Decide on the Details to Avoid Common Legal Mistakes (OPINION)

Once you have come up with the next big idea, what do you need to do then? The more details that can be decided and agreed upon at the beginning, the better off the company (and its founders) will be. 

• Select the right type of entity. For simplicity’s sake, a small startup might initially favor establishing a sole proprietorship or a general partnership over forming a limited liability company (LLC) or a corporation. However, that might be a mistake, because LLCs and corporations offer many advantages over less structured entity forms. 

Furthermore, corporations have some advantages over LLCs. They can do certain things that LLCs cannot, including issuing stock options and convertible notes. Also, if the plan is to raise funds from sophisticated investors, like venture capital firms or angel funds, those investors often work only with corporations. 

More specifically, investors might work with only Delaware-registered corporations, due to the state’s stable, advanced corporate law system. That does not necessarily mean that you need to start out as a Delaware corporation, but you need to be aware that this entity type is preferred by many investors. 

• Have clear agreements with co-founders. In the beginning, it’s critical that the company has clear agreements in place regarding how much equity each co-founder has or how much capital each must contribute.

A written operating agreement for an LLC or bylaws for a corporation spell out the rights, duties and requirements of each person involved with the company. Make sure to agree on the amount of time that each co-founder is expected to commit to the operation and whether co-founders are entitled to receive salaries.

The agreements should also delineate how co-founder equity is determined, how it is vested in the company and what happens to that equity if one of the co-founders should leave the company. Issues that need to be considered include whether the other co-founders can buy the equity from the departing co-founder or if the company has to buy it. 

• Comply with securities laws. Raising money from outside investors has many legal requirements, and startups frequently get into trouble by not complying with applicable securities laws, both state and federal. Even if you raise money from friends and family, you can violate securities rules on limitations for types of investors or on the disclosures required to be given to potential investors. 

These requirements have recently changed with the inception of what is commonly known as Regulation A+, which allows for new types of startup financing. Thus, seeking the help of a knowledgeable attorney when you are attempting to raise money will save many future headaches. 

• Protect intellectual property. If you have created something new that can be considered intellectual property, do what it takes to protect it as early into the process as you can. Obtaining a patent, trademark or copyright will protect valuable trade secrets and ensure that the company establishes ownership rights in these ideas. Additionally, co-founders should assign to the company their intellectual property rights. Don’t forget to have an agreement with third-party developers who assist you in the process that assigns their intellectual property rights to the company as well. 

• Develop appropriate contracts. When starting a new venture, it behooves you to prepare a standard contract when dealing with clients and customers. This allows you a starting point from which you can negotiate, and the hope is that the other side will not want to make significant changes. Pricing should be spelled out and liability limitations should be clear. Ensure that dispute resolution is defined.

These are just a few areas that startups need to address.  Remember that you are not alone in your new venture and that the use of dedicated professionals to assist you with these issues makes good business sense. 

P. Delanna Padilla is a partner with Wright, Lindsey & Jennings LLP. Padilla practices in the areas of tax law and heath care. She counsels in the areas of LLC and partnership taxes, corporate taxation and personal taxation and assists clients with health care regulatory and compliance issues. She can be reached at 479-631-3278 or [email protected].