Each week I meet with prospective clients that are excited to be launching a new startup or video game studio. Regardless of the differences between these clients, I inevitably end up asking two important questions at the start of every meeting:
1. Have you incorporated?
Many clients incorporate without legal counsel, which I have no problem with. However, by incorporating without a lawyer, prospective clients are often left with a few problems that I am attempting to unearth and that I know will need to be remedied:
A. The company’s paperwork is incomplete. While a company exists once the filings are made with the state/province/federal government (if a federal, Canadian company), there are a number of resolutions, registers, receipts and other documentation that a company requires in order to have a complete minute book. The preparation of the foregoing is the bulk of a lawyer’s work incorporating a company and will need to be prepared, especially if the company aims to raise capital as this documentation will be requested as part of standard due diligence.
B. Too few shares were issued. If you incorporated a company with 1, 10 or 100 shares, too few shares were issued and should be split or additional shares issued. This avoids fractional shareholding in the future (imagine offering someone .25% and 10 shares are issued to date) and also makes equity offers to prospective employees more appealing (10,000 shares appear more attractive than 1 share, even if the same percentage ownership results).
C. Too many share classes created or the wrong share classes created. I always ask clients their reasons for a particular share class as both client and lawyer should understand the reasons behind the company’s structure. Since most startups are incorporated with a single, common, share class, I push prospective clients to explain and even justify other classes. Additionally, if a preferred share class exists, what are the rights and restrictions associated with this class? Inevitably, no preferred rights and restrictions were specified,requiring the creation of these rights or restrictions or, more likely, deleting the preferred share class.
2. Have you Transferred IP to the Company?
Clients mistakenly assume that the company they incorporate automatically owns the intellectual property they create. While someone may be a shareholder (even the sole shareholder) or a director, this does not automatically transfer ownership of intellectual property created by such person(s) to the company. Indeed, without a contractor, employment or assignment agreement in place, each founder remains the owner of the intellectual property they create. As a result, the company may not own a core asset and cannot be in a position to license that asset to third parties. Additionally, by asking this question I am often told about contractors who created intellectual property for a founder or the company without an agreement in place, which will also need to be corrected.
Based on these two questions, I am often able to obtain a full picture of a company and its history and put in place the key documents required to address any issues unearthed. If you are embarking on a new venture be sure to keep these two questions in mind – doing so may prevent future legal headaches (and fees). Or, you could read my suggestions on corporate structure and IP assignments here and here.