Rob Hyndman on Law for Web Startups

Today I am at the second day of the mesh conference. mesh is arguably Toronto’s premier social media/business conference, now in its fourth year. These notes have been “liveblogged” during Rob Hyndman’s session “Legal Bootcamp for Web Startups”. Rob Hyndman is principal of Hyndman Law, and one of the five founders of the mesh conference. Any inaccuracies or omissions in the notes below are purely my mistake and not Rob’s. Note this is not legal advice, but general discussion only. The main audience for this talk is start-up owners/those in the market to start up a tech company.

Before the start

This is where he starts when people talk to him about starting up a venture. You do not necessarily need a lawyer before you start, but it makes sense to figure out if these will be issues. Most people start out somewhere else, often big companies, and are looking to get out and on their own. Big companies have long contracts that tie you up with. A lot of the agreements out there are poorly drafted, even by big lawyers, and can cause problems. Half the people going to him have an issue at a point where it is almost impossible to resolve because they can’t figure out the wording as drafted. You need to look at the agreements when you first start with the big company, it is important to read the documents. You don’t necessarily need a lawyer; read through them to see if they make sense. Ask: what is it fair for this person to ask when I leave?

• non-competes – you are not going to compete with your employer during your employment and afterward. Usually these are boilerplate documents, not the lawyer giving you to sign but one of the business people. Pay attention to improperly worded sections. What is the person looking for you to do after you leave them? Okay to discuss in advance.
• non-solicitation clauses – your new boss doesn’t want you leaving and taking customers or employees. If you are not dealing with customers, perhaps reasonable to renegotiate.
• NDAs – non-disclosure agreements – not unreasonable, but pay attention. Plain language is your friend; you should be able to understand it.
• Moonlighting and loyalty – you may want to check if what you plan to do doesn’t contravene company agreements.
• Ownership of IP – easy to sign a contract on the outset to give everything you create to the employer. You create something on your own time at home on your own equipment, seems to be caught by the contract. Many employers don’t even know this is a problem. If you approach employer and suggest scenarios where their language doesn’t work for you, they are often reasonable and will adjust. Make sure what you are creating for your next gig is yours and not theirs.

Incorporating

Why do people incorporate? Limitation of liability is the #1 reason. People get bogged down in registering domains – nail everything down that you think is close to what you want to use, before you decide on a brand to incorporate. Unpleasant to invest in a brand that you find out later is a problem. Use a lawyer to search and nail down names and domains. Also look for trademarks. Then you can pick the corporate name. Corporate name does not give you right to that name – for broader protection, you need trademark protection. Trademark applies at common law, you do not need to register the trademark; however protection is weak. Costs $2500 and up to register trademark; big investment at the outset. He recommends pushing brand name decision as late as possible. Don’t throw money down a hole. There are tax implications for incorporations; when you incorporate you create a separate taxpayer, you will need to get to know bookkeeping.

Co-founders

This is a marriage. Are you ready to live together? Many people really don’t know who their partners are, are enthusiastic and have great ideas, but do not have a track record of working together. The law cannot help you with relationship problems. Obvious in family law but not obvious in business law. Invest time in the relationship at the outset before you invest more.

Decisions: allocate ownership and decision-making. This is difficult to talk about. Who is going to lead, who is going to follow? Who is going to make the greater personal investment. Working through this is part of the relationship-building to see how you work together. Everything is not equal; there is always someone who contributes more, contributes less. This takes you to a written agreement between the shareholders. This is where you start spending legal money, so can intimidate those starting out. As a lawyer, he can present agreements that have worked in similar situations, and you need to review to make sure they work. If you need to draft the founder agreement differently, that can cost time (and obviously money). It is a time-consuming process to walk people through what they want.

For example with mesh, five guys with different opinions; their agreement sets it out so that they have to agree on everything when there is a decision. Can make it challenging to make a decision. It does not have to be set out this way; you can set someone as the main decision-maker.

What does 75% ownership of the company mean? Can you fire somebody? Can you fire your co-founder? Etc. Some people will push these decisions off, in guise of looking for financing from third party in which case you may need different agreement. However, what if you decide not to take outside money, if an exit opens up, do you really want to be at a deadlock because you didn’t have a written agreement? Smarter to make sure these things are locked up in advance. It should cover governance and veto rights based on ownership.

No relationship is perfect. Rare that people have set things up considering a founding partner who leaves voluntarily or involuntarily. You try to anticipate these sorts of situations.

“e-Bay clause” – shares are fully transferable; to prevent your co-founders from selling their shares to the competition, clause prevents this outright, or make it subject to right of first refusal.

If you have a diverse ownership and enough of the ownership wants to do something, the minority should not be able to frustrate the transaction. “Drag along; tag along” clause – minority has to sell into the deal. You don’t want the minority to hold the rest ransom. You also want to prevent the majority selling and leaving one behind.

Shotgun clause – with two founders, one can sell to the other to get out of the agreement. Limited time to choose; if you don’t choose, other person gets to choose. Strong incentive to give a fair price. With a start-up there usually is no money, so it is a strange type of clause to have. Worst-case problem solving. Often goes to arbitration if not. Never satisfactory, no one is happy afterward.

If your relationship changes, it may be appropriate to change the agreements. For example, if someone is not pulling his/her weight.

Employees/Contractors

The next thing you have to deal with typically – dealing with “outsiders”. You do have to treat contractors and employees differently, the difference has tax implications. Someone is not a contractor just if you call them a contractor; they are a contractor if they are a contractor. Legal tests have become stricter. If they do not pay their income taxes, CRA will audit you and you will be on the hook. You don’t want them working in your office, using your equipment, following your instructions. You don’t want them coming back a year later looking for overtime pay or not paying their taxes. You need a contract to help protect you in case of an audit. Also, under intellectual property laws the contractor owns the IP created while working with you unless you have a specific contract. Not so with employees.

You are also creating a relationship with this person; how are they going to treat you after they leave? Non-compete and non-solicit clauses.

How do you compensate people? Not likely to work for free. Putting stock option plans in place are expensive – takes time to explain to everyone. Better to start by having simple written agreement with key terms on what you are planning to give them. He has boilerplate language to cover this. You are trying to incent someone with potential ownership, vesting them gradually. If they leave early on they only get what was vested up until that point. Canadians tend to be less aware of equity options, unlike those in the Valley. We are generally more trusting and “relaxed” about these kinds of issues. K

Key question – difficult to determine what size of an option grant someone should get. Fred Wilson and Venture Hacks have some info that work for the Valley, generally work here [in Toronto] as well. Early stages of the company, set aside 10-20% of the company equity for compensation. Have a clear idea of the hiring plan before you hand out equity options – do the research on this. Do not assume if you are a shareholder that you have influence over the company.

The Office

Many people don’t bring the lease to the lawyer; they are all different. If they bring him a 25 page lease to review, he is very specific about what he will do because it takes time to review and can be expensive. Lately he is seeing there are often personal guarantees on the property, it does not matter if you have incorporated. He doesn’t know if you can renegotiate the terms, but you need to read and make sure you are committed to the space before signing.

Developing the Website

The important part is the developer, not the agreement. Your agreement may look nice, but not effective if someone doesn’t deliver e.g. if in another country. Better to have interim deliverables and have someone on your end who understands if these have been delivered.

Terms of Use & Privacy Policy

If you aren’t doing anything “funky”, he has terms that are simple and work. Lots of great samples of this out there. Look for something with the same business model and jurisdiction for it to work. Don’t be an idiot in your terms of use; you could alienate your community.

Exits

What you are hoping to do is sell your business. Due diligence – from the buyer’s perspective – who owns the shares? Do the owners really own the shares? Due diligence on IP. Customer relationships may be reviewed, called, agreements reviewed as well.

Key deal issues: price and payment. True value of the company difficult to predict of the outset, is revealed in performance.