So you’ve just started your company, and as with most entrepreneurs, you have very limited money for service providers of any sort.  That said, you have heard in the past that it is always best to get a lawyer involved in the company sooner rather than later, especially if you’re looking to raise capital in the near future.  You’ve decided to bite the bullet and hire a lawyer, but you want to spend wisely. Lawyers can provide a large portfolio of services, but for the entrepreneur on a limited budget here are some suggestions for targeting your legal dollars:

1. STOCK OPTION PLAN.  In order to attract and retain the best executives and key employees, particularly in the technology industry, you will need to be able to offer attractive equity packages.  Potential hires respond to offers of cash for sure, but if that’s in limited supply, giving an equity stake in the future success of the company will make an offer more attractive.  However, if not done properly under an option plan, grants of equity are fraught with pitfalls for the unwary—unintended ambiguities in the grant language, failure to implement vesting, a lack of compliance with securities laws, unintended tax consequences to the company and its employees, and the list goes on and on.  These issues often lead to costly disputes.  At an extreme, they can make a company unfinanceable, for investors will rarely put money into situations where the capitalization of a company is unclear or in dispute. A properly drafted stock option plan is money well spent.

2. FOUNDER ARRANGEMENTS.  Preparing the appropriate arrangements between the company and the founder is an important step and should be done before capital investment is made.  These arrangements typically include the purchase of founder’s equity, assigning intellectual property from the founder to the company, documenting founder loans to the company, and putting in place a founder employment agreement with the company.  Often, founder’s stock is subjected to vesting similar to stock options.  Investors like to see vesting for founder’s stock because this gives the investors comfort that the founders will be around for awhile or at least until their stock is fully vested.  It is also important to put in place legal arrangements amongst multiple founders.  Fact is, it is the rare management team that is 100% the same from inception to exit event.  How will you feel if your 50% partner leaves the company but keeps his stock while you continue to build the company’s success?  Co-founders need to put in place legal arrangements, most typically either through a simple vesting schedule or else through a more detailed buy-sell agreement, setting forth what will happen to the equity of the company in the event the co-founders’ participation in the business changes over time.

3. EMPLOYEE AND INDEPENDENT CONTRACTOR AGREEMENTS. Clarifying in writing the terms of employment and contractor relationships is one of the best ways to ensure your company is protected and avoids disputes and litigation down the road.  Ask your lawyer for a form employee offer letter and a form independent contractor agreement.  Particularly if you are a technology company, you also want a form employee proprietary information and inventions agreement (see intellectual property below).  The forms you use should be geared toward entrepreneurial companies and therefore include appropriate language for making stock option grants and covering other issues unique to emerging growth companies.

4. INTELLECTUAL PROPERTY ARRANGEMENTS.  Any intellectual property created by one or more of the founders should be properly transferred and assigned to the company such that the company now owns that intellectual property.  With respect to employees and contractors, it is important to document terms such as confidentiality and the assignment of intellectual property developed by the employee or contractor while working for the company, including those of any founders that are also employees.  Any future investors or potential buyers will want to have assurance that the intellectual property of the company is in fact owned by the company and not by one of the employees or contractors.  Accordingly, preparing the documents to evidence such terms is one of the most important steps in “getting your ducks in a row.”   Likewise, if you hire software developers or others to help you code, you need appropriate legal arrangements to ensure that the end product will be 100% owned by the company.

5. FINANCING TERM SHEET.  Experienced emerging growth attorneys have seen hundreds if not thousands of financing term sheets.  What likely looks like a foreign language to you is actually standard fare for your lawyer.  Your lawyer can walk you through an Angel or VC term sheet to help you understand where the risks and areas of opportunity for negotiation are.  This is time well invested.  It does take some time for new founders to come up to speed on this stuff, and you are best to begin your education regarding financing terms in advance of negotiations with potential investors.  With a solid foundation of the impact of various terms, and the knowledge of the range of what comprises market, you will be able to negotiate a financing deal that emphasizes the terms that are most important to you and also is reasonable and attractive to investors.

In my next post I’ll talk about the top five worst uses!

As promised in my last post, here’s a brief checklist and some rules of thumb to determine if a patent is right for your business. Before you go through the time and expense of filing a patent application, go through the following checklist and honestly answer the questions.

Question 1:  Is the invention (product or process) different in any way from information that has been available to the public for more than a year (e.g., described in a printed publication, offered for sale, used to produce a product)?

Significance:  “The public” means anyone who does not have a confidential relationship with you.  The information can be in any form, for example a product, a written publication (including for example, a U.S. or foreign patent, a scientific or trade journal, or a trade brochure), a publication on the Internet, or a display at a trade show.  A sale, or offer for sale, of the new product, or of a product of the new process is also “information”.

Question 2:  Does the invention provide us a competitive advantage?

Can it do something not done before?

Can it do it cheaper?

Can it do it better?

Significance:  If the answer is no, it’s not worth filing since a competitor can practice an equally good option.

Question 3:  How large is the potential market?

Significance:  If the market is less than $50,000 per year, then it is possible no one will compete.

Question 4:  How long will the market exist?

Significance:  If the market will not exist two years from now, patent protection may not make sense since it generally takes at least two years to get a patent.

Question 5:  How likely is it that there will be competitors in the market?

Significance:  If there will be no competitors, there is no reason to file.

Question  6:  Can I contractually prevent all customers from doing it themselves or purchasing from a competitor?

Significance:  If the answer is yes, there may be no reason to file.

Question 7:  Is this an invention that can be licensed to third parties?

Significance:  If the answer is yes, then most likely file since royalty rates are generally higher for a patented invention.

Question 8:  Can I protect this as a trade secret?

Would it take considerable effort to reverse engineer the invention?
Will disclosure to the customers be unnecessary for them to use the invention?
Will disclosure to the government be necessary (which may destroy trade secret protection)?
Does anyone already know the invention such as consultants or university researchers (which may destroy trade secret protection)?
Can I protect the invention from ex-associates and partners and ex-spouses?

Significance:  If the answer is yes, trade secret protection may be the way to go.  An option is to file a patent application, and reserve the trade secret vs. patent decision for later.

Question  9:  Will filing a patent application and satisfying the “best mode” requirement require disclosure of valuable trade secrets

Significance:  A “yes” answer may mean no filing.

Question  10:  Can I protect this with a copyright or trademark or trade dress rights?

Significance:  If the answer is yes, there may be a cheaper and easier way to obtain protection than through a patent.  Consult an attorney regarding these options.

Question  11:   Is this invention unobvious compared to what came before it?

How different is the invention from the prior art?
How long have people been trying to solve the problem?
How much effort and time did it take to solve the problem?

Significance:  To actually receive a patent, it is necessary that the invention be unobvious.  However, I recommend that a patent application be filed for any commercial product that is “different”, even if “obviousness” is problematic.  The “patent pending” notation generally slows down competitors enough to more than justify the cost of a patent application.

Question  12:  Has anyone who does not have to assign his or her rights to me contributed to the invention?

Significance:  If third parties will have the right to practice the patented invention, it may not be worth filing.

Question 13:  Can I obtain an enforceable patent? Can I detect if someone is infringing?

Significance:  If the patent is not enforceable, there may be no reason to file.  For example, if the invention is a new process for making a product, but the product is indistinguishable from products made by the old process, it may not be possible to detect infringement.