Should early-stage startups invest resources in obtaining legal counseling? (and not a word about fundraising, yet).
To put it simply — YES. Early stage start-ups (and entrepreneurs) are not rich enough to go cheap on early legal counseling.
When is the best time for an early startup to engage with a legal counsel? That would be even before inception.
The implications of not obtaining legal counseling on time can be costly. Those implications are often discovered as part of the early stage financing rounds- not a good time for a start-up to be caught with its pants down.
Hands down, I admit- obtaining legal counseling requires resources — both financial and no less important– time and effort. It requires the entrepreneurs and officers to think, read, learn, analyze, anticipate future events and outcomes, negotiate, even amongst themselves and learn of a new language.
However, it is way too often that we come across mistakes that could have easily been avoided, if dealt by a legal expert. As you would go to see the doctor when sick or a mechanic if your car broke down. For some reason though, legal expertise does not always get the same recognition and that, together with defining the legal arrangement, is often a low priority for early-stage ventures.
So, what can possibly go wrong? To name a few, often disregarded matters:
- Not Engaging in a Founders Agreement. Unfortunately, there is an option that at some point, your honeymoon as co-founders will reach its end. When this happens, you want to make sure that you are not continuing the work, only to find out, that your partner, who meanwhile dropped out or reduced its efforts, continues to hold 50% of your venture. This is just one example (and an extreme one) of why a founders' agreement is so important. But it also serves to regulate what you would think to be obvious and is not often so (the amount of time to be devoted by each founder, the position in the new venture, financial efforts to be made etc.). Most importantly, a founders' agreement serves as a great tool for setting expectations among the new partners before the mutual escapade.
- Not Keeping Track of an Accurate Capitalization Table. Creating a capitalization table ("cap table"), reflecting all shares, options, warrants and other convertible notes issued, granted or promised by the company and entrepreneurs, is another whole field of expertise. The combination of those constitutes the holy grail that is in the basis of the calculation of the capital allocation — the fully diluted basis. When promising someone to receive a percentage of your venture, it is usually made on a fully diluted basis — that is, on the assumption that all warrants, options and other convertible securities are converted to shares. Making mistakes here can have a heavy price and may be hard to fix. A good lawyer can help to create and guide you through the creation of you cap table, after reviewing and listing all your written and oral commitments and setting the hierarchy between them. The importance of keeping track of your accurate cap table at all times cannot be stressed enough.
- Not Ensuring the Proper Assignment of Intellectual Property. Anyone who is contributing, expected to or might contribute to the creation of the intellectual property of the Company must assign all rights associated with such IP to the company. If restrictions apply to such person's right to do so (such as if this person is employed elsewhere during this time or is affiliated with any governmental, health, academic or other research institutions), a written consent must be obtained.
- Not Registering Intellectual Property Rights. Patents, trademarks, designs. The sooner, the better.
- Not Complying with Terms of Licenses. Best example here is probably copyleft software licenses. While the commercial use under those licenses is permitted, the proprietary nature can be lost, since the distribution of the software, allowed by the license, must be made under the very same license that permits such use. The implications can result in great efforts to fix this (for example here, replace the code) that might cause delays in your development. In other examples, finding the right compatible component to replace non-compliant component can take a lot of time, again causing great delays.
- Not Signing NDAs. Discussing your venture with potential investors, partners, services providers, agents, finders and other third party without signing them first on a non-disclosure agreement (an NDA). NDAs are meant to ensure confidentiality obligations of your counterparts with respect to any confidential information you may share during discussions (whether oral or written) as well as ensure your ownership of such information. Here too, the importance of NDAs cannot be stressed enough.
- Not Getting a Tax Advice. From tax benefits, exemptions and unknown tax implications to making an educated decision on where geographically to register the legal entity (a crucial decision, not affected by tax only) — a tax advice is worth obtaining on your first day. In this example, obtaining a legal advice on time can potentially save a lot of money to the company, entrepreneur, shareholders, employees, service providers and others. It can also save time and trouble. Wouldn't you like that?
- Reinventing the Wheel. When going through too much trouble to regulate or handle a legal issue where a standard practice exists. Abandoning the comfort of the known structures and solutions that are easy to swallow for experienced players (and their lawyers) can turn to be a big mistake.
- Being Unfamiliar with Industry Practice and Standards. Probably the saddest of all, not knowing what would constitute the standard and engaging in various engagements on terms less favorable of. The standard consideration, the standard terms and conditions, standard periods of time, standard structures and other norm criteria. Lawyers come across many ventures, in many fields and industries, handle various engagements have a broad view and a good sense of criticism for what deviates from the standard. This is an alarm you don't want to miss.
Those are just some examples and obviously not an exhaustive list of the potential sad implications of not getting a legal advice on time. Another point to consider is the signal those mistakes can send out — to potential investors, industry experts, service providers and other players you would want to partner with. A well represented early stage company can avoid those and other mistakes and send a clear message of a well-organized team that is working on all fronts to achieve its goal.
Originally Published by: Medium.com
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