Legal Landmines

What to Know When Starting Your Start-Up

Daniel Zimmermann

May 5, 2015

Stanford Venture Studio

WilmerHale 2

Categories of Most Common (and costly)

Mistakes

• Founders’ Equity

• Protecting Intellectual Property (IP)

• Employee Compensation

• Capital Raising

• Independent Contractors and Interns

• Choice of Legal Entity

• Working With (Managing) Legal Counsel

WilmerHale 3

Founders’ Equity

• Automatically splitting the “pie” into equal shares

• Promising a set ownership percentage

• Over complicating the capitalization table

• Failing to subject shares to vesting and/or seeking

full acceleration upon termination/change of control

• Missing the filing deadline for 83(b) elections

• Failing to comply with securities laws

• Waiting too long to issue equity to founders

WilmerHale 4

Protecting Intellectual Property

• Assuming that former employers have no rights in

IP created by a founder during his/her employment

• Failing to have founders (or others) assign

ownership rights in IP to the company

• Pre-inception v. on-the-job inventions

• Using third party IP without a license

• Misunderstanding the implications of open source

software

• Failing to adequately protect trade secrets

• Hiring someone who worked for a competitor

without addressing IP issues head on

WilmerHale 5

Employee Compensation

• Failing to adopt an appropriate equity incentive plan

• Tax benefits

• ISO requirements

• Creating stock valuation problems (409A)

• Impact of recent developments on stock price

• (Over)-estimating the discount of CS from PS

• Backdating options (and premature option grants)

• Internal v. third party valuations

• Vesting and acceleration, revisited

• Post-termination acceleration

WilmerHale 6

Capital Raising

• Having a poorly articulated or no go to market

• The importance of an executive summary, elevator pitch

• Highlighting the market, product, competitive advantage

and team

• Misunderstanding financing structures and/or terms

• Taking money from anyone who offers or from

unaccredited investors

• Utilizing a “finder” to secure investments

• Failing to comply with securities regulations

• Rescission liability

• Broker-dealer issues

WilmerHale 7

Independent Contractors and Interns

• Misclassifying employees as independent

contractors

• Income tax obligations (W2 v. 1099)

• 20 factor test (control v. independence)

• Back taxes, penalties and interest

• Classifying anyone you can’t afford to pay as an

“intern”

• School credit

• Back taxes, penalties and interest (yes, it applies here too)

WilmerHale 8

Choice of Legal Entity

• Failing to appropriately limit personal liability

• Selecting a legal entity form that addresses short

term (but not long term) goals

• Misunderstanding or over-emphasizing taxation

issues (single v. double level taxation for start-ups)

• Incorporating in a jurisdiction other than Delaware

• Understanding the difference

• Down the road pitfalls

• Failing to maintain adequate corporate records

WilmerHale 9

Working With (Managing) Legal Counsel

• Hiring a lawyer who has no start-up experience

• Hiring a lawyer who has some start-up experience

• Allowing too many (legal) cooks in the kitchen

(“over-lawyering”)

• Over-complicating the incorporation process

• Failing (or being afraid) to seek advice

• Managing (or mismanaging) expectations and costs

WilmerHale 10

Questions? Contact:

Daniel Zimmermann | WilmerHale

Partner

950 Page Mill Road

Palo Alto, CA 94304 USA

+1 650 858 6034 (t)

drzimmermann2000 (skype)

daniel.zimmermann@wilmerhale.com