There are many business questions founders need to ask (and hopefully answer) before taking the plunge with a new venture. Often overlooked, however, are some of the legal questions founders should consider. Asking and answering the questions below will help you start your business on firm legal footing.
Do I have any obligations to a former employer that could impact my new business?
If you’ve left a job to strike out on your own (or if you’re thinking of doing so), you need to determine whether you have any obligations to your previous employers that would impact your new business. For instance, many employees sign an agreement, usually at the time they are hired, that gives their employer rights to intellectual property developed by the employee that relates to the employer’s business. These agreements may also prohibit the use or disclosure of the employer’s confidential information after you leave the company, and sometimes prohibit you from operating a competing business. Some restrictions, such as a prohibition on competing with your previous employer, lapse after a period of time (usually about six months to two years), but others, such as the obligation not to disclose your employer’s confidential information, can last forever. If you violate one of your obligations, your previous employer may be able to sue you for monetary damages and require you to shut down your business.
If you’re concerned about the terms of an agreement with a previous employer, speak with a lawyer before starting your business.
Do I have (or can I obtain) rights to the IP my business needs?
Intellectual property is the most important asset of most start-up companies, so making sure it is protected is crucial. This often involves filing for patent, copyright or trademark protection of your intellectual property, but also requires that a company have written agreements with its founders, employees and other service providers to make clear that the company owns the intellectual property developed on its behalf and that it cannot be used by anyone else without permission. If the founders do not already own the rights to the intellectual property the business needs, it is important to determine whether it can be obtained at a price that isn’t cost-prohibitive.
How should ownership of the business be structured?
How you divide up initial ownership among the founders of your business is entirely up to you, but you will want to think hard about what should happen to a founder’s ownership interest if he or she decides to leave the business. Let’s say you start your business with four founders and divide ownership of your company equally, but after a few months one founder decides to leave. It may be unfair for the departing founder to continue to own a quarter of the company, but that’s what happens unless the company has the right to get some or all of the shares back. One solution is for each founder to grant the company the right to take back a portion of that founder’s shares when he or she leaves. The number of shares the company has the right to take back usually depends on the length of time the founder has been with the company and sometimes on the circumstances surrounding his or her departure.
Terms of the relationship among founders are more easily defined early-on – before a problem arises – and the last thing you want is to spend your company’s resources suing your partners. We strongly advise our clients to consider putting a founders’ agreement in place at the time of business formation.
Should equity incentives be offered to employees and others?
Because most start-ups need to conserve cash, they often prefer to compensate employees in part by issuing them stock options or other equity incentives. Even if you don’t plan to hire employees early-on, adopting an equity incentive plan is beneficial because you can also grant equity as compensation for the work of consultants and other service providers. Start-up technology companies typically reserve 10-20% of the total equity of the company for incentive grants pursuant to an equity incentive plan, but businesses that expect to make significant hires early on may want to reserve a bit more (the amount reserved under the plan can also be increased at any time, but generally requires shareholder approval). Equity grants are usually made subject to various conditions that are spelled out in the incentive plan or in the grant itself, including that the grants “vest” over time or upon the occurrence of some event, and that unvested awards are forfeited should an employee leave or be terminated.