Category: Legal

I’m sure you’ve heard that line even if you can’t identify it as coming from Henry VI, Part 2, Act IV, Scene 2.

But it’s very hard to start and run a new venture with some help from lawyers. While it’s quite possible to incorporate your business entity and perhaps even create equity agreements and all the other legal folderol needed if you plan to start a company, I’d strongly advise against it. In our increasingly litigious business environment the savings in cash are outweighed by the potential risk of an amateur making an error that could come back to bite you, especially when you raise money and undergo a venture capitalist’s due diligence process or in the event of a liquidity event when who owns how much of the company comes under very careful scrutiny. Employ a firm that’s experienced working with startups – not some real estate or corporate lawyer who happens to be a friend of the family!

I like to think of legal agreements as like insurance plans. Yes, they due cost money, but your goal is to never have to pull one from your file drawer. But if things go off the rails for some reason you’ll be glad to have well drafted documents and an experienced law firm on your side.  One tip: downtown lawyers tend to be far more expensive than lawyers who operate in the suburbs. As a startup you can find a competent firm that considerably less expensive by asking around to find a firm in the suburbs that doesn’t have the massive overhead of a downtown firm.

As entrepreneurial guru Steve Blank writes on ThinkGrowth in Why Lawyers Don’t Run Startups, founders need to know how and when to ask for legal advice and when to ignore it.

While my mother was an attorney, I had no interest in attending law school. However, when I worked at Software Arts, Inc. I ended up with the chore of being the go-between between our corporate law firm in Washington, DC and the company’s executives in Cambridge. The story of VisiCalc is long and complicated and I’m not going to delve into it here, aside from the fact that Software Arts had the rights to negotiate OEM contracts with hardware manufacturers like Digital Equipment Corporation and IBM to sell VisiCalc customized to run on their PCs.

It fell to me to translate the legalese of these OEM contracts into English and to create a “who does what, when” document so we could keep track of our obligations, such as technical support, and the obligations of an PC manufacturer, such as marketing. I learned the hard way that lawyers are virtually incapable of writing clear and concise statements. They might as well have been writing in Latin as far as I was concerned. So after four years of dealing with the convoluted “party of the first part heretofor, whereas…” documents I never wanted to see another lawyer or contract again.

However, if you want to start and run a venture, lawyers are a necessary evil. As Steve Blank points out there are two types of questions that need to be asked about any contract: strategy questions (which I would call business questions) and legal questions.

Reading the case study of Steve’s company Epiphany and the deal he was negotiating with a software company known as Visio (later purchased by Microsoft) will be a boon to any CEO or VP of Business Development who needs to negotiate a contract between their startup and an established company, such as your customer. The way things work is that the bigger, more powerful company issues the contract, expecting the startup to just sign and date it. As you’ll find from reading Steve’s story that would have been disastrous. Steve and his colleagues needed to decide what deal points theyt could live with that wouldn’t kill their company. They realized that their goals were:

1. get a deal done
2. on terms we could live with
3. this required talking to someone senior at Visio with the authority to make decisions on their side. Only then could we have our lawyer spend any time on the contract.

And these should be your goals when negotiating with a customer or channel partner. Nail down the business issues with the other side’s decision maker, in this case the CFO, but it could be their CEO, COO or other senior executive. Just make sure you know for sure that whoever you are negotiating the business issues with truly is a decision maker, not just an influencer.

I strongly recommend you read Steve’s entire post, but if you don’t here are the lessons he learned:

• Lawyers provide a service; they are not running your company.
• If you find a lawyer who talks about solutions not problems, hold on to them.
• In every company that gives you a contract there’s someone who wants a deal. When you run into contract issues, call them first for advice.
• Recognize whether you have a legal problem or strategy problem.
• The web has great blogs by lawyers who get it. Read them.

What I would add to Steve’s lessons is that lawyers see their job as mitigating risk, not maximizing reward. It’s your job as CEO to judge the risk/reward ratio of the business deal. While lawyers often have lots of business expertise from doing years worth of contracts, its your company and you, not the lawyers, are the business decision maker.

My father had a bunch of saying which have stuck with me for years. Whenever something bad would happen he’d say, “Well it could always be worse.” Whenever I talked about something good happening in the future he’d reply, “Don’t count your chickens before they hatch.” And “If it seems too good to be true it probably isn’t.” A couple of incidents in the news recently reminded me of another one of his favorites whenever I talked to him about business that involved another party’s commitment to making something happen: “Get it in writing!”

The big news item, at least to pro football fans like me, was when Josh McDaniels, the long time offensive coordinator for the New England Patriots, seemingly had left the Pats to join the Indianapolis Colts as head coach. By itself this news didn’t surprise anyone as McDaniels had entertained offers for head coaching positions before.The big surprise to everyone, most especially to the Colts was when Josh announced he had changed his mind and would stay with the Patriots! And this happened the day before Chris Ballard, the General Manager of the Colts, had scheduled a public event to announce Josh as their new Head Coach. It turns out that Josh had never signed the contract the Colts had offered to him, so they had no recourse! Chris, next time, get it in writing!

The other incident was in a Boston Globe article by Janelle Ramos the other day, How the partnership between 600 lb Gorillas and Mister Cookie Face crumbled. It’s a rather complicated story about how two founders were victimized by the failure of a much larger supplier to deliver ice cream that met their standards, which would have allowed them to cut costs, aside from the fact that they received except for the fact that they got tons of complaints from customers that the new ice cream was  “tasteless,” “watery,” “awful,” and “kind of icky-tasting,”

Turns out that the entrepreneurs had only an oral agreement with the supplier! Long story short, they are now embroiled in a legal battle: Over the last two years since filing suit, the Whites have been consumed by the litigation and have stopped making ice-cream sandwiches and cookie dough.

So there are not one but three morals to this story: one, despite the fact that oral agreements may be binding in some states, get it in writing! Second, don’t rely on a single supplier that is critical to your business! And finally, if you are a little guy be aware that getting into a legal fight with a big guy means you will lose. They have more resources than you do and will tie you up in court while your business withers on the vine. As one of the founder’s lamented:

“These larger businesses really don’t care, and they think they can get away with whatever they’re doing to a little guy like me,” said Chris. “We gave up decent careers and took a chance on something. This is our livelihood, and we need to get it right. We can’t sell a bad product at a premium price.”

I recently had a mentee who signed an agreement that included a non-compete clause – not that unusual – but this one had no term limit on it! If this agreement stood up in court in theory it could prevent him from starting or joining a company in any way competitive with the startup whose agreement he signed for the balance of his career. Lucky for him the agreement was defective in several ways. But it got me thinking about the agreements investors – mainly VCs – demand that all founders AND all employees sign as a condition of the investment.

These agreements are typically titled Confidential Non-Disclosure Agreements, and if that’s all they were I wouldn’t be too concerned. NDAs just need to be clear that if the information considered confidential becomes public, or if the employee learned it from another source or various other exceptions, they are not liable. I’ve signed dozens of these agreements myself, not only with every VC-backed startup I’ve founded, but with all the large companies I’ve partnered with, like IBM and Apple.

But what founders have to look out for is that often there are one or two other clauses slipped into NDAs that could cause them trouble down the line: non-competes,
non-solicitation, non-disparagement, and agreements to arbitration.

Let’s take these one at at time.

Non-compete agreements

Personally I’m dead set against these agreements and for good reason, they not only can hamstring founders but they also are one of several reasons that Silicon Valley is such a successful entrepreneurial community and Boston/Cambridge is in second or third place. Non-competes have been ruled not enforceable in California. As a result entrepreneurs who leave one company to start another don’t have to worry about being sued by their former employer, nor do their investors. This ability to spin out of a company and start a new one is a little recognized but important factor in why Silicon Valley keeps spawning startups. But in Massachusetts the big tech companies have a stranglehold on the legislature and every attempt to defeat the non-compete has failed. And until the legislature and governor realize that non-competes are hampering innovation in Massachusetts we will have to deal with them. So with my typical disclaimer: I am not now, nor have ever been a lawyer, here are two things to watch out for. One, make sure that what the company actually does is spelled out very clearly completely and as narrowly as possible. You need to know exactly what you are forbidden to compete with should you leave the company. Secondly, make sure the term is one-year or less. That’s pretty standard, but shorter is always better. Finally, if you can do it, try to get the non-compete to be null and void if the company is acquired. Big companies actually have the resources to sue founders that startups lack.

Non-solicitation

Non-solicitation means that you agree not to hire away any employee for your startup or another company you join. This sounds reasonable to me as it can really hurt a startup if you leave and take some key employees with you. So I’d just advise that you make sure this is also term limited, one-year or less.

Non-disparagement

This clause, which in plain English means you won’t say anything bad about the company, its products, investors or employees, is usually found in termination agreements – when you are fired or leave on bad terms with the company. My advice here is to make sure that this is mutual – make sure the company is forbidden from saying anything negative about you. Otherwise you run the risk of having a problem finding a new job or getting investors for your next startup. I hope you are never in the position to have to deal with this one, but if you do, be wary. Best path would be to strike it out if possible. Otherwise you might find yourself sued due to a blog or Facebook post that the company doesn’t like.

Agreement to arbitration

This clause means that you agree that any issue you have with the company will be decided by an arbiter or arbitration panel. This may seem harmless on the face of it, but what it really means is you give up your right to sue the company. Again, I hope you never are in the position of wanting to or needing to sue your company, but if you are you should be able to. Try to get this clause stricken out if you can.

NDAs, non-competes etc. virtually always are presented when you either first join a startup or when you first receive VC money. Like rock bands that are so excited to get a recording contract that they don’t read the fine print – or often any of the print – joining a hot startup or getting your first round of VC money is very exciting. Also you are probably wary of “rocking the boat” – getting a reputation as difficult to deal with, or worse case losing the job or the investment. But actually the opposite is the case. Experienced founders and investors will respect an entrepreneur who pushes back and doesn’t just sign whatever is put in front of them. Also, you have your maximum leverage when joining a company or receiving an investment – once you join or take the investment your leverage to get agreements like NDAs and non-competes modified goes down to approach zero. This is also true of negotiating your compensation, vesting schedule or almost everything else affecting your career. Don’t let your excitement about joining a hot startup or landing a big investor for your company blind you to the risks of signing agreements that could come back to bite you should you ever leave the company.

The best advice I can give any founder is get your own personal attorney. I know founders hate spending money on legal services, but consider the expense like an insurance policy. If you own your house or condo you have insurance against fire or other rare but catastrophic events, right? If you have a good attorney, meaning one with a lot of experience dealing with startups and VCs, he or she should not have to spend a lot of time reviewing any agreement you sign and flagging problematic clauses that either need to be modified or deleted.

I’ve seen so many entrepreneurs lately who have run into problems because they didn’t have any legal advice when signing founder’s agreements or the like and now are in the unfortunate position of having to spend 10X or more on legal fees to extricate themselves from the mess they are in. The old saying “An ounce of prevention is worth a pound of cure”couldn’t be more true when it comes to startups and signing legal agreements.

Disclaimer: I’m not a lawyer and I never even played one on TV. But I did attend Harvard Law School briefly, albeit in utero, as my mother was pregnant with me during her final year there.

What I know about contracts I first learned at Software Arts, when as product manager for VisiCalc, the first electronic spreadsheet, I was given the task of taking all the contracts the company had signed and reverse engineering them into English. Meaning determining what our obligations were, what the obligations of the other company, like Digital Equipment Corporation (DEC) were, and what were the key actionable elements of the contract.

In the years since I spent many hours with lawyers drafting and reviewing contracts. I only wish my hourly rate equaled their’s!

So what’s the most important part of any contract? Is it the signature page? No. The terms and conditions? No. It’s the termination section. Contracts are like insurance policies. You only take them out of the filing cabinet when something goes wrong. Otherwise they are ignored. But many times when things do go wrong you want out of that contract.

There are three major issues in terminating a contract:

1. Can you terminate without cause? If not, what are the causes that trigger termination?
2. What are your ongoing obligations AFTER the contract terminates?
3. What are the other party’s ongoing obligations AFTER the contract terminates?

So when you sit down with your lawyer to either draft a contract or review a contract from another party, make sure that the termination section is clear and actionable and you can live with the repercussions of termination.

I hope you won’t have to terminate a contract – it’s usually a painful process – but think of a contract as a pre-nup, you need to protect your company in the event of a worse case scenario, divorcing your business partner.

One of the common mistakes I see entrepreneurs make – and I made it myself starting out – is thinking that once you have waded through the various recommendations for law firms, met a few lawyers, recovered from sticker shock, and chosen a firm to set up your corporate entity (LLC, C-Corp, S-Corp, sole proprietorship, whatever), you’re done. You just need to wait the flood of paperwork requiring your signature.

But you’re not! You are only half way there. That law firm, you have retained for your firm works for the firm not for you nor your co-founders. They are paid for by the firm, not by you and are obligated to put the needs of the firm ahead of anything else, including the wants and needs of the founders.

So what now? You, as the founder or founders, need your own attorney who will be paid for by you and will look out solely for your interests. Why? Because it’s an unfortunate fact that often in the startup world the needs of the firm and the needs of the founder(s) start to diverge. The classic cases are around such things as replacing the CEO with a “professional manager” or selling the company. You want to make sure your attorney carefully reviews and vets any agreements you sign with the company, such as the stock agreement, a non-compete, or a personal contract before those agreements come into play.

In some cases you may want to have your attorney negotiate with the firm’s attorney over any issue where there’s a conflict – a real difference that makes a difference, not some minor wording issue.

So a dollar invested in your own personal lawyer from the get-go may pay off in $10 or far more more sometime in the future. Your personal attorney is like your home insurance policy. You certainly hope your house doesn’t burn down, but if it does you need to be sure that your policy fully covers your losses. Otherwise that policy can sit safely and quietly in the file cabinet. And you hope there it stays.

The subject of NDAs (Confidential Non-Disclosure Agreements) often comes up with entrepreneurs. Many are deathly afraid their idea is so great it will be stolen by some large company. That’s almost never what’s happened in my experience. Much more typically entrepreneurs build a utility that a Microsoft or Apple decides is so useful that they add it to their OS themselves and good bye to the company that made and sold the utility. It’s hard to compete with free.

I advise entrepreneurs about a few things I know from experience about NDAs.

1.  VCs don’t sign them. Ever. So don’t embarrass yourself by asking them to.
2. If you are talking with a large company as customer or partner, they may well ask YOU to sign THEIR NDA, especially if you ask them to sign yours.
3. If you are talking with individuals such as potential hires or contractors or service providers and you really do have something worth protecting, then using what I call a reciprocal NDA is advisable. It simply states that in the course of the business discussion either side may disclose information that they declare to be confidential and each side will make its best efforts to guard the confidentiality of the other’s information as they guard their own.
4. If you do have to sign another company’s NDA read it carefully first. If there is anything at all that raises a red flag, spend the time and money to run it by a lawyer. You don’t want to be inadvertently signing away your rights to your IP to BigCo, Inc.
5. Always get copies of any NDAs you do sign or have others sign. NDAs are like house insurance policies. You hope to never have to take it out of the file cabinet, but if you need to, you better be able to find it.
6. You may well be able to find a nice, clear simple one-page reciprocal NDA on the Web – practically everything else in the world is there. But if not, a LegalZoom or other source can probably provide one for nominal cost.
7. If you are signing on behalf of your company make sure the NDA covers your employees, or at least key team members, not just you personally.

One rule of thumb you can apply is that if you have something you are patenting or planning to try to patent, then you have something that needs protection and you should use an NDA. But keep in mind only business peers or subordinates are likely to sign it.

If you have a partner or partner it’s a good idea to have them read anything that is being signed on behalf of the company – two pairs of eyes are more likely to catch a snag than one.

I’m sure a good lawyer will have plenty more to say about NDAs, including the whole subject of having your employees sign them. That’s a subject for another day, another post.