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…]

You Should Only Sell Stock to Accredited Investors

If you are a founder of a startup, you may have heard this before. You may not know what an accredited investor is, or you may not understand why it is incredibly important to only sell stock and notes to accredited investors. Here’s a quick primer on selling your startup’s securities.

Securities Laws

You’ve probably heard of the “Securities Laws.” Securities laws are the federal and state laws and regulations that govern the sale of securities, i.e., stocks, notes (including convertible notes), and other financial instruments. The securities laws are very complex, so I’m going to try and simplify what you need to know as regards accredited investors, however there are many other aspects of the securities laws you need to take into consideration. [Read more…]

How to Value Stock Options in a Private Company

Many founders have questions about how to value stock options and around Section 409A. The following is a primer to help them.

Why is it important to accurately value stock options?

Under Section 409A of the Internal Revenue Code, private companies (such as tech startups) must determine the fair market value of their stock when they set stock option exercise prices (or “strike prices”) in order to avoid early income recognition by the optionee and the possibility of an additional 20% tax prior to option exercise.  Since most companies want to avoid these tax problems for their option holders, it is important to value the options correctly. [Read more…]

Founder Stock Vesting

Have questions about founder stock vesting? then read on to learn more about what it is and what market terms look like.

What is founder stock vesting?

When we say founder’s stock “vests”, we typically mean that the founder or founders of a company have granted the company a “repurchase right” to their stock that diminishes over time in exchange for the founder’s continued employment or association with the company.  Note that stock options can also vest, but here I am only discussing the vesting of actual stock, rather than options.

It might work like this: A founder purchases 1 million shares of stock in the newly formed corporation subject to an agreement that gives the company the right to purchase the shares back if the founder leaves the company. If the founder remains associated with the company, after one year from the date of purchase the repurchase right has diminished so that it only extends to 75% of the originally-purchased stock, after two years it only extends to 50%, three years 25%, and after four years the repurchase right is extinguished and the founder owns the shares free and clear. What “vests” over time is the right of the founder to leave the company and keep the purchased stock. [Read more…]

Should I Buy Stock with IP?

When founders of a company buy their initial shares of stock in a newly formed corporation, sometimes they wish to do so by exchanging intellectual property (IP) such as a business plan or a website, or other types of property (the below applies to many types of property, not just intellectual property). Purchasing stock with property raises a number of issues and risks that need to be addressed. This post is intended to help founders evaluate the issues when they buy stock with IP. [Read more…]

Presentations at MEDA on Business Law Basics and Contracts

I do pro bono volunteer legal work with the Lawyer’s Committee for Civil Rights – Legal Services for Entrepreneurs program, which provides free legal services to low-income individuals and immigrants that are starting businesses. It’s a terrific program, and I really enjoy working with new entrepreneurs to help them establish their businesses.

I’ll be giving two workshops in Spanish at the Mission Economic Development Agency over the next few weeks. The workshops are intended to help immigrant entrepreneurs understand basic legal issues affecting their business. [Read more…]

Startup Visas Are a Great Idea!

Congress is currently considering a bill that would provide 75,000 visas to persons who currently hold H-1B or F-1 student visas who have started businesses with investment of at least $100,000 and that employ at least 2 other people within a year and at least five in the following three years.

The bill, the Immigration Innovation Act, received support from President Obama in his State of the Union speech. [Read more…]

A Tale of Two Incorporations

I filed an incorporation mid-December, and just received the acceptance notice from the State of California today, nearly two months later. I could have gotten it back sooner, but we had some time and wanted to avoid the $500-1000 expedite fees charged by the California Secretary of State.

But that seems to be the new normal here in California: If you want to form a business, it will take two months to do so, unless you pay an expedite fee on top of your regular fees and taxes. [Read more…]