Five Ways You Can Protect Your Startup Without Hiring a Lawyer

Startup - shutterstock_191690525Let’s face it – every dollar counts when you are going from zero to funded or cash-flow positive. And good startup lawyers are expensive! While you will undoubtedly need to hire one at some point, you can minimize the cost by allowing them to do what lawyers do best – providing advice, both legal and strategic – rather than filling out forms, putting out fires, or fixing mistakes. Here’s a couple of ways you can take charge and reduce your bills:

Check your employment documents. Many startup founders come up their ideas or even start working on their startups while employed by someone else. The danger here is that your employer may have a claim to whatever intellectual property you develop as a result, and even if they don’t try to exercise that claim, an overlap might scare off seed investors. So before you do anything, pull out those employment documents and look for the provisions regarding “invention assignment” or other IP assignment. While “inventions” may seem like something that doesn’t apply to you, it is probably broadly defined to mean just about anything you create. And if you create something on company time, using company equipment, or even if it just relates to your job responsibilities, your employer may have a claim to ownership over those inventions. So plan in advance how you will avoid this, and be able to document it so you can show investors you took appropriate precautions.  Consider speaking to a lawyer if you are concerned about any overlap.

Incorporate and do basic formation tasks online. Did a business lawyer just say we should incorporate online? Yes! But don’t just use any service – almost all of them will not be right for the typical scalable, investment-ready startup, and will cost you more in the long run if you try to use them. However, there is a service called Clerky that I can’t recommend enough. The founders are startup attorneys that went through Y Combinator and built a service that automates the incorporation and formation tasks that many (but not all) startups should address. You may need to know a bit about typical startup formation (see my next point), and/or should consider finding a Clerky-friendly attorney who can advise you. But using Clerky could save thousands compared to paying a lawyer to take care of these tasks manually.

Read up on equity financing terms. Investment transactions will involve some of the most important decisions your startup will face. Smart founders should understand terms, valuations and how it all comes together well in advance of negotiating a financing round. You can do that by reading Venture Deals by Brad Feld and Jason Mendelson. Subtitled “Be Smarter than your Lawyer and Venture Capitalist,” that description is not far off. In this slim, easy-to-read volume, these experienced VCs walk you through the economics, legal terms and mechanics of raising money. Reading and understanding this book will help you get financing, improve your terms, and cut down on your legal bill when the time comes to negotiate and close your round.

Manage your cap table online. Once you have stockholders beyond the founders, managing your equity issuances, capitalization tables and certificates will get complex. You can pay paralegals or associates at your law firm to manage it for you, or you can consider a tool like eShares. Designed to reduce and automate the tasks involved in equity management. It is again a complement (rather than a replacement) for your startup lawyer, and could save you a lot on legal fees in the long run. And they can help you with your 409A valuation, too.

Build electronic signature processes into your workflow. Being a startup founder means signing lots of documents. There are board consents, equity grants, customer contracts, partnership agreements, license agreements… the list goes on and on. Fortunately there are a number of electronic signature providers out there that can disrupt the old “print, sign, scan, send back” routine that is inefficient and insecure. As a startup law firm we have high-volume needs so we don’t mind the cost of premium solutions like Adobe EchoSign or DocuSign, but there are cheaper options as well such as HelloSign or RightSignature. It should go without saying that your lawyers should be using these as well, because not only does it cut down on legal fees (time spent chasing, collecting and assembling signature pages in documents) but it also helps protect you from fraud (in an age when you can swap signature pages in and out of any old PDF, having an audit trail of the documents and signers is a terrific innovation).

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Ultimately, whether you jump in and learn and use these tools yourself or not, you should be making sure your lawyer is leveraging technology to improve efficiencies and reduce costs. Good legal advice is invaluable, but paying your firm to do rote tasks is not in any startup’s interest! Feel free to contact us at Accelerate Legal if we can be of assistance.

Why do many tech startups incorporate in Delaware?

Many tech startups incorporate in Delaware. Why? While its not appropriate for all startup companies, there are a number of reasons why tech startups that require significant investment to scale their business incorporate in Delaware:

1) Delaware corporate law is much more developed and streamlined compared to other states.

Because so many companies incorporate in Delaware, and because they have specialized courts that deal only with corporate disputes, there is much more “legal certainty” about how the courts will treat certain contractual and transactional issues, and it is largely seen as “business friendly.” Many of these are issues that a company won’t face until much farther down the line. But some of them affect startups straight out of the gate. Delaware largely lets companies decide minor issues for themselves. On the other hand, California likes to dictate these small issues. For example, in Delaware you can have as many directors as you want, whereas in California you have to have one for every shareholder up to three. So if you are a startup with three shareholders, you are obliged to have three directors, even if that doesn’t make any sense at all and means a lot of wasted time in getting signatures.

2) Delaware makes things easy.

The Delaware filing office is open until 8PM, and usually filings come back stamped in a day. This is huge for fast-moving capitalization transactions. California, on the other hand, takes weeks unless you pay expedite fees, and often sends filings back for minor non-conformities. Like many other California government agencies, the Division of Corporations can be very bureaucratic.

3) Delaware conforms to investor expectations.

Virtually all corporate lawyers in the US (and many around the world) are familiar with Delaware corporate law, and indeed for many of us Delaware corporate law is probably even more familiar to us than the law of the state we are in! Thus, you don’t have to worry about your investor’s lawyer not knowing the intricacies of whatever state you are in. Most California venture capitalists are reluctant to invest in California corporations, much less a corporation from Wisconsin, New Jersey or Arkansas.

Why shouldn’t you form a Delaware corporation? Cost. If you form a Delaware corporation, you also have to qualify the business in the state in which the corporation is doing business. All told, it probably costs an extra $1-2K to form a corporation in Delaware rather than the state you are in (costs of qualifying in your state + legal fees to qualify + cost of Delaware franchise tax), and you will have some additional costs going forward in terms of franchise taxes, filing and agent fees. However, I often think this is more than than made up in just the first financing transaction you go through. And it will be much more expensive to convert later if that is a route you take. But if you will not raise capital and want to keep things simple, it probably makes sense to simply incorporate in the state you are in.In short, if you are aiming to raise capital to scale your business, incorporating in Delaware is often a smart choice (though like all things there are exceptions).

SEC Invites Comment on Definition of Accredited Investor

SEC Definition of Accredited InvestorHat Tip to Joe Wallin for noting the SEC has requested public comments as to whether and how they should revise the definition of “accredited investor.”

As I’ve previously noted, for most tech startups it’s very important that they only sell stock to accredited investors. It comes down to this: the securities laws impose a number of onerous obligations on startups whenever they sell securities to someone who is not an accredited investor. [Read more…]

Lumio Lighting a Path in Design and Entrepreneurship

Lumio LogoClient Spotlight: Lumio

When you are passionate about helping entrepreneurs, it doesn’t get much better than working with Max Gunawan. The founder of Lumio, Max is an architect, designer, maker, supply chain analyst, publicist, salesman, executive officer, marketer and shipping clerk all rolled into one. Not only that, but he manages to do all those jobs better than many who have just one of those titles. And he does it all with a smile. [Read more…]

Venture Capital Deals: Founders’ Equity Sapped by Preferences

There is a terrific article on venture capital deals by Steven Davidoff in yesterday’s New York Times’ Deal Book titled In Venture Capital Deals, Not Every Founder Will Be a Zuckerberg. Davidoff examines a case recently litigated in Delaware courts where a company, Bloodhound Technologies, was sold for $82.5 million eleven years after its first funding round. The five founders of the company only received $36,000 in the sale, whereas the management team at the time of the sale received $15 million and the VCs received virtually all of the rest (~$66 million).

How does this happen? The terms venture capitalists negotiate when they make  investments can, over time and successive investments, give the investors the power to push the founders out of management and gain control of the company. Moreover, the “liquidation preference” in preferred stock allows investors to get their money back before anyone else gets anything, and they will often then “participate” in the remaining proceeds. In some circumstances investors negotiate preferences that are even more than what they put in, or can, as they did in the case of Bloodhound, negotiate a “cumulative dividend” that grows over time (cumulative dividends are rare, but preferences and terms that give investors control leverage are not). [Read more…]