Want to avoid making big mistakes when growing your startup? Heed the advice of these lawyers.
the Start Smart Legal Series — a series of online events hosted by the Big Idea Center at the University of Pittsburghthe Pitt School of Law and Carnegie Mellon University’s Olympus Project — aims to answer legal questions related to business creation, intellectual property, technology transfer and more. Previous panels have focused on topics such as hiring and firing, starting a business on an F-1 student visa, and negotiating term sheets.
The most recent, held on Tuesday night, brought together three lawyers to share some of the worst mistakes they’ve seen made over the years. The three panelists included innovation works Jural advisor Deborah Walker, Denton National Venture Capital Technology and Emerging Growth Companies Group Leader David Kalson and FJ Lucchinowho runs his own business, Lucchino Law.
The lawyers shared stories across a wide range of experiences they’ve had in their technology and business law careers. Below we’ve rounded up some key advice the lawyers shared at the event – but be sure to check out the full recording too.
Be careful when setting up your business
Before entrepreneurs can really get off the ground with a business idea, they need to legally set up a business, whether it’s an LLC, C corp, nonprofit, or whatever. While LLCs tend to be the most popular choice for start-ups due to lower tax rates and protection of personal assets, Kalson and Lucchino warned entrepreneurs to take the leap. training.
“There are times when it makes sense to be a C corporation,” Kalson said, especially if the end game of the business is to raise millions of dollars in capital and be acquired or taken public by the through an IPO.
Lucchino agreed that a common mistake startups make is not thinking about their endgame in advance. Another is “not getting good advice early on in considerations [business formation] decision, instead of going down the instinctive path of, ‘I’m going to do an LLC, because that’s what everybody does,'” he said.
There can also be serious consequences for not starting a company early enough, aside from the tax and investment drawbacks. One of the dangers of not having a formal Founder’s Agreement can be a vapid intellectual property mindset. The founders break up all the time for various reasons, Kalson said. It is therefore important to create a formal agreement from the outset that any intellectual property created by company employees must be handed over as company property if they decide to leave.
“If someone owns some of that intellectual property and doesn’t give it back, you can just kill the company on the spot,” he said.
Beware of “dead equity”
One of the main motivations for founders and their successors to create and join a startup is the promise of a return on investment. By joining a company early on, employees can maximize their chances of obtaining high-value stock options if that company succeeds and is acquired or goes public. In a perfect world, an employee’s equity should be proportional to the amount of work they put into the startup. Dead Equity comes into play in cases where this proportionality is disabled.
Lucchino said he often sees this problem in academic spin-off companies looking to commercialize a faculty member’s research. In those cases, “you have a faculty member, maybe a tenured faculty member at Pitt or CMU, and he’s been an advisor to some team members, so he has a role [at the beginning],” he said. “And so they end up getting a bigger stake in the [equity]but they will be too busy to do much with the business.
This can prevent a company from attracting new talent and ward off investors who are concerned about the imbalance of financial power. This also presents a tricky situation for students or former entrepreneurs looking to reduce that faculty member’s equity, as they may have conflicting interests regarding the need for a professional recommendation from that individual and access to other university-related resources.
So what can founders do? Kit Needham, director of the Olympus Project and assistant dean for entrepreneurial initiatives at CMU, said she enjoys showing faculty members data on the distribution of equity for successful spinoff companies. The hope, she said, is that once faculty members see this data, they’ll be more willing to back down, knowing that their dead capital could get in the way of investment and growth opportunities.
Downloading forms for the Internet is probably a bad idea
In order to save money at the start of a startup, founders might be tempted to download templates for employment contracts, nondisclosure agreements, and other business forms from the Internet, rather than paying for them. a lawyer drafts and advises on these forms. But that can become a big mistake, Walker said.
“People know they should have confidentiality agreements, and so they will take a confidentiality agreement off the internet,” she said. But often they misuse patterns for mutual NDAs, when a one-sided NDA is usually what is needed instead. Additionally, these NDA templates generally do not cover the attribution of inventions, representing intellectual property protection.
“It’s critical for tech companies to have those bases covered,” Walker said. During her time at Innovation Works, she has seen many start-ups rise to this challenge. One, in particular, “had a good deal and knew what he was supposed to do, but failed to collect the signed NDA and assignment of inventions from one of the co-founders.” The result was disastrous: “A few years later there was a dispute and he ended up suing the company, because in the absence of this assignment of inventions, he was a co-owner of the IP.”
Lesson? Even if your startup is strapped for cash, it’s worth consulting legal resources to make sure your bases are covered when it comes to intellectual property protection, confidentiality, and employment contracts.
At least that’s what three startup lawyers say.
Sophie Burkholder is a 2021-2022 corps member of Report for America, an initiative of The Groundtruth Project that pairs young journalists with local newsrooms. This position is supported by Heinz endowments. -30-