Start-Up and Business Entrepreneurship - Legal Thinking First

The manner in which parties consolidate prior to the enterprise goes out into the world has great effect on the relationship between them further down the road. Arranging the matter at the outset will prevent future headaches, and even unnecessary legal proceedings

22.01.19 | Adv. Yaron Sobol

While the term startup may sound dreamy, novel, groundbreaking and a reality changer, a significant part of the future success of the venture lies in taking the correct legal steps at the outset. Even the most innovative initiative will not take to the skies if it is not firmly anchored by rules and arrangements.

We will attempt to describe a number of legal arrangements that are essential to the existence and survival of a startup enterprise. Typically, quite a few entrepreneurs give up on legal advice before they start, on the assumption that they’ll fill in the gaps at a later stage. In addition, many entrepreneurs, in order to save on costs, consciously decide to relinquish legal advice and make do with a friend or a cousin who has a lawyer’s license, even though they do not have even the faintest clue about the field of entrepreneurship, and particularly when it comes to setting up a startup.

     The start of the journey. The manner in which the parties strike an agreement before the enterprise goes out into the world has great effect on the relationship between them further down the road. Setting the issue in order at the very outset will prevent future headaches, battles and even unnecessary legal proceedings. It is correct to draft a founders’ agreement, a shareholders’ agreement, a partnership agreement –or any document regardless of its name that forms the basis for an agreement between the parties. The distribution of shares, ownership of the enterprise, the division of roles, the repurchase of shares from anyone who leaves, the assigning of intellectual property, decisions requiring a special majority, and signatory rights. Regulation of these issues will enable the establishment of an enterprise in which the rules of the game are clear and understandable. This will ensure each entrepreneur knows his share in the venture, what level of holdings will remain in his hands if he retires before he has been active in the enterprise for several years, whether the intellectual property will belong to the enterprise alone without any third-party rights, etc. Application of all of these will provide the venture’s activity the calm it needs in order to focus on technological and business development.

     Protecting the intellectual property. Intellectual property is the most important asset of the venture and constitutes the foundation for setting the value of the venture and its outputs. The more unique the intellectual property, the higher the value that can be attributed to it and thus to the venture. Intellectual property must be protected from within and without. One of the problems encountered in young people’s ventures is the “stealing” of ideas, technology and know-how from their previous workplaces, or from a friend who told them something and they are implementing it. In this scenario, they are exposing the venture to claims since the product is based on the technology of a third party. Sometimes this can end very badly, with injunctions and monetary claims. This should therefore be considered.

On the other hand, it is important to protect the intellectual property that is developed in the venture: patents, trademarks, designs as well as trade secrets that do not amount to patents. Such defense is intended to prevent third parties from making use of the intellectual property of the venture without obtaining permission.

Intellectual property should be protected on two levels: The better known of them is the registration of intellectual property, i.e., filing patent applications, registration of trademarks and patterns. In this scenario, the decision in which countries an application is to be filed is critical to the venture and in fact carries a considerable financial cost. One should choose the countries in which the applications will be filed, based on the forecasted business model of the venture. In many cases, young entrepreneurs save on filing patent applications (or they do not have the means to do so) and the result is partial protection and unprotected exposure in other countries.

At the second level, the internal one, the venture must ensure its ownership of the intellectual property and its disclosure, if any, under defenses. Employment agreements should be worded to include clauses on the assignment of rights in the intellectual property, including a global compensation component per employee, in order to protect oneself against workers’ claims in respect of their right to developments or compensation for them.

Consulting agreements must include a clause that defines the work as contractor work, whose outputs belong solely to the company, including agreement to assist in the legal realization of these commitments.

     Investors. Entrepreneurs usually seek to recruit investors in order to finance continuation of the venture’s activity and development. The agreement reached with the investors will, over time, determine the internal regime of the company and affect the work capabilities and development of the enterprise. The agreement will lay the foundation for the freedom limits of the entrepreneurs, will determine the budget, the expenses, the wages, and the manner in which decisions are made on issues with financial implications. You should strive to achieve a balance between the interest of the investor, which in its most extreme form is expressed as full control over everything happening in the venture, and between the interest of the entrepreneurs to act to realize their vision under minimum restrictions. Each side has weighty arguments to support his position. One needs to find the balance between the rights of the investor vis-à-vis the aspirations of the entrepreneurs: On the one hand, the entrepreneurs need to recognize that the person who believes in them is not giving them a free hand to do whatever they like with his investment and expects monitoring and control mechanisms to be in place; on the other hand, the investor needs to understand that investment in the enterprise is a matter of venture capital and not the acquisition of ownership and control, and that the protection he receives must protect his financial interests without pledging the venture in his favor.

Thus, legal thinking at the beginning of the road and an understanding of the need to integrate classical legal mechanisms with innovative activity, are the key to minimizing obstacles that are neither technological nor of a business nature and that may impede the success of the project.