Start-up founders often overlook legal housekeeping and compliance aspects in favour of commercials during the initial stages of setting up a business. As their business grows, these start- ups often seek external funding or institutional financing. It is at this juncture that the importance of having robust legal systems and agreements in place comes to the forefront. There are also instances where a founder may face issues either externally with third parties or internally with his/her co-founder at a future date. In this article we discuss ways in which founders may mitigate the risk of disputes in the future and may accelerate the timeline while seeking external funding.
The first aspect to consider before starting any business would be the type of corporate structure. Especially, if one was to start a business with another co-founder, it is imperative to have a structure in place which will both limit each co-founder’s liability and divide the roles and responsibilities among the co-founders. Funders may consider setting up a private limited company, limited liability partnership, partnership or proprietorship. It is important to evaluate the costs of compliance vis-à-vis mitigating future liabilities and disputes while selecting such a structure. If there are two or more co-founders, it is extremely important to enter into an agreement amongst the co-founders which sets out the rights, roles and responsibilities of each co-founder and a dispute resolution mechanism. Depending on the legal structure, such an agreement may include a shareholders’ agreement or limited liability partnership agreement.
While hiring talent, founders should consider entering into employment agreements rather than simply issuing offer letters. This is particularly important if the business is technology driven or has other trade secrets and confidential data to which an employee is privy. It is therefore advisable to enter into watertight employment agreements which inter-alia contain confidentiality, data protection and intellectual property clauses.
Start-ups often use a similar approach with vendors and customers wherein they conduct business purely on the basis of purchase orders instead of agreements. In cases where the business owns intellectual property and know how, in particular, founders should consider entering into agreements at the initial stages itself or at least entering into standard form non-disclosure agreements with such vendors and customers. Additionally, there may be certain cases where a start-up is asked to enter into a standard form agreement drafted by a customer. In such cases, founders should endeavour to get such draft vetted by a lawyer to ensure that there aren’t any heavily onerous clauses such as unlimited liability that could cause issues in the future.
It is common for start-ups to offer employees incentives in the form of employee stock options. Before issuing such employee stock options, founders should seek legal advice on whether they should offer equity options or similar shadow stock. Employee stock appreciation rights are also a good option where the employee is given the monetary benefit of holding equity shares while not overcrowding the cap table.
Another important aspect to consider is the branding and trademark aspect. Once a founder starts conducting business under a specific brand name and the business starts doing well, the public at large and the industry will begin to associate the business with a particular brand name or logo mark. Businesses often do not register their brand names, tag lines or logo marks with the trademark authorities till much later. The risks associated with leaving such registrations for later are that there may already be a pre-existing conflicting mark registered in the same class as the business. In such case, it is extremely unlikely that the applicant founder will be granted registration and it is likely that even if the trademark registrar were to accept such application, it
would be opposed by the proprietor of the pre-exiting mark. Additionally, if the mark is not registered, another user may attempt to register the same or similar mark or copy the branding. Certain online market places and e-commerce websites require entities to have a registered trademark before selling goods on their website. It is therefore advisable for a founder to apply for trademark registration at the early stages of doing business itself.
Therefore, start-ups should consider their corporate structure, entering into agreements with employees, founders, vendors and customers and registering its trademark at the initial stages of business itself. Founders should also seek legal advice before offering equity in the form of employee stock options and before signing any agreements with third parties.
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