TEN THINGS I WISH
MY LAWYER HAD TOLD ME ABOUT STARTING A TECH COMPANY
John F. Delaney, Esq.
Morrison & Foerster LLP
1290 Avenue of the Americas
New York, NY 10104-0050
Telephone (212) 468-8000
Telefacsimile (212) 468-7900
Summary of SAEC's
"CEO Meet" Presentation
March 5, 2002
The information provided herein may not be applicable in all
situations and should not be acted upon without specific legal
advice based on particular situations.
10. FORM A CORPORATE ENTITY!
- Don't do business in your individual capacity -- form
a corporation ("C" corporation or "S"
corporation) or a limited liability corporation ("LLC")
and do business through this corporate entity.
- So long as corporate formalities are observed, you will
generally be shielded from personal liability. For example,
in general, your company's creditors will not be able to
attach your personal property (e.g., your house or car)
to satisfy the company's debts. However, if formalities
are not observed or if there has been gross negligence a
court could "pierce the corporate veil" and hold
you personally liable.
- It is important to consult an attorney or accountant regarding
what type of entity is best for your needs. Also, get advice
regarding in which state to incorporate.
9. AVOID HAND-SHAKE DEALS!
- Get it in writing -- handshake deals can result in disaster,
with disputes arising over what terms were agreed to by
- Putting together a formal written agreement forces the
parties to think through the issues involved -- whether
its money, ownership, control, or allocation of risk.
- If you get the better end of the deal, you will want to
put it in writing -- or the other side may seek to back
out when that fact becomes clear to him or her!
- Potential investors can't review hand-shake deals! They
demand to see written agreements.
- If your business becomes successful, you will find it
nearly impossible to go back and document the deal! At best,
you will be "held up" for more money, renegotiated
8. REFUSE TO SIGN ANYTHING
YOU DON'T UNDERSTAND!
- If you don't understand a draft contract, have it reviewed
by someone with relevant expertise who can explain it to
7. HAVE A "HEART-TO-HEART"
TALK WITH YOUR CO- FOUNDERS UP FRONT!
- Co-founders need to work through "worst-case scenarios"
and memorialize how they want to handle those situations.
- For example, if a co-founder walks away from the venture
before funding, should he or she continue to own his or
her same percentage in the company? If a departing founder
is able to keep the same percentage, there is a risk that
he or she will get a "free ride" on the efforts
of his or her co-founders (especially in the case of an
early-stage company where there is still a lot of hard work
to be done).
- Key: Discuss these issues while everyone is still friends
-- and enter into the corporate version of a "pre-nuptial"
6. RAISE MONEY FROM RICH FRIENDS
BEFORE RAISING MONEY FROM RICH STRANGERS!
- Don't assume that you need a venture partner. Especially
in this market, venture capital is essentially unavailable
to early-stage start-ups. Also, remember that venture capital
always comes at a price. A venture capitalist expects to
have a say in your company, including its strategic direction
and key issues like budget and compensation.
- Try to fund early growth of your company from revenues.
Approach friends and family for money before looking to
angels. Approach angels before venture capitalists. Note
that, with limited exceptions, you should only seek out
"accredited investors" who meet certain income
or net worth requirements established by the SEC. Generally,
an "accredited investor" is someone who has individual
net worth that exceeds $1 million, or a natural person with
income exceeding $200,000 in each of the two most recent
years and a reasonable expectation to earn the same in the
current year. Raising money from non-accredited investors
is significantly more costly from a legal perspective (perhaps
requiring a full-blown disclosure document) and a bad idea
generally (can non-accredited investors afford to buy into
an early stage risky venture?).
- When selecting a venture capitalist avoid the tendency
to simply go with the one offering the highest valuation.
Make sure you take into account the venture capitalist's
reputation and the "value add" they can offer,
including the depth of their expertise and whether they
show a willingness to make a long-term commitment to your
- Remember to begin your search for money at least six to
nine months before you'll need it. Avoid the "I have
to close by Friday to meet payroll" problem.
5. SECURE YOUR COMPANY'S NAME!
- If you are going to spend money "branding" your
company, make sure that you have rights in the "brand."
- It is not sufficient to have secured your company's name
through incorporation in a given state. It's essential to
do a trademark search and, if the search reveals no problems,
to register the trademark.
- Trademark rights are established through actual use of
the mark in commerce -- such use will not be reflected in
state incorporation records. A party that has trademark
rights can prevent others from using the same mark in the
same "field of use"-- so, if your new Internet
start-up is called "Apple Software," you've got
a problem. In contrast, Apple Bank and Apple Computer can
co-exist because they operate in different fields of use.
- You can conduct a trademark search through companies like
Thomson & Thomson for as low as $350 per mark searched.
Filing an application to register the mark can cost as little
as $1,500. Also, you can now file an "intent to use"
application if you are not actually using the mark yet.
If you are the first to file an intent to use application,
once the application has matured to registration, you may
be able to prevent others from using the mark after the
application's filing date, even if their uses precede your
first use of the mark in commerce.
- Remember that in choosing a name for your company, fanciful
and arbitrary names are better than descriptive names. Good
examples include "Amazon.com" for an online bookstore;
"Yahoo!" for an online portal. On the other hand,
"Super Fast Software" for a software company is
too descriptive. "Pets.com" is not a great name
- Bottom line: If you are going to incur the expense of
creating business cards, reserving a domain name and so
forth, make sure you have the appropriate rights to use
4. IDENTIFY AND PROTECT YOUR
- If your company is a technology company, much of its value
will be tied to intangible intellectual property. At a minimum
your company should set up a system to consistently identify,
manage, and protect its intellectual property assets, including
establishing policies and procedures to be followed by employees.
- COPYRIGHTS protect expression, not underlying ideas. Examples:
Software, manuals, drawings, schematics, memos, reports,
articles, advertising and promotional materials. Although
copyright protection now attaches upon creation, you should
nonetheless use the copyright notice on your copyrighted
works and register the copyright in such works with the
U.S. Copyright Office. For more information see the U.S.
Copyright Office's website at http://lcweb.loc.gov/copyright/
- PATENTS protect inventions -- that is, ideas -- so long
as they are useful, novel and non-obvious. Examples: Machines,
devices, processes, and business methods. Unlike copyrights,
patent rights do not attach upon creation -- rather, the
U.S. Patent and Trademark Office decides whether your invention
qualifies for a patent. Beware of statutory bar issues:
a patent will not be granted on your invention if you have
sold (or offered for sale) your invention or disclosed it
to the public, in a publication or otherwise, more than
one year prior to filing the patent application. Provisional
patent applications are now available-- by making this simplified
(and generally less expensive) filing you can establish
an early priority date. Filing a provisional patent application
gives you a full year to assess the invention's commercial
potential before committing to the higher cost of filing
and prosecuting a non-provisional application. For more
information on patents see the U.S. Patent and Trademark
Office's website at http://www.uspto.gov/main/patents.htm.
- TRADEMARKS protect names, words, symbols, logos, and sounds
used to identify the source of good or services. Trademark
rights can attach upon use of the mark in commerce, but
prudence dictates that you should conduct a search and register
your mark prior to investing time or money in the mark.
Use the "TM," "SM" or "R"
notices as appropriate. In order to avoid forfeiture of
your rights, it is important to impose quality-control restrictions
when licensing the mark for use by others. For more information
on trademarks see the U.S. Patent and Trademark Office's
website at http://www.uspto.gov/main/trademarks.htm.
- TRADE SECRETS are confidential and proprietary information
that give your company a competitive advantage. Examples:
Manufacturing processes; source code; technical and marketing
"know-how"; customer lists; formulas (e.g., Coca
Cola formula); market research; and so forth. Trade secret
protection lasts only as long as the information is kept
confidential. So your company must set up procedures to
maintain the confidentiality of its trade secrets! For example--
consistently mark your company's confidential materials
with a "Confidential & Proprietary" legend;
have employees and consultants sign confidentiality agreements;
and keep trade secrets in secure areas.
3. JUST BECAUSE YOU PAID FOR IT DOESN'T MEAN YOU OWN IT!
- Be cautious when using consultants -- just because you
are paying for them to create something for you doesn't
mean that you own the IP rights in what they create!
- Indeed, the law is counterintuitive -- generally speaking,
if a consultant creates software, marketing materials, or
other work for you, and there is no signed agreement assigning
IP rights to you, the consultant retains ownership rights
in the work!
- Example: Cybration/ICUII, a supplier of online video software,
hired a programmer for work related to Cybration's core
product. Though Cybration paid the programmer $300,000,
there was no written contract at all between the parties,
and therefore no assignment of rights from the programmer
to the company. The parties eventually settled-- but not
before Cybration had to expend financial and other resources
in filing a lawsuit to force resolution of the matter. Result:
Serious set back to Cybration's business. See Tara
Copp, Local Startup in Court Battle, CORPUS CHRISTI
CALLER-TIMES, June 7, 2000, at C7.
2. PAY ATTENTION TO THE TAX
ASPECTS OF YOUR ACTIVITIES!
- For example, as noted above, your choice of corporate
entity can have a dramatic impact on your bottom line.
- Another example is the "83(b) election." In
the case of restricted stock, which is typically granted
early in the life of the company, failure to file an 83(b)
election can have negative tax consequences for the recipient
of the stock if the stock subsequently increases in value.
- Tax issues are too complicated to explore in detail here
-- but make sure that your attorney or accountant are helping
you to identify these issues.
1. PAY ATTENTION TO EMPLOYEE ISSUES!
- There are more lawsuits against start-ups generated by
current and former employees than any other source!
- The law doesn't allow you to run your company like a frat
house party! Educate yourself on what the law considers
to be inappropriate behavior within the workplace, and set
up mechanisms within the company to prevent inappropriate
behavior from occurring.
- Have all new employees sign offer letters characterizing
the relationship as an "at will" relationship.
This ensures that the "at will" status of a relationship
is not jeopardized by any oral representations to the contrary.
- Address the ownership of any works and inventions created
prior to the establishment of the company. Make sure you
get IP assignments up front, before the employee begins
work -- otherwise, disaster can result! The last thing a
startup needs is to become embroiled in costly litigation
(even the threat of litigation can scare away investors).
- Make sure you correctly characterize personnel working
for the company as either independent contractors or employees
-- you'll want to avoid facing tax liabilities and penalties
if your "independent contractor" is actually an
employee in the eyes of the IRS. Even Microsoft made this
mistake -- and it cost the company millions to correct it!
- Don't use an "off-the-shelf" employee stock
option plan -- a stock option plan needs to be tailored
to your particular needs -- potential buyers have walked
away from companies with ill-considered stock option plans.
For example, a buyer is most likely to balk at option plans
that call for acceleration of existing options upon a change
of control. Work with an expert to develop a plan that suits
your company's needs.
- Never make promises regarding benefits that are not subject
to the terms of the plan under which the benefits are provided.
The terms of a plan, for example, will typically specify
that the employer retains the right to amend or change the
- Establish standard practices with respect to hiring and
firing employees. Appropriate entry procedures can help
ensure that new employees are all "on the same page"
with respect to company policies. Exit procedures can be
used to remind employees of any continuing obligations (e.g.
confidentiality) and to confirm the return of company property.
* This is a summary of a speech
given by John Delaney, Partner, Morrison & Foerster LLP
for SAEC's "CEO Meet" on March 5th, 2002.
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