Incorporation of a company
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This article is written by Bushra Asif who is pursuing Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.

“We have always been shameless about stealing great ideas!”

– Steve Jobs

Ideas are just that – “Ideas!”, till they are put into action. However, it is rightly said there are a thousand sips between your lip and cup of tea. Imagine you come up with a great stupendous idea and in excitement share it with your friends, only later to find that while you were still in the planning stage one of your friends quickly got into action implemented and owned the novelty of your Idea. It might sound sleazy but sadly you will not be able to do anything about it, other than curse and gripe.

It sounds similar to what happened in the famous Winklevoss brother’s suit against the Facebook owner Mark Zuckerberg (Winklewoss – Zuckerberg Dispute). Similarly, in 2010, Heinz revolutionized the ketchup packet as they released their ‘Dip & Squeeze’ model in the market, however, David Wawrzynski, a Michigan native vehemently stated that he had presented that idea to Heinz years ago as the ‘Little Dipper’, he sued Heinz but the Grand Jury rejected his case due to lack of evidence (Heinz v. David Wawrzynski). Another example of Ray Kroc vs the McDonald’s brothers depicts the same where the salesman Ray Kroc took their idea and expanded it to make his own dream for it come true (Ray Kroc – McDonald’s brothers).

All the above-mentioned scenarios entailed millions of dollars of lawsuits, but what about a simple startup who does not have the privileged access to unlimited litigation funds to resolve disputes over the ownership of a product or an idea, especially in the early stages of the business.

Timing, perseverance, and ten years of trying will eventually make you look like an overnight success.” – Biz Stone, Twitter co-founder.

Yes, true experience has no substitute, but a lot of pitfalls can be avoided, and you can reach your goals earlier if you are well prepared. How can startups save themselves from lengthy litigations and disappointments? What is the best way to protect not just your ideas but your Company as well?

Fortunately, the law protects the person who is knowledgeable and well-prepared. There are few MUST HAVE Agreements that a startup should enter to secure himself and his budding business right from the start. There are several contracts that a startup will need to get into, e.g – with  co-founders, investors, employees, clients, vendors, etc., but here I will delineate the most important FIVE:

1) ARTICLES OF INCORPORATION

A common mistake startup founders make is failing to decide what will be the proper structure for their business. It is a big mistake not to consult a lawyer and as a result of forming wrong kind of legal entity they often incur higher taxes and become subject to liabilities that could have been easily avoided had they started their business on correct premise. Setting up as a sole proprietorship can attract huge income tax bills and legal liabilities for which the founders shall be personally responsible. While the different business structures carry their own pros and cons, however, it is generally advisable that startups with multiple shareholders should form a C corporation. Businesses that want fewer tax obligations and want to avoid heavier fees during early growth should consider forming a limited liability company (LLC).

2) FOUNDER’S AGREEMENT

“65% of high-potential startups fail due to co-founders fall out.”

Noam Wessman, Harvard Business School Professor and author of The Founder’s Dilemma rightly stated the above quote as it is true that co-founders get embroiled in disputes stemming out of many poorly attended reasons, such as athe appropriation of money, business strategy, and leadership.

Taking the abovementioned example, imagine if the Winklevoss brothers had signed a founders Agreement with Mark Zuckerberg, maybe they could have signed a work-for-hire Agreement instead. This one agreement would have altered the course of history for them, it is that important! No start-up is secure without having clear demarcations right from the onset. 

A usual scenario is that you start a business with people you trust and are close to, with a verbal deal and a handshake, i.e.- your friends, colleagues, family members. I once told a dear friend of mine, who was starting a business with her sister, that she must have a Co-Founders Agreement and I even volunteered to make it for her for free, however, she said it was not needed as she totally trusted her sister. Just in their second-year year things started getting sour and they had to terminate their venture over irreconcilable differences.   

More often than not one of the founders realizes that the other side Is not doing enough, or differences arise in how to run the business. Since there is no Agreement in place a lot of rifts start which either end up in terminating the startup and parting ways or “I said -You said” scenario continues for long. Therefore, you must have a good clear Agreement where things are well defined, like: 

  1. Who gets what percentage of the company?
  2. Is the percentage ownership subject to vesting based on continued participation in the business?
  3. What are the roles and responsibilities of the founders?
  4. If one founder leaves, does the company or the other founder have the right to buy back that founder’s shares? At what price?
  5. What salaries (if any), are the founders entitled to? How can that be changed?
  6. How are the key decisions and day-to-day decisions of the business to be made? (majority vote, a unanimous vote, or certain decisions solely in the hands of the CEO?)
  7. Under what circumstances can a founder be removed as an employee of the business? (usually, this would be a Board decision)
  8. How much time commitment to the business is expected of each founder?
  9. What happens if one founder isn’t living up to expectations under the founder’s Agreement? How is it resolved? Or what will be the dispute resolution mechanism?
  10. How will the sale of the business be decided?
  11. What assets or cash into the business does each founder contribute or invest?
  12. What is the overall goal and vision for the business?

3) EMPLOYMENT /INDEPENDENT CONTRACTOR AGREEMENT

Once the business has initiated you will soon be required to hire people to do different jobs to run the day to day operations of the Company. It is paramount that you have employees’ or independent contractor’s Agreements in place. This Agreement will state and outline all that is expected out of both the parties. If you neglect this portion and do things verbally or meekly there is a high chance that an employee can try to take ownership of IP he was working on, or claims ownership to a portion of the Company because they put ‘sweat equity’ into building the business, or claim that they were not adequately paid for the services they rendered, etc.

To safeguard the interest of the Company and avoid getting dragged into such kind of disputes and lawsuit you must have a written Agreement, which should mainly cover these points:

  1. Terms of employment (e.g., compensation, role & responsibilities, working hours, and grounds for termination);
  2. IP ownership of work;
  3. Required commitments;
  4. Share vesting;
  5. Reporting structure;
  6. Expectations;
  7. Company policies (e.g., vacation days, paid time off structure, dress code).

4) NON-COMPETE/ NON-DISCLOSURE AGREEMENT

This is another area where startups fail to realize that if they discuss their idea with a prospective investor or employee without having any confidentiality Agreement signed before, they risk their shared information to leak thus causing them irreparable loss -sharing is clearly not caring in this case. Therefore, it is imperative that startups should not reveal their business ideas or trade secrets or any other information vital for their business which gives them a competitive edge, to anyone without them signing a Non-Disclosure Agreement (NDA) first. It could be with employees, investors, potential investors, vendors, board members, suppliers, and manufacturers or anyone else. In the famous case of Hallmark Cards, Inc. and Janet Murley, the ex vice-president of Hallmark marketing who was responsible for product and business development a similar scene arose. After her services ended at Hallmark she signed a non-compete and NDA with Hallmark, however as soon as the term of her Agreement expired she was hired by RPG with whom she shared confidential documents of Hallmark (Hallmark – Janet Murley).  

The more comprehensive your NDA is the more protection you will have as it will act as a major deterrent and enable the Company to enforce its rights in court and seek compensation in case of an infringement. Some of the salient features of an NDA are:

  1. What constitutes confidential information;
  2. How confidential information should be handled;
  3. Who owns that information (the Company);
  4. The time period that the information will be disclosed;
  5. The time period confidentiality will be maintained;
  6. What will be the consequences of the breach.

5) INTELLECTUAL PROPERTY ASSIGNMENT AGREEMENTS

If your company has developed some unique product, technology or service, you must consider to protect the intellectual property before it gets robbed. Ideally, every individual working for the startup must sign an agreement assigning intellectual property that they create for the Company to the Company. Startups usually, due to lack of experience assume a lot of things – such as that if some employee is developing some software of course it shall belong to the Company – WRONG! The employee can go rogue and claim ownership on it and then it can only be claimed back after a long legal haul and till then a lot of damage already has been incurred. Here are some of the common protective measures undertaken by start-ups:

  1. Patents. If you are developing a new product then Patents give you best protection. It will secure the right to prevent others from making, using, or selling the patented product described in words in the patent’s claims. 
  2. Copyrights. Copyrights will give you complete protection if your work includes original works of authorship, such as art, advertising copy, books, articles, music, movies, software, etc. 
  3. Trademarks. A trademark right will protect the symbolic value of a word, name, symbol, or device that the trademark owner will be using to distinguish its product/Company from those of others. 
  4. Service marks. Service marks resemble trademarks and are used to identify services.
  5. Trade Secrets. A trade secret right allows the owner of the right to take action against anyone who breaches an agreement or confidential relationship or who steals or uses other improper means to obtain secret information. Trade secrets can range from computer programs to customer lists to the formula for Coca-Cola.
  6. Assignment Agreement for Employees. Every employee must be made to sign such an agreement. It achieves multifold purposes. Firstly, it obligates the employee to keep the proprietary information of the business, both during employment and after employment completely confidential. Second, it ensures that any inventions, ideas, products, or services developed by the employee during the term of his/her employment and related to the business belongs to the Company and not the employee.

Conclusion 

More awareness is needed on this front as people take it for granted and do not attain counselling from a lawyer who can easily make you avoid many mistakes that might not be visible to you. It is a misguided effort to save on expenses, startups often either do not hire legal counsels or hire inexperienced incompetent ones. A good legal counsel will also steer you rightly apprising you of all the legal compliances that the Company needs to undertake, failure of which may make them suffer serious disadvantages later on. Clear and comprehensive agreements are a big support to the Company helping it to avoid legal disputes and lengthy litigations later on, which only serve to exhaust the Company’s monetary resources and distract the Company from building and expanding its business. If you have proper Agreements in line then you will attract more investors too as they will be inclined to do business with someone who is better streamlined and organized. 


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