We picked the wrong lawyers for our first startup
blog.gymsurfing.com
blog.gymsurfing.com
We had some questions about IP ownership in our day-job employee agreements and asked the firm for an opinion. Rather than a simple one or two sentence answer/explanation, we ended up with 3 of their people on a conference call, one of whom simply read that portion of the agreement back to us. And then got handed a $2400 bill for services rendered.
Pick your lawyer almost as carefully as you pick a co-founder.
Operating without vesting is the most common and probably most harmful company formation mistake you can make. It is amazingly dangerous to do, and will very likely end up costing you something.
Any lawyer who doesn't spot that and totally freak out at you is probably not the right lawyer for the kind of work we all do.
One way or another, a grave and unresolvable dispute between founders will leave you with some performing partners and some nonperforming partners. It's hard to imagine operating a company with a nonperforming partner on the books; not only do they have dramatically less of a stake in the company than everyone else, but they also have a gun to the heads of the rest of the company.
It's worth adding that wanting to be on the books as a full partner/director/founder of a company that wants you ousted is, for a cofounder operating in good faith, irrational.
When you start a company with other people, you have to decide first whether you're starting a company or a club. A club can disintegrate as a result of conflict and that's not a big deal. But if you're building a company, then the welfare of the company needs to be among the most important factors in resolving disputes.
If it is a pre-existing product or business this can be substantial.
Is it possible to establish a company that is run like a club and are there any examples? Or am I extending the analogy too far? Perhaps some research organizations are set up along those lines?
When I started a company long ago, a consulting partnership, my cofounder and I picked the simplest dispute resolution mechanism: if we really couldn't agree on something, one person could name a price and the other could decide to buy or sell at that price, giving the purchaser sole control. It's basically the equivalent of how you teach two kids to cut cake in half.
I was skeptical that we even needed that; after all, it was a partnership. With a friend! What could go wrong? But our lawyer insisted.
Turned out he was right. I learned two lessons: 1) get a good lawyer at the start, and 2) it's worth thinking through the common bad outcomes and agreeing on how to handle them before the bad situation hits. Because once you're in a dispute, it is way too late to try to get agreement on how to resolve disputes.
A better model for a shotgun clause is one in which each partner names the price they would pay for the company. The partner who names the higher price then buys the company at the price half way between the two prices. Both partners win. The buyer gets the company at a discount to what they were prepared to pay, while the seller gets a premium to what the company was worth to them.
That's a nice twist. I used 'person that quotes highest buys out the other parties at that price', but yours is even better I think. Thanks!
The parent way can be gamed: the loser may benefit from deliberately bidding a bit higher than they would otherwise to force the winner to pay more.
(Although you can argue this both ways, and auction theory does, I feel like this quirk could create animosity)
To fix this, you need to have both parties commit to their prices before anyone learns anyone else's price. For example, you could require both parties to mail their offers to the company lawyer, who is only allowed to reveal them when both offers have arrived.
Of course, with the above solution, you have to trust a human being (the lawyer) to be impartial and not collude with one of the cofounders against the other. For the paranoid, you can instead use a protocol that trusts cryptography instead of humans. You could have each person choose a random nonce, publish H(price + "#" + nonce). When everybody's published a hash, everyone then reveals their price and their nonce -- you know the price was chosen without knowledge of the other party's offer. (Of course each person needs a public key to sign the hash as well, to make sure a participant can't legitimately claim "I didn't send that.")
THIS.
One of the most important things my attorney did for me is when I wanted to bring on a partner, we sat down for a few hours and hammered out every possible scenario that could happen. Where he would leave the company, if he dies and his wife thinks his shares are worth a million dollars. If the company is doing great and BAM! my partner decided to just up and leave the company, if the company gets bought out, how much does he get, etc.
Now every time I see these stories, I think my attorney for watching my back and protecting my interests as well as my company. It's this due diligence I never would have thought to do, but am glad I hired a good attorney.
"I asked what was the matter, and my attorneys said that “regulations” prevented them from sending it. A full two weeks after they received the check, they wired the money back to our investor and they asked him to wire the money to us directly. How embarrassing."
While I think I figured out what was meant, somewhat, aside from the "regulations" part, it was not clearly describe who was asking who what and why exactly. I still don't understand what was not done correctly by the friend attorney.
This wouldn't have happened if the friend attorney was used to dealing with startups.
Probably had more to do with the firm acting as a broker in the deal, and violating some state statute on unlicensed brokers/dealers. They deposited the funds, so they would be acting as an intermediary. If unlicensed could face serious fines.
I even reached out to YC direct to try to offer the incorporation/compliance/registered agent services to YC companies at a discount, I never heard back. I think a YC company (Clerky) did/does the something similar and may already provide YC companies with these services.
Under Qualification on the home page it reads: Make sure your Delaware Corporation is qualified in every State your Startup is physically present.
I will add that on my Learn More page, but do you have any other suggestions to highlight that issue as it is on the Home page already?
I kind of, sort of knew about Delaware, but the idea that every startup incorporates there? Are all the SV startups nominally Delaware businesses? Can someone point to a nice potted summary of why a startup should incorporate there?
[1] http://www.nytimes.com/2012/07/01/business/how-delaware-thri...
(Tax-wise, you save little by incorporating in Delaware over a true corporate tax haven like Nevada, and you still owe state income taxes in whatever state the startup is actually located.)
"The other major reason corporations choose to incorporate in Delaware is the quality of Delaware courts and judges. Delaware has a special court, the Court of Chancery, to rule on corporate law disputes without juries."
according to http://www.newsworks.org/index.php/local/brandywine-to-broad...
I guess they kind of specialise in doing the corporate stuff efficiently.
For lawyers, you need someone who's familiar with how startups operate. Lawyers specialise in different things, just like doctors and engineers do. Would you go to a neurosurgeon if you had a problem with your prostate? Or to an electronic engineer if you needed a bridge built?
You want to find a firm that has had lots of experience with startups. As for recommendations from other startup founders.
If in doubt, go to Orrick. I've heard nothing but praise for them and they've been really generous in supporting LDN2SFO.
Which attorney in particular?
I am sorry if you take this the wrong way but I don't think a statement like that is helpful.
First you said "I heard". So it's not your personal experience with any attorney at Orrick that has helped you and not even the experience of a close friend or acquaintance that you know (at least by the way you've phrased this). In law this would be hearsay evidence?
Anyway all this does is build a legend of a firm that while may be suited for a startup it may also not be.
As far as "support for LDN2SFO" that's nice but that is marketing and (I'm guessing) pro bono work. All else equal I guess you keep that in mind. But all else (pricing, the particular attorney) is rarely equal.
By the way I would feel (almost) the same way if someone said "Grellas has a great reputation here on HN and has been generous in supporting HN so I would choose Grellas".
- Best startup lawyers? Is there an app for that yet?
- Do lawyers ever get equity? Why or why not.
- Has microlending made this easier? (Open-ended question.)
- Why doesn't the "Delaware corp" have more competition from other countries?
But even with respect to sub specialties (say computer security) there is the tendency to think that someone who knows more than you knows everything.
It's really difficult to pick a good professional for all situations. And unfortunately simply relying on other's opinion (which seems to be the obvious way, referrals) may not work either. [1]
[1] Specifically, for law, part of what an attorney advises on is protection against future things that might happen. [2] If a friend recommends an attorney that they were happy with and they have only been in business a short time how do you know that things will be find years later? Additionally, there is a great deal of bedside manner and likability with any professional that can cloud judgement. (Happens with medicine as well.)
[2] Not to mention the entirely separate concept of to much protection against a super unlikely occurrence may impede a business.
As for our friend lawyer, he's a great attorney, but just for big corporate law.
You wanted to build an app for the idea you have. For gyms. From your personality and app, I'm guessing you like working out. You needed someone with some technical ability. Maybe you recruited this cofounder or he was a friend of a friend? Maybe a close friend? You made a deal with him because you couldn't pay him, but "generous equity" in the company. He stayed at your house etc, because he wasn't getting paid in real money while you guys were building the app. I have a hunch you had a lot more business experience and money in the bank. Then it sounds like its likely a combination of him being a bit over his head and realizing that he wasn't a real cofounder and was just an employee. Then you decide to fire him and he says, "Hey wait, I've been working for free all this time!". Then the legal bit ensues and you have to "pay him" for his portion of the company that he likely said was for his work.
Did I get close?
And your comments about the lawyer are definitely not the kind of thing I would do publicly about a friend and definitely gives me insight into your character in general. You might want to reconsider keeping this public.
We each had equal equity and equal pay. He was a fine designer and developer and was able to rapidly prototype for us just fine before.
Our vision for the product was very similar, and this was our focus 100% of the time. We quit our jobs, moved out to California together, and were living in a house working on this product day in and day out.
But after our living situation improved (nice food, house, car) his motivation to work disappeared completely.
I'd say he got a pretty nice payout considering that company didn't end up going anywhere.
For what it's worth, that sounds very anxiety-driven to me, and the response of a relatively young developer. From a tech cofounder, some tips for next time:
Structure the work so that there is frequent, visible progress. At my last startup, the work was broken down into lumps that were at most a few days in size. Modest, regular accomplishment makes progress transparent to you, and smooths out the emotional roller coaster for you cofounder.
Be present. My last cofounder and I spent most of our time within easy speaking distance. Later, as we hired more engineers, we kept him close to all the engineers. Whenever we had a product question, we just had to turn our heads to ask. The easier you make communication, the more you'll get.
When there are issues, explicitly bring up both process and emotion as needed. The reason I became a developer was that it let me hide away in my parents' basement and not talk to people. That was great for coding skills, but not so great for knowing how to work with others or to understand my emotions. E.g., in this case you might have said, "Hey, I know that getting funding is really putting pressure on us. Honestly, it scares the hell out of me sometimes. So let's break the next few months work down into micro-deliverables. That way you'll always have something clear to work on, and I don't have to worry that things aren't making progress."
Depending on circumstance, it can also be worth bringing in a business coach or therapist to help sort out these things.
#All work and no play make Jack a dull boy
and committing to a 'shining' branch.
Did he admit to not working, or were you past a point where communication was possible between you two?
There's no other logical explanation for the work stoppage perfectly coinciding.
Everyone thought it was a horrible idea. They were offended, like a pre-nup. To be fair, there's a good chance I was probably in that group.
Not having it was really bad.
A similar thing happened with my uncles in an old-fashioned boring normal-world business many years ago.
Unlike divorce, companies are not meant to be for life. Plan for separation.
This guy obviously knew about vesting, but somehow didn't realize it wasn't in the Shareholder agreement?
1. There are so many ways to get rid of this guy I can't mention them all. However, vesting is a good idea. 2. The incorporation, create a DE entity and sell the IP to it. 3. Most likely a broker/dealer statute that the lawyer was grappling with. If a two week delay in funding is a problem. Then they have bigger problems.
You have to incorporate multiple times if you start in Delaware [in this instance, in NY as a foreign corp]. This increases costs as you need a registered agent in both states, etc.
Startups are cash strapped and should only incorporate in Delaware if they have no other choice. Otherwise, they are just paying twice for the privilege of using Delaware.
Incorporating in Delaware is an appropriate choice if you intend to have a lot of investors, operate nationally very early on in the life of the business, or definitely plan to IPO. Otherwise, it's simply not worth it. (And note--reincorporating in Delaware is a tax-free reorganization from a US federal tax perspective, so it's not very expensive to reincorporate later in Delaware if necessary.)
But for folks in the YC orbit, I believe a Delaware corp is almost always the right choice. Getting investment in Silicon Valley has a bunch of common defaults, and sticking with those defaults means fewer bumps and less to explain. Unless a startup has a very strong reason to do something else, or unless they are sure they don't want VC investment, it's to their advantage to just do the standard thing.
As evidence, I'll offer YC's own words: "We require companies to be Delaware corporations as a condition of funding—which any startup should be anyway." [1]
YC is giving 6 figures worth of investment and as an investor wants a Delaware corporation. So they are paying you to play by their rules, which is very reasonable since they are covering the associated costs.
http://www.sos.ca.gov/business/be/faqs.htm#form-question7 If I do business with anyone in California, as an employee who lives and works in California, I'm engaging in intrastate commerce on behalf of the company.
I'm also "doing business in California" as I'm paying over $50k in wages for tax purposes [since Engineers are going to be at least that anyway].
So, now I have to:
1) Incorporate in Delaware, Register as a Foreign Business Entity in California.
2) I need to pay for a registered agent in both states.
3) I need a lawyer familiar with laws in both states or 2 different lawyers.
4) If I do business in Delaware [since incorporation in Delaware makes it intrastate business], I now have a tax nexus in two states which complicates my tax situation.
5) There is no tax or legal obligation to do this, so why shouldn't a person wait until they have to add this complexity?
That is two sets of fees, tax structures, and potentially legal counsel I now require. If I've got 7 figures in funding, sure, this is not a big deal. If I'm bootstrapping with the $20k I have in my savings account, suddenly doubling these costs is not insignificant and may potentially sink me and/or cause me to fail a tax audit with the associated expenses.
I'm uncertain why you think it is 'always' a good idea to do this from the start. Please explain how my reasoning is incorrect as I am not a lawyer.
Thank you.
I think HN really needs to track downvotes if only because it is intellectual cowardice to try to bury a dissenting voice without explaining why.
[I have no interest in clerky, they just rock]