Get the right lawyer now and avoid disaster later
Over the past couple of years, I’ve worked with a few startups to help with their marketing.
What do you think is my first project? Getting a website built? Writing a pitch deck? Signing up customers?
Nope. Invariably, before I can start on what I was hired for, I have to straighten out the company’s legal messes: convert from an LLC to a C-Corp, organize the cap table, issue shares and options, file for business licensees, register trademarks, get tax returns filed. It usually takes months before I’m free to focus on the product.
Fortunately, there’s a simple solution. Get a lawyer. Right now. Every startup needs a lawyer. Not later. Not 2 years from now when you’re negotiating with investors, but from day 1.
And not just any lawyer but a lawyer who specializes in venture-funded startups. You’ll save yourself (and me) a whole lot of aggravation and wasted time in the end.
Why You Need a Lawyer Now
I get it. I’ve been in your shoes. There’s a lot to do and no money to do it with. Anything that isn’t critical is put aside until later. We’ll use LegalZoom or Stripe Atlas and find advice on Reddit.
Other than patents which we can’t afford now anyway, until we start negotiating term sheets with investors, is there anything that really requires the (expensive) expertise of an attorney? Do we need to pay Wilson Sonsini $1000 an hour to fill out the IRS EIN form?
No. But if you haven’t done it before, you’re walking across a minefield. You might blunder through, or you might blow up the company.
Here’s just one example — the proprietary rights agreement (PRA). This little document, consisting of a few pages of legal boilerplate, can destroy your business if you don’t have the right one in place. It’s a detail, one of many, but it’s critical.
So what is this PRA? It’s an agreement with employees and contractors that says that the company owns all its intellectual property.
And by intellectual property, we mean not just big things like patents, but everything from software to graphic design, from website content to Slack discussions, from things we’re building now, to new ideas we might not get to for 10 years. Basically everything about the product and business.
It’s obvious that the company would own all that, right? Well…no. Not always.
What if we hire a contractor? Is their work owned by the company or do they keep the rights? Depends on the PRA.
What if the idea for the product was developed before the company was founded? Is it now owned by the company, or can a founder leave and take it with him? Depends on the PRA.
What if an employee comes up with a great new idea in the shower? Can she leave and create her own startup? Depends on the PRA.
You get the idea. The details of the PRA matter. They matters so much that investors will review the PRAs to ensure everyone has signed one.
So the moment I join a startup, I expect to sign a PRA. Sounds easy. Hand me the form, I review it, sign it, and we’re ready to get started.
Unfortunately, it’s often not so simple. Many early-stage startups don’t have a PRA in place, or their version isn’t suitable for advisors like me.
Attempting to Clean Up an Impossible Mess
At one company I joined, I was surprised to find it had no PRA despite having hired a dozen contractors and part-timers to help on various projects along with a small full-time staff. Ugh.
So my first project was to put together a PRA and beg, bribe, or beseech everyone to sign it.
The current employees grumbled about me take away their rights though I was only formalizing the existing relationship. Though they eventually signed after enough cajoling, I was already the bad guy.
The contractors who’d finish their projects were a tougher nut to crack. A few agreed. Most didn’t reply to my entreaties. I had to offer a substantial bonus to give them an incentive to sign. Some still didn’t reply. One email bounced.
Even worse, a couple of contractors had been fired when their work wasn’t up to standard. When I asked them to sign our legal document, they not-so-politely told me to fuck off.
That left me with a handful of people who wouldn’t sign. We had no choice but to review their work and either eliminate everything they’d done from the project or consider their contribution to be open source that anyone including competitors could use.
It was messy and unsatisfactory and a horrible waste of time that could have easily been avoided by making everyone sign the PRA before starting work.
The PRA is just one example, though, and far from the only legal mistake made by founders. So get a lawyer. And make sure it’s the right kind of lawyer. Because the only mistake worse than not having an attorney is having the wrong attorney.
The Wrong Lawyer is Worse Than No Lawyer
Perhaps your high school friend Carrie has just passed the bar is now working as an immigration lawyer. She agrees to help out for cheap. Or Uncle Bob is a corporate attorney and he’s willing to lend a hand.
Yes, the law’s the law and there’s only one bar exam, so both Friend Carrie and Uncle Bob are certified to provide any legal counsel. However, unless they know the startup world intimately, they’re likely to give bad advice.
Even an attorney specialized in private equity or corporate contracts is working from a different set of assumptions. You need a startup attorney the same way you’d want an experienced defense attorney if the police arrested you for murder.
Friend Carrie might be a great resource for helping employees get work visas, but she’s likely to give wrong advice when negotiating with venture investors.
As an investor, my most frustrating experiences have been negotiating with startups who have the wrong kind of lawyer. Attorneys who aren’t familiar with the specialized world of venture investing insist on clauses that investors can’t agree to and reject standard terms like liquidation preferences and board representation.
When that happens, there’s really nothing to do but walk away without investing. I hate to see it happen, but a founder who can’t pick the right legal advisor is unlikely to navigate all the other hurdles.
There are millions of lawyers with different specialties, from criminal law to patents, from water rights to publishing contracts. There are hundreds of thousands of lawyers who focus on corporate transactions. But that’s not close enough. The startup world is a special place with a unique way of operating. A startup needs a law firm that specializes in this space.
Fortunately, they’re easy to find. They advise at accelerators and startup events. Or ask for a referral from other startups or on startup forums. Many offer special packages to help startups get going on a budget.
Interview at least 3 law firms to find a partner you trust. Ask questions and see what kind of answers you get.
A Simple Question
My favorite question when interviewing a law firm is to ask whether the company should be an LLC, S-Corp, or C-Corp.
If they answer LLC, you can end the interview right there. An LLC is the right answer for a small business like a coffee shop. But if you intend to have venture investors, you’ll need to be a Delaware C-Corp. If the lawyer doesn’t know that, you’re talking to the wrong people.
If they advise you to set up a Delaware C-Corp, you’re getting closer. That’s the right answer, but it’s the wrong approach.
The best answer is to ask you what you want to accomplish. Do you want to build a small profitable business? Or do you intend to bring in venture investors and become a unicorn? Do you want to minimize tax on yearly income, or do you want to eliminate capital gains tax when you sell the business?
Rather than telling you what to do, a good lawyer should listen to your needs, advise you of your options, and explain the pros and cons of each so you can make the best decision for your situation.
Your Lawyer is Your Advisor, Not Your Boss
Working with young founders, I find too many defer to the guidance of their attorney. And an attorney’s advice is usually to avoid any possible risk.
But business is about taking calculated risks, and startups even more so. A good lawyer can’t run your business and shouldn’t tell you what to do. She can only explain the options and the risks so you can make the right decision for you.
Back to that PRA. In an amazing example of synchronicity, a friend and I were both stuck on PRAs recently with startups we were considering joining.
In both cases, the PRA came from a corporate attorney. Both PRAs were overbearing in asserting that every thought we had, every word or image we ever created would become the property of the company. We couldn’t join a competitor, defined as any company selling software, without the startup’s permission.
Uh…sorry, uh-uh. No. I’m not signing that. And neither was my friend.
As an advisor and board member to many startups in overlapping spaces, this PRA was a non-starter for me. If I signed it, the startup would even own these articles I write here and could prohibit me from publishing.
My friend and I both went back to the respective founders and suggested updating the PRAs. The companies needed to own everything relevant to their businesses but didn’t need to claim ownership of our text messages to our wives.
Fortunately, the founders I was working with understood my concerns. I worked with their attorney to create a more appropriate agreement.
My friend, however, was told that their attorney said there was no choice: no changes could be allowed, and everyone associated with the company needed to sign the document or else.
That founder should have fired his attorney and found a better one. Instead, he did as the attorney ordered and let my friend slip away. A potentially profitable relationship was killed by bad legal advice.
When it comes to legal decisions, other than violating the law, there’s always a choice and it’s always a business decision. The lawyer’s can only give you the advice you need to make the best decision, not make decisions for you.
If you don’t have a good attorney now, here’s what you need to do. Today.
- Find an attorney you’re comfortable working with who specializes in venture startups.
- Communicate. Explain the situation and ask for options. There is no single correct answer, only the best for your situation.
- Remember the attorney works for you, not the other way around. You have to make the decisions based on risks and rewards.
- If you’re not getting consultative answers, find a different attorney. But also rethink how you’re approaching the relationship with your attorney.
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