What is the value of a lawyer to a startup?

I get this question a lot. Most recently, a friend of mine was contemplating starting a company with a friend of his, and had several questions about entity formation, IP protection, when to file for patents, stock distribution, and “anything I left out that I need to be thinking about”.

This particular friend had been through the process of building a company before, and based on his subsequent questions it was clear that he already had an answer to his first one: there are a lot of issues in starting a new venture that seem simple at first blush, but that can create thorny issues down the road if not contemplated and handled correctly during a company’s formation. Planning for these issues early on is part of the value of a lawyer to a startup company’s founders.

Blueprints for Your Success

I encourage founders to look at their formation documents as their blueprints, and to not underestimate the importance of solid and professionally developed formation docs. You just can’t trust everything that you find online, and there is real value in talking to an experienced attorney at the formation stage just to make sure that all documents are prepared and executed correctly. Filing services are not qualified to give an entrepreneur the nuanced advice that they need in making decisions about how a company should be set up to best attract investors and, down the road, acquirors. If you use a document filing service and don’t have everything set up correctly, it could be much more costly in the long run to repair the damage, and it could also make your company less attractive to investors. Some of the key provisions to pay attention to are presented here and subsequent posts.

The Founder’s Agreement

First, a startup’s founders should ensure that their founder’s agreement contains clear provisions on confidentiality and IP assignment regarding everything developed for the company. For example, the agreement should use standard and consistent terms to describe the company’s IP, such as “proprietary information” and “materials”, and should make clear when it is and is not appropriate to disclose or otherwise make use of this information and materials. Similar clauses in conformance with state laws should be included for copyrights and inventions belonging to the entity.

Excluded IP

The agreement should also be careful to disclose in an appendix any excluded IP that a founder does not wish to be folded into the new company. This clause should effectively assign any and all IP not listed in the appendix to the company, and may also contain language granting the company a full worldwide license to any excluded IP that is later used in whole or in part in any of the company’s products, services or in any other way by the company. This will protect any IP belonging to a founder that he or she does not wish to become part of the company, but will also protect the company should an excluded piece of IP at some point become part of a product (either inadvertently or on purpose).

Nonsolicitation and Noncompetition

In addition, the agreement should include clauses covering nonsolicitation and noncompetition. The nonsolicitation clause should prevent a founder from leaving and taking key employees or customers with him or her. The term for such a clause can vary, but one year is a fairly standard duration. A noncompetition clause should place restrictions on a founder’s ability to go work on products or services that directly compete with those of the company. This is where having a good definition of “proprietary information” will help. Limiting the duration to one year and scope of competition to projects at the company for which a founder has related proprietary information clarifies this clause, and may aid in enforceability of the contract in the unfortunate event of a lawsuit.

Although for the purposes of this post I am referring to this document as a “founder’s agreement”, the reality is that every employee, contractor and consultant engaged by your company should sign an agreement subjecting them to similar terms.

Conclusion

It is important to observe all of the corporate formalities to make sure that something doesn’t come up later on in the life of the company that may lead to loss of corporate form protection (thus rendering corporate actions ineffective). For example, annual meetings of the Board of Directors may need to be recorded and filed, and action by consent should be properly drafted and executed by every party required to sign off on such action. Your attorney will help to ensure that your company does not miss deadlines for the filing of key documents, and will ensure that all of your consents are properly drafted so as to eliminate any ambiguity of intent.

Stay tuned for future posts on the pitfalls that early stage companies face when choosing how to set up their companies.