30 Mar 7 Steps Successful Startups Take to Protect Themselves Legally
Startups, even ones with significant angel or venture capital financing, are in a constant struggle to stay alive. The best startup CEOs are looking months or years ahead into the future, anticipating the next wave of consumer or enterprise sentiment, while also overseeing day-to-day operations.
One of the easier ways for startups to survive the rigors of creating and maintaining a business and is to surround company leadership with the right advisors. The fact is, most startups will fail. Over 90% of them. Why is yours going to be one of the select 10% that survive?
One key metric of success I have seen in my years of building and counseling startups is a constant forward drive – an anticipation for whatever is “next” and striving to attain it. But with the company leadership’s eyes sometimes glued exclusively to growth, who is minding the ship?
Every startup needs basic advice on corporate formation, contracts, employment issues, intellectual property rights, financing, and the day-to-day legal issues that arise in running any business. And in practice, I have found the sooner company leadership realizes the need to take care of the basic nuts and bolts of a company’s legal issues, the better chances of success.
Below are seven (7) of the most important steps startups should take to protect themselves legally:
1. Choose the right legal entity.
Before you start signing contracts, engaging independent contractors, or hiring employees, you want to protect yourself and any co-founders from financial liabilities. The best business structure for your startup may take a myriad of different forms, but it is most likely an LLC (great for startups wanting minimal formalities and closely-held startups not seeking immediate capital from institutional investors) or a C Corporation (for startups reinvesting profits back into the company and/or startups seeking angel/VC funding).
Filing for the company/corporation is fairly straightforward, typically done through the Secretary of State’s office in the state in which you choose to incorporate/form your business. However, if capital or equity structure issues are involved from the start (which they typically are with most startups I’ve worked with or been a part of), it is best to retain an attorney early in this process to avoid any missteps. The fact is, many startups get the “choosing the correct right legal entity” step wrong the first time around, and they end up spending more in time and money than if the company leadership would have consulted a professional at the time of business conception.
And once your entity is filed, you’re not done – make sure you maintain your business through any annual state and/or federal filing obligations and obtain the necessary local business permits and licenses. Many startups forget this step, and they end up paying penalties and back taxes down the road.
2. Protect your online presence.
3. File for trademarks.
You most likely have spent considerable time coming up with a name for your company and your company’s products. And unless you’re gunning for a quick sale to an industry leading company – an “aqui-hire”, if you will – then you’ll want to protect your company’s name and any products/services’ names you have on the market. Without the proper due diligence in trademark protection, the worst-case scenario is that you will have to change your company’s (or product/service’s) name and lose the goodwill and industry recognition you’ve fought so hard to obtain. Do a federal trademark search. File for federal trademarks. Trademarks are costly, but not as costly as the alternative to realizing you have to change your company’s name because of prior use by a competitive entity somewhere halfway across the country.
Having a federally registered trademark makes it so much easier to recover your intellectual property. For example, if someone is squatting on your company name in a Facebook, Twitter or Instagram handle, having the correct documentation will mean you have the legal rights to stop others from using your company name online or elsewhere. This happens much more than you would think. And it happens to a greater degree the larger and more well-known your startup becomes. Protecting trademarks at the start allows you to avoid costly battles to recover your name across the variety of social and mobile platforms when competitors or cyber squatters inevitably hit.
4. Protect the company’s other intellectual property.
Not all startups have patentable inventions, but for those that do, protecting these inventions can be a make-or-break decision. Most startups simply avoid this step – to their detriment – because of the assumed high costs involved. While patents do not come cheaply, filing for one may not be as financially burdensome as you may think. Many patent attorneys catering to startups now charge a predictable, fixed fee for filing a patent application. And I tell my clients seeking VC financing that the industry standard I have seen is this: the costs incurred on patent filings typically come back at least 2X-5X in terms of adding to the startup’s valuation for the next round of financing. That is, if a patent application costs $10,000 to file and prosecute, you can realistically value that patent application at $20,000-$50,000 in negotiations and in the due diligence when raising your next round.
5. Put your company’s legal house in order – through documentation.
Anyone looking to invest in your startup will be conducting a fair amount of due diligence. Your company’s books, contracts, corporate documents and agreements will need to be reviewed. Investors will want to see that service providers and employees are properly documented, and that you are adhering to proper licensing, permitting and reporting to the government or other regulating entity. Taking this step assures investors a smooth due diligence process and proves your startup to be forward-thinking and professional. It will undoubtedly help in the negotiating process if your legal house is in order.
Many times during the investment process, a startup is hit with a 30- to 50-bullet-point due diligence memo from an investor or VC firm and is unprepared to provide the proper documentation. Investment stalls. The investor/firm gets cold feet. Avoid this result by thinking ahead and documenting everything as you go.
6. Buy insurance and understand employment law issues.
Your startup is growing and taking on clients/users. You have the proper corporate documentation in place, and therefore limited liability protections, but as you’re working hard to ship the product, the legal paperwork isn’t your No. 1 priority. You hire your first – or 25th employee – but are you taking the proper steps in regard to your obligations under federal and state payroll and withholding taxes, OSHA regulations, unemployment insurance, workers’ compensation issues, wage and hour issues, and anti-discrimination laws? As soon as you hire that first employee, all of these obligations begin. Are you prepared to take on the burden to deal with these issues yourself? Or is it easier –and through the time-value of money, actually cheaper – to hire a professional to watch your company’s back on legal and regulatory issues? As always, the answer is it depends, but unless you’re a completely bootstrapped startup, it’s typically best to have company leadership more focused on growth and sales at the business’ earliest stages.
7. Hire a lawyer on day one.
This last bit of advice may seem self-serving, but I assure you it’s not. The caveat here is that startups should not hire just any lawyer, or a lawyer who may be a friend or the lawyer your angel investors or VC firm foists onto you. No, startups should hire a lawyer who understands the entrepreneur mindset. A lawyer who says, “This is how to do what you’re looking to accomplish” instead of “No, you can’t do that.”
Understanding and navigating the laws affecting your startup helps eliminate much of the guesswork typically involved in starting a business. Your chances of success rise. You become one of the “lucky” 10% of companies that make it. Only then do you realize it wasn’t really luck, but preparation, that got you there in the first place.
Jonathan R. Pasky is Principal & CEO of Pasky Gruber Scatchell LLC, which provides companies with corporate and intellectual property legal counsel. Through its innovative service Openlegal, the firm provides flat-fee counsel to high-growth startups. He is co-founder of multiple technology conferences, including DeveloperWeek, Integrate, DataWeek + API World and Techweek, with a combined audience of 20,000+ yearly attendees. He mentors through startup accelerators Techstars, Healthbox, and a variety of other programs. Connect with Jon on Twitter: @jonathanpasky.
The content of this article is for informational purposes only and does not constitute legal advice.