Legal Advice for Start-ups. (and stories from resultant miscues)

My legal advice for start-ups : GET SOME.

I am a layman so that is the summation of the legal advice contained in this blog. The rest of it is stories of encounters with legal matters as well as some tips I have learned on when and how to effectively use legal counsel.

One of the perpetual challenges of early stage start-ups is lack of money. What precious little funds are available is used for developing product, acquiring customers and occasionally, paying staff. The idea of paying a lawyer thousands of dollars often falls to the bottom of the priority list. As a result, a number of legal short-cuts are made, often with unintended effects. Here are a few situations that I have seen:

Internet  self service. Three founders incorporated their own company. To save money, they did it themselves. They found a shareholder agreement on the Internet and modified it. Unfortunately, the agreement didn't contain a dispute resolution clause. After a number of months, the founders are having a major disagreement. What could have been straight-forward may now become ugly, lengthy and expensive to resolve.  

Incorporating a business does not have to be grossly expensive. Many lawyers have fixed price packages available for straight-forward situations.

Employment Contracts is another favourite for fans of downloading legal agreements from the internet. One of my daughters received a job offer from a small business owner. This company had experienced a former employee leaving and starting a competitive business so they decided to make all employees sign an employment contract. Their contract came from the internet (with a simple Google search, we found it). Unfortunately, the contract was from the US and was an "at will" contract. "At will" is not recognized under Canadian law and usually invalidates the contract. Furthermore, the contract contained a Non-Compete clause that was very restrictive, lasted three years and covered a wide geographic area for a company that was essentially a local business. Courts have frowned on companies whose Non-Compete clauses unreasonably restrict a former employee from earning a living so it is highly unlikely that this clause would be enforceable even if the rest of the agreement had been okay. Finally, for the existing employees, employment contracts that are unilaterally imposed on employees without a contract are generally found to be unenforceable.  The net is that the owner saved a few bucks in legal expenses, and got exactly what they paid for, ZERO.

Employment law is one area that every founder must have a working knowledge of the law.  Dealing with employees can be a minefield if you don't set up your business correctly in the beginning and don't comply with employment standard acts, human rights legislation, health and safety legislation and a myriad of other statues.

Partner Contracts. In their early years, many start-ups will sign up a sales partner to re-sell their products into geographies or industries where the start-up does not have the skills or capacity. These arrangements are always euphoric at the outset because the opportunity for both partners seems so easy to capitalize on. Eventually, it does not work out to be so lucrative and the two partners are stuck with a contract that was written through the lens of "the venture will be successful" versus the "reality of impeding failure".  By this point in the relationship, the two parties are disappointed with each other, often feel that promises have been broken, that the other party can't be trusted, and both feel that they are the aggrieved victim of the relationship.  This occurred with a company who was selling to retailers. One large opportunity was a chain of franchisees. A former franchise owner was so excited about the company's product that he wanted the rights to sell to all the other franchises. The company thought this was a perfect situation. The partner would be creditable to the other owners because he used the product and understood their business. The deal was struck, without performance clauses or ability for the company to revoke the exclusive right of the new partner to sell their product into this large chain. Eighteen months later, the partner had only sold to a few other franchisees, all of which were customer satisfaction train wrecks, and were poisoning the company's reputation. In the end, buying the partner out was the only course available.

Good lawyers are trained to ask what happens when something bad occurs in the future. They cut through the sales euphoria and ask tough questions that you may not otherwise contemplate. Don't under-estimate this value.

Intellectual Property:  An entrepreneur had an idea for a new product but did not have all the technical and scientific skills needed to create it. He hired a friend to help him develop the product. There was never intent for the friend to have any ownership stake and the contract clearly stated his work was for fee and that he waived his ownership rights. As the entrepreneur was telling me about his product, I asked about the background of his friend. He was reluctant to tell me because his friend was still employed by a company and had been moonlighting to help him. My spidey sense flared. This entrepreneur may have a major IP ownership issue on his hands. Generally, most employment contracts have a provision that anything invented while you work for a company is the property of that company. I asked if he had checked this regarding his friend's employment contract and he admitted that it had not occurred to him. His friend may have waived ownership of something that he didn't own.

Lawyers can't protect you if you don't tell them the whole story. This entrepreneur patented his product so clearly he engaged legal counsel for that. I found out about the friend's employment situation only by digging into the story. I may have uncovered important information that his lawyer did not know.

How I learned my law: I was fortunate at PeopleSoft to have worked with great external legal counsel. In 1996, PeopleSoft Canada was not big enough to employ our own lawyer so we used David Takenaka at Aird & Berlis. For the next 10 years, David was my lawyer. When he started, he was an associate. Along the way he became a partner. We taught David the software industry. David taught me law, or at least when I had to capitalize nouns in a contract. To be effective, David had to know our business as well as we did. He had a great approach of bucketing issues into "legal issues" and "business issues". Legal issues were typically issues pertaining to liability, compliance to revenue recognition policy, protection of IP and many complex technical issues that generally a business leader should not have to deal with. His other bucket was business issues. These were the business terms of the agreement. David didn't try to impose himself into these decisions, but rather ensured we understood the decisions that we were making and the future possible implications of our decisions. He was a great second sober thought for a bunch of sales guys racing to get a deal done.  His job was then to ensure that the language in the contract reflected our exact intent, without ambiguity.

My advice to a start-up is to find a lawyer like David and establish a long term relationship. Teach them your business and through osmosis, gain as much legal knowledge from them as you can. Using lawyers is a necessary business expense. Using them wisely and effectively only happens when you understand as much about the law as you can and they understand your company.

© 2011 Meaford Group

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