What are essential legal documents for a startup?
Starting a new business can be an exciting yet daunting endeavor. With so many things to think about, it’s easy to overlook some of the key legal foundations every startup needs to have in place.
Proper legal documentation not only protects your interests as a founder but also provides credibility with investors and partners. Having the right agreements and structures from the outset prevents potentially costly issues down the road.
As a startup founder and entrepreneur myself, I’ve learned the hard way how important it is to cover the legal bases early on. Here are the key legal documents I recommend every startup prioritize in their first year.
LLC Operating Agreement
If you are forming your business as a limited liability company (LLC), an operating agreement is essential. This document outlines the ownership structure, establishes roles and responsibilities, and lays out rules for operations.
An operating agreement helps prevent conflicts and confusion among LLC members. It’s wise to work with a business lawyer to customize it to your specific needs. Key sections to define include:
- Ownership percentages: How is ownership divided among members? This determines equity shares.
- Member roles: Will there be a managing member or members with specialized roles? Specify responsibilities.
- Voting procedures: How will key decisions be made if there is disagreement? Set thresholds for different actions.
- Capital contributions: How will members provide funding? Will it be proportional to ownership?
- Profit distribution: How will you divide profits or losses? Based on ownership or active involvement?
- Departure procedures: What happens if a member wants to leave? How can they divest?
Having an operating agreement makes things much smoother if the startup reaches key milestones, brings on new members, or has changes in ownership.
Stock Purchase Agreement
For startups forming as corporations, stock purchase agreements are key. These agreements document the sale and transfer of shares in the company to initial owners and investors.
Stock purchase agreements should specify details like:
- The purchase price per share
- Number of shares being transferred
- Vesting schedule (if applicable)
- Shareholder rights and obligations
- Repurchase rights
It’s wise to work with a lawyer to include clauses about company valuations, vesting schedules, and shareholder protections.
These agreements act as enforceable contracts between the company and shareholders. They provide clarity on stock acquisition terms and prevent misunderstandings.
Founders’ Agreement
For multi-founder startups, a founders’ agreement is highly recommended. This contract amongst the founders outlines equity splits, voting rights, roles and responsibilities, decision-making procedures, and more.
With clear expectations set from the start, founders can prevent disagreements down the line. Important sections of a founders’ agreement include:
- Ownership split: How is equity divided among founders?
- Vesting schedules: Are share distributions over time tied to service milestones?
- Leadership roles: Who fills which C-level and operational roles?
- Decision-making: What areas need unanimous or majority consent?
- Founder departure: What happens if a founder leaves, voluntarily or involuntarily?
By proactively addressing potential sources of conflict, founders establish trust and alignment from day one. This sets up the business for success.
Confidentiality & IP Assignment Agreement
Startups deal with confidential information and intellectual property (IP) from the start, so confidentiality and IP assignment agreements are essential.
These agreements prevent team members and contractors from sharing sensitive information or using your IP for unauthorized purposes. Key sections include:
- Definition of “confidential information”
- Obligations to keep information secret and procedures for sharing
- Clauses for handling IP and rights assignments
- Terms for non-disclosure period after relationship end
- Remedies for breaches
Having team members and partners sign these agreements provide legal protection for your core assets and peace of mind.
Vendor, Contractor, and Employee Agreements
It’s important to use written agreements anytime you engage vendors, contractors, employees, and other service providers.
These agreements memorialize the terms of the relationship, deliverables, compensation, rights, and confidentiality obligations.
For contractors and employees alike, you should have:
- Services provided and performance standards
- Fee/compensation schedule
- Confidentiality and IP clauses
- Non-compete and non-solicitation terms
Consult an attorney to ensure you use the appropriate agreements for your jurisdiction.
The more detail upfront, the less potential for misunderstandings later. These agreements also provide legal recourse if things go south.
Term Sheets for Investors
Pitching to investors? Using a term sheet allows you to summarize proposed investment terms before drafting full agreements.
Term sheets provide an outline of conditions like:
- Amount invested
- Type of shares issued
- Share price and valuation
- Investor rights
- Repayment schedule
Term sheets help gauge investor interest and get agreements drafted more quickly. They keep negotiations focused on key terms before spending time and money on comprehensive contracts.
Customer and Vendor Contracts
Of course, contracts with customers and vendors are essential as you build out products or services. These agreements govern pricing, delivery, terms and conditions, quality control, payments, liability, and more.
Key sections to define clearly in any customer or vendor contract include:
- Definitions: Define all relevant terms used.
- Delivery: Set expectations for timing, shipping, and logistics.
- Quality: Include service levels or acceptance criteria.
- Payment: Set payment amounts, stages, schedules, and processes.
- Ownership and IP: Clarify who owns materials, including IP rights.
- Indemnification: Address liability for breaches or claims.
- Dispute resolution: Define procedures for resolving conflicts, including jurisdiction.
Involving legal counsel ensures you adequately protect your interests and avoid costly errors.
Non-Disclosure Agreements (NDAs)
NDAs ensure outside parties keep valuable information confidential. Require potential partners, contractors, vendors, and employees to sign these.
NDAs should define what is considered confidential information, obligations to keep it secret, limitations on use, and term length. Make sure NDAs have strong IP rights clauses too.
circulating NDAs before engaging with external parties prevents unauthorized disclosures that compromise your core business assets.
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The Takeaway
Structuring a startup without proper legal documentation exposes you to substantial risk. With clear, comprehensive agreements in place from the outset, founders can avoid painful disputes on equity, IP, decision-making authority, departures, investor terms, and more.
Although legal paperwork may not seem glamorous, having the right foundations sets your new business up for success. The relatively small time and expense invested upfront can prevent much costlier issues in the future.
Prioritizing essential legal documents in a startup’s first year helps put all owners and partners on the same page. With core rights and obligations spelled out, it’s easier to build processes and operations tailored for growth and scale.
If you take away only one lesson from my experience, let it be this: Do not neglect the legal formalities. Doing so early on provides immense peace of mind as you transform your vision into reality.
