Startup Legal Guide
Though there is an increasing amount of legal information available on the internet, oftentimes founders still make basic mistakes because they don’t understand how the pieces of information fit together or how and when a rule may apply. Also, startups often overestimate what it requires to take care of loose ends early on and underestimate the amount of time and resources it will take to fix things later. This post aims to provide a roadmap to help founders navigate those legal issues.
PART I. STARTING UP
Formation (a.k.a. “Incorporation”)
- Business Registration– The type of your entity affects how profits and losses are shared among the shareholders, tax requirements, and the founder's personal liability. Most startups incorporate as a C Corporation in Delaware and then, as needed, register to do business in the state in which they actually operate the business.
- Articles of Incorporation and Bylaws (together, a.k.a. “charter documents”) – These documents set out some basic rules of how the company must be run. Some of the rules are required by law, others are customary. Key things to note are what kind of actions require the approval of the Board of Directors or the Stockholders, and how officers and directors are elected.
- Apply for Employer Identification Number (EIN) from the IRS
- Bank Account – A company’s bank account should be established under the company name. Funds from the founder’s personal account and the company’s bank account should be kept completely separate. Even if a founder wants to give money or lend money to the company, the transaction should be properly documented.
- Cap(italization) Table – Often in the form of a spreadsheet, the cap table keeps track of any and all of your shareholders (including investors, employees, and anyone that is promised equity in the company), what each of their ownership is of the company, and any restrictions on each individual/entity’s equity ownership.
- Stock Plan – The plan lays out the total amount of equity that the Company can allot to its work force (employees, consultants, advisors, etc.) and any restrictions or processes. The Stock Plan must comply with various tax and securities law requirements. A typical company may reserve 10-15% of the stock plan for hiring. Think through how much equity you can offer to employees, include a vesting schedule to limits loss when key employees depart.
- Founder’s Restricted Stock Purchase Agreements - Basic agreements to grant founder’s stock usually in exchange for cash, intellectual property, business plan of the company, or a combination of the above. These in addition to other employee equity documents often contain vesting provisions ensuring that the individual receiving stock can’t just leave at any time without doing any work and take a chunk of the company. Discuss further with your lawyer to learn what the standard terms are.
- Various actions taken by the company require the consent of the Board of Directors and sometimes also the consent of Shareholders. If certain actions that require Board Consent or Stockholder Consent are taken by the Company without the necessary approvals, then the Company or the Officer opens themselves up to future lawsuits or liability.
- Board Consent or Board Minutes – These documents track actions that the Board approves. Very important to keep track of given what is mentioned above; some example of items that the Board of Directors commonly must approve are equity grants and any Company financing transactions.
- Stockholder Consent or Annual Meeting Minutes - Very important to keep track of given what is mentioned above; one example of items that stockholders commonly must approve is issuance of a stock plan.
Accounting, Finances, and Record Keeping
- Personal and company accounts should be kept separate.
- Track receipts for cash purchases.
- If you’re in the hardware, retail or similar business, it’s important to keep track of all your suppliers/vendors, the amounts of all purchases, and annually updated W9s for each of them for annual state sales tax filings.
- Former and Current Employee/Consultant/Advisor List – Be disciplined about tracking each person’s start and end date (important for confirming the equity they have vested in), salary, keep track of all work product, documents, and IP tied to each employee. To the best of your ability, have each person’s personal contact info in case you need to reach out later regarding any shares they own, IP, etc.
- Budget Plans and Burn Rate
- Profit and Loss Statement, and Balance Sheet – These are some of the most basic finance documents of a company and investors will ask for them so stay updated with your books whether you use QuickBooks or a startup accounting service.
- Lease – Your office lease is especially important when something breaks or an accident (whether caused by human or nature) occurs. Make sure you understand what you and your landlord are each responsible for in commonly occurring scenarios. For example, if the electrical system needs repairing, the roof leaks, the place gets broken into.
- Sublease – If you are subleasing instead of leasing directly from the landlord, ask to see the master lease and know under what circumstance the landlord can terminate the lease. If you are subleasing out, make sure that the sublease is clear about who is responsible for fixing something if it breaks.
- Zoning - Be sure that your location is suitable for your business purpose so you won't run into problems when you need to get inspected for a seller's permit or other licenses.
Business Specific Licenses
Depending on what your company does, you may be required to get specific licenses. Always remember to check both federal requirements AND state requirements.
Taxes – Founders often don’t know that they need to file both federal and state taxes. Even if you are losing money, you still need to go through the actions and file taxes each year.
- Federal – Remember you need to file for the company and also for yourself as an individual.
- State – State calls this annual tax by different names (DE calls it the Annual Report Filing, CA calls it the Statement of Information and Franchise Tax) but each requires you to update information about your company and pay a fee at the end). After being delinquent in your state taxes and annual report filing for some time, your corporate status is “suspended” meaning that your company does not legally exist and that your contracts signed under the company’s name is not valid! Your company can be “revived” but save yourself a few hundred dollars and another few hours trip to the state’s treasury office.