Structuring your startup and getting the most out of your legal team
The following is a guest blog from Chase Irwin and Sean Del Giallo at Dentons’ Venture Technology and Emerging Growth Companies group.
Structuring your business properly at the outset is one of the most important considerations a founder can make. Partnering with the right startup lawyer and legal team is crucial in your corporation’s early success and ensuring your business has the proper foundation and legal structure to scale effectively.
A skilled startup lawyer is an essential partner for any new business – your lawyer should be an advocate and a connector for you in the startup ecosystem. As your business continues to scale, choosing a lawyer who understands the needs of your business and industry can help pave the way for future acceleration, while preventing anticipated obstacles down the road.
Obtaining proper advice early on will prevent due diligence challenges and potential roadblocks as your business begins to gain traction. Choose a lawyer that can structure your company properly at inception with a view to long-term success and fundraising, with a team behind that lawyer that can service your business as it grows.
This is what makes Dentons’ Venture Technology team so integral to a company’s success. We have a nimble and boutique approach to service your startup early, with the backing of a full-service delivery model as you scale in specialized areas such as regulatory, IP, commercial, transactions, capital markets, employment, data privacy, tax and more.
Here are some DO’s and DON’T’s when selecting a lawyer to ensure you get the most value out of your legal budget:
1. When selecting your startup lawyer, do ensure that lawyer and their firm is focused on and has a breadth of experience in the startup and technology space. Some firms will dabble in this area given the high growth technology sector’s emergence, but you will receive the most benefit from a firm that is entrenched in the technology sector and has specialized their work with emerging companies for a long time. To get a sense of this as a potential client, don’t hesitate to ask your prospective lawyer how many startup clients they service, for a representative sample of transactions that lawyer has closed in the last six months, and if they have a focus on a particular sector or industry. To determine whether a particular lawyer is the right fit for your venture, inquire about whether the lawyer has specialists on their team to support your business as it grows, as well as the firm’s cost structure and alternative fee arrangements.
2. When structuring your startup, do take advice from your legal advisors. Key mistakes in legal structure can be avoided early with good legal and business advice so that you can hit the ground running when going to market for fundraising. Here are some key considerations:
- Intellectual property chain of title – Ensure your company’s IP is properly assigned and owned by the corporate entity. Founders, contractors and employees should be entering into proper confidentiality and IP assignment agreements on or before their engagement with the company. Ensure all third party intellectual property rights are properly assigned or licensed (i.e. from universities, former employers or employees, etc.).
- Capitalization tables – Keep things simple and do not overcomplicate your share capital structure. This means founders should be in a single class of founder voting common shares. The corporation may also have non-voting common shares authorized or issued as well for a stock option pool. In addition, the corporation may require a class of preferred shares or other fixed redeemable shares for any IP or other assets being rolled into the company, but that should be discussed first with your legal and tax advisors. Unless there are unique tax reasons for doing so, avoid layering on a multitude of different classes of shares. These classes of shares will more than likely be removed in future financing rounds, particularly on future preferred equity rounds. The basic tenet here is founders and friends/family of founders, employees, contractors, and other early stage investors should be in their own class of common shares. In later stages, sophisticated investors will be in preferred shares, with the terms of those shares to be negotiated and created in a future financing round.
- Founder vesting – Consult with your legal advisor on structuring the proper vesting and share restriction arrangement for initial founder shares.
- Fundraising – Consult with your legal advisors early in the fundraising process to properly assess the right financing round for your business, address dilution issues early to avoid giving up too much, too soon, and structure a proper shareholders agreement and equity incentive plan for the business. Model your capitalization table early and assess how the pre-investment ownership among existing shareholders may be impacted under different valuation scenarios.
3. Do engage your lawyer early and keep them up to date and apprised of any potential legal work as early on in the process as possible. This will ensure that proper specialists (if needed) can be brought in, and that your counsel allocates the proper amount of time to a pending matter or transaction. This also allows your legal counsel to turn documents around urgently so you can avoid waiting on your lawyer to close off potential sales, deals or investments.
4. Do be upfront about your budget. It is completely acceptable to ask for a quote or fee cap if necessary. Anytime you reach out to your lawyer for a business-related matter, your lawyer is likely billing you for that time. Understanding your expected costs in having a Software-as-a-Service “SaaS” agreement drafted or transferring shares from one shareholder to another will help you budget accordingly so you can avoid sticker shock.
5. Do keep things simple and avoid creativity with your legal documents and structures. In the long run, standardized structures will save you heavily on legal fees and will streamline future due diligence processes when the time comes to raise capital or exit. Although tech investors love innovation when it comes to your business and technology, the same can’t be said for legal documents and corporate structures. If you are trying to sort out how to deal with a particular business issue from a legal perspective, loop in your lawyer early and allow them to offer suggestions on structure based on what they see in the market.
6. Don’t try to draft legal documents yourself. Some entrepreneurs think they can save fees by taking on the work themselves, but your lawyers will often have off-the-shelf templates and will likely incur more time (and fees) reviewing or correcting documents they aren’t familiar with. Although you may be trying to draft a contract based on a seemingly good template you found online, you may be using a template that is intended for other uses or is governed under an international jurisdiction and deals with concepts or terms that aren’t applicable or don’t exist in Canada.
7. Don’t make changes to a legal document before signing unless you have sent these to your lawyer first for review and approval. What appear to be minor changes can have unintended consequential effects throughout a contract. For example, contracts often use capitalized words for defined terms, meaning that the same word, if not capitalized, could be interpreted by a Canadian court as being distinct from the defined term. Not to mention, you should be extra cautious in making changes to any agreements with an employee as any discrepancy or vague term in an employment contract will be interpreted in a manner that is most beneficial to the employee.
8. When fundraising, don’t wait until you have received investor funds to loop in your lawyer. A financing needs to be properly documented, and there may be certain requirements built into your corporation’s constating documents before a prospective investor can become a shareholder. Always engage your lawyer early on in the process (at term sheet stage or earlier) so that the necessary agreements can be signed simultaneously with funding and so that you understand the terms early and don’t unintentionally agree to off-market or unnecessarily punitive terms and conditions.
For more information, please contact Chase Irwin and Sean Del Giallo or another member of Dentons’ Venture Technology and Emerging Growth Companies group.