The Achilles heel of startups: law and contracts

"We hear many impressive stories of success and fame of startups. Young, ambitious, technologically advanced startups (not a mistake here) usually focus all their attention on their product or service and its marketing, and legal matters remain in the background. For investors or team members to observe startup founders arguments are causing similar emotions as when visiting a friend's house, when the friend's parents are angry: you are hesitant to go out, you may be blocked yourself, and it is very uncomfortable to watch the show.

 

More than one founder of today's famous startup started without any contracts or mutual agreements. In industry, these are usually shareholder agreements, employment contracts, intellectual property transfer agreements, confidentiality agreements, or other similar legal instruments. The purpose of these documents is to accumulate and maintain the value and innovativeness of the business idea in the startup itself, as well as to prevent or reduce the risk of disputes between business founders, team members or even investors in advance.

 

Pains of famous organizations

 

Facebook, Twitter, Snapchat, Yik Yak, Tinder and others have made such mistakes. In the case of Facebook, co-founder Eduardo Saverin lost control of the company when his stake was diluted, and he was eventually forced out of the organization. Snapchat co-founder Reggie Brown, who may have invented the app's basic operating model, also left the business after a patent dispute with the rest of the founders changed passwords and barred Brown from any access to the then-early-stage business idea . The consolation in this case is that it was agreed on the peace for 158 million US dollars.

 

There were similar situations in Lithuania, e.g. The cases of MailerLite or Manilla, about which the founders of these businesses decided to speak publicly and share their assessment of situations from their positions. While working in the legal services sector, there is also more disagreement among startups, but confidentiality obligations prohibit commenting on this.

 

When is it too late?

 

There's really no need to judge the startups that allow these situations to happen. After all, the concept of a startup is often associated with speed and growth. Understandably, the world does not wait and the product usually moves much faster than the legal processes. It is important that the latter catch up with the product on time.

 

It is too late when the person who created the intellectual property for the business decides to work for himself and "takes away" the created objects, and the startup is left without the main asset.

 

It is also wrong when competitors or other interested parties start a lawsuit against the startup, and the legal entity has never been established.

 

Finally, one of the founders leaves, but still owns the shares and there is no forced option to buy them out. Such a structure does not please other founders or potential investors. It is possible to invent or find in practice many more scenarios where basic legal agreements could have prevented disagreements.

 

The legal ABCs of a startup

 

Everything already listed is just the surface. There is much to think about and much to learn from. Here's a basic ABC of what needs to be done:

 

1. Establish a legal entity that would limit the liability of natural persons and be the center and repository of all interests of the startup. This is the condition without which the next steps are not possible. Although in relations with investors you will have to assume one or another personal responsibility (not to stop working at a startup without a good reason, etc.), but in developing a product and participating in civil relations, you will be safe in making bold decisions. This is the essence of a startup.

 

2. To conclude a shareholders' (English founders) agreement and to discuss mutual relations, the startup's activities and the rules for share redemption, in case one of the shareholders prematurely withdraws from the activity without a serious reason, makes decisions without consultation, or in other cases. Attracting an external investor will undoubtedly result in such a document, but if you are the lucky startup that can grow without external investment (bootstrapping) for a long period of time, an internal shareholders agreement is mandatory.

 

3. Enter into contracts with employees, including non-competition and confidentiality obligations, and agree on the transfer of intellectual property to the startup. This will help protect trade secrets and the uniqueness of the business idea.

4. Register trademark protection. We live in a time when adventure and the pursuit of profit at the expense of others are very common. Without registration for trademark protection, such an identity can be appropriated by competitors or malicious actors with other goals. If you have a name in the market, it is likely that you will be able to fight back the trademark, but it will cost time and money.

 

5. Create HR procedures for attracting people, keeping them, and saying goodbye to them. Working with people is complex, so it is important not to get lost in happy or crisis situations and to follow the best practices in the market All this will not ensure that the processes will run smoothly or that there will be no disputes. However, this will definitely reduce the chances of misunderstandings, and you will be prepared for the unexpected.

 

One of the biggest headaches for startups is attracting investment. It is the orderly processes and documents that can be an additional reason for potential investors to choose you.

 

To manage the "garden" is to show understanding of business processes, organizational maturity and competence, and preparation for serious challenges when rapid growth (scale) begins. Insightful, discussed processes and documents can also be a reflection of the startup's internal culture. This is also relevant when attracting new team members who may feel the chaos in the startup and refuse to join the team.

 

The author of the ad is Rokas Jankus, attorney, partner of "Motieka ir Audzevičius"."