Building Up Your Start Up One Foundational Aspect at a Time
By: Sarah Caruso
In the beginning, startups often have many moving parts; developing your business plan, furthering your idea, and obtaining the necessary funding to complete all of your goals. However, often some critical legal steps (and protections) get sidelined. But these crucial steps should not be overlooked. Every startup has different needs and different paths it may need to take, but a few basic steps that most startups should consider are corporate formation and intellectual property protection. Please consult with the IDEA Legal Officer to discuss additional legal considerations for your specific venture. Below is a brief summary of the different corporate entities you can form as well as intellectual property protections.
Corporate Formation
Corporate formation means creating a separate legal entity from the individual owners and founders. However, each corporate entity has its own benefits and disadvantages, including liability protection and taxation. The three main types of legal entities are corporations, limited liability companies (LLC), and partnerships. Corporations can be incorporated as either a C-Corp or S-Corp. C-Corps are the most common corporate form, yet C-Corps are subject to double taxation, meaning it is taxed at the corporate level for profits and the shareholder level for any dividends received. S-Corps are treated more similarly to an LLC in terms of taxation but cannot be foreign-owned and are limited to only 100 shareholders. LLCs are not subject to double taxation but instead enjoy “pass-through” taxation, meaning that they pass their tax implications onto their members. In other words, members are taxed directly on the LLC’s profits. Equity in an LLC is treated a bit differently than that of a corporation. An LLC’s equity is known as ‘membership interest,’ which similarly gives the owner of the interest rights to the assets and profits of the LLC. Similar to the equity of a corporation, membership interests can be designated to have different rights, namely voting rights in the company’s day-to-day operations. Directors and officers of corporations and LLCs are generally insulated from the company’s liabilities and obligations. But there are circumstances in which a court will apply direct liability onto the directors/officers of an entity, this is known as piercing the corporate veil.
On the other hand, partnerships do not insulate the founders from the business’s liabilities. Founders may set up a general partnership with the founder(s) run the day-to-day. Sole proprietorships are similar to partnerships but with just one founder. If you are the sole individual running your business, you will automatically be classified as a sole proprietor even without registering. To properly register as either a corporation, LLC, or partnership, one needs to file a certificate of incorporation, formation, or partnership, respectively, with the Secretary of State in which you wish to incorporate in. One can choose where they would like to incorporate, but some considerations may include where you plan on running or conducting your business and if you wish to attract outside investors. As many of you may know, Delaware is a popular state to incorporate in and is especially attractive for venture capitalists. Even if you are registered with one state but conducting business out of another you may be required to register in the state that you are conducting business from.
In addition to the certificate to form a corporate entity, you will also be required to adopt by-laws that dictate how a business is going to run its day-to-day operation. In addition, you will likely have to draft other agreements to formalize how the founders, directors, or owners of the business will work together by setting out their roles and responsibilities.
Lastly, you can convert to a different corporate entity, and it may be as simple as filing a few forms with the Secretary of State. But this process can have tax implications and can also be time-consuming and costly, so think of your long terms goals in choosing the legal entity to find the best fit for your business.
Intellectual Property Protection
Perhaps one of the most important, and often overlooked, legal protections that a startup can take is to protect its intellectual property (IP). There are four main pillars of IP: trademark, patent, copyright, and trade secret. Trademark and patent are two of the most common IP startups encounter. Trademark protection is used to protect a business’s brand name and logo (collectively as “mark”) by preventing others from using your mark or those similar to it. However, this also means that you are prohibited from using a mark that is similar to those already registered or in use. To ensure that you are free to use your mark, a search must be conducted of registered marks with the United States Patent and Trademark Office. The IP CO-LAB Clinic associated with Northeastern’s School of law may be able to assist to determine whether your mark is free to use as well as to assist with registering your mark. Please contact the Legal Officer for more information. It is better to start the trademark process sooner rather than later; not only does it save you time if you have to re-brand, but also helps ensure you are not on the receiving end of a trademark infringement suit.
Patents protect, simply put, new, useful, and non-obvious processes or inventions. There are a few additional requirements to obtain a patent and other circumstances that might prohibit you from obtaining one; please see the Legal Officer for a comprehensive explanation of patents. However, one of the major inhibitors to obtaining a patent, and most likely to present trouble for startups, is if the process is publicly disclosed. This is why it is important to protect your invention from disclosure, but it can be tricky as many ventures need to show off their invention in order to obtain funding. While not all disclosure may constitute public disclosure (e.g., it may depend on how much information is disclosed and if the disclosure was available to the public), one step to help protect your invention is to have anyone working on or seeing the invention sign a non-disclosure agreement (NDA), also known as a confidentiality agreement. Another method to protect your invention is to obtain a provisional patent. Provisional patents allow the applicant to use the date they filed the provisional patent as if it was the date, they filed a patent. It also allows the provisional patent holder a 12-month grace period before they have to file for a patent, but the patent must be filed within those 12 months for if not, one is unable to utilize the earlier filing date. A potential benefit of the earlier filing date is that if there is any disclosure within that 12-month grace period, one may still be able to obtain a patent as the disclosure will effectively be after the patent application. To obtain a patent, you will need to hire outside legal counsel as the process and its requirements are quite complex. But IDEA ventures may be able to use their one pro bono session with a service provider to assist with a provisional patent application; again, please contact the Legal Officer to discuss further.
Copyright and trade secrets are also important IP protections for startups. Similar to trademark, copyright protects original works of authorship fixed in some type of medium. Copyright is automatically obtained once you created it, but to enforce your right and prevent others from copying your work, it will help to register your work with the US Copyright Office. Copyright may be utilized to protect slogans, novels, songs, and even computer software, but only those pieces of software that are original to the creator (i.e., nothing created by the computer). Trade secrets are simply pieces of information that have value to the owner and are not generally known to others. A trade secret does not need to be registered, but steps must be taken to protect the secret from disclosure; for example, requiring everyone who has access to the trade secret sign an NDA. Trade secrets are often complementary to patents in that the invention should be treated as a trade secret before obtaining a patent, again, to ensure the invention’s patentability.
Intellectual property is the essence of many startups. You may not have deep pockets, but you have your ideas and your inventions. Taking the necessary steps to protect your IP early is critical to the future success of your business, especially for confidential information related to patents and trade secrets.
While corporate formation and IP protection are two main legal areas of concern for startups, there are a myriad of other requirements and considerations. To name a few, ventures working with any medical device may need to register with the FDA and those conducting online sales should consider the various privacy and data security laws.
Please contact the Legal Officer sooner rather than later to discuss your specific venture. The Legal Officer is a resource for all IDEA ventures to ensure your venture’s long and prosperous future. To contact the IDEA Legal Officer please email idealegalofficer@gmail.com. Please note that the Legal Officer may not be able to assist non-IDEA ventures.
