If you are a startup or small business, the number of tasks you are juggling at any given time can be daunting. Whether it is trying to land your next big customer, improving your website, building relationships with vendors or securing top talent, the list goes on and on. It’s for this reason that many times startups do not focus on getting legal documents in order at the outset. However, with a little upfront legal planning, startups can avoid a lot of headaches down the road.
Below are four areas where startups should have sound legal documentation in place:
If you are a startup, you will likely want to want to form a C-corporation or limited liability company for your business. One of the main reasons startups choose to form an entity is because it generally shields business owners from personal liability. In other words, the debts and obligations of the business are distinct from the owners and if there is a loss, the owners’ assets are not subject to being utilized to satisfy those losses. Common considerations in deciding which entity is appropriate for your business usually involve the number of founders, employees, frequency of equity grants, limitation of liability, tax treatment and whether there is a need to raise outside capital.
Forming a C-corporation or limited liability company is relatively easy and usually requires simply filing a certificate of incorporation or certificate of formation, respectively, with the applicable Secretary of State and paying applicable filing fees. In addition to forming the legal entity, a corporation should have bylaws in place and a limited liability company, an operating agreement. These agreements are important because they outline how the entity will operate and include provisions related to voting, decision-making authority, election of directors or managers, and if desired, consent thresholds required for undertaking certain important actions (for instance, raising debt or issuing additional securities).
Employment and independent contractors
As your business grows and you need to hire employees or independent contractors, it is important to have appropriate documentation in place that sets out the terms of the relationship and the expectations of each party. For instance, an employment agreement or offer letter should include concepts relating to reporting obligations, title and role, compensation and benefits, and the nature of the employment (i.e. at-will or for a fixed term). Even if you retain an independent contractor for discrete services, you should enter into an independent contractor agreement that sets forth, among other things, the scope of services, payment terms and terms of the services. If a relationship does not work out, both the company and employee or independent contractor have a clear sense of what their rights and obligations are.
Protection of information
Protecting a company’s information can be vital to the success of any business. After all, it is likely that your business is based on something that makes it unique. That is exactly why when there is a need to share your sensitive information, it should be done under appropriate circumstances with appropriate protection for the company. This is true whether the information is being shared internally amongst employees or with third parties. In the context of employees, they should be required to sign a non-disclosure agreement as part of their employment. The terms of the non-disclosure provision may either be in a stand-alone document or incorporated as part of another document, such as an offer letter or invention assignment agreement (see below).
In the context of third parties, a non-disclosure agreement should be utilized if there is any possibility that sensitive information will be disclosed. A non-disclosure agreement does two things: (i) protects disclosure of sensitive information to third parties, and (ii) protects against information disclosed to be used for purposes not expressly provided for in the agreement (for instance, entering into a mutually beneficial relationship). The latter concept ensures that potential competitors to whom you have shared information with don’t use the information for their own benefit to gain a competitive advantage.
Protection of intellectual property
Similar to sensitive information, for some businesses (especially tech and software companies), a lot of the value of the business can be derived from its intellectual property. It is important that all intellectual property relating to the business is owned by the business, as opposed to being individually owned by the founders or other employees. If an employee or founder leaves, you don’t want the intellectual property they created leaving with them. An invention assignment agreement should be utilized to prevent this from occurring. Simply put, this agreement gives the employer ownership rights in the intellectual property created during the employee’s employment with the company.
It is important to note that if founders created any intellectual property relating to the business prior to an entity being formed, they should assign the intellectual property to the entity.