4. Making Improper Or Untimely Disclosure Of Confidential Information
Entrepreneurs want to share the ideas behind their ventures, but untimely, disclosures can irrevocably forfeit rights. As one example, the public disclosure of an invention before a patent application is filed can forfeit many potential foreign patent rights, as well as limit the opportunity to seek a U.S. patent. Similarly, disclosure of otherwise confidential information usually means that such information cannot be protected as a trade secret. In general, all important business and technical information should be designated as “confidential,” and all employees should understand that they have a duty to keep such information confidential. In addition, there should be no disclosure of such information outside the company without special consideration and protection, such as the use of non-disclosure agreements. The smart entrepreneur decides what is disclosed, when it is disclosed and to whom, and otherwise ensures that information is not disclosed. Find out what discussions have been had, and with whom, and what those discussions have disclosed.
5. Not Having Proper IP Assignments Or Rights
A famous politician once quipped, “Companies are people, too.” While companies are legal entities that can own property, including IP, they do not usually create it in the first place. And by default, under US law, most rights to the ownership of IP go to the creators of that IP, and such rights must be transferred or assigned to the company. A person may assign rights to IP that has yet to be developed, for example, by signing an employment or “work-for-hire” agreement that includes a blanket IP assignment. Use of such agreements is the best way to ensure that all IP developed by employees, consultants, contractors or advisors to a company is owned by the company. This fundamental issue—the ownership of the company’s IP—is too often addressed carelessly, and that carelessness can create significant legal issues and erosion of investor value at the point in time when the company’s technology becomes commercially viable.
6. Not Incorporating Early
Corporations and limited liability companies are legal entities that can own property, enter into agreements, and have debts and obligations. The creation of a legal entity allows the founders to separate business assets, liabilities and capital from their personal assets, liabilities and capital. In particular, creating an entity insulates the founders’ assets from the debts and liabilities of the business, and can provide important clarity for investors looking to understand the scope of the assets and liabilities in which the investor will be participating. Make sure that the entity in which the investment is being made has been properly incorporated and is truly separate from the founders’ other activities, assets and liabilities.
7. Improper Or Unwise Issuance of Shares
The formation of a legal entity creates the opportunity to compensate founders, employees, investors and others with equity in the entity. Equity that is provided to employees should vest according to some specified period, so employees are incentivized to continue working for the entity and help create value for the equity – theirs, the founders’ and the investors’. Carefully managed companies will take care to ensure that all issuances of equity are approved prior to issuance, correctly documented and comply with applicable securities laws. The basic rule is that all securities that are sold must be registered unless exempted from registration. Failure to comply with both state and federal registration requirements may delay future funding and can give rise to costly rescission rights and regulatory compliance costs. A company that has skipped or “short-handed” these technical requirements in connection with early capital raises has set itself up for costly compliance issues down the road—and for disputes with former employees, advisors, consultants and others arising from badly documented (or undocumented) “promises” of future equity participation.
8. Lack Of Proper Written Agreements
Entrepreneurs are busy people making lots of deals, and many of those are made, at least initially, with a handshake. In reviewing an early-stage company opportunity, be wary of placing reliance on informal arrangements and unwritten “contracts.” Many entrepreneurs may think that they do not need written agreements because they are working with friends and do not want to impose upon those relationships. But, while unwritten agreements may be testaments to friendship or informal understandings, they are unreliable and create legal uncertainty for the start-up and its investors. We advise our early-stage clients that if someone is unwilling to put an agreement in writing and sign it, they either do not have a friend or do not have an agreement. Be skeptical of “handshake” deals and unwritten commitments, and do not hesitate to ask for written documents be put in place before you invest. After all, an entrepreneur needs a reason to get documentation in place, and getting an investment is a great one.