As an entrepreneur, you want to focus on building your product, closing deals and scaling your company. Legal is often a distracting and time-consuming challenge for first time founders. To help you navigate the maze, we talked to Christian Meisser, CEO at LEXR, about legal basics for startups. Here are the areas you need to have covered for a sound legal setup of your company:
- Contract Law — Know what you agree to
- HR Law — Keep your employees happy and protect your business
- Corporate Law — The money and power structure of your company
- Regulations — Know the regulatory framework of your sector
- Intellectual Property Law — Protect your ideas
- How to find the right legal partner
You can listen to the full interview with Christian here.
Contract law — Know what you agree to
In the early stages of your venture, you will likely encounter two types of contracts and you should be aware of what to look out for. For many low-risk day-to-day contracts, you don’t always need a lawyer as long as you apply common sense, read carefully and flag up any points you don’t understand. Lawinsider.com is one of the most comprehensive websites, cataloging over 3m contracts covering all types of business interactions. This can help you check whether a particular contract corresponds to the standard in your industry.
Your standard sales contract is part of your sales process and as such, should be efficient and conducive to getting deals closed while protecting your company from unexpected liabilities. Practically, this means having a standard main contract of 1–2 pages which is simple and transparent enough to be signed on the spot. The main contract should reference to Terms and Conditions for all the legal details. With such a two-document-approach you can ideally exclude the Terms & Conditions from the negotiations. If you don’t know what you should include in your Terms and Conditions, consider looking at one of your established competitors to get an understanding of the scope.
Things you should have covered in your sales contract:
1) The scope of exactly what you owe and how much you will be paid for it. Be very specific here. Even if you feel you have a common understanding with your negotiation partner, you are signing the contract not with him or her personally, but with a company. Your counterpart may be replaced and another person may not see eye to eye with you anymore.
2) Include a liability cap for the damages that you can exclude under applicable law. If your product causes unexpected harm to the client, the liability may break your company’s neck. Therefore, cap the liability at an appropriate value.
Especially in the beginning, when you still haven’t built up all the necessary expertise in-house, you may rely on third parties to help build your product. Similar to when you’re on the sales side, for the buying side you should also make sure to know exactly what you are agreeing to. This includes price, price changes and general conditions. Furthermore, make sure that your company owns all the rights and IP of anything that other businesses or freelancers produce for you.
HR Law — Keep your employees happy and protect your business
When setting up employee contracts you should balance between fair employee conditions to attract and retain talent, and clauses that protect your business, during and after the employer-employee relationship.
Consider a stock option plan or phantom stock options as part of your hiring package to incentivize your employees. The decision between the two options should be driven by the tax policies of the Cantons where your company and employees are domiciled as well as the expected value increase of the shares that could eventually be taxed.
- Employee stock options: The advantage of stock option plans is that the capital gain of the shares will be tax free for employees. On the downside, having additional shareholders will put a larger administrative burden on the company.
- Phantom stock options: Phantom stock options are an alternative to regular stock option plans. They don’t confer actual shares to the employee but rather “mirror” the share’s price development. In case of an exit, the value of the “hypothetical” share is paid to the employee as a lump sum payment. Phantom stocks place less of an administrative burden on the company. The payments resulting from phantom stocks will however be taxed as income at the employee level.
Specify the handling of any IP produced by the employee and make sure it is transferred to your company automatically.
Ensure post-contractual confidentiality is part of the contract, so that employees cannot disclose your secrets to competitors. Such clauses are more effective than non-compete clauses, which are usually difficult to enforce due to a lack of specificity.
Corporate law — The money and power structure of your company
There are two elements to corporate law for startups: The power structure that determines who takes important decisions with regards to corporations, hiring or new investment, and the money structure that regulates who gets how much money out of the company in case of profit or a potential exit.
Corporate law & cofounders
Talk about potential scenarios and how to handle them with your co-founders and put them in writing in a shareholder’s agreement to avoid disputes later. Clarify what happens when co-founders want to leave the company, invest less time etc.
Vesting schedules are one important point to this. In general, you want vesting schedules to be as fair as possible, however they shouldn’t be too much administrative effort either. In Switzerland you see a move towards the American model, which is typically 4 years vesting with a one year cliff (after one year you get a fourth of your allocated shares and then on a quarterly basis you’ll vest your additional shares until you have your full stake).
Corporate law & investors
In general, you have to be aware of the attached strings when getting investors on board. If you’ll decide to get investment on board, it’s of vital importance that you do a due diligence on the investors to find out how other startups have experienced the investor — startup relationship and especially if they were “fair game”
When it comes to shareholders, especially be wary of liquidation preference clauses in shareholders agreements. Often they’re set-up in a way that in case of an exit, your investors will receive their payout first, potentially leaving you and your co-founders with little to no money left over.
To get an idea of how a term sheet, an investment agreement, a shareholder’s agreement, articles of association and board regulations looks like, check out free templates, e.g. from Swiss Private Equity & Corporate Finance Association. These can help you get prepared for upcoming negotiations and manage expectations. Be aware however that these templates tend to favor the investor side and might need to be adapted to your startup’s needs.
Regulations — Know the regulatory framework of your sector
Most other regulatory matters are very sector specific. If you’re operating in a regulated industry, knowing the law is crucial. As a first step, talk to founders in the same industry or check out what regulatory hurdles competitors had to overcome. Once you have a clear business idea, it is advisable to talk to a lawyer. For businesses in highly regulated industries (e.g. finance, healthcare) it may also be worth having a lawyer in the founding team to avoid skyrocketing legal costs.
Intellectual Property Law — Protect your ideas
Intellectual property is one of the most valuable assets for many companies. Depending on your type of business model, different laws and possibilities to protect it can be applied:
- Software is generally difficult to protect legally. While it’s protected under copyright law, it’s often the idea behind that’s valuable and not the exact code itself. Thus, the same idea could be executed with different code and copyright doesn’t necessarily help you in this case. Therefore, the only way to protect your source code is to make sure you own it and not to disclose it.
- An invention — typically a physical good or hardware can be protected under patent law. In this area, filing patents and making sure you’re not infringing any can be important. Patent law is a rather challenging field, so consulting a lawyer may be advisable.
- Brand names can be protected under trade mark law. If your business is heavily dependent on your brand name, secure the trademark. If your brand name is not vital and you’re on a tight budget, a Google search, checking the commercial- and the Swiss trademark register might be enough to start. Be aware that if you don’t register your brand, you might need to change your brand name later if someone else claims it.
How to find the right legal partner
Invest time into evaluating your legal options, ideally already before “the house is burning”. Here are a few of the things to look out for:
- Ask for a free half hour chat with your prospective partner to find out whether they have enough expertise in your particular business area.
- Get references from other startups to find out how they work and if they’re competent.
- Ask for fee caps, to ensure that costs for a certain task will not exceed a pre-agreed budget.
- Check out law firms that offer flat-fees. LEXR for example develops more and more flat-fee packages that cover specific services on a transparent fix price. This means you know exactly what you’re getting, and the package has usually been tested and improved with other startups before yours and services can be delivered fast.
- You can find flat-fee packages which cover documents and advice in the five areas (HR, Corporate, Contracts, IP and Regulatory) for CHF 2500.