, have sound contracts and agreements, and are consistent with all regulatory requirements in the jurisdictions in which you intend to operate. If you are not, you will be deemed unsuitable for funding. Gatto suggests approaching it similarly to selling a house: “Before you put your home on the market, you should do a thorough examination and address any issues. Nobody will buy a house if it has cracks and holes that could cause major difficulties in the future.”
For instance, if your product incorporates open-source software, you should ensure that none of the open-source licenses creates legal complications. According to Gatto, “certain open-source licenses demand that you make the source code of your product available to others if you use the open source in your work.” If an investor learns about this during due diligence, it could be a deal breaker. Conduct a code scan prior to diligence to weed out any dangerous open source.
Before you seek money, consult with a lawyer to create a detailed checklist of the legal steps you must complete first. Take note that the checklist will change depending on the type of finance you’re seeking—for example, crowdfunding will require a different legal structure than private angel investment.
Without a legal structure, your business may halt just as it begins to acquire momentum. By addressing these processes early on, you and your firm will be able to sail effortlessly into the more exciting phases of your journey, without worry of needless stumbling blocks.