In the fast-paced, high-stakes and high-pressure world of startups, financial resources are scarce. Time is of the essence. Product and business development are high priorities. Against this backdrop, legal matters may seem a nuisance and not get the attention they deserve. The reasons for this neglect vary, but often include a lack of legal knowledge, insufficient prioritization, not knowing where to turn for help and, of course, the need to control costs.
When it comes to legal matters, startups may understandably be tempted to procrastinate, take shortcuts and even bury their heads in the sand. Taking that approach, however, is dangerous and may plague a company later when it pursues financing, a sale or an IPO. At that time, the consequences of inattention and missteps may negatively impact the company’s value, the credibility of its management and an audit firm’s willingness or ability to audit its financial statements. The company may be delayed in entering into and closing transactions or may even be prevented from engaging in transactions altogether. Investors may be incredibly unhappy to learn that, following a sale of the business, they will for a period of time be required to indemnify the buyer for any losses resulting from these early-stage mistakes. And, of course, as a result of this neglect the company may find itself in the middle of protracted and expensive litigation.
These are 10 examples of early-stage legal missteps that may later come back to haunt a company:
- Not properly documenting investments in the company;
- Inadequately protecting the company’s IP and/or not taking steps to avoid infringing the IP of others;
- Having untrained and unsupervised personnel handle the company’s legal function;
- Inadequately maintaining document control and retention procedures;
- Not attending to governance requirements, including non-compliance with charter documents;
- Failing to comply with local employment laws or enter into appropriate employment agreements, offer letters and employee confidentiality and assignment of invention agreements;
- Not qualifying or registering in other states or overseas jurisdictions;
- Allowing unresolved claims to remain hanging;
- Failing to establish a set of form contracts, or else using form contracts without tailoring them to specific transactions; and
- Overlooking the need for company-friendly assignment and change of control provisions that will benefit the company in the event of a sale or IPO.
What, then, should a start-up do to avoid these missteps and their fallout? The bottom line is that the company needs to commit a minimum of time and financial resources to its legal needs and to efficiently and effectively use those resources.
- A company’s efforts may include hiring skilled internal personnel and/or partnering with outside counsel.
- Outside counsel should be chosen carefully and should have experience working with companies from inception through later stages of the business life cycle; a broad range of subject matter expertise; knowledge of the relevant industry and of applicable law; and, ideally, a presence or relationships in jurisdictions in which the company’s business has or is likely to have substantial operations.
- Working with one or a limited number of outside firms will eliminate the burden of managing a large number of firms, facilitate consistent and coordinated legal representation across practice areas and geographies, and provide counsel with an in-depth and comprehensive understanding of the company’s business and legal needs.
As startup activity continues to grow in markets across the world, so will the tension between these companies’ business and legal needs. By prioritizing and addressing their early legal needs, startups will best position themselves to avoid costly, undesirable and even embarrassing consequences down the road.
By Katherine Ashton