When starting a small business, it’s much easier and cheaper to avoid legal potholes than it is to fall into one — and then have to spend time, effort, and money to try to undo the damage.
So, before you get into a situation that you’ll wish you’d taken steps to prevent, ponder these proactive alternatives.
Sign a Founders Agreement
A founders agreement is a critical legal document that establishes the status of everyone who’s involved in a company from the very beginning.
As you move forward, you may find that one or more early partners drop out, lose interest, or need to be replaced. Without a founders agreement, those early partners may later return and demand a large slice of what you’ve built in their absence, often citing email or verbal accords as the basis of their claims.
A founders agreement prevents this by clarifying all claims to early stage ownership. It protects your small business from having its expanded value subdivided unfairly.
Issue Stock and Elect to Pay Immediate Taxes
If you wait to incorporate until your small business is actually taking investments from outsiders, the IRS may tax the founders’ shares at their post-investment value. It may also declare that value to be income and seek income taxes on these “earnings” for the current tax year.
Incorporating your small business at its start helps to sidestep these tax issues. By setting up the legal framework for your small business, and issuing shares to its founders, you establish those shares’ relatively low value for tax purposes.
Coupled with an 83(b) election, which each shareholder must file with the IRS within 30 days of obtaining company shares, you may immediately pay the relatively small tax bill on your shares. After that, you’ll pay income taxes on their increased value only when you sell them.
Keep Quiet About Inventions Until Patents Are Filed
It’s natural for startups to want to share news of their innovations. After all, new technology helps to attract investors! But disclosing your invention before you file for a patent [PDF] can actually let someone else beat you to the U.S. Patent and Trademark Office.
Provisional patents are so easy and cheap to file, there’s really no excuse for delay. They protect your invention for a year while you file a full patent application — and prevent anyone else from cutting in line ahead of you.
If you must talk about your invention, protect your intellectual property with signatures on a bulletproof non-disclosure agreement.
Honor All Agreements With Previous Companies
Contracts have consequences, so it’s important that you ask about non-compete, non-disclosure, and other restrictive agreements that your company’s founders or employees have previously signed. If they can’t get out of them, your new business will have to honor them.
That’s why’s it’s important that you ask new hires about any existing contractual limitations on their ability to work for you. If you find out about any, you may be able to work around them by
- Maintaining strict separation between the work your new hire does and those contractual limitations, or
- Negotiating a satisfactory arrangement with the previous employer.
Do Legal Paperwork Properly When Accepting Investments
From day one, follow all of the rules about soliciting and accepting investment money, particularly from investors who aren’t in the business of financing startups. Begin by having an experienced attorney review your agreements for compliance with applicable securities laws.