Some entrepreneurs believe that one of the legal issues they must address when they launch their business is to register their trademark. However, what they often don’t realize is that, at the beginning of their business, they have no trademark to register. Unlike copyright, which is acquired when a work is fixed into tangible form (i.e., when you write a story, paint a painting, compose a song, etc.), trademark rights are acquired through use. Like copyright, it is not necessary to register a trademark in order to have trademark rights. However, registration does provide several important benefits, such as jurisdiction in the federal courts, statutory damages, and constructive notice to other parties. But until a company actually uses a trademark in commerce, they do not have trademark rights, and therefore cannot register a trademark. However, the Trademark Office does allow companies to file an “intent-to-use” application, which essentially allows a filer to reserve a trademark for later use. Companies often use intent-to-use applications to reserve names and slogans for products and services that they are developing, but have not yet launched into the market. Note that an intent-to-use application does not grant the rights of an actual use application — it is merely a reservation system. A company that files an intent to use application must then update their application to an actual use application by submitting an example of the trademark in use within 6 months — a company may file for a six-month extension as of right, and then may only file for additional extensions with the permission of the Trademark Office. So while a company can file a trademark application when a business is being launched, the application must most likely be an intent-to-use application; the company can only update to an actual-use application and gain trademark rights when the mark is actually used.
Incorporation or LLC formation generally requires that the relationship among the founders be formally resolved and committed to paper — things like equity splits, operational roles, IP ownership, dispute resolution mechanism, and founder exit procedures are covered by incorporation/formation documents such as operating agreements, stock purchase agreements, and/or shareholders’ agreements. But many founder teams wait until they have a product, or at least a MVP, ready to go to market or to pitch to seed investors, before they incorporate or organize their company. Of course, the product develop process can take weeks, months, sometimes even years. In that span of time, the dynamic of the founder team can change — roles, responsibility, and input can grow and shrink, and founders can often leave the team to pursue other opportunities. Unfortunately, pre-incorporation founder teams rarely have agreements in place to handle these eventualities, leading to uncomfortable and potentially legal-issue inducing situations where different founders may have differing expectations of what they are entitled to — for example, a founder who departed prior to incorporation may think he or she is still entitled to some piece of the company based on their contribution to the product’s development. Ideally, when setting out with a founder team to develop a product or service that is intended to eventually become a startup, the team will write out a founder’s agreement. There’s no need for magical legal incantations, so it is not always necessary to have a lawyer draft one (although if the team is having trouble coming to consensus, a lawyer may be needed to mediate disputes among founders and suggest compromises and solutions), as long as the agreement clearly spells out what the team wants. However, it is important that the agreement discuss the important issues in a pre-incorporation founder team and provide the answer to resolving disputes when they come up — it’s easier to agree on how to resolve a contentious issue before it arises when the founders still like each other, rather than after the issue arises and founders may like each other a little less. Some of the more common issues addressed include: – Equity split: The team can agree at this point how to split the equity of the to-be formed company. However, they should also recognize that roles and responsibilities can shift as the team dynamic works itself out. Accordingly, the agreement should also provide for the ability to shift the equity split. For example, the team can set benchmarks and milestones leading up to the company’s formation that will “vest” equity in a particular founder. Alternatively, the team can set up mechanisms to review the equity split when the team goes to incorporate. Ideally, the team should ensure that everyone is comfortable with the split when the company is incorporated — many disputes arise when a founder feels he or she did not get his or her fair share of the company. – Roles and responsibilities: Connected to the first topic are the roles and responsibilities of the founders, which can be spelled out in an agreement. If everyone understands their responsibilities in getting the company launched, it can minimize the chances that other founders feel that someone did not pull their weight because they believed that founder had some responsibility they did not complete. – IP ownership: Usually, it is understood and should be agreed to that all IP generated in the development of the product/service will belong to the company to be formed, and that the founders will execute any necessary assignment agreements. Of course, some founders may believe that the work they did belongs to them, especially if they leave the team prior to incorporation. – Early exits: Perhaps most importantly, a founder agreement should address what happens in the event that a founder leaves the team prior to the company’s formation. Most draconian would be that a departed founder surrenders all interest in the company and any work they did on the product or service. If the agreement sets milestones for equity vesting, the departed founder could be granted equity for the work they did perform, or (if the company wants to avoid having “dead” equity in a non-participating founder) there could be cash-out mechanisms to compensate the departed founder for work performed. The early exit provisions may be the most important in a founder agreement, since it resolves a departed founder’s interest in the company, rather than leaving it as an open question, which could be an issue for the company if it takes off or could be a red flag to investors.
If you’re leaving your 9-to-5 job to launch your own startup, and especially if you’re in the white-collar or tech sectors and your startup is in the same industry or uses similar technology as your current job, you will likely need to worry about employment agreements you may have signed that include restrictive covenants. Such covenants include invention/IP assignments, NDAs, and non-compete agreements. If you’re bound by agreements such as these, you may be prevented from starting your company for a period of time after leaving your job, or even prevented from starting your company altogether. If you’ve signed an invention or IP assignment, you must be careful when beginning to work on your startup while at your current job. Such agreements state that any intellectual property you develop during working hours, while on company property, and/or while using company resources is automatically assigned to the company you are currently working for. Depending on how broadly those categories are construed, intellectual property you’ve developed for your startup while working in your current job might actually belong to your employer, which could prohibit you from starting your company altogether. Similarly, post-employment restrictive covenants such as NDAs and non-competes can delay or restrict your ability to start your new company. NDAs can prohibit you from taking any IP or know-how from your current employer to your new company, so make sure that you aren’t taking any algorithms, software, manuals, etc. from your current employer with you to start your new company, even if they would be supremely helpful. Non-competes can delay you from starting your venture. First, make sure that your employment agreement doesn’t prohibit you from “moonlighting” — if it does, working on getting your new company ready to start may constitute moonlighting and would be a violation of your agreement. When you do leave, you may be prohibited by a non-compete agreement from starting your company if it competes with your current employer, by being in the same or similar industries. Of course, non-competes must be limited according to positional and industry scope, geography, and time — non-competes that are too broad are either invalid or must be reformed by a court to be more limited. Assuming that you are bound by an applicable, valid non-compete, you may likely be unable to launch your company for the duration of the non-compete. Also worth noting is whether your non-compete has non-solicitation and no-hire provisions; the former prohibits the solicitation or retaining of the company’s clients, while the latter prohibits the hiring of the company’s employees. Finally, as a piece of career advice, it is always preferable to ensure that you are leaving your job on good terms, both from a legal and professional standpoint. Not only is it best to leave with your company’s blessing and understanding that you are not violating any of their legal rights, but you should also make sure that you burn no bridges on your way out as well. Your former supervisors and colleagues can be an important resource for advice, feedback, and mentorship; scorning them can turn them into your new company’s biggest enemies.
If you have a corporation for your startup, you’ve hopefully elected or appointed officers, and one of those officers is the corporation’s secretary. It is the secretary’s job to keep the corporate records, such as the corporation’s articles of incorporation and bylaws, and to keep minutes and records of the corporation’s meetings. “Wait,” you interject, “what are ‘minutes’?” Hopefully, you’ve been holding meetings of the board of directors (or of shareholders, if the corporation is directly managed by them) to decide significant corporate decision, such as amending the articles of incorporation or bylaws, the appointment or election of new directors or officers, selling stock in an equity financing event or as part of employee/contractor compensation, or taking on debt (including opening a company credit card), among other things. State laws and the corporation’s bylaws require a corporation to keep minutes of its meetings, and to make those minutes available to shareholders on request. It is generally the secretary’s responsibility to take the minutes of a meeting, although another person can be appointed to this task in the absence of the secretary. Minutes should record several items of information, including: – When the meeting was called to order and adjourned – Who was present at the meeting, including if any attendees arrived or left early or late or objected to the holding of the meeting – What items of business were discussed at the meeting – What corporate actions were approved (including which attendees, if any, objected to the action) Only a handful of states, Delaware chief among them, do not require meeting minutes. It is also important to note that the minutes requirement is only imposed upon corporations; to my knowledge, no state requires a LLC to keep minutes of its meetings. Lest you think that a small startup with only two or three founders working on it at the moment needs to have a meeting anytime they want to take a corporate action, most, if not all, states authorize both shareholder and board of directors action by unanimous consent, also known as a consent meeting. A consent meeting negates the need for shareholders to directors to meet in person or by teleconference, and simply authorizes an action to be taken. A consent meeting document should describe the action to be taken, and the signatures of all shareholders or directors entitled to vote upon that action. Bear in mind that, as the term ‘unanimous consent’ implies, an action by unanimous consent or consent meeting is valid only if *all* the persons entitle to vote on an action consent to the action. If only a majority of shareholders or directors approve the action, it is necessary to hold a full-fledged meeting and have the action approved by the necessary majority required by state laws, the articles of incorporation, and/or the bylaws.
I’ve had founders come to me worried about dilution of their equity stake cause by bringing on investors — although they’re more worried about keeping control than simply a bigger chunk of the company, they ask me how it’s possible to keep their same equity stake. The fact is, founders are going to get diluted. Although there are several anti-dilution provisions that permit any shareholder to keep their equity share (or something close to it), when founders grant those sorts of provisions to themselves it sends a red flag to investors, who expect founders to take the first hit when it comes to dilution, and may insist on having anti-dilution provisions themselves — if everyone is protected by anti-dilution, then there’s no one to dilute! Besides it’s better to own 20% of a company worth millions rather than 100% of a company worth nothing. Of course, there are some protections against dilution, particularly if founders are simply interested in keeping control over their company. The first step is to avoid “full ratchets” — these allow investors to receive additional stock in the event the company does a further funding round at a lower valuation, as if the earlier investors had bought in at the now lower price. But if a founder is simply concerned with not having their control diluted, they can make changes to the governance structures of the company, such as classes of stock, the board of directors, or voting power. The board of directors can be structured such that certain seats are elected by certain shareholders — professional and institutional investors may insist that they be given board seats that only they can elect people to — but founders can also create board seats that only they can elect themselves to. Founders can also give their class of stock super-voting power, such as having 10 votes for every share they own. In that example, a founder who owns 200,000 of 1 million outstanding shares only owns 20% of the equity, but has 2 million votes to the remaining 800,000 votes. Of course, founders must be careful not to go too crazy with structures such as these. Investors may be leery investing in a company in which a founder retains complete control, and thus could simply ignore an investor’s recommendations or concerns. If an investor is going to give you hundreds of thousands or millions of their dollars, they will likely want some say in how that money is spent. Therefore, while protecting your ability to direct the company, you will also want to provide for your investors to have a voice in company operations.