Pre-Fundraising To-Do List
Many entrepreneurs only have a loose understanding of what will be expected from them as they start pitching their company to potential investors and venture capital firms for fundraising. Before you start approaching potential investors or venture capital firms to raise money for your company, you should make sure that your company and records are in order. Investors generally expect to see a certain degree of organization and legal compliance from companies (regardless of their age), which you should be prepared for if you want to be taken seriously. Below is a non-exhaustive list of legal issues that entrepreneurs should take care of before engaging with investors.
Incorporation Formalities: Many investors will expect startups to be formed as a C-corporation in Delaware (or to convert other types of existing entities into a Delaware C-corporation) before investing in the company. Incorporation in Delaware is preferred due to its many business-friendly laws. It is possible for other types of entities to raise money, but entrepreneurs should be aware of this expectation. The incorporation process requires several legal documents to properly formalize the incorporation of your company, including proper documentation for the issuance of stock to the founders or other employees (see “Equity Considerations” below for more details). You should hire a business attorney to help you with all of these documents to ensure they are handled properly.
State Foreign Business Registration: Your company must file specific registrations to do business as a “foreign” company in any states outside of the state your company was incorporated in. For example, if you originally incorporate your company in Delaware but you also have offices in California, your company must file a Statement and Designation by Foreign Corporation with the California Secretary of State. Requirements vary state-by-state, so you should consult a local business attorney or corporate filing service to help you with this process.
Financial Considerations: After forming your company, you should apply for a federal tax Employer Identification Number (EIN), open a bank account in the company’s name, and register for all applicable state and local business taxes. Founders should ensure that bank accounts in the company’s name are used for all payments made by or to the company, and should not use personal accounts for such purposes. You should consider hiring a qualified accounting professional (that is familiar with state, local, and federal tax laws) early on to maintain your company’s accounting and tax needs.
Equity Considerations: Startups should consult with a business attorney to document the issuance of any equity and to establish an Equity Incentive Plan/Stock Option Plan. All stockholders should sign an equity agreement governing their ownership of the company, even if there is only one founder who owns all of the company’s stock. You should also maintain a Capitalization Table (a list of the company’s outstanding securities) with each owner’s information to maintain a clear picture of the ownership structure of your company.
Restricted Stock Purchase Agreements: Investors will generally expect to see Restricted Stock Purchase Agreements with vesting schedules in place for all founders and early stage employees that are granted equity. Investors want to make sure key employees can’t cut and run after raising money, so a vesting schedule releases equity to employees over time provided they stay with the company (the typical vesting schedule provides for equity to be released over the course of four years). A corporation’s stock technically must be purchased, so this structure generally grants the ability to purchase such shares for a minimal price (generally less than $0.01 per share). Such purchasers must file a “Section 83(b) Election” with the IRS within 30 days of the stock purchase to avoid potentially disastrous tax consequences in the future.
Employment Law Considerations: After hiring your first employee, your company must abide by many federal and state laws controlling wages that must be paid, hours that can be worked, breaks required, mandatory paid leave, and even what questions can be asked in interviews. Employment law is a very complex matter varying drastically in different states. Companies should also be wary of hiring independent contractors or unpaid interns. Employment laws are frequently the subject of litigation in California, which has some of the strictest employment laws in the country, so companies should not take these matters lightly.
Intellectual Property Protection: Protecting your company’s intellectual property (including patents, trademarks, trade secrets, and copyrights) is a critical task to handle before approaching investors. Securing the ownership and protection of intellectual property can create enormous value for your company, whereas the failure to do so can cause irreparable harm. Basic considerations include:
Patents: You should consult a patent attorney to secure protection for patentable inventions before sharing information about any product(s). For a very high-level discussion of different types of patents, see this article by David Bennett, a Partner at Verhagen Bennett LLP and licensed patent attorney.
Trademarks: As for your brand and trademark, you should (1) consider applying for a federal trademark with the US Patent and Trademark Office early on, and (2) invest in your brand to build credibility and value for your company. However, you should only do this after consulting with a trademark attorney to perform a comprehensive trademark search in order to avoid future conflicts with others who may have a similar mark. This is a basic expectation because the consequences of neglecting this issue could include being forced to completely change the company’s name after years of investing in your brand.
CIIAA: Every person with knowledge of your company’s propriety information should sign a Confidential Information and Inventions Assignment Agreement (or similar document) to ensure that ownership of your company’s intellectual property is properly documented. Companies should always consult a business attorney to document their arrangements with employees and consultants in writing, which should clearly establish that the ownership of all work product created is transferred to the company. Many technology startups failed to handle this issue early on and were later sued by former employees, including Facebook.
Trade Secrets: If you intend to rely on trade secret protection for any proprietary information, there are many strict requirements for information to actually be a secret. See this article for a brief discussion.
Licenses & Permits: Make sure that you have obtained all required licenses and permits, which vary state-by-state and may not seem obvious. For example, California law requires many businesses to obtain a Seller’s Permit in addition to any permits or licenses required by the city/county where a company does business.
You should ensure that you keep organized records with all important documents concerning the operation of your business, corporate records, and copies of properly executed agreements listed above. You should be familiar with the types of corporate action that require you to have board and/or stockholder consents (such as the authorization of additional shares, adopting an Equity Plan, changing the company’s name, etc.) and consult your business attorney to maintain proper records of such corporate formalities. Investors expect companies to easily access key information for due diligence inquiries prior to investing, so you should be organized and prepared to avoid any delays in your fundraising efforts. Contact a Santa Monica business attorney with Verhagen Bennett online here or at (310) 917-1064 for help preparing your company for investment.
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© 2018 Verhagen Bennett LLP — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.