We’ve all heard the grim statistics on how many startups fail. Forbes says 90% will fail; Harvard says it’s 75%. Even if you reject those bleak numbers and buy into Inc.’s comparatively chirpy estimate–that only 50% of young firms will fail–it would be understandable if you believe that startups are well, doomed. It isn’t until you ask why startups fail, that a different story emerges: Most of those startup deaths were entirely preventable. And all they likely needed to survive was some good legal advice.
That’s not hyperbole.
When American Banker identified the ten most common reasons for financial and technology startup fatalities, five were legal issues. Forbes and others have made a similar conclusion in startup autopsies: Startups run (and die) on hand shakes and energy drinks instead of sound legal and business practices.
It’s time to change that. So let’s discuss just a few examples of how solid legal advice can benefit a startup at its early stages: from the very beginning to initial and rapid growth.
1. In The Beginning
Company Creation / Administration
In the beginning, there’s an idea. Then, suddenly, a small group of people are working together, and they call themselves a company. Then what?
Potentially, each person becomes responsible for anything done by that new company. As an example, if one person buys a truckload of supplies on the group’s behalf, but he failed to pay for them, then each person could be held personally responsible for paying the cost.
However, the partners’ legal liability can be limited by creating a corporate structure for the company. The corporate filings effectively establish a legal wall between assets of the company and the assets of its owners and employees: The corporation is responsible–and not the individuals who work for it.
Because there are different structures available–such as a C Corp, S Corp or LLC–having an attorney involved can ensure that you choose the right form at the outset.
Most VCs and angels require that their funded companies be C Corps, incorporated in Delaware. Expect legal fees to pile up if you needed to change an LLC into a C Corp: It’s an expensive, time consuming process.
And in case you’re wondering–yes, Delaware, specifically, because Delaware has developed an unparalleled body of corporate law.
Adoption of a formal business structure has other benefits, too. Well-drawn articles of incorporation and bylaws can enshrine a company’s values and purpose. Such documents will divide up ownership interest, control over the firm, identify exactly who is responsible for what, and prevent disputes before they begin–including what happens if individuals want to part ways.
Informed business counsel can also help a startup with other crucial decisions, as well. Perhaps you want your staff to sign a noncompete clause. If that’s the case, you should be aware that they may be legal in New York when carefully and narrowly drafted, but they’re completely unenforceable in California.
As early as possible, you should start considering the company’s intellectual property–which likely will consist of both trademark, copyright and patent.
Trademarks are really intended to identify a product or service as belonging to one particular provider–therefore protecting a consumer from getting falsely labeled goods, and protecting the provider from damage to its reputation done by those copycats.
Before you settle on a brand name, your trademark attorney should examine existing trademarks, internet registrations and copyrighted works– to make sure that your company name and branding will be free and clear of the. Once you’ve done the initial research, then you can file for trademark applications: You’ll have options to register your name and/or designs (such as a logo).
To be granted a trademark, you need to already have been using the mark–and provide evidence of that use. However, if that hasn’t happened yet, you can file on an “intent to use” basis to get the ball rolling.
Copyright protection has a different purpose. There is no way to protect an idea on its own, but copyright grants you control over the way you expressed this idea. You can receive copyrights for written materials (from novels to software), visual material (photos, selfies, video) and designs (e.g., ship hulls, toys, fabric and jewelry designs).
IP law will also be relevant if you want to keep your work under wraps for now. If so, you may want a nondisclosure agreement ready to go.
How will founders and employees be entitled to ownership in the company they will help build? How can you entice the founder or employee to remain with the company? What’s sweat equity really worth, on the other end?
One way to answer those questions: Restricted stock. In a typical restricted stock agreement, an employee can buy company stock at the current low price, but there’s a vesting schedule–so that the company can retake the stock if the employee leaves early. (Often, vesting is set on a four-year basis, with monthly accrual along the way.)
Additionally, there will be decisions for when to use independent contractors versus employees. There will be vendor invoices, leases and sales contracts to be negotiated and reviewed. And since the other side has lawyers, any company without counsel is at a disadvantage.
Another benefit to having attorneys involved at this stage: Fixing a mistake is always more costly than preventing one. With counsel already on board, a company can take compliance seriously, fulfilling regulatory requirements and more. (A third of small businesses say regulatory issues threaten the life of their business.)
Once you’ve gotten the initial trademark and copyright filings, you want to continue filings of the work product that you generate along the way–updated versions of a website, product catalogues or marketing materials.
New IP issues will arise. For instance, you may want some contracts with vendors to include a license provision that allows them to use your copyrighted materials (e.g., a store could use images from your catalogue).
And what about staff or vendors? When they contribute to your product design or come up with something for your webpage, do your contracts specifically address who owns those contributions?
If not, your employees or vendors probably own them, not you. Discovering that, after the fact, can get expensive. The much better course is to have a contract that addresses that issue, beforehand.
3. Rapid Growth / Scaling
Scaling is a make-or-break point: 74% of high growth startups fail because of premature scaling. Legal counsel can help scaling be more workable–with contracts that include escalation or escape clauses and altered payment schedules, depending on changing conditions.
Lawyers can advise you how a contract can be terminated or what to do if a contractor is in violation.
As the cash flow shifts from investors to sales revenue, lawyers can offer ideas on structuring that cash, to minimize the tax liability. And as the company grows, it’s advisable to consult with attorneys on the decision to award stock options as an employee benefit.
A stock option agreement doesn’t require that an employee purchase the stock on that day, but it gives her a right to buy it, later down the road, at today’s stock price. This is a valuable, powerful incentive for staff, but option plans can be costly to set up and administer.
With stock options, there is regular accountancy and administrative work that must be done. (Given this time and expense, option plans are usually put in place after the company is already on solid ground.)
Beyond compensation packages, hiring more employees can trigger additional requirements. The use of a company handbook becomes increasingly important as the company grows.
Just as staffing will change as you grow, so too will compliance issues. You may have new requirements once your products cross state lines or go international. (One example: If you sell food, FDA label requirements are based on your sales and number of full-time employees.)
And there are new concerns on the radar, such as data management and security. 42% of small businesses were hacked in 2015.
Just getting a trademark, adding the prized ® adjacent to your logo, isn’t the end of the story. Between the fifth and sixth year, you need to file new forms to prove you are still using the mark. (one more round of filings need to happen in the ninth year and every ten year after that.)
By the same token, you may also need to file additional applications. Perhaps you are adding a new service or product line. That would probably mean a new trademark filing–because it’s a new product in a new market.
And once you’ve got all the rights and registrations, then you need someone ready to protect your rights. You’ll need someone on the lookout for possible infringement, and someone ready to take action if it is discovered.
Legal Counsel Is An Investment In Your Startup’s Future
As we said, reports of startup death are greatly exaggerated. Startups can make a successful go of it, but, as we’ve seen too often, they fail because of simple mistakes that could have been prevented with a good lawyer. Startups that don’t have counsel are refusing to invest in their own company’s wellbeing. What smart VC is going to pour money into a company, when that’s the case?
At Buchwald & Associates, we do understand it may be daunting to hire a lawyer, throwing money down a black hole of hourly fees. That’s why we offer flat fee services for startup companies, beginning with our startup package. For $2,900, we’ll prepare initial bylaws, corporate resolutions, employee agreements and much more. No matter where you are on in your startup’s growth, call us to help you move to the next stage. It’s time to invest in your company’s future.