Jan 23, 2019
DOs and DON’Ts of startup idea testing
As an entrepreneur, you want to focus on building your product, closing deals and scaling your company. Legal is often a distracting and time-consuming challenge for first time founders. To help you navigate the maze, we talked to Christian Meisser, CEO at LEXR, about legal basics for startups. Here are the areas you need to have covered for a sound legal setup of your company:
You can listen to the full interview with Christian here.
In the early stages of your venture, you will likely encounter two types of contracts and you should be aware of what to look out for. For many low-risk day-to-day contracts, you don’t always need a lawyer as long as you apply common sense, read carefully and flag up any points you don’t understand. Lawinsider.com is one of the most comprehensive websites, cataloging over 3m contracts covering all types of business interactions. This can help you check whether a particular contract corresponds to the standard in your industry.
Your standard sales contract is part of your sales process and as such, should be efficient and conducive to getting deals closed while protecting your company from unexpected liabilities. Practically, this means having a standard main contract of 1–2 pages which is simple and transparent enough to be signed on the spot. The main contract should reference to Terms and Conditions for all the legal details. With such a two-document-approach you can ideally exclude the Terms & Conditions from the negotiations. If you don’t know what you should include in your Terms and Conditions, consider looking at one of your established competitors to get an understanding of the scope.
Things you should have covered in your sales contract:
1) The scope of exactly what you owe and how much you will be paid for it. Be very specific here. Even if you feel you have a common understanding with your negotiation partner, you are signing the contract not with him or her personally, but with a company. Your counterpart may be replaced and another person may not see eye to eye with you anymore.
2) Include a liability cap for the damages that you can exclude under applicable law. If your product causes unexpected harm to the client, the liability may break your company’s neck. Therefore, cap the liability at an appropriate value.
Especially in the beginning, when you still haven’t built up all the necessary expertise in-house, you may rely on third parties to help build your product. Similar to when you’re on the sales side, for the buying side you should also make sure to know exactly what you are agreeing to. This includes price, price changes and general conditions. Furthermore, make sure that your company owns all the rights and IP of anything that other businesses or freelancers produce for you.
When setting up employee contracts you should balance between fair employee conditions to attract and retain talent, and clauses that protect your business, during and after the employer-employee relationship.
Consider a stock option plan or phantom stock options as part of your hiring package to incentivize your employees. The decision between the two options should be driven by the tax policies of the Cantons where your company and employees are domiciled as well as the expected value increase of the shares that could eventually be taxed.
Specify the handling of any IP produced by the employee and make sure it is transferred to your company automatically.
Ensure post-contractual confidentiality is part of the contract, so that employees cannot disclose your secrets to competitors. Such clauses are more effective than non-compete clauses, which are usually difficult to enforce due to a lack of specificity.
There are two elements to corporate law for startups: The power structure that determines who takes important decisions with regards to corporations, hiring or new investment, and the money structure that regulates who gets how much money out of the company in case of profit or a potential exit.
Talk about potential scenarios and how to handle them with your co-founders and put them in writing in a shareholder’s agreement to avoid disputes later. Clarify what happens when co-founders want to leave the company, invest less time etc.
Vesting schedules are one important point to this. In general, you want vesting schedules to be as fair as possible, however they shouldn’t be too much administrative effort either. In Switzerland you see a move towards the American model, which is typically 4 years vesting with a one year cliff (after one year you get a fourth of your allocated shares and then on a quarterly basis you’ll vest your additional shares until you have your full stake).
In general, you have to be aware of the attached strings when getting investors on board. If you’ll decide to get investment on board, it’s of vital importance that you do a due diligence on the investors to find out how other startups have experienced the investor — startup relationship and especially if they were “fair game”
When it comes to shareholders, especially be wary of liquidation preference clauses in shareholders agreements. Often they’re set-up in a way that in case of an exit, your investors will receive their payout first, potentially leaving you and your co-founders with little to no money left over.
To get an idea of how a term sheet, an investment agreement, a shareholder’s agreement, articles of association and board regulations looks like, check out free templates, e.g. from Swiss Private Equity & Corporate Finance Association. These can help you get prepared for upcoming negotiations and manage expectations. Be aware however that these templates tend to favor the investor side and might need to be adapted to your startup’s needs.
Most other regulatory matters are very sector specific. If you’re operating in a regulated industry, knowing the law is crucial. As a first step, talk to founders in the same industry or check out what regulatory hurdles competitors had to overcome. Once you have a clear business idea, it is advisable to talk to a lawyer. For businesses in highly regulated industries (e.g. finance, healthcare) it may also be worth having a lawyer in the founding team to avoid skyrocketing legal costs.
Intellectual property is one of the most valuable assets for many companies. Depending on your type of business model, different laws and possibilities to protect it can be applied:
Invest time into evaluating your legal options, ideally already before “the house is burning”. Here are a few of the things to look out for:
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