23 Apr 2018, 09:57 — 9 min read
What is the most common mistake startup founders make during early growth? While it’s tempting to dig into the vision for your company and start making your idea a reality, it’s important that founders pause and cover their legal bases. This article explores the core legal documents that founders need to have in place to avoid costly legal battles down the road.
Bylaws define how a company needs to carry forward itself in a legal fashion. In simple, it is a good way to spell out your startup structure, individual roles including governance. Take for instance, a bylaw can help in settling a dispute on a person’s tenure or explain if there needs to be a simple majority to approve a decision.
1. Articles of incorporation
A common mistake startup founders make is failing to put the proper business structure in place. Setting up only a sole proprietorship can result in huge income tax bills and legal liabilities for which founders are personally responsible. By not filing with the Internal Revenue Service to form a distinct legal entity for their business, founders risk losing their personal savings and, in some extreme cases, their homes.
While all options have their pros and cons, for the most part, startups with multiple shareholders should form a Pvt Ltd Company. Businesses that want fewer tax obligations and want to avoid heavier fees during early growth should consider forming a limited liability Partnership (LLP).
2. Intellectual Property (IP) assignment agreement
An intellectual assignment agreement is a key legal document that determines whether your startup can attract investments in order to flourish. In a startup, founders must posses complete ownership of all intellectual property assets, in writing, to avoid companies attempting to copy your business model. During the formation of a new company, the best thing to do is to assign all important intellectual property to the company.
There are two types of intellectual assignment agreements that need to be taken into account:
Technology assignment agreements assign startups intellectual property created before the formation of the company.
Invention assignment agreements assign company’s intellectual property ownership of any work or product created by employees after the company’s formation. A confidential invention assignment agreement is signed by founders and employees. Moreover, the company will own all rights to the Intellectual property portfolio.
Bylaws define how a company needs to carry forward itself in a legal fashion. In simple, it is a good way to spell out your startup structure, individual roles including governance. For instance, a bylaw can help in settling a dispute on a person’s tenure or explain if there needs to be a simple majority to approve a decision.
4. Operating Agreement (Founder’s Agreement)
To avoid any conflict among founding parties, all co-founders should sign a comprehensive operating agreement. The agreement should define the relationship of the founders, provide the expectation that all work will belong to some entity in the future and outline a basic communication and conflict-resolution clause that can help prevent disputes.
5. Non-Disclosure Agreements
This type of an agreement is entered between parties in order to protect company’s classified information. Also referred to a non disclosure agreement, this bond identifies company’s confidential information and maintains its confidentiality. Basically, a non-disclosure agreement is executed by a company or individuals who are doing business together. For example: A company that’s inducting an investor in to its ambit, will sign a non disclosure agreement with the investor before sharing information about themselves.
A non disclosure agreement must include the following:
What is so confidential about the information?
How confidential information should be handled?
Who owns the information?
The time period the information will be disclosed.
The time period for which the confidentiality should be maintained.
In simple, your business information such as financial records, ideas, customer list etc. must be considered private. A non-disclosure agreement is your first line of defence that protects your company’s confidential information. This agreement creates a confidential relationship between your business and its contractors, employees and employers, partners etc.
6. Employee Contracts and Offer Letters
Startup CEOs and founders should draw up clear employment contracts and offer letters when hiring new employees. These legal documents are key to ensure employees understand what’s expected of them. They should clearly state the following.
Terms of employment (e.g., compensation, role responsibilities, working hours and grounds for termination)
IP ownership of work
Company policies (e.g., vacation days, paid time off structure, dress code)
Shareholder agreements: When a startup is ready to take on private investments, CEOs should create a shareholder agreement that determines the rights of shareholders and defines when they can exercise those rights. Those rights can include shareholders’ right to transfer shares, right of first refusal, redemption upon death or disability and shareholders’ power to manage and run the startup. It’s also important that founders document the sale of any shares to avoid huge financial penalties under state and federal laws.
Share purchase agreement: A share purchase agreement is basically used in times when you induct an investor or partner in your company. It consists of details regarding terms of purchase and sale of shares and the consideration for which shares are being exchanged. It specifies the conditions required to be fulfilled to consummate the sales and guarantees that both the company and entrepreneurs make to the buyer or investor.
7. Devising a Business Plan
A business plan may not be a legal document, but instead its a basic formality that keeps your business financially healthy. Devising a map of your businesses’ future is a concrete area of thinking, as building a future plan of your startup will result in a competitive and challenging ecosystem for your employees growth and development. Your startup’s game plan must have clarity on the company’s growth at present and in future and possesses a crisis management plan in case of any internal or external issues. It highlights the the ways in which you can improve strategies within your business and draws the roadmap to accomplish it.
8. Memorandum Of Understanding (MOU)
An MOU is an agreement between two or more parties in a gentle and formal manner. An MOU falls anywhere between a formal contract and a handshake. It includes all formal conversations you have made with suppliers, potential partners and others involved in the business. An MOU is a great way to lay out the terms of a project or relationship between employees and employers in writing. However, in certain cases an MOU will not be legally binding depending on factors like presence and absence of legal members not mentioned in the document.
9. Non-Compete Agreement
A non-compete agreement is a restrictive agreement wherein one party agrees not to enter into/engages/commence any activity, trade or profession which is in direct competition with the other party. The legality of a non-compete agreement varies as per jurisdiction.
Section 27 of the Indian Contract Act, 1872 states that, “Every agreement by which anyone is restrained from exercising a lawful possession or trade or business of any kind, to that extent may be considered as void”.
Therefore the Indian law makes it clear that a non-compete agreement shall not be binding on the parties and the same shall be considered null and void.
While time is a precious resource for any startup, founders should prioritise putting these agreements into place to secure their company’s future.
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