EVENT: The Practical Implications of Equity and Non-Equity Crowdfunding

Sheheryar Sardar, Partner at Sardar Law Firm, will be moderating this panel on crowdfunding.

• This month, the New York Legal Hackers will meet to discuss crowdfunding.  In 2012, Congress passed the JOBS Act to facilitate startup fundraising through so-called crowdfunding platforms, as well as other modifications to existing securities regulations.  At this meetup, we will provide a quick primer on these important changes to the securities laws and then move on to a holistic discussion on the vices and virtues of equity vs. non-equity crowdfunding.

  Panelists:

  Nathanial Cotanch – Head Analyst, Rock the Post

  Benish Shah – Founder/Attorney, Before the Label

  Michal Rosenn – Deputy General Counsel, Kickstarter

  James Fanto – Professor, Brooklyn Law School

  Moderated by:

  Shezi (Sheheryar) Sardar – Attorney, Sardar Law Firm

  With a short intro presentation from:

  Graham Travaligni – Student, Brooklyn Law School

  RSPV HERE.

Letters of Intent & Buying a Business

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.

Follow Sardar Law Firm on Twitter @CorpCounselNYC

Follow Social Media Legal Twitter @socialmedia_law 

 

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.

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

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 atrademark 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.

Stock Dilution: an infographic

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 addressesemployee 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 willneed contracts to protect your financial interests.

Spending a little time developing your legal architecture is a strategic investmentin 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.

Instagram’s New Policy: Yes, it does mean what you think.

You do have the rights to your Instagram photos, but you share the rights to your photos.  That means when someone pays Instagram to use your photos, you can’t do anything about it (like litigate.)

There’s been a lot of talk on the web about two issues related to Instagram’s newest policy updates:

• The tech-lovers pointing out that the new policy isn’t too different from the old policy; and
• Users panicking that Instagram can now sell their photos online.

The fact is, both are pretty correct.

Yes, the terms are not that different. But what does that mean exactly?

It means that from the get go, Instagram reserved the right to use your photos in the public space.  Those Instagram users that are not private are aware that almost anyone can access their photos, either through the app or the web version.  That’s the idea behind the “open-web” theme propagating by companies like Instagram and Facebook.  Their concern is not user privacy, and to their credit they never pretend that it was their number one priority.  They are focused on bringing you an open platform to be social and create new social ties; if you are concerned about your privacy on social media sites, you can do one of two things: (1) get off the interwebs; or (2) memorize those privacy settings so you know what to do and not do to keep your data safe.   (Yes, we said all of the interwebs, because even Google tracks your searches in order to give you a better user experience).

While Instagram has always reserved the right to use your personal photos in their own advertising campaigns, what’s got everyone in a tizzy is that the new language seems to indicate that Instagram can now sell your photos to third parties.  That’s where it gets interesting.

Instagram, technically, does have a right to “sell” your photos.

We read this great article yesterday in The Verge that said, No Instagram does not have the right to sell your photos – except that it does.  The article pointed out that companies can’t take a picture of you and slap their logo on it because that goes beyond “displaying” the photo into the world of modifying the photo.

But what advertisers can do is pay Instagram to take user photos and display them on their own site or advertising real estate.  This means, if you take a photo of your baby wearing Baby Gap, then Baby Gap can pay Instagram to use your photo and display it on their site.  They can say something like, “Look at the cute babies wearing Baby Gap!”  There are deeper rules as to whether they can modify that photo (which they can’t), but that’s not enough to make parents feel safe about using Instagram to take pictures of their families.

Here’s the biggest issue: people don’t want their personal photos displayed on a company’s site/ad real estate because, well, people don’t like to be used without getting paid and without consent. In addition, many users post pictures of their families to Instagram –  they don’t quite fancy having their 12-year-old’s picture on a company’s advertising.  This isn’t the generation that sees their picture somewhere and thinks, “Oh my God that’s awesome!”  This is the generation that says, “That’s not okay.”  We’ve had clients file complaints with multinationals based on these scenarios.  It’s not good for anyone, really.

So why the outrage?

The most interesting argument we’ve heard is, “Well you are consenting because you signed up for Instagram.”  Yes, that’s true.  Absolutely.  But people are angry because they either have to agree, or they can’t use the service.  That’s because it’s not a free market contract; you cannot call up Instagram and negotiate your own contract terms with them.  It’s boilerplate and that’s that.

And when you take away a real choice, people get upset.  It happens more often than not with web startups – because it’s a tension between how to make money and how to keep users.

What now?

Instagram has come out and try to do damage control.  They are saying that they will not be selling user photos; but until they release an actual policy stating this, it’s still up in the air and the terms stand where they are.

For us – ours is an office divided.  I, as a litigation attorney, am pretty positive I’ll be deleting my Instagram account.  As for our corporate partner that knows all things tech-startup, he says he will be keeping his account.

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

 

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

3 Key Things for Your Social Media Training

Social media is about interaction, and for growing companies that interaction is critical.  However, both companies and employees make mistakes, whether it be on social media platforms or in some other aspect of their job.  Instead of reacting to that mistake, sometimes (most of the time) it is better to preempt that mistake with a comprehensive social media policy training.  Yes, that’s right – if social media is about interaction, then the policy must have an interactive component too.  Otherwise, how many people do you think really read that 20-30 page, expertly crafted policy book?

Just as we train incoming professionals on how to use the company’s intranet system, it’s time to start training them on social media policies as well.  Here are 3 key things to include in that training:

(1) Pertinent Laws.

It is not enough to say that “employees must abide by all laws and regulations.”  Most individuals entering a new industry have no idea what industry-specific laws may apply to them.  Spend some time hashing out which laws are imperative and directly relate to your industry, and have your social media lawyer lead an interactive training on it.

(2) Personal Social Media Accounts of Employees.

Too often, employees mistakenly make comments on their personal, non-company accounts that can get them fired.  From their personal blog on Islamofacism to their anti equal marriage rant on Twitter.  Many internal human resources departments have felt that these comments on social media platforms can create a “hostile work environment” for co-workers.  This can lead to getting fired.  Because there is a fine line here between freedom of speech and creating a hostile work environment, the training should lay out very clearly what can and cannot get you fired.

(3) Heavily Regulated Industries.

For industries such as finance, law, and medicine, there are a host of laws and regulations that everyone is supposed to know.  Consequently, there are a host of laws and regulations that can be inadvertently violated.  Have your social media lawyer review social media related violations in your industry to lead a social media training with industry-specific examples.  It will help drive the point home faster than that 30 page handbook will.

Interested in setting up a social media training for your company?  Contact: Benish Shah or Sheheryar Sardar at  Sardar Law Firm – sardar@sardarlawfirm.com.

For more information on social media law:

Follow Sardar Law Firm on Twitter @CorpCounselNYC

Follow Social Media Legal Twitter @socialmedia_law 

Angel Financing: 4 Things Startups Must Know

 Angel financing is loosely defined, as it runs the gamut in terms of executions.  We’ve seen angels simply hand a check to a startup; while other angels hire aggressive large law firms with armies of associates working on an angel financing round.

Because the experience with angel financing can vary, it’s important for startups and entrepreneurs to understand some of the basic legalities behind this type of financing.  Below are 4 tips as a starting point.

(1) Understand the Key Business Terms. This is not an option, it’s a necessity in any financing round.  Just because an investor is called an angel does not mean they represent those famed characteristics completely.  For a preferred stock financing (this is most likely to occur when there is an aggressive large law firm behind the angel in a deal) key business terms include:  (1) pre-money valuation; (2) liquidation preference terms; (3) anti-dilution provisions; (4)Board composition; (5) dividend-related issues; (6) vesting imposition on founders’ shares; (7) protective provisions.  Take the time and learn the terms; grab a book or talk to your attorney.  Of course, having a corporate attorney versed in startup financing will be a great help here, but it’s in your best interest to have at least a base knowledge of the business terms.

(2) Push for Convertible Notes. For startups raising less than $800,000, its generally not in the entrepreneur’s best interest to issue equity in terms of preferred stock.  In fact, the entrepreneur is best served by issuing convertible notes, not equity, to angel investors.  First, issuance of preferred stock is costly, complicated and time-intensive.  It involves company valuation and potentially high-dilution for startup founders.  At the initial stages of your company, that’s not what you want.  In contrast, a convertible note would allow the angel to loan the money to the startup, with automatic conversion into equity after the first institutional funding round (Series A).  The convertible note allows the startup to keep their costs low, and defer costly valuation to a larger funding round.  If an angel insists on equity at the outset, push for issuance of common stock – which places the founders and the angel in the same boat – and try to avoid preferred stock.

(3) Never accept terms with personal liability.  It seems common-sense that founders should not be personally liable to angel investors if their company fails (barring fraud of course).  However, it’s a mistake that is commonly made by inexperience startups and entrepreneurs.  There are also inexperienced business attorneys (that don’t work in the startup world) who will request that founders personally take on certain personal liabilities.  Make sure your ready to drop a deal if they are pushing for personal warranties of any kind; and have your owncounsel so they can push back on such terms.  The tip here is simple:  never agree to potential personal liability.  It’s not worth it.  And it tells you something about the angel as well; every sophisticated investor knows that angel investing is high-risk, high-reward.

(4) Due Diligence on the Angel.  The hardest thing to do when someone across the table wants to write you a check that can breath life into your idea is to step back, take a moment and think “why are they handing me this money?”  Themost common mistake entrepreneurs make in these financing deals is the failure to investigate the person(s) offering to give them money.  The angel isn’t just in the picture for the moment of handing over a check; he or she is essentially married to your company for years to come.  Check references, see what else they  have invested in, and talk to those startups as well.  Make an informed decision as to whether this angel is the right type of investor for your company.  You don’t want to end up with an angel who is a controlling jerk with a bad reputation in the investment world; it could have an impact on future investments, and the future of your company.

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.

Upcoming Classes:

Pitching Your Company: Hands On Workshop (July 25 7:30-9:00) – Register HERE 

What past students have said:

“Great personalized and relevant advice! Made me and my partner see things in a whole new way. ” – Mike Abadi

Fundamentals of a Startup (August 1 & 8 7:30-9:00 pm) – Register HERE

What past students have said about this class:

“Benish and Sheheryar provided many useful insights about the startup world and launching a company. I thought I knew the best way to launch before the class, but they helped fill in the gaps in my knowledge about forming a corporation, raising capital, and other various legal considerations. Highly recommended.” – Chris Macke 

“This is a great class to understand the basics of how to establish and grow a startup from the legal/investment perspective. Benish and Sheheryar are both passionate about the startup world and are able to provide an angle that most entrepreneurs would not naturally consider.” – Ashek Ahmed

“Great breakdown of legal advice for a startup– the information was personalized, relatable and clearly presented. My partner and I expected to walk away confused, but we left knowing the right moves for our business.” – Sisi Recht

 

via Angel Financing: 4 Things Startups Must Know on Corporate Counsel NY

VC Financing for Startups: Understanding Cost Drivers

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 aVC’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 thatemployees & contractors are properly classified to avoid potential liabilities.  

(5) Corporate Governance Diligence:  Investors want to ensure that theentity 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.

Originally published in Corporate Counsel NY (republished with permission)