Do It Right The First Time: Avoiding “Janitorial” Legal Work

Antone Johnson , Founding Principal , Bottom Line Law Group

1 Dec 2011

What is a startup really?  When meeting with early stage entrepreneurs for the first time, after reviewing a demo or hearing their pitch, I often ask them to articulate what they’re most focused on building.  In most cases, the answers are (1) an outstanding product or technology; (2) a successful growth business built around that product; and (3) a top-notch team to build and execute the business.

Notice what is missing from this list of priorities:  The company itself – that is, a business entity, most often a corporation, that will own the entire business (however defined), issue equity to founders, take investment capital, enter into contracts, make sales, pay employees and contractors, and so forth.  I don’t fault entrepreneurs for relegating startup legal work to the bottom of their daily triage list; founders are spread incredibly thin.  Nevertheless, choosing to defer basic corporate housekeeping items can be disastrous in some circumstances, as when the failure to spend a few thousand dollars on legal fees to clarify IP ownership and equity arrangements comes back to bite a successful company to the tune of millions of dollars on the eve of a liquidity event.  To add insult to injury, the more spectacularly successful the company, the more costly the mistakes can be.  Every startup lawyer is familiar with variations on this theme and can recite cautionary war stories, but the Winklevoss brothers’ dispute with Facebook, made famous in the movie The Social Network, has become the iconic example.

There are countless related subjects, such as what type of entity to form and in what jurisdiction, how to handle equity compensation and vesting arrangements, determining titles and Board membership, and so on.  I’ve written extensively on these subjects, as have other lawyers, notably Yokum Taku and Scott Edward Walker.  For purposes of this two-part article, I want to slice off one specific issue:  Which actual pieces of paper are required at what stage, and who should prepare them?

In the days before online document repositories and do-it-yourself sites such as Docstoc and Legalzoom, as a practical mater, the answer to the latter question was that early stage startups either went to a friends-and-family type lawyer to do the basic setup work, found their way to one of the handful of large law firms that have extensive experience representing venture-backed startups (such as my “alma mater” firm WSGR), or went without.  Serial entrepreneurs or those with close ties to the investment community would usually go straight to the big firm.

Founders now have more options, which is a double-edged sword.  It’s easier than ever to find example documents on the Internet, use a service to file your certificate of incorporation or trademark application, and so forth.  Entrepreneurs are quintessential do-it-yourselfers, but it would be a mistake to think that because these items and activities consist of documents, there is little to be gained from involving an attorney.  In much the same way a good primary care physician adds value by diagnosing illnesses and prescribing treatment, a good startup lawyer brings to bear professional judgment, perspective across many clients and deals, the wisdom of experience, and – near and dear to most founders’ hearts – a history of mistakes (often made by DIY clients or by other lawyers working outside their area of expertise) with lessons learned accordingly.

In next week’s post, I will get into specific documents.  For starters, let’s examine the question of who, when and what:

Who:  Find and engage an experienced startup lawyer.  The advantage of using documents you find online or through a document service is largely illusory.  Startup law firms have vast collections of documents, templates and examples to work from; this allows us to create most if not all of the standard documents in very little time, and at relatively little expense to the client.

When:  Ideally, involve a startup lawyer as early as possible upon deciding to start a new venture.  This is most urgent when more than one founder is involved, when “outsiders” touch IP related to the new business, or when the startup is engaged in a business closely related to the current or former employer(s) of the founder(s).

What:  The foundational corporate formation, governance, equity issuance and intellectual property assignment documents.  We’ll get into these in more detail next week.  Suffice it to say that going without good advice in these areas can result in mistakes and messes that will need to be cleaned up later in the company’s life cycle – usually at much greater expense than it would have cost to do them right in the first place – and that doesn’t even count the cost of litigation, which can be orders of magnitude greater if a serious dispute breaks out.

In Part II, we’ll get into certificates of incorporation, stock purchase agreements, IP assignments and related matters.  Good stuff!

This article is for general informational purposes only, not a substitute for professional legal advice. It does not result in the creation of an attorney-client relationship. All opinions expressed are those of the author, and do not necessarily represent those of Gust.

Gust Launch can set your startup right so its investment ready.

SETUP RIGHT