It’s time to raise your first round. Maybe you’ve been bootstrapping for a while or you’ve been relying on the funds (and goodwill) of friends and family. Either way—as you’re thinking about raising your first round in 2015, make sure you get your legal house in order first.
We’ve compiled a list of a few essential legal formalities you should have ready before you hit the market for funding.
Legal Formalities Before You Start Fundraising
To seek investors in your company, the company must first exist – this means you chose an appropriate business form. Your entity will hold capital, take on debt, own intellectual property and employ talent.
As a result, you want to form a corporate entity, typically either an LLC or a corporation, to shield you from personal liability. Investors tend to prefer C-Corporations because of standardized rules and obligations for the corporation, shareholders and directors, the lack of pass through tax treatment and eligiblity for Qualified Small Business Stock; however, there may be compelling reasons for you to choose a different business form, including some of the reasons why investors gravitate towards C-Corporations.
While the state where your business is physically located is a common choice for incorporation, there may be a compelling reason to choose “out of state” incorporation—Delaware is a popular incorporation state because it offers well-developed body of corporate law and deference to the board of directors.
Consulting with an attorney will help you decide both on your form of business as well as the jurisdiction of incorporation.
Corporate Documents & Governance
Make sure you have corporate bylaws or an operating agreement in place to outline all owners’ rights and responsibilities. Especially between cofounders, it’s important to understand who owns what before you seek investment.
If you have chosen to form a corporation, a lawyer can help draft your corporate bylaws. While a lawyer should assist in tailoring your bylaws to suit your corporation, generally bylaws contain:
- Identifying Information (e.g., Name, Purpose and Location)
- Number and type of shares and stock classes
- Board of Directors
- Committees (if any)
- Directors and Corporate Officers
- Meetings and Notification Requirements
- Conflict of Interest Provision
- Process for Amending Bylaws
Like a corporation, when you choose to form an LLC, it is important to create document that governs the business’s operations. For an LLC, this is known as an operating agreement. While many states don’t require it to register, an operating agreement can help prevent and protect the LLC from financial and management disputes.
Like corporate bylaws, an operating agreement establishes the structure of ownership, the power and duties of members and managers, the meeting and voting rights, the distribution of profits and losses and the withdrawal protocol for members.
When you’ve chosen a partnership as your business form, a partnership agreement is essential to resolve future conflicts and avoid expensive litigation. Don’t make the mistake of waiting too long to enter into these agreements. It is difficult to predict when or how your vision might differ with a co-founder, and you want to have a strategy in place to deal with the issue.
A partnership agreement, among other things, will define the ownership, management and decision-making, distributions and salaries, and withdrawal procedures.
Because your company’s intellectual property is one of its most valuable assets, it is important to ensure that all employee and contractor-created works have been assigned to the company, prior to seeking investments. For this reason, agreements with all employees, independent contractors and service providers should ideally contain well-drafted assignment clauses, which assign the IP in any work done while engaged with the company, to the company. You should consider protecting your patents and trademarks sooner rather than later.
If you have a patentable product, it is best to engage an IP lawyer to file a patent application. Depending on your situation, it might make sense to file one or more provisional patent applications to preserve your first-in-time rights. Filing a patent application (provisional or not-provisional) also establishes priority over competitors with similar products, who might also be pitching to the same investors.
Ensure that you have trademarks for your company name and/or logo. When you pitch to investors, you are often relying on the traction you have gained. If it turns out that you don’t have rights to the name or image consumers identify with your brand, it could create a serious impediment to seeking investments.
Employment and Independent Contractor Agreements
In addition to your business, your company’s key talent can create interest when raising investments. Enlisting a lawyer to create the terms and conditions of employment in a comprehensive employment agreement will allow you to protect your company. Of particular importance is employee equity ownership or stock options, so discuss with a lawyer on how to keep diligent records and clearly delineate these arrangements in your employee agreements.
If you are hiring independent contractors, you will want to have an agreement that outlines the relationship. Simple saying that an independent contractor relationship exists in writing doesn’t always make it so. Some of the factors that you may want to highlight are that the independent contractor is not on your payroll, controls his/her working hours and conditions, uses his/her own materials and tools, and whether the work is temporary or permanent.
Regulatory Clearances and Tax Obligations
Depending on the type of business your startup conducts, you might need certain Federal or State permits and licenses to be able to conduct your business. Obtaining the necessary licensing and permits ensures that you are legitimately conducting business in accordance with the laws in the place where you operate. Similarly, you want to verify that your business is up-to-date with all federal and state tax obligations, including sales, employment and income. Violations of such regulations create unnecessary delays in conducting business, growth, and can even result in hefty fines.
Whether you need to raise capital for research, development, operations or growth, getting your legal house in order can give you an advantage over your competition for investors. Priori Legal is the easiest way to find your company a trusted, vetted attorney at a below-market, fixed rate. Request a Lawyer through Priori and find the right startup attorney to provide the necessary guidance to ensure that you are fully prepared to confidently and successfully pitch to investors.