Co-written by: Ksenia Sourina, General Counsel, Bitooda
- Formation Documents
Before starting any business, the most important initial legal decision is “what’s the right business structure.” A sole proprietorship may be a tempting choice for someone who’s planning to run a one-woman shop, but it may subject that person to a tremendous amount of personal liability. A couple of people starting a business together may think of forming a partnership, but partnerships also have limitations that need to be considered. The most common legal structures for startups are C-corporations and limited liability companies (LLCs). Each presents its own advantages and disadvantages that we will explore in a different post.
Once the decision is made as to the form of the structure, the next important step is to file with your state of incorporation a distinct legal entity for your business. After that, a filing must be made with the IRS to receive a unique employer identification number. Your entity will be a unique legal “creature” that must file its own tax returns.
Some states, like Delaware, are known to be friendly to founders and company management. Additional registrations, such as those involving registered agents may be required if a startup, for example, does most of its business in New York, but is incorporated in Delaware. The choices of the entity type and the state of incorporation are important ones to make, as they would impact the life of entity (i.e., its corporate governance), taxation, and more.
- Corporate Governance Structure and Documentation
Corporate governance is the rules by which entities are operated and controlled. These rules apply to all types of entities; corporations, LLCs, partnerships, and may even be helpful for sole-proprietorships. Since most startups have more than one founder, or even for startups that have just one founder, it is important to establish a clear corporate governance structure to allocate the rights and responsibilities of each founder. For example, a company’s corporate governance documents would typically specify what happens if the founders disagree on a decision or what kind of approval is needed for an item of capital expenditure.
Corporate governance documents should go beyond what is required in the incorporation documents. For example, it is not necessary to spell out in your incorporation documents what happens if each founder has 50% of the shares and they disagree on a decision, but it is something important to put into your corporate governance documents, since those decisions will have a big impact on the corporate entity.
Sometimes, founders of startups start out as friends and family, with quite a few conflicts of interest, and corporate governance allows for the running of the company in a way that minimizes the problems due to these conflicts. All co-founders should sign an operating agreement or by-laws which define the relationship of the founders, how decisions are made, and how conflict resolution will happen.
- Employment Agreements
Employment agreements are used to document the rights, responsibilities, and obligations of the employer and the employee during the employment period (and sometimes thereafter). For both, the employer and the employee, it is important to have an employment agreement. A good employment agreement should include the responsibilities, rights, and obligations of both the employer and the employee. The agreement should basic terms such as salary, hours, and benefits, but also provisions that deal with termination.
A simple misunderstanding about salary, when it’s paid, or what an employee is supposed to be doing as part of her/his job, can turn into a disaster if there is no document that spells out what can be expected. It is also important for the startup employer to protect itself from solicitation, disparagement, or competition upon the termination of employment, and these provisions could all be addressed in the employment agreement.
- Trademarks
A trademark is a symbol, word, or words legally registered or established by use as representing a company or a product. It is important to trademark the name of your company and/or your product if they are unique. The best time to trademark is right at the beginning (sometimes even before the entity is registered but as soon as an idea is born), since that helps protect the startup from others claiming they were using your trademark before you were.
If a trademark or other intellectual property is already established but is not owned by the startup, it should be transferred to the startup via an intellectual property assignment agreement.
Before selecting a company or product name, it’s prudent to search the USPTO Trademark Electronic Search System (TESS) to see if the name you want is taken. This is the link: http://tess2.uspto.gov/bin/gate.exe. But note, just because your search may come up with nothing, doesn’t mean that a similar name isn’t already out there for a similar class of goods.
It is also a good idea to search the database in whatever state you will be incorporating to see if the name you’re looking for has already been taken. Even if it hasn’t been trademarked, but is already taken at the state level, may pose some unique challenges.
- Non-Disclosure Agreements
A non-disclosure agreement (NDA) is a contract that outlines what your startup considers confidential information that you will be sharing with your employees, vendors, etc., but would not like them to share with other parties. For example, perhaps your company has a unique process by which it generates leads, and this process is something your new marketing employee needs to know in order to do her job. In the NDA you could specify that your employee isn’t allowed to share this information with anyone outside the company, and the penalties that would apply if she/he breaches the contract.
Oftentimes the definition of confidential information is quite broad, which would discourage the party from disclosing anything about the company. It is also important to consider what specific information should be included within the definition in order to expect the maximum likelihood of it being enforceable, should the contract ever be challenged in court.
- Licenses
A license is official permission to do something. Many businesses require licenses in order to operate. For example, a business that provides facials may need a salon license, even if it’s not a true hair salon. In some states, only certain licensed individuals can open certain businesses, such as medical practices, so a non-doctor can’t own a medical practice, and a non-lawyer can’t own a law practice.
Businesses dealing with food may need a license from the Food and Drug Administration. Businesses that provide financial services, accounting, or other professional advisory services, may need licenses from the respective regulators. In each case, the startup should consider what federal, as well as state-level licenses, may apply to them depending on the nature of their business.
- Commercial Leases
A lot of startups are born in someone’s living room, garage, etc. However, once the company grows, it will be ready to lease a commercial space. Commercial space may anything from a desk in a co-working space to an entire building. At that point, you’ll discover that commercial leases are very different from residential leases. For example, 5-year lease terms are common, 2-3 months of security deposits are expected, and the agreements are often 50+ pages long. Paying for your share of building expenses like taxes, maintenance, etc. are all common are well.
Unlike residential leases, commercial leases are often heavily negotiated, so a startup should be ready to address its rights and responsibilities, as otherwise, it may end up with quite one-sided terms in favor of their landlord. It is important to have your commercial lease reviewed by an attorney because it is usually a substantial financial long-term obligation that you don’t want to get wrong.
For a lot of startups, a commercial lease may need to be personally guaranteed by the founder(s) in order for the landlord to rent the space to the company. Thus, an important discussion among founders may have to be regarding this obligation and who’s going to be the one to guarantee the lease and how will they get compensated for doing so. Such terms may be addressed in the corporate governance documentation that we discussed earlier.
- Customer Agreements
A startup should establish clear rules by which its customers will purchase its products or use its services. A good customer agreement would help avoid misunderstandings, bad online reviews, and expensive lawsuits, Initially, the founders may not know exactly what their product or service may be, and may pivot 100 times. However, having clear terms of use on the website and a clear return policy on the receipts are examples of the types of customer agreements that are essential.
- Vendor Agreements
Many startups don’t make goods or services from scratch and thus have key vendors with whom they do business. Other startups may outsource some of their services, such as website maintenance. Having written vendor agreements is important to avoid misunderstandings when a business arrangement goes sour. The agreement should be in place before doing any business.
If having a particular vendor’s services or goods is critical to your startup’s success, it would be prudent to put in that vendor agreement the consequences to the vendor of failing to meet obligations. A vendor agreement should spell out any penalties that the vendor would be required to pay should such vendor fail to meet its obligations. Other important terms to have in vendor agreements are price and the timing of delivery of the vendor’s goods or services.
- Shareholder Agreements
Once your startup is ready to take on investors, it’s crucial to have the investors sign a detailed shareholder agreement, so they know what to expect from the startup (and sometimes, more importantly, what not to expect). A shareholder agreement is a legal contract agreed by all the shareholders of the startup. It regulates the way that business between shareholders, and between the shareholders and the startup is conducted.
By the way, bylaws and shareholder agreements are two very different documents. A corporation’s bylaws set out the day-to-day operations of the company; whereas shareholder agreements govern the rights of the shareholders of the company.