This episode of Thomson Reuters Down the Hall with Practical Law features Practical Law Startup & Venture Capital Senior Legal Editor Joe Green discussing common legal mistakes made by startup companies. Joe talks about his background working with tech startups and his current role creating legal know-how for practitioners advising startup companies. After setting the stage by defining what he considers a “startup,” he provides insights into why many startup companies fail. Joe covers what startups can do if a co-founder decides to leave early on and the benefits and potential pitfalls of providing equity compensation to employees. He closes the interview with his list of the three things that anyone representing startups should know and the best piece of advice that he’s ever been given.
Mentioned in This Episode
Joe mentioned several potential legal pitfalls startups can avoid with the proper planning. For a more robust discussion of those issues, view the Practical Law Startup Company Toolkit.
This Toolkit includes resources to assist startup companies and the attorneys representing them with the array of legal issues facing new business ventures, including entity formation, capital raising, corporate governance and housekeeping, shareholder relations, real estate and insurance issues, acquiring and protecting intellectual property, data privacy, software and information technology issues, commercial transactions, liquidity events, workplace and labor issues with employees, contractors, and service providers, and employee compensation and benefits.
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Thomson Reuters: Down the Hall with Practical Law
Top Legal Mistakes a Startup Can’t Afford to Make
Intro: Welcome to Thomson Reuters: Down the Hall with Practical Law. The show that provides practical insights and expert know-how on trending legal issues. No legalese, just expertise. With your host Renee Karibi-Whyte.
Renee Karibi-Whyte: Hello, and welcome to Thomson Reuters: Down the Hall with Practical Law. The show that provides practical, legal know-how that makes lawyers’ lives easier. I am your host, Renee Karibi-Whyte, and today I am joined by Joe Green. Joe is a Senior Legal Editor specializing in startups with Practical Law.
Joe Green: Hi Renee. How are you?
Renee Karibi-Whyte: Good. I am so glad you could join us today.
Joe Green: I am thrilled to be here.
Renee Karibi-Whyte: So today we are going to talk about how to avoid the top legal mistakes that startups typically make. But before we get started, I want to learn a little bit more about you. How did you end up at Practical Law? What’s your background with Startups?
Joe Green: Sure. So I started my career at a Law School at Simpson Thacher in New York where I was a securities lawyer and working on kind of high profile Wall Street type financial transactions but I did a lot of pro bono work working with startups while I was at Simpson Thacher, and then a few year into my career an opportunity came up to move over to Gunderson Dettmer’s New York office. Gunderson Dettmer is a Silicon Valley based law firm, had a growing New York presence as the New York Startup scene was really taking off and that’s where I spent the bulk of my career working exclusively with tech startups helping them raise Venture Capital money, basically cradle-to-grave services all the way from incorporation, before incorporation, straight through IPOs merger, selling the company or winding them up if they didn’t turn out like the founders had hoped.
Renee Karibi-Whyte: And now how does that work that you did there translate to what you do now at Practical Law?
Joe Green: Well basically I take all of my experience working with startups and that forms the basis for the content that I create, the resources that I create for Practical Law. So I am pretty much writing exclusively resources focused on practitioners who practice in the startup space who are doing the things that I used to do, trying to explain how to do them, market practices and just the nuts and bolts of how to get these transactions done, what to expect, what to look out for, so that’s what I do.
Renee Karibi-Whyte: So I was reading an article recently and it said that something like 90% of startups fail. Now presumably it’s not always due to legal reasons but we are going to talk about today is how to not make a legal reason, one of those reasons for failure.
Joe Green: Yeah, if 90% of startups are failing for legal reasons then those startups need to find new lawyers. It usually has something to do with the market, the timing, whether the product really fits, has a market out there, whether the team is able to execute on their vision, but there are a lot of legal issues that come up for startups and a lot of them can potentially put a company out of business, others, even if a company is extremely successful can be extremely painful when founders have to end up giving a lot of the gains that they were expecting over to legal issues of one stripe or another.
Renee Karibi-Whyte: So to make sure that everyone is clear in what we’re talking about when we are talking about these legal mistakes, how are we defining a startup? Are we talking about my uncle going and opening a bodega? Are we talking about only tech startups, what’s the scope of the conversation we are going to have today?
Joe Green: Yeah, so that’s a really great question because the term “Startup” is just, it’s used constantly in the press and just in everyday speaking, and it’s really important to distinguish when you’re giving legal advice in particular what type of company you are talking about because the advice may differ dramatically depending on the type of company.
So when I talk about startups, when I write about startups for Practical Law, what I’m really talking about are types of companies that would be attractive to potential Venture Capital investors and that’s usually a specific type of company. It’s a company that is attacking a very large market, has plans to grow very quickly using invested capital as opposed to starting very small nudge kind of using the money that they are making the business to reinvest, so they keep taking additional capital to try to scale the business up as quickly as possible. And, then the goal of, once you have all these outside investors who have put money into the company and grow into a sufficient size, the goal usually is to provide some kind of exit for those investors whether that’s initial public offering, whether it’s sell stock and the investors are able to get some liquidity or they sell the company to a Google or a Facebook.
That’s usually the goal of these types of companies and that’s very distinct from your uncle opening a bodega or really any other small business. So the way I like to think about it is there are startups, which you might say are tech startups, a lot of them have to do with technology, that’s where these kind of highly scalable business models tend to show up and small businesses — you may have a new small business but wouldn’t call that a startup per se.
Renee Karibi-Whyte: So for shorthand purposes we can say the kind of entity that would get invested on if it went on shark tank?
Joe Green: Yeah, that’s not bad, although, I think actually the shark tank investors are interested in even wider ranges of types of businesses than traditional venture capitals might be.
Renee Karibi-Whyte: Okay.
Joe Green: Yeah.
Renee Karibi-Whyte: So from a legal perspective what is the biggest danger of that type of company you are talking about today?
Joe Green: So, the way that these companies tend to get themselves in the most trouble is by not speaking to their lawyers early enough or not speaking to their lawyers frequently enough. Entrepreneurs have — I think Facebook’s motto is “Move Fast and Break Things”, that’s kind of the mentality of a lot of entrepreneurs, is that they are trying to innovate, they are trying to do something new, it’s all encompassing, it takes up their entire lives and they don’t a lot of times have the wherewithal to slow things down and think about all the risks that they are taking, because if they ever did they probably wouldn’t continue. These tend to be risk-taking individuals who undertake these types of ventures.
Renee Karibi-Whyte: So it sounds like there might be a propensity to not even have a lawyer early on?
Joe Green: Yeah, that’s absolutely right, I mean, a lot of people when they started thinking about starting a business they are still working somewhere else. They are doing this as a kind of a project on the side. They have no money to put up into doing it, they are just kind of if they are an engineer or a coder, they are just hacking away at whatever they are working on, or if it’s more kind of a businessperson, they are coming up with their plans and talking to people, potential investors, but until they are really at a point where there is an investor is willing to give them money and they need to figure out how to do that, a lot of times those people won’t be reaching out to attorneys.
Renee Karibi-Whyte: So what is the right point at which they should get that attorney?
Joe Green: So it depends. I think that if you are still employed and you are just kind of working on something yourself, until you are ready to make a move or actually launch something, kind of get something out there or raise money, you don’t really necessarily need to speak to an attorney. Sometimes having just a consultation can be helpful, because you can find out that a bunch of things that you were planning on doing, you really shouldn’t be doing or can’t do, so good things can come from that.
But, usually when you’re kind of ready to leave and try to go after something full-time, that’s a good time to think about, incorporating, creating an entity and then thinking about how you are going to finance the business.
Renee Karibi-Whyte: So that brings me to one of the areas that I now is a focus area in terms of creating the right structure. What are some of the things people should consider when they are determining what the right structure is for their business?
Joe Green: Yeah. So this is another regular question because it also varies depending on the type of business. So we are talking about tech startups here, and a lot of people that just go into any lawyer who incorporates businesses and general practitioner so to speak, might hear, oh! Well, you should have an LLC, because a Limited Liability Company allows you to pass through your taxes, you don’t have to pay corporate level tax, and then personal tax on any distributions from the corporation.
But, if you go to a lawyer who specializes in working with startup companies particularly ones that are looking to attract Venture Capital money, Venture Capital funds for the most part won’t invest in pass-through entities, because they have their own tax considerations with certain of their investors who can be harmed by having that income pass through on their tax returns.
And so, as a lot of times it’s cheaper and easier just to start as a C corporation. The forms are a little bit more straightforward and everybody is just a little bit more familiar with them. And so, for tech startups usually forming as a C corporation is the right way to go from the start than that’s if you go to lawyers who specialize in assessment will tell you.
Renee Karibi-Whyte: So by not actually getting the structure right they could lose potential investors?
Joe Green: It’s not necessarily they’ll lose the investors; it’s that they will have to incur some costs down the road. So if you start as an LLC, because you went to a lawyer who told you, that’s what you should do, and then you have venture capitalists who are interested in you, there is a couple of different ways that you can fix that problem.
The company can convert from an LLC to a C Corporation which costs some money and involves some legal gymnastics and sometimes depending on how well you have kept your books, it might be straightforward, and if you haven’t, it might be a little bit more complicated. The little cleanup work to do, which usually is for startups when they are early on.
Another thing is that sometimes the investors would be willing to create what they call a Blocker Corporation. So they would basically create just as their own C Corporation to invest in and then the investor C Corporation would invest in the startup LLC. But the issue with that is that they prefer to be just investing usually directly into the —
Renee Karibi-Whyte: Yeah, because it seems like that could cause some kind of additional concerns.
Joe Green: Yeah. It’s really more that they — it’s more work for them to do, it’s kind of pushing the work off on the investors, something that they have to pay for that they would rather, the company just deal with and it’s going to be an issue for investors in the future, so for the most part these companies by the time that they raise their first Venture Capital round of investment have become a C Corporation. So better to start that way, that’s usually the advise.
Now if you are a bodega or if you are a service business, or any other kind of business where you may not be looking to get Venture Capital investment and the business is going to throw off a lot of cash that you might be able to take out of the business and used to live, then an LLC could be much more effective because you don’t have to pay two layers of taxation.
Renee Karibi-Whyte: Now can the structure decision also affect the relationship between the parties? There is a lot of startups, I know I started between people who kind of trust each other, so they may not be as formal in the agreements. What kinds of things should they think about with respect to that?
Joe Green: Yeah, a lot of times that informality has to do kind of with the startup culture a bit. We don’t want to have to pay a lot of lawyers come up with all kinds of fancy documents. We are friends, we have been doing this for a long time together, we trust each other, all of those types of things.
A lot of times it also just happens that those are difficult conversations to have, how are we going to split the equity? What happens if one of us leaves? That’s where lawyers can really help a startups founder stop make a terrible decision very early on whenever there are multiple founders in a startup company.
Renee Karibi-Whyte: So it’s easier to say, the lawyers making us have this conversation than to raise it, have that difficult conversation yourself.
Joe Green: It is. Ultimately the founders need to have the conversation, but the lawyers can definitely play a role in making sure that they do have the conversation and documenting things is a forcing function requiring them to actually have those difficult conversations about all of those different eventualities.
Renee Karibi-Whyte: Have you seen in your past practice situations where there were break-ups that were difficult and what happened with those? Like give us an example of one of those.
Joe Green: The founder divorce, it happens all the time. It happens very, very frequently whenever there are multiple founders. If there are more than two founders, the odd is that at least one of them at some point is going to move on and do something else is very, very high.
And so, as a general rule, anytime there is more than one founder, I always advise companies to put some kind of vesting in place on the founder stock. Basically, what that does is that you have all of your stock on day one, but the company has a right to repurchase it if you ever leave the company.
And so what that does is — and this is just simple time-based vesting, there is no milestones involved or other targets that you have to hit or responsibilities you have to meet, just the passage of time.
So let’s say over the next four years, I am going to kind of earn my stock on a monthly basis in equal increments, and so as long as I am sticking around —
Renee Karibi-Whyte: So they are not pulling out all the capital at once and potentially endangering the company?
Joe Green: Yeah, actually it has nothing to do with the capital, it’s just about the stock, so the ownership percentage of the company. And so, if they do something where the other founders decide it’s time for you to go or they just decide I am not quitting my job or I have another great opportunity or my family is sick and I can’t do this anymore. We have two founders that split the company 50-50 and one of them walks away with 50% of the company, the other founder is left with the choice of shutting the company down, or continuing to work for only 50%, but doing a 100% of the work. That’s a terrible situation.
And so having that vesting provisions in place can really save founders a lot of heartache. It’s in there on day one, everybody knows the deal, and if you leave or you end up not performing that’s what happens, you walk away with loss of the company and then the rest kind of reverts to the people who are still there doing all the work.
Renee Karibi-Whyte: In addition to vesting, what are some of other documents or considerations that business partners should enter into to prepare for the potential dissolution of the company?
Joe Green: So the time-based vesting actually for most companies is helpful to have that just serve as a proxy for all of the things that you could imagine that might go wrong, but you could if you wanted to, I mean, we are talking about contracts here, you could legislate all of those things. You could think of every horrible thing that could possibly happen and come up with a response to each of those things that you all agree to beforehand.
The problem with doing that as it’s incredibly costly, you are never going to think of everything that might eventually happen, and so most companies are best served just by having time-based vesting and leaving it there.
That said, it is really helpful for lawyers to make sure that the founders of their companies do have difficult conversations early on about what kinds of roles, what kinds of responsibilities each of them is going to have, what happens if they don’t meet those responsibilities so that at least everybody is going in on the same page.
The splits in equity is also a very big part of that conversation when you are talking about what kinds of roles and what kinds of responsibilities each founder is going to have, how much equity is associated with that, do you just do an equal split among all of the founders regardless of what they are doing with the understanding that maybe their operational responsibilities are going to shift from time-to-time or do you have those conversations early where you decide, well, I am going to be doing X, Y and Z, so I should have 60% and you should have 40%. Those are really important conversations in having people take the easy way out and having founders who don’t have those conversations early on can be a major cause of companies failing or just having terrible, painful divorces that they eventually get through but that really — it can drain a lot out of a company.
Renee Karibi-Whyte: So another early consideration revolves around the naming of the company. What are some of the dangers there?
Joe Green: So you will notice that most startups that you see nowadays have made up words usually ending in an L-Y or — yeah, the reason for that is that it’s hard these days to find a company name or a brand that’s going to be clear and also not something that somebody else is already using in the technology space.
So trademark law is really what comes into play here and a lot times the company will come up with a name and they think that if they can get a domain name for it then it’s theirs and that’s all they need to worry about, but other companies may be having trademarks on things that are very similar or could cause confusion in the marketplace, and if that’s the case, you may spend a lot of time coming up with ideas and marketing campaigns and start going out to the market with this name only to get a letter from a big company saying, hey, you’re infringing on our trademark and you need to stop.
Renee Karibi-Whyte: So while we are on IP generally in terms of company names, is there a specific IP strategy that you use to recommend to the companies that you worked with?
Joe Green: Yeah, so for most software startups, I typically wouldn’t recommend getting software patents, it’s not something that those companies typically do. For hard tech companies, I would usually refer them to a patent attorney, which I’m not, get them the specialists who can make sure that they go through that process and are able to secure patents for hard technology, hardware or things like that, it’s very important.
But generally speaking for startups, it’s very important to make sure that whatever intellectual property you’ve created is owned by the company, that’s incredibly crucial. Every investor that looks at that company, every acquirer that looks at that company, it’s the first thing that they are going to do is make sure that all of the intellectual property is owned by the company. Lot of founders start working on their products, their concepts, their businesses before they incorporate, it’s very important that the investors who invest in the corporation are sure that the intellectual property that was created beforehand is actually owned by the corporation.
Renee Karibi-Whyte: So you are saying by the corporation instead of the individual who is starting the corporation?
Joe Green: That’s right.
Renee Karibi-Whyte: You are making that distinction?
Joe Green: Right, so if the founder started working on it before the corporation was created, there needs to be some kind of assignment to all that intellectual property, usually in exchange.
Renee Karibi-Whyte: It has to be a paper trail.
Joe Green: Paper trail, exactly, and usually it’s an exchange for the stock that they are getting in that company but making sure that that’s there is very important, also making sure that all the engineers that work for the company, all the people who are creating intellectual property have signed proper employment agreements and inventions assignments, incredibly important.
Renee Karibi-Whyte: So that brings us a little bit more toward the employees, let’s say a startup has gotten some funding, the founders are making a little bit of money and they need to hire a team now to help them actually push the business forward, at what point should they be really concerned about various labor laws?
Joe Green: Right away, unfortunately a lot of companies think that they can get around that by if they only hire a few people and they hire them part-time or that they can call them independent contractors and not have to withhold taxes for them and not have to comply with labor laws and pay unemployment insurance and all of those various things that big employers have to do.
But that’s actually not the case, even if someone is working part-time, if they are only working for you, if they are not a true independent contractor, someone who has their own entity, let’s say, and goes around providing services to a whole bunch of different companies and controls the way that they work and take assignments kind of as they decide, if it’s not that situation, if it actually is more like an employee who just isn’t working a full-time job, they are still an employee.
And so, even from that very first employee you need to set up with the payroll, you need to set up to do tax withholding; all of those things start from the very beginning; paying minimum wage, overtime. So founders don’t want to believe it because it’s a lot of — it can be a lot of work. There are a lot of firms out there now, a lot of companies that actually take care of this for early-stage companies basically from beginning to end, they call them PEOs, and that’s basically what most of these founders will end up doing, they will get those folks to take care of the vast majority of the things. Those companies don’t take care of everything for them, it does not sound like they’ve now out-sourced having to think at all about dealing with employees, they should still make sure that they are talking to their lawyers and complying with the various things that they need to comply with, but in terms of the withholding and taxes and all that kind of stuff, PEOs can be really helpful.
Renee Karibi-Whyte: So have you seen any companies in the past, have people who are technically employees but they give them a little bit of equity and say, okay, now you’re a partner and I don’t have to comply with those laws?
Joe Green: Yeah, so that doesn’t work, all of these tech companies usually provide some form of equity compensation.
Renee Karibi-Whyte: In lieu of kind of hourly wages —
Joe Green: No — yeah, that doesn’t work, but the vast majority of startup employees do get some form of equity, their stock options or if it’s company’s still really early stage they might actually get stock, and that’s a very big part of working for a startup, a whole idea of going to a startup that can’t afford to pay you what you were making at your last job if you were at a big company.
That’s where the equity comes in. It really comes in more because that’s a form of compensation that they have, whereas cash is a form of compensation that they don’t have. And so to pay market salaries to engineers who can command hundreds of thousands of dollars in some markets when they have no cash is not possible. So that’s where you see a lot of equity compensation being used.
Renee Karibi-Whyte: And is equity compensation a risky area as well?
Joe Green: It can be. It’s an area where you really have to make sure that you are observing all the formalities and complying with the laws, particularly tax laws, when you are granting stock options. This is particularly the case for startups once they have set a price on their stock, usually by taking some form of outside investment.
So once you have done your first round of investment, somebody has given you money, they have put a value on the company, that’s how you determine how much to charge them and how much the company they got to buy. The employees at that point, you are usually going to want to give them stock options, because giving them stock, just giving it to them would require them to then pay taxes on that stock. But they can’t sell the stock at that point to pay the taxes and usually they don’t have the cash or don’t want to come out-of-pocket to pay the taxes.
So you give them a stock option that’s not taxable at the time that they receive it, but that stock option has to be granted at the fair market value of the stock on the date that it’s granted. You can’t grant an option at below the fair market value. They call that in the money option. Public companies got into a lot of trouble back in the early 2000s for granting in the money options to their executives, so now there are very punitive tax laws, particularly Section 409A of the tax code, that if you don’t grant an option at fair market value, you can have major tax implications for doing that.
Renee Karibi-Whyte: And what happens if you violate that?
Joe Green: If you violate that there is a very large excise tax on top of interest and penalties, yeah, it can be a really big problem. And even if the IRS doesn’t come after you and you are not audited, which a lot of companies aren’t these days, the IRS is stretched pretty thin, when a potential acquirer is looking at you, thinking about buying you, they are going to inherit all of your tax problems. And so they very often are the ones who are scrutinizing this most closely and it can end up, they may say, well, fine, we will buy all your tax problems, but it’s going to be for $10 million less than we said we would at the outset.
So when you tell founders that, they are much more likely to think about playing it safe on the stock option pricing front than if you just tell them, well, you might get audited. They are hoping to sell the company one day for a lot of money and the idea that that’s somehow going to hurt them is usually something that they will listen to.
Renee Karibi-Whyte: So speaking of money and selling the company, what are some of the risks inherent in raising capital?
Joe Green: So it’s just really important to know what you are getting into. When you are raising capital from venture capitalists and professional investors, you have to understand why they are doing what they are doing and what their expectations are.
If you are a founder who wants to have a lifestyle job, you started this company so that you can have a great lifestyle and eventually the company will start throwing off enough money that you can hire somebody else to take over and travel around the globe and have the income coming off of that company, you don’t want to take money from venture capitalists, because venture capital funds are raised, they have a 10 year life, where they invest in the first couple of years of that, the companies grow, and then they want their money back. And they don’t want their money back just for someone to necessarily buy them out, they want that company to go public or to be bought at a large multiple of whatever it might otherwise be worth. And so that’s an important thing to know going into that.
It’s also important to know what are kind of the market conventions around how venture capitalists interact, not all investors are the same. A lot of West Coast venture capital investors have more of a hands-off approach when it comes to how restrictive they are with the company and things that they need, where the founders would need to go get the investors’ approval to do X, Y or Z.
Renee Karibi-Whyte: Yeah, I have heard there is like a West Coast version and an East Coast version; can you provide a little more insight around how that came to be?
Joe Green: Yeah, so there is less of that than there used to be, but venture capital really grew up on the West Coast, and I think a lot of West Coast investors eventually realized that they were betting on founders, these were largely — especially early stage investments were largely lottery tickets, and so having a whole bunch of downside protections and a whole bunch of restrictions and shackles on the founders was counterproductive at that point.
And that later investors who came on roll began to ask for more and more and more. And so for early stage investors they end up looking a lot more like the founders at the end of the day than someone who is putting $100 million in a Series F financing round. And so I think a lot of West Coast investors realized that.
And on the East Coast the investors were much more from the financial world. They were private equity, hedge fund guys who were now investing in startups, and so I think that that — they come to it with a different mindset, a different type of investing.
There was also a lot more competition on the West Coast in the startup world, at least in the past, now, New York, Boston are pretty big VC centers.
Renee Karibi-Whyte: How did that difference change the advice that you as a lawyer gave to your clients?
Joe Green: So, so much of the advice that you give is driven by the investors that the company has to work with and what — I mean, at the end of the day even if the terms of a deal are really bad, if that’s your only choice, it’s between that and shuttering the company, then I guess you are going to be taking that money or you can move on and do something else. And so a lot of it is driven by the investors.
In my experience, even in the time that I was practicing, by which point the East Coast terms had already converged quite a lot with West Coast terms and become more founder-friendly, in my experience at this point, while there were some investors who still expected much heavier terms, the pendulum had really swung so much. And this also has to do with the fact that we are in a bit of bubble right now in the startup world, where a lot of terms are becoming much more founder-friendly. So, that has a lot to do with it.
Renee Karibi-Whyte: So one of the things that all companies have to deal with is liability of third parties, like in their supplier contracts, in their vendor relationships, any kind of business partners. Are there special risks inherent in those relationships for startups?
Joe Green: Yeah. I don’t know if there are special risks, a lot of times startups end up having to take terms that larger companies wouldn’t have to take, because just of a total lack of leverage that they are trying — when they are negotiating with large companies they are very often having to take whatever those large companies are willing to give them in terms of the contracts that they enter into. But it’s very helpful to have, even though those larger companies may be saying you are going to use our form and we are not going to change it, having someone at least look out for really big issues that may end up coming into play can be really helpful.
So when you are first starting out having a lawyer help you kind of come up with your own standard master agreements and at least try to use those or at least try to get the larger company forms closer to those, wherever you can around the margins, can be really helpful.
Renee Karibi-Whyte: Let’s say you have a friend or a colleague who doesn’t typically advice startups and this is a lawyer friend, what three things would you tell them to focus on?
Joe Green: If they are going to advice a startup?
Renee Karibi-Whyte: Yeah, they have a startup client, they haven’t really dealt with startups, what three things would you tell them to look out for?
Joe Green: I would tell them to read a lot of Practical Law resources actually, because it’s funny, I have represented a lot of lawyers who become founders of startups, and so not just going to represent a startup, but they are going to try to do it themselves, and a lot of times they think, I will do my own legal work and save costs because I am a lawyer.
And it’s a particular world, the startup world, and just because you are a lawyer of one stripe for another; I was a securities lawyer at Simpson Thacher, there were a lot of very specific things about working with young companies and startup companies, particularly companies that are looking to raise venture capital money, that it really makes sense to get lawyers who have done it before. And if you haven’t done it before, then you really need to find a trustworthy source to read about how this practice works, because it’s not necessarily intuitive, and it’s really something that if you don’t know what you are doing, you are not going to ruin a company over it, most likely, but —
Renee Karibi-Whyte: Most likely?
Joe Green: Most likely, but you can be much more efficient if you are able to understand the market conventions of working with early stage startups.
Renee Karibi-Whyte: Okay, great, that’s one.
Joe Green: That’s one.
Renee Karibi-Whyte: And what are the two biggest danger areas that you would tell them to be on the lookout for?
Joe Green: Yeah. So I would say one of the biggest danger areas is dealing with founders when they are first coming over and their previous employment relationships. So a lot of founders are leaving companies that — especially technical founders leaving companies that they have been working for.
Renee Karibi-Whyte: You mean non-competes.
Joe Green: Non-competes, non-solicits, people who leave a company together, it’s so easy for large companies, just with the threat of a lawsuit, to basically —
Renee Karibi-Whyte: Or they will be seen as taking client even if they have no agreement.
Joe Green: Exactly, exactly.
Renee Karibi-Whyte: Or even trade secret.
Joe Green: Right. And so documenting all of those things and making sure when you get a startup on your door and they are working somewhere, the first thing I always ask for is all of their employment documentation, to take a look at all — go through all of it. And then I will also ask them about their practices and make sure that they are not using their company’s laptop or their company’s computers or anything from their company; don’t use a stapler. Make sure that you have completely segregated to every extent possible your work on your startup from your work in your existing employer, because those things really can come back to haunt you, where you end up having to settle with that company for 10% of the equity in your company. That kind of stuff does happen. So that’s a big area.
And then I would say the other area, and these aren’t as much legal issues per se, but having founders have those difficult early conversations when you are setting up the business, making sure that everybody is going into things with their eyes open, about what the expectations are, the equity conversation, people have had that conversation. Those are the biggest things that I see a lawyer being able to tell people who are doing this for the first time, you really need to do this, because not doing it can end the business eventually, or make it so painful, you will really wish that you had.
Renee Karibi-Whyte: Well, thank you Joe. As we wrap up I have one more question for you. What is the best piece of advice you have ever been given?
Joe Green: The best piece of advice. Well, this is a hyper practical one, but it’s something that I always passed along, because it actually did save me on many, many occasions. When I was a summer associate one of the first things that I drafted, and I can’t remember what it was, but I handed it in, and the senior associate called me to their office and showed me the black line that I have sent them and pointed to a few things in the black line that were just silly mistakes, and they were like, did you look at this black line before you sent it to me?
And I said, no, I read the document, I read the Word version, I printed out a copy and I read through it, but I guess I missed those. And when you are a new lawyer having that kind of attention to detail, it comes with time, but the number of times that I have now read a black line before sending out a document and found all kinds of either silly mistakes that are just embarrassing or substantive things that — comments that I got in there that shouldn’t have, it saved me on I don’t know how many different occasions, so I always pass that one along.
Renee Karibi-Whyte: So Joe, it looks like we have reached the end of our program. I would like to thank you so much for helping us to frame some of the issues for consideration with respect to startup companies. Now, if people have questions, where should they go to get more information on any of the topics we discussed?
Joe Green: Well, there is a lot of stuff out there on the Internet with startup stuff, but it’s really hard to know whether the people who are writing these various blog posts really know exactly what they are talking about or they are just kind of talking from their limited experience with it.
Practical Law has a Startup Company Toolkit which lists all of our resources on all of the things that might relate to startups. So that’s a good first place to start looking for resources on any variety of topics that relate to startups.
Renee Karibi-Whyte: Okay. And that was Joe Green, Senior Legal Editor with Practical Law, and this has been another edition of Thomson Reuters: Down the Hall with Practical Law. I am Renee Karibi-Whyte, and until next time, thank you for listening.
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