In the business world, taking on a proactive approach is everything.
As an attorney, one of the most difficult and unpleasant tasks I am faced with is sitting across the table from a client with a legal concern that is either too far gone or too expensive to correct. Often compounding the issue is that fact that the problem could have been minimised or avoided should the client have been more proactive.
On the other hand, some of the most gratifying tasks are discussing unexpected windfalls that have occurred thanks to forward-planning.
Short-sightedness is a common issue, particularly with start-ups; I have therefore devised this guide to help businesses avoid legal pitfalls early on.
So what are some of the main issues I see?
The founders failed to structure stock grants
It is common that startup founders grant shares outright or fail to document agreements. In any startup, it’s common that at least one founder will step away from the business early on for a variety of reasons. In this scenario, they will usually retain full ownership of their stock.
There are a number of ‘pains’ that can occur as a result of this scenario:
- Loss of shares
- Loss of productive work time
- Replacing founders is difficult
- Loss of equity
- Loss of investor trust
An easy way to solve this problem is to craft stock grants with built-in vesting rights. A stock grant and vesting schedule should take into account what each founder provides today and will provide in the future; this ensures that if a founder opts to leave, they won’t receive a windfall.
Case Study - Founder Stocks
A serial entrepreneur, Bob started businesses founded on disruptive technology. As an experienced businessman, he knew that he needed help to bring his ideas to fruition; i.e. he needed co-founders.
In the case of one startup, he brought Charlie on board as his CTO. While their relationship started well, once the honeymoon was over they began to disagree on core aspects of the business – such as the operations of the company and the development of the product.
A few months later, Charlie jumped ship; a dream job offer in New York was too good to refuse. The unfortunate part of the story was that Bob and Charlie didn’t have a ‘prenup’; instead, they divided the company from day one. This meant that when Charlie left, he took his company shares with him.
Bob then needed to hire a new CTO. The trouble was, he needed shares to give that CTO. He couldn’t give them Charlie’s, so he had to hand his shares over to secure a new founder. This left Charlie with a windfall.
When founding a company, remember it’s not always smooth sailing; disagreements can and will happen, no matter who your business partner is or how well you know them. Therefore, you should always structure founder stocks based on agreed upon objectives.
In the case of Bob and Charlie, a better ‘prenup’ could have meant that the structuring of stocks better reflected what each initially brought to the table, as well as the expectations regarding long term commitment to the company. Better structuring would have meant that when Charlie left, the company would have retained enough stock to secure a new CTO whilst also compensating Charlie for the value he provided.
Both parties would have been left satisfied – and Bob and Charlie would have found it easier to part ways as friends.
The founders failed to secure a brand
When it comes to starting a business, branding is everything; after all, branding is what differentiates your company from the rest of the competition. It’s what makes you stand out.
Building a brand name and reputation is not only time consuming – it can also be expensive. While many start-ups put in a lot of hard work when it comes to developing their unique brand, many fail to secure trademark protection – thereby risking the brand’s longevity.
There are a number of ‘pains’ that can occur as a result of failing to secure your brand:
- The need to re-brand
- Loss of customer loyalty
- Loss of brand recognition
- Lost sales
- Poor reviews
- Brand confusions
However, there is no need to worry about your brand being stolen – the United States government has this taken care of in the form of trademarks. As a company, you just need to ensure you act on it!
Filing a trademark isn’t free – but it is easy and not all that expensive.
Obtaining a trademark is an easy decision to make; unfortunately some companies fail to make this easy decision.
The risk of not securing your startup’s brand can be explained by Joe’s case.
Case Study - Dealing With Competitors
Joe is a marketing genius and a brilliant entrepreneur. Joe started a company which produced a number of successful brands; in fact, his company made the Internet Fortune 50 list.
Joe’s company was one that operated on high revenue yet low profit; it was a low margin business. Along came the day when Joe had to cut costs – and unfortunately, he chose to cut his entire legal budget. At the same time, he opted to launch a new premium product line.
The product took off, sales skyrocketed and Joe was a happy man.
However, the success was short lived. A year later, a sharp decline in sales and an increase in customer dissatisfaction became apparent. Eventually, Joe realized that a competitor was selling a similar product under very similar branding.
This competitor had positioned low-end competing products – i.e. products that were similar but of a lower quality – under very similar branding at a price far cheaper than Joe’s ‘authentic’ products.
Joe’s customers were buying the competitor’s inferior products – assuming they were his.
Joe came to me for help. Unfortunately, it turned out that the competitor owned their trademark – while Joe of course did not.
Ultimately, Joe was left with two options:
- Buy out the competitor’s brand
In the end, Joe took the second option and all was resolved – at a cost of course. The truth was Joe could have avoided the hassle and cost by simply trademarking his brand when the product was first launched.
The lesson here? If you are planning to launch a product, identify issues and secure ownership of the trademark before beginning any marketing campaigns. Building a brand is hard, but re-branding is harder – so make sure you speak to an attorney and secure your brand from the beginning!
The founders didn’t protect their innovation
Patents come with a number of benefits: they can increase a company’s value, safeguard product space and protect differentiations.
However, acquiring a patent isn’t all that easy – they can have strict filing deadlines, are costly and are generally more effective as part of a portfolio. Due to these complicating factors, many businesses overlook patents or only file for one – believing that a single patent is enough to safeguard their assets.
This can lead to a number of issues, such as:
- Knock-off products
- Lost sales
Patents influence potential purchasers when they are considering the options or costs associated with acquiring or competing with you. Purchasers care about the quality and quantity of a company’s patents – therefore, as a business you should care about them too!
Startups should develop a patent strategy to maximize the quality and quantity of their portfolio – and this strategy should also seek to minimize upfront costs. Strategies will vary between companies, however they will always have one thing in common – they need to be focused on long term potential.
When developing a patent strategy it’s important to tailor it directly to exit events. A well thought out strategy can offer the following benefits:
- Marketable assets
- Increased company value
- Improved protection against competitors
- Access to funding sources
Case Study - Patent Portfolios For The Future
As a young attorney I worked closely with a serial entrepreneur named Sarah – she gave me complete freedom to develop a patent strategy for her startup. Over the course of three and a half years I spent my time refining and implementing a strategy that included a patent portfolio. This portfolio protected the startup’s products whilst also ensuring ownership of a lucrative market segment.
Unfortunately, her company experienced investor issues and closed its doors. Despite this, Sarah continued to personally fund the patent portfolio – which was five to ten years ahead of the industry. After the company closed, we were able to sell the patent portfolio. In essence, this failed startup managed to return a profit to its founder – showing just how important it is to build a patent portfolio with future vision.
If you are in the process of developing a startup, it is well worth talking to a patent attorney regarding portfolio development and the prevention of a loss of patent rights. I recommend creating a portfolio over three to five years that includes roughly five assets.
From structuring stock grants to securing your brand and building a patent portfolio, it’s important to plan for the future – especially if you are a new venture trying to find your way in the world. As an experienced startup attorney, I can provide your business with the guidance required – get in touch today!
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