As I’ve written before, the race to opening your new venture is characterized by expansive enthusiasm—but that doesn’t make having important legal safeguards any less important. Unfortunately, founders often do not engage in the necessary legal counsel to guide them through the process. In this post I present three essential tasks that, considering the implications of doing them incorrectly, make investing in legal counsel worth every penny.
Clearly Define the Roles and Responsibilities of Founders
Too often, co-founders have known each other for a long time and believe that it will all work out—or if not, they will figure things out at that time. Unfortunately, that does not work out in 99% of all cases. Everyone has different expectations, and if a founder leaves at a critical time without an exit mechanism, it can jeopardize a lot of the value that you have already built, drive investors away, and alienate clients.
The long and the short is that you need an agreement among founders that talks about the roles and responsibilities of each of you when things are still working, but also addresses the possibility of an exit. It should address what happens to a founder’s stock when he departs, and whether or not he or she has any voting rights after he or she is gone. I know it is uncomfortable to talk about a divorce right after getting engaged, but I think it is absolutely necessary.
Comply with Securities Laws When Raising Capital
Many entrepreneurs I get to know do not have a good grasp of US securities laws. The bottom line is that every issuance of securities (notes and SAFEs are considered securities) by a company must either be registered with the SEC (i.e., through an IPO) or fall within an exemption from registration. This applies even to the stock issued to the founders on day one, and friends and family seed rounds after that. To make matters even more complicated, state securities laws (so-called blue sky laws) must be addressed on top of that.
There are a number of exemptions available, but you should consult with an experienced securities attorney to avoid the pitfalls because the rules are complicated. Sanctions are a regulatory action, a rescission right on the part of the investors, and alarming to potential future investors (i.e., VCs or super-angels). One term to know in this context is “accredited investor.” It is the key term in all exempt offerings, since offerings to non-accredited investors are often not practical because of their costs and complexities. Again, talk with an attorney—it will be money well spent.
Comply With Labor and Employment Laws
Comply with state and federal wage and hour laws from the beginning. Classify employees as exempt or non-exempt from the federal minimum wage and overtime laws under the Fair Labor Standards Act (FLSA), and compensate non-exempt employees accordingly. Also make sure that you understand state laws that may be more friendly to employees than the FLSA.
Another favorite topic: Make sure that who you classify as contractor is not de facto an employee. The same is the case for unpaid interns. If they are not what you say they are but employees, you may be liable for overtime pay, taxes, and penalties. Also: specify in offer letters and employee manuals that the relationship is at will, which means the employee can be terminated at any time with or without cause.
I promise to cover these and many more topics in future posts, but in the meantime send me your questions about forming your new business!
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If your company would like to strengthen its business practices, please contact us today so we can leverage our experience to create real-life business and legal solutions to help your business thrive.