Starting a new business is exciting. You have an idea for a service or a product you are convinced consumers want. Before offering your product or service to consumers, certain practical and legal considerations must be addressed to protect your business interests and your personal interests. The decisions you make while setting up your new business venture have a significant impact on many short-term and long-term matters and issues.
This legal resource guide is an overview for entrepreneurs of some of the basic matters they need to consider when formalizing their new start-up. The guide is not intended to be a substitute or replace the counsel and recommendations of a Maryland business attorney.
Draft a Founder Agreement Immediately
If your start-up will involve co-founders, one of the first steps to take is to draft and execute a founder agreement. A detailed founder agreement can prevent costly litigation if a co-founder leaves before the start-up is incorporated. It can also settle issues related to equity, vesting of ownership, roles, responsibilities, time commitments, salaries, who makes decisions, grounds for removing a founder, and process to resolve disputes. Founder agreements protect all parties until the business is incorporated and the business structure dictates the above issues.
Select a Name for Your Start-Up
Your name is important because it identifies your company and sets it apart from your competitors. A business name cannot be the same or similar to a business name already reserved, incorporated, or trademarked. Failing to research and secure the rights to your business name could cause costly and time-consuming legal battles and business liability.
Practical and legal tips for choosing a name for your start-up include:
Avoid names difficult to spell or use spelling that can be confusing, such as replacing the letter S with the letter Z or the letter O with a zero.
Choose several alternatives if your first choice for a company name is unavailable.
Conduct an internet search to determine if another company is using the proposed business name or the name is associated with a product, service, or undesirable slang term.
Purchase a “.com” domain because it is the most commonly used domain. Purchase the other variants to prevent a competitor from purchasing those domains.
Conduct a trademark search to ensure that the name is available.
Take all steps to protect the name you choose for your start-up as soon as possible to prevent another company from selecting the name or a variation of the name too similar. Also, if you intend to use a brand name or product name, take the same steps to protect those names quickly. Failing to protect these names could cause substantial losses if you invest time and resources building your company and your brand only to receive notice you cannot use these names because they are already registered and trademarked by another business.
Selecting a Business Entity for Your Start-Up
The form you choose for your business organization substantially affects your growth. If you expect your business to expand rapidly and you want to allow for the greatest flexibility in seeking outside investment, a corporation may be the best choice for a business entity.
A start-up may want to choose an S-Corp, which can be converted to a C-Corp as the business grows and the need for venture capital investors increases. A S-Corp provides many advantages of a C-Corp, such as protection from personal liability, while allowing your start-up to avoid paying corporate taxes. An LLC may not be the best choice for a business entity for a start-up because it does not have the liquidity options and the full range of exit strategies offered by a corporation.
To protect personal assets, entrepreneurs must always:
Follow all corporate formalities;
Use the corporate name when signing documents (sign as an officer of the company with your corporate title);
Keep company assets and funds separate from personal assets of all investors, shareholders, and officers;
File all corporate tax returns and pay taxes from corporate accounts; and,
Keep detailed financial records.
Accounting, Record Keeping, Tax, Legal, and Employment Matters
A start-up can take off quickly. Taking care of various financial, legal, record keeping, and employment matters during the beginning stages of the start-up can help avoid legal and financial problems when the business grows and expands. Founders focused on marketing their product or service, obtaining investors and funding, and launching their product or service may overlook or forget about basic accounting and legal matters if these important issues are not addressed during the initial stages of forming the start-up.
Examples of financial and employment matters to address include:
✔ Obtaining a Federal Employer Identification Number (EIN) for the company. An EIN is required or benefits a company by allowing the company to open bank accounts, file tax returns, apply for business licenses, establish business credit, hire employees, apply for loans, prevent identity theft, and set up employee benefit plans.
✔ Set up an accounting and bookkeeping system. It is essential to track investments, capital expenditures, income, expenses, profits, and losses. Establishing an accounting system immediately for a start-up allows founders to compare actual financial results with projections, produce financial documents for potential investors, comply with IRS and federal laws and regulations, improve efficiency, and perform an immediate financial analysis to track cash flow, expenditures, assets, and debts.
✔ Set up a detailed month-to-month budget and schedule for reviewing financial statements each month.
✔ Set up a structure for interviewing and hiring employees. The process should include comprehensive reference checks and background checks.
✔ Draft and implement the use of employment forms, including employee offer letter, employment agreement, non-disclosure agreement, confidentiality agreement, invention assignment agreement, and non-compete agreement. A comprehensive employment agreement may include many of these agreements.
✔ Draft and implement the use of an independent contractor agreement and freelancer agreement.
✔ Develop and implement the use of a detailed employee handbook.
✔ Set up ledgers, books, and record keeping procedures for employee records, stocks, tax filings, financial accounts, creditor records, minutes of the board and stockholder meetings, and Secretary of State filings.
✔ Identify all permits and licenses required for the business. Set up procedures for applying for licenses and permits, tracking expiration dates, and filing renewal applications.
✔ Purchase required insurance policies for the business. Examples of insurance policies that a start-up may need include general liability, product liability, property, professional liability, workers’ compensation, business interruption, key man life insurance, data breach/cybersecurity, health insurance, and commercial auto coverage.
✔ Draft and implement the use of business contracts. Business contracts protect the start-up in the event of conflicts or litigation. Because contracts are legally binding on all parties, it can help to invest time and resources in developing standard contracts the company can use regularly. Examples of common business contracts include employment contracts, sales or service agreements, license agreements, vendor contracts, lease agreements, confidentiality agreements, non-disclosure agreement, and consulting agreements.
Seeking and Obtaining Funding for a Start-Up
Founders invest their time, resources, and money in a start-up. However, most start-ups need funding from outside sources once they reach a certain phase. Understanding how to find and obtain funding for your business is essential. The company’s needs and status determine what type of funding option is best.
Some funding options for start-ups include:
Traditional loans may be difficult for most start-ups to obtain unless the founders will accept personal liability for the loan. An SBA (Small Business Administration) Loan may be a way to obtain a loan without some requirements of a traditional bank.
Venture capitalists are professional investors who may invest in a qualified start-up. They often base their choices on specific industries, the stage of the start-up, and the company location. Many venture capitalists ignore unsolicited proposals. The best way to obtain venture capital is through a personal introduction. A start-up needs a strong investor pitch deck and elevator pitch (discussed below).
Obtaining funding through a venture capitalist can be a time-consuming, lengthy process. A start-up should have a lawyer assist with the process to negotiate the terms and prepare the legal documents required for the investment.
Angel investors typically invest in local start-ups that relate to their chosen industry or interests. Some things that an angel investor wants to see include a detailed business plan, investor pitch deck, clearly articulated elevator pitch, reasonable valuation of the company, the potential for the company to grow, the reasonable likelihood of additional funding, and a founder with passion, experience, and commitment. Angel investors are also best approached through an introduction from lawyers, accountants, venture capitalists, investment bankers, and other professionals.
Crowdsourcing or Crowdfunding
Crowdsourcing or crowdfunding is another potential source of funds for a new start-up. People pledge money through online campaigns as donations, pre-purchases of services or goods, or to qualify for a reward from the company. Kickstarter.com and Indiegogo.com are two popular sites for crowdsourcing.
Small Business Grants
Some start-ups may qualify for small business grants. Grants are typically allocated to support important causes such as education or social needs or to support new technologies.
Investments from Friends and Family
This is often a primary source of funds in the early stages of a start-up. These investments can increase your credibility with other investors who recognize that those individuals closest believe in you and your product or service enough to put their money on the line.
Some things that an angel investor wants to see include a detailed business plan, investor pitch deck, clearly articulated elevator pitch, reasonable valuation of the company, the potential for the company to grow, the reasonable likelihood of additional funding, and a founder with passion, experience, and commitment.
Pitch Decks & Elevator Pitches
To assist with obtaining funding from investors, the company needs a compelling “pitch deck.” The pitch deck is a PowerPoint presentation containing approximately 20 slides that showcase the company’s products, services, management team, and history. The pitch deck should highlight the reasons the company is an excellent investment opportunity. You can review pitch decks for popular start-ups here and some do’s and don’ts for pitch decks.
An elevator pitch is a short, compelling introduction to your company. It is about a minute long, but it packs a lot of information into that minute. Your pitch should be strong, positive, and enthusiastic. A great elevator pitch avoids using industry jargon while conveying why the business is unique.
Compliance with Regulation D
A mistake made by some entrepreneurs is failing to ensure that their investors comply with the net worth requirements under the Securities & Exchange Commission’s Regulation D. A person who earns less than $200,000 per year ($300,000 with spouse) and has a net worth of less than $1 million, including their spouse, is a non-accredited investor. Start-ups raising private equity can have unlimited investments from accredited investors. However, non-accredited investors are limited to 35 investors per company.
Protection of Intellectual Property
It is easy to become fixated on developing a new product and raising capital for a start-up. However, entrepreneurs that fail to protect intellectual property risk losing everything they are creating. Some types of protection for intellectual property a new start-up should consider include:
Patents to prevent other individuals and companies from using, selling, or manufacturing your product.
Copyrights apply to original works of art, books, music, advertising copy, software, and other forms of authorship. A copyright gives you the exclusive right to use or publish the material or create derivative works based on the material.
Trademark rights are established by using a name, word, symbol, or device in commerce that identifies your product. Service marks are similar to trademarks, but they are used to identify services. You do not have to register a trademark or service mark, but it is highly recommended to protect your sole right to use the trademark or service mark.
Trade secrets can be valuable assets for a start-up. To protect trade secrets, use confidentiality agreements or non-disclosure agreements (NDA) to retain the confidential status and “secrecy” of a trade secret. Individuals that should sign an NDA include employees, consultants, contractors, potential investors, freelancers, independent contractors, and all other parties who may receive information regarding a trade secret.
Obtain Fractional General Counsel Services for Your Start-Up
Retaining an experienced start-up attorney early in the start-up process can help avoid serious legal problems that could cripple a new start-up. Entrepreneurs should search for an attorney with experience in assisting start-ups with the legal aspects of:
Negotiating and drafting Co-Founder Agreements
Tax issues related to capital investments
Preparing and filing documents for incorporation, including legal advice regarding the types of business entities and legal matters related to issuing and selling stocks
Preparing and filing applications for patents, trademarks, and copyrights
Drafting business contracts and agreements
Drafting employment contracts and agreements, including employee handbooks, stock options, and benefit plans
Help locate and negotiate terms with prospective investors
Negotiate and draft terms of lease agreements
Provide advice and guidance related to tax issues
Assist in locating and retaining professional service providers, such as accountants, tax professionals, marketing experts, analysts, researchers, insurance professionals, and website developers
Things can go wrong quickly for a start-up. An experienced start-up lawyer adds value to your company. A Maryland business attorney is an asset that an entrepreneur should not overlook. By utilizing a fractional general counsel model, you can ensure your start-up is protected without the high costs of a full-time attorney. Trying to save money with a DIY approach could cause serious legal matters that cost far more in the future.
Contact Thienel Law today. Maryland business attorney Steve Thienel is dedicated to assisting clients in Maryland, Virginia, and throughout the DC Metro area.