What is the most typical blunder made by business entrepreneurs during their early stages of development? Not developing a solid legal framework right away. While it’s tempting to get right into your company’s vision and start putting your plan into action, founders should take a step back and make sure they’ve covered all of their legal bases. The basic seven legal documents that founders must put in place to avoid costly legal challenges down the road are listed below.
1. Articles of Incorporation
Failure to establish a correct business structure is a common mistake made by startup entrepreneurs. A sole proprietorship might produce in large income tax bills and legal issues that the founders are individually liable for. Founders risk losing their personal funds and, in some cases, their houses if they do not file with the Internal Revenue Service to form a separate legal organization for their business.
While each option has advantages and disadvantages, companies with multiple shareholders should generally incorporate a C corporation. Businesses that want to reduce their tax requirements and avoid paying higher costs during their early stages of development can consider incorporating a limited liability company (LLC).
2. Intellectual Property Assignment Agreement
An IP assignment agreement may be the most important legal document that decides whether or not your startup will be able to raise the funds it requires to expand. This is especially true for technology companies, because investors and venture capital firms frequently assess the worth of your IP portfolio.
To avoid costly lawsuits from patent trolls and companies attempting to duplicate your business model, among other things, startup founders should have complete ownership of all IP assets in writing. A best practice when forming a new company is to assign all applicable intellectual property to the company. Consider the following two types of IP assignment agreements:
- Technology Assignment Agreements assign any intellectual property generated prior to the formation of the company to the startup. Individual IP ownership rights may be retained by developers in some cases, or they may sell their rights in return for equity or cash.
- Invention Assignment Agreements transfer IP ownership of any relevant work product developed by workers after the formation of the company to the new company. Founders and staff generally sign a secrecy and innovation assignment agreement. The corporation will be the sole owner of the IP portfolio.
Founders should create robust bylaws right away to guarantee that a firm works with as few issues as possible. Bylaws should spell out the company’s internal rules, such as how to resolve disputes, choose leadership, and define shareholders’ rights and powers. Most crucially, bylaws should provide vote thresholds for approvals of specific corporate operations, such as the election of new board members or the incurring of debt.
4. Operating Agreement (Founder’s Agreement)
All co-founders should sign a complete operating agreement to avoid any potential conflicts. The agreement should spell out the founders’ relationship, state that all work will eventually belong to someone, and include a basic communication and conflict-resolution clause to assist avoid future disagreements.
5. Non-Disclosure Agreements (NDAs)
Before any business interactions take place between you and an outside party, you must have a non-disclosure agreement (NDA) on hand. You should have an NDA agreement ready for a potential employee or investor the moment they come through your door. NDAs secure your startup’s intellectual property and the ideas of your founders and employees. The following should be included in an NDA:
- 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
When employing new staff, startup CEOs and founders should create detailed employment contracts and offer letters. These legal documents are essential for ensuring that employees understand their responsibilities. The following should be stated clearly.
- Terms of employment (e.g., compensation, role responsibilities, working hours and grounds for termination)
- Reporting structure
- IP ownership of work
- Required commitments
- Share vesting
- Company policies (e.g., vacation days, paid time off structure, dress code)
Finally, when a company is ready to raise private capital, the CEO should draft a shareholder agreement that spells out shareholders’ rights and when they might exercise them. Shareholders’ rights to transfer shares, right of first refusal, redemption upon death or disability, and power to govern and administer the startup are examples of these rights. It’s also critical for founders to keep track of any stock sales in order to avoid hefty fines under state and federal legislation.
While time is a valuable resource for every startup, entrepreneurs should put these legal agreements in place as soon as possible to ensure their company’s longevity.