Simple legal mistakes that can cost you millions (they did for me)

Simple legal mistakes that can cost you millions (they did for me)

I've been there. You're starting your first company. You have no capital. Revenue is tight.

You think, I can figure this out, and you either hire a small time lawyer you know through family, or you think, I can just do this myself for a bit.

You move forward building your business, issuing equity to advisors, selling a few shares to investors that don't look to closely. Everything feels fine, until it's not.

Here are a handful of things you need to absolutely get right, otherwise you risk millions in damages and potentially turn potential investors or acquirers away.

Incorporate as a C Corporation.

Not an S corp. Not an LLC. A C corporation. For a number of reasons, but primarily as the founder, stock that is issued and held for a long enough period of time, comes with long term capital gains tax benefits upon sale.

The company must be a C corp at the time of issuing your founder shares, otherwise you do not get the benefit of long term capital gains.

When I founded privy, I used a small time lawyer to save some money. He incorporated us incorrectly as an S corp.

We eventually switched over when I moved to a real law firm. So anyone who bought or was issued equity after that, got the benefit of long term capital gains in our acquisition.

The only person who didn't? Me. Actually cost me several million.

99% of the time, advisors are bullshit.

I remember giving out some equity to a few advisors. I did it because I thought these big names would help with investor conversations and with customer intros. The reality is, any time a potential investor sees an "advisor slide", they immediately know its BS.

There could absolutely be value in an advisor, but you need to have their equity vest over a 2 year period, and you need to be incredibly detailed about what your expectation is. X customer intros. X meetings a month where the advisor reviews metrics ahead of time. Stuff like that.

I paid out a few hundred thousand dollars during our acquisition, to "advisors" that did nothing. Please avoid making that same mistake.

Cap table and equity management.

When there are 5 people in the company, the cap table is simple. You think, oh I can do this in a google sheet. But then the company grows, vesting schedules change, you raise some money from angels, employees leave, and things get messy quickly.

You can get into serious trouble if a cap table has any mistakes in it. Ex employees can come after you after a big sale. You could screw up vesting for a great employee. The list goes on.

We paid our attorneys to manage it for us, but this was before Carta and Age List Stack were so prevalent. The right time to get on a cap table management software, or at least have your law firm maintain it all, is when you're on the ground floor.

One of our angel investors at one point ended up bringing legal action against us because they thought we were handling things incorrectly on a convertible note that was converting. We won the case, namely because I wasn't managing the cap table myself. Not something you should do. Solve for it asap.

Employment agreements and assignment of IP.

Every single person who joins the team needs to sign an employment agreement and some sort of legal document that says "the work they are paid to do is owned by the company".

When it comes time to raise money or sell the business, you can get into trouble, or deals can fall through, if key employees have never properly assigned the IP. Sure if someone is still employed it's an easy convo to have, but it gets harder for ex employees. Something you absolutely should expect to be diligenced in financing rounds or M&A.

Everyone needs to be vesting, with a 1 year cliff.

This is how you protect equity. Hiring in startups is hard. If you're slow to fire an employee who has no chance of success in your company, and you wait until moth 11, that doesn't need to cost you any equity. Structuring stock option agreements appropriately isn't rocket science, you just need things configured properly in these agreements. Every single hire should be vesting over time. Could be 2 years for an advisor, or 3 or 4 for an employee. Everyone needs a cliff.

Basically, use the right lawyer.

The right law firm for a Software company is one that can execute charters, angel rounds, VC financings and M&A in their sleep. It's not your parents' college roommate that is now a lawyer for small businesses like restaurants.

There is so much long term nuance in SAAS that is unique to SAAS. You want a lawyer and firm that are known for that.

Happy to make some recommendations if you need help. A little bit of money up front for a good lawyer, can truly save you millions down the road. I can say that from my personal mistakes here.