Founding your own startup is an exciting time, a time full of hopes, dreams, and promises. Who has time for mundane legal technicalities when you’re building the future, right?
Wrong. Although startups are supposed to move fast and break things, being sloppy with your legal documents can break the company in the long run. And often it’s not something you can fix on the go. Mistakes you’ve made in the very beginning can come and haunt you, your company, AND your investors for years or decades to come.
We can’t stress enough how important it is to get your legal ducks in a row before you start talking to investors. Where laws and regulations are concerned, failing to plan is planning to fail. It’s always easier (and cheaper) to prevent legal problems than to solve them. In this article, we'll walk you through the key legal basics of starting a startup off on the right foot.
- Pick the right type of legal entity
- Register your business
- Protect your intellectual property
- Create legal documentation
- Understand securities laws
- Navigate employment law
- Seek legal counsel earlier rather than later
1. Pick the right type of legal entity
When you set up a new business, you need to choose your legal entity. This decision depends on the size of your business, the level of personal liability you're willing to take on, tax implications, and other factors.
The choice of legal entities depends entirely on the country or region of your operation as each jurisdiction has its own laws and regulations.
What are the key considerations when picking your startup’s legal entity?
- Liability protection: some entities, such as corporations and limited liability companies (LLCs), offer limited liability protection for the owners. Others, such as sole proprietorships and general partnerships, do not. The latter means that if your business gets sued or goes into debt, your personal assets may be at risk.
- Taxes: consider the taxation of your company income and expenses to avoid double taxation.
- Ownership and management: the entity determines the flexibility of your ownership structure and the management of your business. If the ownership and management structure is not clear, it can cause trouble among the owners later on.
- Fundraising: your company’s entity can also impact how easy it is to raise capital, e.g. corporations can issue stocks while LLCs can’t.
- Administrative burden: some entities have a relatively lax administrative framework, while others require regular meetings, minutes, and filings with the state.
Can you change your startup’s legal entity later on?
Sure, it's usually possible to change your legal entity as your business evolves and your needs change. However, the hassle can prove to be more than you’d expect and involve filing official paperwork, obtaining new licenses and permits, and updating contracts and agreements with customers, suppliers, and other partners. In addition, changing your legal entity may have tax implications and could result in additional costs and fees. It’s better to carefully consider the choice of entity early on and seek legal counselling to make an informed decision.
2. Register your business
Registering your business typically involves filing paperwork, paying fees, registering for relevant taxes, and obtaining necessary licenses and permits. To make sure everything is done correctly and avoid fines, legal liability, or other headaches, do your due diligence beforehand. It’s a good idea to consult with legal and financial industry professionals. Also, research any resources provided by public offices or industry organizations.
People often joke that picking a company name is the hardest part of registering a business. There’s definitely some truth to it. The name should be unique and not infringe on the trademarks or intellectual property of other companies. Make sure the name is not already registered by another company in your industry to avoid potential legal issues and protect the company's brand.
It's also a good idea to check if the corresponding domain name and social media handles are available on platforms like Twitter, Facebook, and Instagram. If any of the above are already taken, you can’t build a consistent brand across all channels, leading to confusion among customers. While name selection can be tricky, keep in mind that you can always change it later – although it’s a fair amount of hassle, you have plenty of time before you reach your world domination goal, but also after that.
3. Protect your intellectual property
Intellectual property (IP) refers to any creations of the mind, such as inventions, designs, or branding. It’s usually critical for startups as it helps protect the company's innovations, prevent others from stealing your ideas, and provide a competitive advantage. It’s also one of the most complex legal fields, so it’s a good idea to find a specialist early to mitigate risks.
What are the most common forms of intellectual property protection?
- Patents protect the technical innovations of a company, including products, processes, and designs. Consider if your company's inventions are eligible for patent protection and whether it's worth investing the time and resources to apply for a patent (and to enforce the protection later on).
- Trademarks protect a company's brand and identity, including its name, logo, and slogan. Make sure your company name and branding elements are unique and not already used by another company in your industry.
- Copyrights protect original creative works, such as software code, website content, and marketing materials. Ensure you are permitted to use all copyrighted materials in your products or marketing. Also, make sure you understand which parts of your company's creations are subject to copyright protection and then take steps to protect them, e.g. register your copyright or add copyright notices. Also, remember to add a relevant clause to your employment contracts to make sure employee creations are covered.
- Trade secrets are confidential and provide a competitive advantage, e.g. proprietary algorithms or customer data. You can protect your trade secrets, for example, by using non-disclosure agreements (NDA-s) with employees and partners.
4. Create legal documentation
Creating systematic, thorough, and concise legal documentation early on gives a solid legal foundation for your startup. This can include contracts, shareholder agreements, employee agreements, etc. Effective legal documentation protects the interests of all parties involved and helps prevent problems along the way.
The best way to get started with drafting and compiling your company’s legal documentation is the following:
- Find a good lawyer. Similarly to finding a good doctor to monitor your health, it’s worth investing in finding a legal advisor who can help prevent costly mistakes or even litigation in the future.
- Map out all your legal needs from shareholder agreements and non-disclosure agreements to employment contracts. You can definitely use templates for more standard operations, but make sure to check with your lawyer if you want to change something substantial.
- Keep records of all your legal documents, including signed copies and the latest up-to-date versions.
- Regularly review and update your legal documentation to keep them up to date with the latest regulations and your company’s needs.
5. Understand securities laws
Securities are different forms of investment interests issued to those who provide funding to startups, e.g. stocks, membership interests, stock options, convertible notes, etc. Understanding securities laws is extremely relevant for a startup raising funds from VCs or angel investors. Also, it’s one of the most complex legal fields you can face.
The securities laws are designed to protect investors from fraud and make sure startups reveal all relevant information to potential investors. Depending on your region of operation, you can have strict rules regarding raising funds or selling equity in startups, e.g. registering the offerings, filing reports, etc. Going against these rules can result in serious legal consequences. It’s always a good idea to be transparent and honest with your investors, as well as upfront about any potential risks or challenges facing your business.
6. Navigate employment law
Hiring employees brings on a full new layer of responsibility. We already mentioned drafting employment contracts, but you’ll need to actively keep up with the employment laws – from minimum wage and health protection rules to anti-discriminatory practices and taxing intricacies.
What are the key considerations to prevent employment disputes?
- Familiarize yourself with employment laws like minimum wage, overtime, vacation time, parental leave, and other regulations. Make sure that you're paying employees and related taxes correctly and that you're tracking their workload.
- Develop an employee handbook that outlines your company's principles and policies (e.g. working culture and expectations, taking time off, sick leaves, anti-harassment policies, etc.)
- Protect your confidential information with non-disclosure agreements and employee confidentiality agreements.
- Be mindful of potential discrimination or bias related to age, gender, race, and disability. Make sure that your hiring process is fair and that you're not discriminating against any protected groups.
- When you hire remote workers, make sure you know which regulations apply and be mindful of potential taxing issues. It’s also a good idea to clearly define expectations around work hours and communication, necessary equipment, cyber security, etc.
7. Seek legal counsel earlier rather than later
Consider finding a lawyer or legal advisor early on to avoid legal issues and protect your business. You don’t need to hire someone full-time right away, but it’s worth seeking legal consultation before any key events in your company. Look for a lawyer with both startup and industry experience who understands the unique challenges they face.
At what point do startups definitely need legal counsel?
- Legally registering your business – when incorporating your business, a lawyer can help you choose the right legal structure and file the paperwork. How much help you need depends on your local legislation and level of digitalization (looking at you, you lucky e-Estonians).
- Entering into contracts – when you start signing contracts with vendors, employees, or partners, a lawyer can help you draft or validate these contracts to make sure your interests are protected.
- Developing intellectual property – a lawyer can help protect the intellectual property related to developing your product or service through trademarks, copyrights, and patents.
- Understanding and ensuring regulatory compliance – if you are subject to industry-specific regulations or laws, a lawyer can help you preemptively understand and navigate the relevant intricacies.
- Raising funds – securities laws are no joke. Experienced legal professionals can help you understand all relevant legal obligations and make sure that all necessary documentation is in place to protect your businesses and investors.