4 Tools to Legalize Your Startup

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So, you and your friend have a great idea for a startup. You've worked out the idea, done some preliminary market testing, maybe you've been dogfooding your app and tweaking it for deployment. Either way, you're in business now, have some users and are trying to figure out what's the next step? Here are four things you can do to make sure you have the important legal bases covered.

Founder's Agreement

This is the agreement between you and your partner that covers all the basics of how your business will operate, how decisions will be made, what percentage of ownership you both have (doesn't always have to be 50/50). This agreement provides for what each person is bringing to the table and what it's valued at. It sets in stone how you will operate, share liability and share profits, issue payments, etc. It also covers the parts of business nobody wants to think about, like what happens if one person wants out? What happens if both of you want to close up shop...who owns the IP that one of you put into the business?

You probably want to do this part sooner, rather than later.

Speaking of IP...

IP Transfer

I wrote about this not too long ago. If one or both of you have IP that is necessary for the operation of your service, it should probably be owned by the business. This prevents the person who created it from walking away with it when they aren't happy...like a kid taking his ball and going home. It also can equalize the financial contribution in the case where one person puts in money for the necessities of getting started and the other has nothing to contribute. Their contribution could be the IP that the business will be using to operate. Plus, sometimes the IP is what gives your startup its value and an investor will be looking to see your IP transfer documents to confirm the corporation, and not the individual founder, owns it. This is how they're putting value into the business and buying their shares of ownership.

Speaking of shares...

Incorporate

The founder's agreement will determine issues of ownership, transferring ownership, bringing in new partners, etc. But that does not replace incorporating your business. The incorporation and the corporate statutes put a buffer of liability between you and the business. The corporation will exist as its own entity and allow you to bring on investors who will own shares of the company. If you have any intention of bringing in an angel or a VC, there's a 100% chance (am I being too dramatic here?) that they will require you to be incorporated. There's a 99% chance they will want you to be incorporated in Delaware. This is because Delaware's corporate law is established and the case law can be relied upon when making decisions about investing. They even have their own special court for corporate matters, called the Court of Chancery. When an investor puts their money in a Delaware corporation, they can be comfortable that there will not be any unexpected legal issues that arise.

Speaking of dealing with unexpected stuff...

Stock Vesting Schedule

You probably shouldn't give each founder all the available stock on day one. What prevents one person from working really hard for a year or two and then walking away with half the shares of a business that is worth $20 million a few years later? For this reason you should go with a vesting schedule. Probably a 4 year with a 1 year cliff. Let me explain what that means.

You will each be entitled to a certain number of shares of the business. However, in order to actually have access and true ownership of those shares, you have to be involved with the business over a certain period of time. A 4 + 1 Vesting Schedule would look like this:

  • For the first year, nobody owns any shares
  • At the end of year 1, each founder gets ownership of 25% of the total shares they're entitled to
  • Starting from that moment of the initial 25% vesting, each month afterwards they each receive ownership of 1/48th the stock they're entitled to receive in total.
  • If the founder leaves the business before the end of year 5, that founder leaves with only the stock that vested based upon the length of time they participated in the business.

To address your likely freak out at this moment, vesting schedules always have a trigger that causes full vesting - such as being acquired by another company.

Final Thoughts

There are way more things you could do, but these four should at least keep you covered, protected, and attractive to investors. If you have a killer name or logo, you might want to trademark it. If you have some invention you're selling, you might want to get a patent on it. If you have employees or programmers working for you, then you might want to get them all to sign employment contracts that include NDA's and invention assignment provisions.

These are all issues that you can discuss with an attorney to determine which, if any, apply to you in addition to the ones above.

Good luck!