INITIAL LEGAL DOCUMENTS AND TASKS FOR STARTUPS
Starting a new business venture is exciting. Ambitious founders have a vision and drive to bring an idea to life, often with the goal of disrupting an entire industry. But, even for the more modest personal business "empires," it's crucial not to overlook the legal aspects of a proper foundation. With the help of a startup law firm with flat-fee startup packages, you not only streamline the legal process and ensure compliance, but also enjoy the certainty of cost transparency. In this article, we will explore essential legal documents and tasks so that small business founders can have a sense of what is necessary and, if not needed, still desirable. Most of these matters will be common to all startups; some will be particular to other new ventures.
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First, Choose the Right Legal Structure
One of the first critical decisions you'll face as a startup founder is selecting the most suitable legal structure for your business. This decision will impact your personal liability, tax obligations, and operational flexibility. Common legal structures include sole proprietorships, partnerships, limited liability companies (LLCs), and corporations. A business law firm specializing in startups can guide you through the pros and cons of each structure, taking into account your long-term goals, funding plans, and growth aspirations.
Next, Form and Organize
To establish your startup on a solid legal footing, there are several foundational and post-formation documents and tasks you need to complete. These include:
1. Prepare and File Charter
The charter of a company is the document that, when filed and accepted by the proper state authority, brings it to life. I analogize it to a human being's birth certificate. If you are forming a corporation, the charter is often called a certificate of incorporation, articles of incorporation, or, simply, a charter. The charter document for an LLC is often called a certificate of formation (or of organization) or articles of formation (or organization), depending on the state. Corporate or LLC law requires certain information to be included, may forbids certain information from being included, and permits other information to be included. The charter outlines the basic details of your business entity. Required information for a corporation typically includes the entity's name, contact details of a qualified person to receive service of process (notification of a legal proceeding), authorized shares, par value (if applicable), incorporator's information, and general purpose statement. Some states may require slightly different or additional information.
For California Startups: Note, that for a business formed in one state (e.g, Delaware) but intending to do business in California, California corporate law has some unusual (and arguably unconstitutional) requirements that purport to supersede the internal governance provisions of other states. Startups intending to seek VC funding should be sure their charter includes relevant provisions addressing these anomalies.
2. Prepare Bylaws/Operating Agreement
Bylaws establish the internal rules and procedures that govern your startup's corporation, including decision-making processes, management structure, and shareholder/member rights and responsibilities. A corporation's bylaws typically consist of sections covering stockholders' rights and meetings, board of directors' composition and responsibilities, officers' roles and duties, meeting procedures, record-keeping obligations, indemnification policies, amendment procedures, and other provisions. They might also address indemnification policies and restrictions on transfers of shares of stock
On the other hand, an LLC's internal governance provisions are memorialized in an operating agreement (sometimes called an LLC agreement). An LLC's operating agreement typically includes sections covering the LLC's membership interests, voting rights, management and control, profit allocation, cash distributions, transfer of membership interests, dissolution and termination procedures, and other provisions. An LLC operating agreement provisions can be viewed (sort of) as a hybrid of a corporation's bylaws and stockholders' agreement.
3. Hold Organization Meeting
California, New York and Delaware corporate law require what is generally referred to as an "Organization Meeting." This meeting, typically held shortly after incorporating, is where the incorporator or incorporators adopt the bylaws, elect directors, and complete other necessary organizational tasks. The Organization Meeting should end with the resignation of the incorporator(s). It is common for the meeting to be replaced by a written consent in lieu of a meeting. In that consent, the same resolutions are included that would have been written in minutes of the meeting.
4. Hold Initial Meeting of the Board
After the organization meeting, the directors who were appointed at the Organization Meeting hold the first meeting of the board to discuss and approve significant matters, such as ratifying the actions taken by the incorporator, appointing officers, authorizing stock issuances, setting a fiscal year end, and adopting key policies. If the board will have a formal board of advisors, a charter for the advisory board might be adopted. Startups may also here want to approve forms of agreements they want the company to use, such as restricted stock purchase agreements, proprietary information and inventions assignment agreements (PIIA's), advisor agreements, employee stock ownership agreements, and/or others. As with the incorporator(s), the actions taken at the initial meeting are often approved by written consent in lieu of a meeting.
5. Issue First Shares of Capital Stock
Normally, at the initial meeting of the board, the board will authorize issuance of shares of common stock (or perhaps founder's preferred stock) to the company founders. Of course, it is possible for the board to authorize other issuances, such as to employees, key contractors, or advisors. It is extremely to properly document these transactions to establish ownership rights and comply with securities laws, and also to ensure that federal and state securities laws are followed with any issuance of stock or any right to acquire stock.
6. Hold Initial Meeting of Stockholders
Once stock has been issued, an initial meeting of stockholders would be conducted if any actions approved by the board at the initial board meeting legally require stockholder approval and discuss other matters pertinent to the stockholders' interests in the company's operation. Even if stockholder approval is not legally required, it is not a bad idea for the initial stockholders to acknowledge at a meeting where minutes are taken (or in a written consent in lieu of a meeting) the actions of the board at the initial board meeting. In such a case, care should be given to properly document that any such acknowledgement or consent by the stockholder does not give them a right to approve of any actions over which stockholder approval is not legally required.
7. Obtain EIN
Once a company is formed by the acceptance of its filed charter (the company's "brith certificate), it needs an Employer Identification Number, or "EIN" (a human being has a social security number). Getting an EIN for your new company is necessary to establish its identity for tax, hiring employees, banking and other financial transactions, legal purposes, and other business arrangements that require an EIN. To apply for an EIN, the IRS offers several methods. The preferred option is applying online through the IRS website, where you can complete the application through the EIN Assistant. Alternatively, you can submit Form SS-4 by mail or fax. International applicants can also apply by phone by calling the 📞 IRS Business and Specialty Tax Line. You, your lawyer, or your accountant (I typically suggest clients to have their business accountants obtain EIN's) can apply for the company's EIN.
8. Open Company Bank Account(s)
Opening separate business bank accounts is essential for startups to avoid commingling funds, which refers to mixing personal and business finances. This practice helps mitigate significant legal, tax, and accounting risks. Commingling funds might undermine the limited liability protection associated with forming a separate legal entity, potentially exposing personal assets to business liabilities. It can also complicate accurate income and expense reporting, leading to compliance issues and potential penalties, while blurring the distinction between personal and business transactions, affecting financial clarity and accurate record-keeping. By prioritizing separate business accounts, startups demonstrate responsibility, transparency, and establish a solid foundation for long-term success. Additionally, it establishes credibility, aids in accurate accounting, simplifies financial transactions, and enhances their chances of securing funding, loans, and credit.
9. Satisfy Other State Demands
- Obtain Registered Agent—In some cases, you may be required to name a Registered Agent in the company's charter. Or, you may be required to appoint a registered agent if doing business in another state. A registered agent will receive legal documents and official correspondence on behalf of the corporation and report them back to the company's management. Normally, a registered agent can be any responsible individual with an actual address in the state. There are also many registered agent businesses available for reasonable annual fees.
- Annual Report—Some states, like California (which refers to it as a "Statement of Information"), require all companies to file its first annual report within a certain period after its formation. In California, corporations file annually, while LLC's finel every two years. In New York, LLC's and corporations both file every two years beginning in the second anniversary month following formation.
- "Foreign" Qualification—If the corporation or LLC intends to conduct business in states other than the state where it is formed, it will probably need to make a special filing for foreign qualification to legally conduct business there. This raises the question of what activities rise to the level of "doing business" and require qualification.
- Pay Franchise Taxes—Some states require a business franchise tax, even if they do not have a business income tax. In California, a new LLC must pay its first franchise tax ($800 as of the writing of this post) on the 15th day of the fourth calendar month following formation. But, California corporations do not have to pay the franchise tax in their first taxable year (though they do pay thereafter). New York may also impose a business franchise tax, but its arrangement is more complicated than other states. In Delaware, the amount is different for LLC's and corporations, and the two alternative methods of calculating the franchise tax for corporations are somewhat complex.
- Licenses or Permits—Some states and/or cities in those states Certain industries or professions may require specific licenses or permits to operate legally. It is important to research and comply with any applicable state or local licensing requirements.
Make It Real: Sign Your Contracts!
Law school Contract Law text books would probably be far less voluminous if everyone not only had written contracts, but did not forget to sign them. (Read this related post: 7 Common Contract Traps.) Some years ago, I worked for a brand whose head had years of finalized agreements, all unsigned by her/him. Don't do that! Either at or shortly after the post-formation meetings or written consents are done, and the company has approved its own forms of various contracts, sign them(!) and deliver them to all parties and their lawyers, and record securely them in the company's books and records. Contracts are the backbone of any business, and startups are no exception. Particular urgency should be given to the following contracts.
RSPA's
Restricted Stock Purchase Agreements are customarily entered into between the company and its founders. Click the link to read more about RSPA's. If you are not using the more formal RSPA, you at least should have your lawyer prepare an abbreviated, written subscription or other stock purchase agreement for each founder.
PIIA's/CIIA's
Contemporaneously with signing their respective RSPA's, founders should sign their own Proprietary (or Confidential) Information and Inventions Assignment Agreement. Click the link to read more about PIIA/s/CIIA's. Similar to my suggestion about RSPA's, even if you are not using a robust PIIA/CIIA, at a minimum have your lawyer prepare some form of assignment agreement and non disclosure agreement for each founder, as well as for any third-party if you had them develop or work on any of your IP. (More below.)
Employment/Contractor Agreements
Founders might also enter into employment or contractor agreements. Caution: due care should be given to properly classifying workers. The law determines whether someone is an employee or a contractor. This is not up to any agreement between the company and the worker. If the startup will have other workers, management-side employment law counsel should be retained to discuss hiring practices and policies, and in particular for preparing offer letters, employee handbooks, and other contracts. If the startup will offer employee benefits, specialized employee benefits counsel should be retainer. Absolute compliance with labor laws is critical, especially in California and New York, where the laws are complex, are not necessarily intuitive, and are subject to change more frequently than one might expect.
NDA's
A Non-Disclosure Agreement (“NDA”), sometimes called a confidentiality agreement protects information that belongs to or concerns one party (like your company) that will be disclosed to or learned by another, or is given to the owner by another (like your founders and contractors). An NDA is typically used with a business relationship or transaction, or with discussions about a possible relationship or business deal. The party with information to be protected is often referred to as the “Disclosing Party,” and the party getting access to protected information is commonly called the “Recipient” or “Receiving Party.” The NDA provides a framework by which the Recipient may use, and is required to keep confidential, the Disclosing Party's information, as well as remedies if the Recipient breaches.
Other Agreements
If applicable and management is ready shortly after forming the company, other contracts that the company will frequently use, or which are otherwise material to the business, should be discussed with legal counsel and prepared, including: customer/client agreements; vendor/supplier contracts; website terms of use; master services agreements; website privacy policies; and other agreements that may be appropriate for your particular business.
Intellectual Property Protection
In addition to executing any PIIA's or NDA's (discussed above), shortly after formation a new business venture may want or need to take formal steps to register and protect any intellectual property ("IP") they have. IP protection is vital for startups to maintain a competitive edge. A seasoned business law practitioner can assist with various aspects of IP protection, including:
- Trademark Registration (to safeguard brand names, logos, slogans, and other trademark-able things
- Copyright Registration
- Licensing Trade Secrets
- Patent Filings (to protect novel inventions ... Note: patents are IP of a very special nature, and require the advice and counsel of a lawyer admitted to the patent bar. Most established corporate lawyers should have a network that includes access to patent attorneys)
Regulatory Compliance
Startups must navigate a myriad of laws and regulations specific to their industry. This may include data protection, privacy, securities, consumer protection, and more. A business law firm can provide valuable guidance on understanding and complying with these legal obligations, helping you avoid penalties and reputational damage.
TAKEAWAY
Navigating the legal landscape is crucial for the success and longevity of your startup. By partnering with a business law firm that offers flat-fee startup packages, you can access the expertise and support needed to form, organize, and operate your business seamlessly. From choosing the right legal structure to protecting your intellectual property, drafting essential contracts, ensuring regulatory compliance, and handling foundational and post-formation tasks, a knowledgeable legal partner will help you mitigate risks and focus on growing your startup. With their guidance, you can confidently steer your startup towards a prosperous future.
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A.I.
I have become very impressed with the efficiency possibilities of AI. So, I gave ChatGPT a try. I generated this text in part with GPT-3, OpenAI's large-scale language-generation model. After it generated its own draft language, I reviewed, edited, revised, and expanded on it to my own liking and to ensure accuracy in all material respects. WLF takes ultimate responsibility for the content of this article.
Disclaimer
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