
The Biggest Legal Mistakes that Startups Make - icey
http://walkercorporatelaw.com/ask-the-attorney/%e2%80%9cask-the-business-attorney%e2%80%9d-what-are-the-biggest-legal-mistakes-that-startups-make/
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grellas
This is a nice summary of many of the legal issues affecting early-stage
startups.

Any entrepreneur or startup lawyer can take issue with any given issue but
this does not detract from the overall value of this piece.

Points of difference and/or clarification:

1\. LLCs often work fine for early-stage startups, offering an easy and
inexpensive way for founders to get started in many cases (caution here: if
there is an "always" to be said in these situations, _always_ do an initial
consultation with a knowledgeable startup lawyer to at least understand what
trade-offs and compromises are involved in doing this sort of "simple" setup
because it is not without risks - such a consultation is very inexpensive and
well worth it for the knowledge gained - for a start on the main pluses and
minuses of an LLC, see my comment here:
<http://news.ycombinator.com/item?id=1276805>).

2\. High on the list should be to make sure that IP assignments are done in
connection with any equity grant made to founders for work performed before
the company is formed. If you don't do this, all such IP will normally belong
separately to the founders who did the work and not to the company, even if
they do get a fat stock grant at the start. A formality, but a very important
one.

3\. I am not dogmatic about Delaware and, indeed, have pointed out that
Delaware is more VC-friendly than it is founder-friendly
(<http://grellas.com/faq_business_startup_002.html>) - therefore, think very
carefully before making this decision. Delaware can be a good pick and may be
the best - it just should not be automatic in my view.

4\. Vesting for founders is not always required. It normally is when you have
a founding team of relatively equal founders (for the reasons stated in this
piece - you don't want someone casually walking away with a big piece of the
company). If one founder is dominant in relation to others being brought in
for more secondary roles (and for comparatively small equity pieces), there is
no need necessarily for the primary founder to make his shares subject to
vesting at inception. Of course, if the company gets funding, investors likely
will insist that vesting apply but not all startups look to fund in this
manner. At the start, (1) all founders can have their stock subject 100% to
pro rata vesting; (2) none of them need do so; (3) some may be subject to
vesting while others are not; (4) any given founder can have his equity grant
partly vested immediately while the balance is subject to vesting; (5) such
vesting as is used may vary widely, from one to four years or more, with or
without cliff (usually not for founders); or (6) any of all sorts of
variations on the foregoing. Hence, there is no dogmatic rule here. It all
depends on what the founders needs are and how much value they have built up
before starting the company (this is relevant because vesting necessarily
raises the risk of forfeiture and no one wants to forfeit that which has
already been made valuable prior to the start). Collateral issues: accelerated
vesting on certain events, such as termination without cause and acquisition -
each of these has a variety of issues associated with it and investors in
particular will often object to any liberal forms of acceleration.

5\. Tax is often a _huge_ issue at the start if the company formation is
mangled - that is, if founders take their "cheap" stock at or about the same
time as investors pay large dollars for theirs, there may be a serious risk of
service income being attributed to the founders on which they must pay tax.

6\. Concerning 83(b), this is also _huge_ but irrelevant if there is no
vesting and no risk of forfeiture connected with the grants made to founders
(it is virtually mandatory if stock is granted as restricted stock, with its
attendant risk of forfeiture, but not otherwise). It also is not needed for
stock options unless there is an early exercise provision which is exercised
at the start.

A nice checklist for going through legal issues at the start, with related HN
commentary, may be found here: <http://news.ycombinator.com/item?id=1198968>.

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alain94040
I'll insert my ad in here, because this topic is so close to my heart: Before
incorporating, _if you have co-founders_ , protect yourself with
<http://fairsoftware.net>.

I know many people who didn't use us (or a similar co-founder agreement,
except we are the only game in town if you are looking for a reputable,
lawyer-approved, silicon-valley, tech-friendly one).

They regretted it dearly, later. In general, first time founders are pretty
clueless about IP assignment (if my co-founder dumps me, what happens to his
10,000 lines of beautiful Python), vesting (if my co-founder doesn't work out,
why does he keep 50% of my company), etc...

You know better than start coding without some kind of code repository. Don't
start cofounding without an agreement. You've been warned :-)

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enjo
A couple gripes:

\- You will find a number of angel investors happy to invest in LLC's
(depending on the stage and complexity of the funding round). While it's true
that some investors require a more complex structure, the blanket statement
that it's "required" is just wrong. It can also be destructive. There are REAL
benefits to an LLC for a pre-revenue startup.

\- Place of incorporation. I've never had an investor care about the state
we've incorporated in. There are obvious tax implications, but it's often
easier and cheaper to just do the paperwork in your state. It really just
depends.

Points of emphasis:

83b election: This is SUPREMELY important, and applies to anyone attempting to
invest equity (under any legal structure). Without properly handling the 83b
you run into incredibly onerous tax issues. Learn about it and do it when you
incorporate.

~~~
walkercorplaw
I disagree re LLC's: not only won't VC's invest in LLC's, but conversion to a
C corp can be extremely complex and expensive. Indeed, it cost one of my
clients about $15K to address tax issues relative to such conversion. In
addition, issuing "stock options" is a nightmare with LLC's - not to mention
the extraordinary complexity of operating agreements, with their complicated
layer of partnership tax provisions.

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jsiarto
All good points--I don't completely agree on the LegalZoom issue. Our company
incorporated in Illinois through LegalZoom and it worked out great. I've done
LLC/partnerships on my own and the paperwork is easy. It's good to think of
LegalZoom as a paralegal service and not as a lawyer. We had an actual
corporate lawyer draft contracts and other important documents but I'm not
paying someone $300/hour to fill out forms.

~~~
slapshot
You incorporated in Illinois?

I don't know Illinois law well, but there are good reasons why most
corporations are Delaware (with a few in Nevada and a couple other states),
including tax and governance issues. Did you ask an attorney if Illinois was
the right state for you?

~~~
anamax
> I don't know Illinois law well, but there are good reasons why most
> corporations are Delaware (with a few in Nevada and a couple other states),
> including tax and governance issues.

CA works really hard to ensure that there are no tax advantages to
incorporating elsewhere. If you do biz in CA, you pay CA taxes on that biz
(and possibly some other biz - CA wants money).

In fact, CA even has a minimum fee ($5-800 IIRC) for doing biz here even if
you don't make money.

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jonpaul
You don't need a lawyer of LegalZoom to incorporate. Do it yourself, it's even
cheaper. Just make sure to do due diligence in your operating agreement.
DocStoc has a lot of template that you can reference. However, you should find
a lawyer for legal matters when doing agreements for other companies.

If you don't plan on seeking investment, it the short-term you should go with
an LLC for simplicity and tax reasons.

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mkramlich
That post read like a job security pitch for his field. I think as a general
rule you want to avoid and delay using lawyers as much as possible: too much
complexity, paperwork and cost, too early. Get to a sellable (and selling)
product/service first, otherwise you're wasting your money and time.

~~~
slapshot
On the flip side of that, a few hours of lawyer time in the first year of
Facebook might have saved the IP ownership dispute that has now cost about
$100 million dollars in settlements, and might still go higher.

There are a lot of stories of startups that went under because the 50/50
owners couldn't decide on a plan of action, or turned out to not own any of
the IP that they thought they owned.

~~~
fghjkoi8uygt
So pay us (lawyers) lots now or pay us more lots later.

Last time I heard an offer like that it was some italian americans commenting
on how flammable a restaurant was

~~~
slapshot
Pay us (doctors) for vaccinations or pay us more later for treatment?

Pay us (construction workers) for high quality materials now, or pay us later
for repairs?

Pay us (clothing manufacturers) for high quality clothes now, or pay us again
later when yours wear out?

