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Sheheryar Sardar and Benish Shah were recently on a panel regarding Equity Crowdfunding in the wake of the Jobs Act.  As Title III of the Jobs Act is what directly affects most equity crowdfunding platforms and startups looking to use them, we thought it would be helpful to summarize some of the main points:

1.  Deals will now allow investments from non-accredited investors.  The term “non-accredited investor” is thrown around a lot, but most people don’t know what it means.  Non-accredited investors are those that are below a certain threshold of income that prevents them from qualifying as accredited.  In simple terms – it’s the SEC trying to protect people from losing all their money in a bad investment.  To do that under Title III, there are camps on how much non-accredited investors are allowed to invest in a given year:

• For income below $100,000, invest a max of $2,000 or 5% of income or net worth
• For income over $100,000, invest a max of 10% of income or net worth
• Investments made in a Title III crowdfunding transaction can’t be resold for a period of one year

2.  Restrictions on how much you can raise.  Companies are restricted to raising $1 million in a 12-month period.  For acceleration purposes, this limit may have larger consequences for companies.

3.  High costs associated with raising under Title III.  Higher compliance and reporting costs that in many instances require an audit.  Let’s break this down in real world terms:  your company is trying to raise $300,000.  You will end up shelling out approximately $20K before you can get approved to raise, and then around $80K+ if you raise.  For a startup looking to raise a seed round, almost half of it may end up going to fees.

4.  Disclosures. Disclosures. Disclosures.  Companies raising under Title III of the Jobs Act must disclose financial statements of the company that, depending on the amount offered and sold during a 12-month period, would have to be accompanied by a copy of the company’s tax returns or reviewed or audited by an independent public accountant or auditor.  Disclose officers and directors information, and owners of 20 percent or more of the company.  They must also disclose: use of proceeds, price to the public of the securities being offered, target offering amount, deadline to reach offering amount, and whether excess investments will be accepted.

 

Questions about equity crowdfunding?  Email Sheheryar Sardar at sardar@sardarlawfirm.com.

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Buying a pre-existing business – the need to know.

We get a lot of requests to meet up and talk business with professionals that want to switch to “business.”  Many times those professionals are looking to buy a business but have not had any experience on how to do so.  So we thought it might be helpful to lay out some tips on the first part of formalizing a deal to buy a business:  the letter of intent (referred, brilliantly, as the “LOI” during conversations).

The letter of intent is not the end of a negotiation to buy a business; in fact, it’s the first step to formalize mere discussions into an actual business deal.  A letter of intent is way to draft out the assumptions and views of both parties regarding the critical elements of the business deal.  It’s a tried and true concept:  getting it on paper is the first path to understanding what you are getting. Note:  remember, the letter of intent is NOT the actual agreement that governs the buy/sell of a business; in fact, it is not an agreement in the contractual sense and should not reflect an agreement (that’s kind of key). 

(Some) Things to include in your letter of intent when purchase a business

First. This is not an exhaustive list.  These are guidelines.

#1:  Mark the document as a Letter of Intent.

The document should be clearly marked as a letter of intent and not a binding contract.  Your lawyer should include such delineating language in the subject, title, or first paragraph of the LOI to ensure that it is clearly stated and not lost in any fine print.  This prevents your LOI from being arguably used as a contract or offer.

#2:  Good faith language. 

Your LOI should include (and some states may actually impose this via statute) the requirement that all negotiations must be done in good faith.  This sounds like an obvious, clearcut idea but “good faith” can be construed in different ways.  When including a “good faith” statement, parse it out and define it.  Or at the very least, define what can be considered “bad faith” to ensure that all parties are on the same page.  For example, your “bad faith” definition can include the barring of the parties from using the negotiation and diligence process as an information collection expedition for competitive purposes.

#3:  Is it a sale of stock or assets.

We’ve discussed before the importance of understanding the difference between stock and asset purchasing deals from the seller’s side.  It is just as important from the buyer’s side of a deal. Your LOI should make it clear what the parties are negotiating for.  This core question is going to be the basis for the deal structure itself, and should be addressed first rather than last.

#4: The purchase price roadmap. 

While the LOI is not an agreement, it should include the potential purchase price as well as what the purchase price is based on.  This purchase price, as well as the under lying assumptions, will be proved or rendered incorrect during the due diligence process.  If the LOI is clear about how the potential purchase price was reached, parties will be able to adjust it better per findings in the due diligence process.

#5:  Payment method and delivery. 

Will it be an all cash deal, a note, or an alternative retained interest deal?  The LOI should state this so that, again, all parties are on the same page.  Make a note of what the payment method will be, as well as the payment delivery method.

Withe letters of intent, the key thing to remember is that while it is not an agreement between to parties for the purchase or sale of a business, it is the first step of formalizing negotiations to enter into a business deal.  Your LOI should address major points of the potential deal to help all parties get on the same page before wasting valuable time.

Questions about letters of intent?  Email Sheheryar Sardar at sardar@sardarlawfirm.com.

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The Twitter War: they stole our name

Recently one of our clients launched their revamped site only to find out that someone else had snapped up the company’s name as a Twitter handle.  As they had not registered the Trademark for their name, they were told by fellow startups that nothing could be done and Twitter wouldn’t release it.

Then they came to us.

The Trademark Question for Twitter

Twitter’s policy says:

What is a Trademark Policy Violation on Twitter?

Using a company or business name, logo, or other trademark-protected materials in a manner that may mislead or confuse others with regard to its brand or business affiliation may be considered a trademark policy violation.

But the question comes down to, can you claim a trademark if you have not registered it officially with the USPTO.  The language Twitter uses is “we receive reports of trademark policy violations from holders of federal or international trademark registrations, we review the account.”  However, you can prove that you hold a trademark without having registered it.   As we noted in a previous article on trademarks:

Any distinctive name, symbol, or word can be designated as trademarked by using the symbol “TM” – it notifies others that the company owns the product’s name and design. However, by simply using the “TM” symbol you are not protected from another company that produces a similar product or uses a similar name without having to prove that you were the first to use the name or design.

What it comes down to is this:  can you convince Twitter that you owned the Trademark first?  As in, you’re company created, published, and owned the name being used in an unauthorized manner by another individual trying to impersonate your brand.  The first in time portion will be greatly necessary; you will need proof (screen shots, emails, etc.) that you do in fact own the trademark at issue.

Simply because another user has snapped up your company’s name on Twitter does not mean you can never get it back.  Review Twitter’s rules thoroughly, have your lawyer review them as well, and put together a solid case for why the user is infringing on a trademark you own.  It can be done.  We know.  We’ve done it.

Have more questions?  Email Sheheryar Sardar of Sardar Law Firm LLC.

B the Change You Wish To See: Is a Benefit Corporation Worth It?

The deeply flawed protagonist of the iconic show Mad Men once remarked, “There is no big lie. The universe is indifferent.” If Don Draper witnessed what precipitated the financial crisis of 2008, he may have conceded the big lie in bewilderment.  We all know how the story goes since – there is public outcry over the home mortgage crisis and the ensuing government bailout, Congress enacts legislation to institutionally reform the financial sector and capital markets, and, one could posit, the universe isn’t so much indifferent as it is self-correcting. Still, while much of the reform may seem cosmetic, imagine a state legislator or civil servant-lawyer in Maryland thinking about the dire state of things and, to make things better, comes up with one novel solution – a private corporation that benefits people and the environment, thereby making people feel good about business. Maryland quickly passes legislation in 2010, the first state in the union to do so, and voila, the benefit corporation is born.

So, what’s the deal? One would think having the word ‘Benefit’ before ‘Corporation’ may provide a garden variety of practical advantages, but a deeper look begs the question: does a Benefit Corporation really live up to its name? To add further confusion, a Benefit Corporation, a legal entity created by state statute, is distinct from a B Corp, which is a classification designation obtained through a strict, rigorous process that inherits a massive amount of ongoing scrutiny.

Come Again? Please Distinguish

Remarkably, the only minimum requirement to become a Benefit Corporation is the motivation to join. Yes, following the standards aligned with a Benefit Corporation are entirely voluntarily. Whereas the certification process to obtain B Corp classification will make any founder go Mad Hatter on his dinner table subjects. Simply put, a B Corp is similar to a non-profit that must focus on the greater public good, but is still taxed as a business.  Please, have a seat with your tea and crumpets, sir, as you are about to receive some alarming news –  there are no tax benefits for a B Corp or a Benefit Corporation over traditionally incorporated companies.

So, no tax benefits, and yet, unlike C Corps or LLCs, B Corps must adhere to the most elevated ethical standards of conducting business, while being subjected to thorough scrutiny of the powers-that-be. To become a B Corp, a company must complete an Impact Assessment.  The company must score a minimum of 80 out of 200 points to qualify. There are 40 different versions of the Impact Assessment depending on your industry, company size, et. al. The criterion is byzantine but, I argue, productive. Does the company have a history of financial disclosure and transparency with its employees? Do the company use renewable energy sources to power its operations, and if so, how much? What social and environmental criteria does the company impose on its vendors and suppliers? Has the company’s explicitly incorporated its commitment to social impact and the environment into its mission statement?

Why Bother Obtaining B Corp Status?

Because it’s good for humanity. And, it embraces moral, ethical and social values that promote the ideals of how business should be conducted.

Many companies that have obtained B Corp status have done so not for any legal or financial advantage, but to join a movement that is socially conscious.  Inviting the rigorous standards of maintaining B Corp status further motivates these founders to continue their social stewardship and not fall off the bandwagon. The world is indeed not indifferent.

 

Sounds Great, But Can I Just Become a Benefit Corporation Instead?

Sure you can.  The uber-cool prescription glasses company Warby Parker is, and here’s why being a Benefit Corporation is a good thing: Quintessentially, a corporation’s first priority and mission is to maximize its profit to the benefit of its shareholders.  A Benefit Corporation however, and by extension its Board of Directors, must consider the social and ethical components of any such decisions.  A great textbook example cited by major business journals is when Unilever acquired Ben and Jerry through a hostile takeover. Ben Jerry initially rejected Unilever’s offer and instead accepted a lesser offer that embraced its socially conscious corporate mission. Unilever sued and won on the grounds that Ben Jerry had a fiduciary obligation to ensure the maximum return to its shareholders.  Ben and Jerry lost control of their own company.  If it had been a Benefit Corporation, Ben and Jerry may have been able to prevent such a takeover.

The Benefit Corporation is a legal creation barely out of its diapers, so before you dismiss it outright, think about how you want to conduct business and what type of company you wish to run – for yourself, your employees, and your stakeholders. An old Nigerian proverb says, “better a single decision maker than a thousand advisors.” Your key decision now may very well determine the direction of your company for years to come, with benefits that is.

Have more questions?  Email Sheheryar Sardar of Sardar Law Firm LLC.

Trademarks Simplified

Trademark infringements are one of the most talked about issues faced by young companies – both because they unknowingly infringed on another’s trademark and because someone else is using their trademark without permission.  So we decided to help clarify some frequently asked trademark questions:

1. What is a trademark?

A trademark is a word, symbol, or phrase, used to identify a particular company’s products and distinguish them from the products of another.  Example:  Nike & the Nike “swoosh” are both used to identify the products made by Nike.  They give the consumer the ability to distinguish a Nike product from products made by another company (Walmart brand, Reebok, etc.).

If the company is a service-oriented one that does not create products, their marks are called “service marks” and are generally treated just the same as trademarks.  (Ex: law firms, accounting firms, etc.)

2.  What is the difference between a trademark and a registered trademark?

Any distinctive name, symbol, or word can be designated as trademarked by using the symbol “TM” – it notifies others that the company owns the product’s name and design. However, by simply using the “TM” symbol you are not protected from another company that produces a similar product or uses a similar name without having to prove that you were the first to use the name or design.  Further, you may still not have a legal defense without registration.

A registered trademark can be identified by the symbol “®” being used.   This symbol can be used once the trademark is registered with the US Patent & Trademark Office (USPTO) and is considered a “Federally Registered Trademark.”  Once registered, a trademark is protected against another company’s use of the name or image.  Any future companies wishing to register its own design/name/image has to check to be sure that it is not like any registered trademarks.

3.  Why should I spend the money and register a trademark?

Registration of a trademark constitutes nationwide constructive notice to others that the trademark is owned by the registering party.  It confers a lot of additional benefits, such as:  (1) enables a party to bring an infringement suit in federal court;  (2)  allows a party to potentially recover treble damages, attorneys fees, and other remedies; and (3)  registered trademarks can, after five years, become “incontestable,” at which point the exclusive right to use the mark is conclusively established.

4.  What can be seen as trademark infringement?

To bring a suit for trademark infringement that standard is called “likelihood of confusion.”  What this means is, generally, by using a mark that is too similar to yours in the sale of goods you are likely confusing the customer as to who created the goods in the first place.  (Example:  using a “swoosh” symbol but not using the word Nike on a pair of shoes may confuse people into thinking they are buying a Nike product.)

In deciding whether consumers are likely to be confused, the courts will typically look to a number of factors, including: (1) the strength of the mark; (2) the proximity of the goods; (3) the similarity of the marks; (4) evidence of actual confusion; (5) the similarity of marketing channels used; (6) the degree of caution exercised by the typical purchaser; (7) the defendant’s intent.  Polaroid Corp. v. Polarad Elect. Corp., 287 F.2d 492 (2d Cir.), cert. denied, 368 U.S. 820 (1961).

5.  What is trademark dilution?

Owners of a trademark can also bring suit for “trademark dilution” under either federal or state law.  Under federal law, the standard is that the mark must be “famous” – and to determine whether it’s  famous or not, the court will look at the following factors:  (1) the degree of inherent or acquired distinctiveness; (2) the duration and extent of use; (3) the amount of advertising and publicity; (4) the geographic extent of the market; (5) the channels of trade; (6) the degree of recognition in trading areas; (7) any use of similar marks by third parties; (8) whether the mark is registered.

Under (most) state laws, a mark does not need to be “famous” for a dilution claim.  Instead, the standard is that:  (1) the mark has “selling power” or, in other words, a distinctive quality; and (2) the two marks are substantially similar. 

Have more questions?  Email Sheheryar Sardar of Sardar Law Firm LLC.

5 Crucial Questions to Ask Before Hiring a Startup Lawyer

I’m going to be honest from the get-go: I hold a legal degree, and I’ve spent a long time advising startups after they’ve already gotten themselves into a small (or big) situation. I’ve worked as both a large-firm lawyer and a boutique lawyer. And I think large law firms are great — I just don’t think they happen to be the right choice for every startup.

That said, as an entrepreneur myself, I’m also a big fan of working with service providers that want to grow with your company.

Getting the right legal counsel for your company is like getting a great base for your startup, but you have to know how to pick the lawyer or firm that will best serve your goals. Here are five questions to ask as you embark on your own search:

1. Do they understand your industry?

My biggest gripe with lawyers is that they often don’t understand their clients’ industries. Many firms are excellent with contracts and document preparation, but if they don’t understand the industry your startup lives in, they aren’t going to be the best counsel for you, because they simply won’t know what to look out for.

So test their industry knowledge a little, and make sure they get your business. We’re in the fashion world at Viciare NY, which means we looked for someone who understood everything from international textile buying to copyrights, manufacturing contracts, and e-commerce. If our legal counsel doesn’t know key industry information, they won’t know what to advise you except what you tell them. And in that case, what’s the point?

2. Have they worked with early-stage startups?

Early-stage startups have very different legal needs from mature startups. For early-stage companies, the focus has to be on building a legal infrastructure for the company; for later-stage companies, the focus is often on securities, funding, etc.

If a firm hasn’t worked with early-stage companies, it may not understand what goes into that architecture. I once worked with a startup that had incorporated a C-Corp in Delaware and then registered in New York as a foreign entity – and, as a result, was paying twice the fees and taxes it would have if it had chosen to register in only one state. It just did what its lawyer said to do, without having the lawyer explain exactly why he/she was advising this course of action. The startup folded after two years and paid taxes even without having made any money.

Remember, a lot of firms work with very established clients. Many don’t have the experience of setting up a business from scratch. Look for a lawyer that understands the inception-to-launch process.

3. Which lawyer will actually be working on your matter?

This is critical, because you may get a great presentation by an experienced partner and find out later that the person handling you as a client is a first-year associate who doesn’t understand exactly what your company does.

Those conversations become very annoying, very quickly.

4. What is their fee structure?

Startups want everything for extremely cheap or for free – especially when it comes to service providers (hey, it’s bootstrapping – we get it!).  But when someone starts offering you free legal services, I want you to consider this: What are they getting out of it?

If you can’t find an answer, then there is something wrong with the scenario. Last year, I ran into a startup that was two months away from closing a funding round and was in a panic because its lawyers were now demanding legal fees in excess of $30,000. Until that point, the lawyers had been working on the startup’s matter for a mere $150/hour (a heavily reduced rate). What the startup had not realized was the firm was not bound by any obligation to continue that rate – and exactly when the startup needed lawyers the most, the firm upped the charges.

This is not all that unusual — it’s just rarely discussed. There’s a reason they call us sharks — because lawyers are good at knowing the right time to get what is needed.

So look for legal counsel that is up-front with its fee structure or has a startup legal package.

5. Do you actually like the person you’re talking to?

This is something we all forget to consider: Do we actually like the lawyer we’re hiring? In any hiring decision, personality matters. If you don’t want to talk to your lawyer more than you absolutely have to, they not be the right person to represent and advise your company. Treat your legal counsel like any other hire.

– Sardar Law Firm LLC is a startup focused law firm in New York City that has worked with over 60 startups.
ORIGINALLY PUBLISHED IN:  http://venturebeat.com/2013/02/09/5-crucial-questions-to-ask-before-hiring-a-startup-lawyer/#duYA5QMpL8KkWwbb.99

Understanding Dilution

Every now and then we have meeting with an individual in the market for investment and they say, “We want to make sure our stock does not get diluted.”  We nod and agree, and then they say, “Could you explain to me what diluted stock is?”

So here it is:  the Sardar Law Firm attempt at creating a simple explanation of stock dilution.

 

 

by, 

Sheheryar T. Sardar, Esq.

Sardar Law Firm LLC
New York, New York

Core Practice Areas:  Technology, Corporate & General Counsel, Startup Law, Project Finance, VC/PE, Arbitration/Mediation, Entertainment, and Human Capital

 

Disclaimer: The contents of this article shall not to be considered legal advice or to create any lawyer-client relationship. The article may contain attorney advertising.

Top Six Legal Issues Facing Today’s Online Media Companies

Social and digital media has grown exponentially in the last decade, with enterprising companies creating uncontested market space in the online and digital industries. Whether your company is engaged in a new search engine, an analytics platform, or ecommerce; social media as a tool has become a necessary component of both the customer acquisition process and marketing from within the company.  Without viral capabilities and digital readiness, companies are unable to harness quick user engagement with their platforms and services. Further, now many individuals within a company serve as brand ambassadors through social media, often listing where they work on Facebook, Twitter, Foursquare, Quora, among others.

 

Due to the fast-paced nature of social media, companies often overlook the legal issues inherent in social media that serve as silos of protection.  While staying ahead of the competition is paramount, creating and maintaining well-drafted legal content will reduce the chances of getting mired in disputes that deviate attention from the core focus of growth.

 

Here is a brief list of legal issues to consider:

 

1) Terms of Service.  If you have a website or ecommerce platform, you will need to publish terms of service or use on your website, to put customers and users on notice as to the various limitations and conditions to which they are consenting by using your site. This document will serve to govern the relationship between your company and the audience that interacts with your site. Each Terms of Service is unique to the industry and nature of your company. For example, terms for a fashion ecommerce site will differ greatly from a software development business.

2) Privacy Policy.  A sound privacy policy is important for purposes of maintaining certain state, federal and even international regulatory compliance. Privacy has become a politically charged topic within the digital and electronic landscape, with Congress and international bodies penalizing companies that violate certain privacy laws.  For example, if you collect customer information such as addresses, emails or demographic data, you may need to clearly identify the purpose of such an activity.  In the absence of a well-constructed privacy policy (and thereby user consent), your company may be subject to liability or run afoul of the law.

3) Non-Compete and Non-Solicitation.  Consider protecting your company by prohibiting your partners and employees from competing directly with your company immediately upon their departure. A Non-Compete provision would be framed within a specific time period and limited to a geographic area, but these clauses are very important because these key individuals may possess inside knowledge of your competitive advantage.  A Non-Solicitation provision would prevent ex-partners or employees from soliciting high value colleagues and/or customers away from your company.

4)   Moonlighting and Loyalty:  Moonlighting and Loyalty addresses employee activities outside of the normal course of business. This clause may or may not be necessary, depending on the nature of your business. A lawyer can assess your contract’s needs once you discuss your commercial goals together.

5)  Ownership of Intellectual Property:  You may want to protect any processes, templates, systems, or methods created by an employee, by retaining any IP rights over these items. A contract at the outset will provide necessary protections so that any work products created under your business do not ultimately go to a competitor.

6)  Use, Licensing, Technology Transfer:  Companies often look to outsource their products or services through digital or online channels, often with third party agencies and partners providing additional marketing, acquisition or branding services. Partnerships are often created to facilitate such business development. In this context, contracts protect the use and licensing of your work product so that it isn’t leaked or misappropriated.  A strong vendor/services contract will make your transition to the next stage of development that much more efficient while protecting the proprietary nature of your company’s work product.  Similarly, if you are interested in commercially exploiting your methods, processes or inventions (Technology Transfer), you will need contracts to protect your financial interests.

Spending a little time developing your legal architecture is a strategic investment in your company. Failing to do so may result in a costly dispute that takes valuable resources, including your time and attention, away from the company.  Not implementing a sound legal platform is a risk far too great for any company to take, as the landscape of digital and social media continues to evolve.

by, 

Sheheryar T. Sardar, Esq.

Sardar Law Firm LLC
New York, New York

Core Practice Areas:  Technology, Corporate & General Counsel, Startup Law, Project Finance, VC/PE, Arbitration/Mediation, Entertainment, and Human Capital

 

Disclaimer: The contents of this article shall not to be considered legal advice or to create any lawyer-client relationship. The article may contain attorney advertising.

Critical Questions for Co-Founders

As the wave of startups continues to heat up, many entrepreneurs are entering into companies without asking the right questions.  Often, they don’t know what questions are absolutely critical in order to move forward on solid footing.  We at New York City’s startup focused law firm, SLF, sat down and pulled together the 3 top questions co-founders should ask.

This comes down to the basic architecture of ownership: who own’s what percentage of the company.  Deciding this early on prevents ownership problems from arising as the company grows. The answer is not always easy, because it’s rarely ever going to be divided equally down the middle.  So have the hard conversations.

This is another difficult question, because: (1) no startup co-founder wants to admit that they would leave; and (2) it’s hard to imagine why anyone would want to leave an innovative idea.  The unfortunate truth is that it does happen, and it happens often.  In fact, it’s better that a co-founder that is not fully committed to the startup takes his/her leave instead of holding the company back.  Map out the steps that can be taken if a co-founder decides to exit.

Even though co-founders may not be drawing a salary at the inception of the company, there should always be a plan for when salaries will be drawn and how much each co-founder will get paid.  There should also be a frank discussion about who can change compensation, and when compensation can be increased/decreased.  This should include salary, benefits, commission, etc.  The more thorough you are at the outset, the less ambiguity will exist years from now.

More questions?  Come to the Startup Fundamentals class with Sardar Law Firm.

VC Financing for Startups: Understanding Cost Drivers

By:  Benish Shah
Sardar Law Firm LLC
New York, New York

Core Practice Areas:  Fashion/Retail, E-commerce, Commercial Litigation, Art Law, Startup Law, Social Media, Mergers & Acquisitions, and Corporate & General Counsel

 

There has been a lot of debate on the legal costs associated with financing rounds for startups.  Fred Wilson’s challenge to startup lawyers called for legal costs to be reduced to $5,000.00 for a seed financing round.   The issue, brought up by many lawyers is this: (1) large firms are not going to drop their rates from $17k+ to $5k because their costs are too high based on the army of associates working on each piece of the matter; (2) startup focused firms aren’t well known enough to VCs but they could get the work done in between $5K-$10k because they are lean and understand the startup world because they themselves are startups.

To understand what drives legal fees (aside from an army of associates) during a financing round, it’s important for startups, especially those going through their first few rounds, to understand why a transaction costs more than a few hundred dollars.  It’s also important to understand why choosing a firm that’s a good fit for a startup matters in these rounds.

Leveraging Knowledge 

Few things can hurt a startup more than a vague or hurried term sheet that will result in increased costs down the road.  To avoid these problems, smart entrepreneurs and investors involve counsel early on in the term sheet process to make it as smooth as possible.  For entrepreneurs, they need to understand that a VC’s counsel is not the startup’s counsel and that they absolutely need their own counsel as well. It’s like buying an insurance policy that will cost your startup much less than potential future problems stemming from vague term sheets.

Involving attorneys from the get go also allows lawyers to provide increased value-add through market knowledge; entrepreneurs and investors can leverage that knowledge and experience for their own benefit.  For startups, they can also discuss with their lawyers what is “normal” or “market-value” and what safeguards they should be pushing for, and what they can be more lenient on.  Lawyers have a knack for seeing what can cause a potentially massive lawsuit down the road, but clients need to involve them early on to leverage such knowledge.

Understanding Due Diligence

In most funding rounds, costs start increasing due to due diligence required by investors before a deal is closed.  This means due diligence on the following (if not more) subjects:

(1) Litigation Diligence:  Investors want to ensure that there are no pending or threatened suits against the startup that could materially reduce its value  (they cannot just take your word on this).

(2) Tax and Liability Diligence: Investors need assurance that the startup is up to date on all taxes and potential obligations.

(3) IP Diligence:  The assurance that each IP the startup claims as its own really belongs to the startup and not anyone else. This also includes review of whether there are any open source or similar issues, that all former/current employees/consultants/contractors/founders have legally and properly assigned rights to any IP to the startup, and if reverse vesting of common stock held by key employees is necessary.

(4) Employee Diligence: Ensuring that employees/contractors/consultants/founders have signed properly drafted non-compete, non-disclosure and non-solicitation agreements.  Also ensuring that employees & contractors are properly classified to avoid potential liabilities.  

(5) Corporate Governance Diligence:  Investors want to ensure that the entity is properly formed and corporate governance matters have been properly followed (i.e. startup’s corporate records must be in order; if they are not, lawyers and the startup must go into overdrive conducting a “cleanup” to ensure that everything is up to date, properly documented, and ready for inspection – this can add significant costs and often can be delay, or kill, a deal closing).

(6) Stock Option Diligence: Legal diligence to ensure that all stock option grants were properly approved and 409A compliant; this may also result in a change to the price per share if contemplated on a “pre-money valuation” basis.

(There are more aspects that can drive up the costs, but those listed above can be some of the most time-consuming).

Setting a Cap

Anytime a startup (or an investor) hires counsel, they should ask for a cap on the legal fees; SLF works to ensure that in closing deals such as early financing rounds, our legal bill comes under the cap, however other firms have been known to bill at the cap regardless of complexity or simplicity of the deal.

If an attorney or firm does not want to talk in terms of a cap on the legal fee, it may be prudent to search around a little more.

For more information on startup legal services, email us at sardar@sardarlawfirm.com or join us for a class taught by Benish Shah and Sheheryar Sardar.