A Legal How-To for Startups
You're very excited to start your venture, but you need to know the legal landmines to avoid before you hang your shingle. We got the lowdown from two attorneys who counsel startup business owners on the little-known legal issues that often trip up new entrepreneurs.
A big issue startups overlook is document retention, says Jeffry W. Smith, a partner with law firm Lathrom & Clark LLP in Madison, Wisconsin. People tend to accumulate so much written material that "they don't have any practical way of inspecting it at a later date," he says. "The general rule of thumb is that anything [you] generate or put down in writing could someday be an exhibit in a lawsuit." This goes for e-mail communication as well--so be very careful of what you write and to whom you are sending it before you hit send.
Smith also advises against keeping a copy of each draft of a document. "It's discouraging to see three to four drafts of the same document being pulled from a file in litigation," he says, "because that means that every change of a document could be the subject for questions in a deposition." Only keep the previous draft around long enough to see that all the proper changes were made--then discard, he says. However, be sure to seek the advice of counsel before destroying potentially vital information (� la Enron).
Smith, an expert in intellectual property, also advises inventors to keep documents such as e-mail and interoffice correspondence that establish a date of invention. "If there's ever going to be a contest as to who was the first to invent a particular product or process...[you] need to have documented records and evidence of [your] dates of invention," he says.
And if you run a consumer products company, for example, be careful of outside inventors pitching unsolicited product ideas. They might pitch an idea that's already on your drawing board and later sue you when you bring that product to market, claiming it as their own. "It's really dangerous for a company to keep a copy of that letter, or to really review it in any detail," says Smith. "There should be a standing policy to send it back with a letter indicating that it wasn't reviewed, no copies were kept [and] it's [your] policy not to review [them]."
Kenneth W. Chung, a senior partner with law firm Kring & Chung LLP in Irvine, California, notes that legal issues are intertwined within every aspect of any business, especially during the startup stage. Startups need to be especially mindful of things like buy-sell and shareholder agreements, for instance. "Startups often involve two or more founders who continue to grow their company without a shareholder or buy-sell agreement," Chung says. "However, when an irreconcilable dispute occurs between the founders, they may find themselves in a deadlock."
And though it may not be the most obvious thing to think about while starting your company, Chung advises entrepreneurs to come up with an exit strategy. Ask yourself, "Is [the business] to be acquired, or [do I] desire to stay on with the company for the indefinite future?" says Chung. Settling this issue early will also affect how you structure your business.
As the startup phase of your business wears on, you'll deal with setting up your business entity, labor and employment issues, intellectual property and vendor contracts--just to name a few issues. Both experts suggest running your plans by your legal counsel, who can cater to your specific startup needs. One of the key questions you should ask yourself at startup, according to Smith: "How are we going to establish proprietary rights in what we're developing, and how can we avoid infringing on the rights of others?" Hmmm...seems like a good rule to live by in general.
What to Ask Your Prospective Attorney
You don't want to take that legal jump alone, and good counsel can really help you navigate the early phase of your business. Kenneth W. Chung, a senior partner with law firm Kring & Chung LLP in Irvine, California, lists the following questions every startup entrepreneur should ask their prospective counsel:
1. What is the extent of your experience in working with startups?
2. Do you have expertise with various startup legal issues, such as entity selection, securities law, intellectual property and labor and employment?
3. What is your experience in the particular industry that we are pursuing?
4. Do you have contacts or a working relationship with other professionals who could be of assistance--accountants, investment bankers and venture capitalists?
5. Who will be handling my file?
6. What distinguishes your firm from others?