What do Mark Zukerberg, the Beatles, and John D. Rockerfeller all have in common? All of them have been embroiled in disputes that drained resources, time, and control over their business. Business partners and businesses fall apart 80% of the time, almost double the divorce rate for families in the U.S.
In the newly found Silicon Beach community, built around start-up Tech companies, there are a number of pitfalls new companies can fall into that can lead them to failure. The following are measures to consider in order to prevent issues from occurring.
1. Creating a Founders Agreement
Before you put any time into creating your business, hammer out the terms and make sure that they are on paper. While all founders may be excited about the prospect of working together, issues arise when the day-to-day stress of the business hits or one founder believes they put in more effort than other founders. When creating this document, it is important to think about a variety of scenarios and look at factors such as:
- Who gets what percentage of the company?
- Does the interest vest?
- Is the company able to buy back the interest of the founders if they leave?
- What are the roles of the founders?
- How are decisions made?
- What assets are contributed to the company by the founders and what are their values?
- What is the overall goal of the business?
2. Determine the proper entity
In the start-up world, it is imperative that new tech start-ups have a Delaware corporation. This is important for a number of reasons. First, and most important, VC’s want to invest in a company that can issue stock. An LLC does not provide the same mechanism since LLC’s do not have shareholders and can not issue stock. Second, VC’s do not want to invest in a company that has a pass-through tax. LLC’s and S Corps have pass through taxes, which could significantly impact whether a VC is able to invest in the company, due to the VC being a foreign individual. Pass through taxes can potentially require the VC to pay a significant amount in taxes because the company’s income will not be taxed at the corporate level, rather taxes“pass through” to the VC. Third, a corporate structure gives liability protections that are not afforded to other entity structures such as a sole proprietor or partnership structure.
3. Creating contracts that favor the company
Many companies believe that they can use form contracts that they get off the Internet. The issue with these contracts is that they are not tailored to be more favorable to your company. Since form contracts are not tailored to the company’s specific industry, market, or structure, this can leave the company open for liability and the possibility of these contracts being used against the company if issues arise. This is why hiring an experienced attorney is essential to ensuring that you are protected.
4. Lack of documentation for employee
Start-ups encounter problems when they do not maintain adequate documentation for their employees. Since most start-ups have employees that work at reduced wages and take equity in the company, if the documents are not properly executed, this can open the company up to significant employment liability. Some of the major employment documents that should be included are:
- At-will” employment offer letters signed by both the company and employee.
- Confidential Information Agreements and Inventions Assignment Agreements.
- Employee Handbook.
- Stock Option documents (Incentive Plan, Notice of Stock Option Grant, Option Agreement).
5. Intellectual Property (IP) Protection
A unique technology, product, or service can trigger the need for a company to protect the property being developed. If IP protection is not sought, the company could be infringing on the IP rights of a 3rd party. Protecting IP ensures that the company avoids infringing on 3rd party rights and protects a 3rd party from infringing on another company’s rights. Some of the important IP protections that a company should consider are:
- Service Marks
- Trade Secrets
- Non-Disclosure Agreements