New Model Startup Docs Give Entrepreneurs a Head Start - Do You Still Need a Lawyer?

Startup companies just got new tools to make the formation process a little easier.  With the help of the law firm Wilson Sonsini Goodrich and Rosati (if you are a California startup, you have undoubtedly heard of them), TheFunded.com offered up this week its contribution to the recent and growing trend of publishing early stage documents for startups and emerging companies with publication of the following form documents:

• Bylaws
• Certificate of Incorporation
• Initial Stockholder Consent
• Invention Assignment Agreement
• Restricted Stock Purchase Agreement
• Indemnification Agreement
• Initial Board Consent
• Action by Incorporator
• Plain Preferred Term Sheet

These are the basic documents used by startup companies to get their ventures off the ground.  The Certificate of Incorporation is the only document that is filed publicly with the state, the others govern internal matters within the company.

This is not the first set of legal documents to be released, but most of the other forms have been in the early stage equity investment area.  Wilson Sonsini itself published a term sheet generator for each stage venture investment deals, TechStars published a set of model early stage investment documents earlier this year, and of course, there are also the National Venture Capital Association forms for early stage venture investments that have been out for several years.  In fact, other firms and organizations have released form documents in an effort to make the process of formation early stage financing easier, cheaper, and more efficient.  Wait, did someone accuse lawyers of being inefficient?

So startup lawyers are now expendable?

Don't jump to conclusions too soon.  These documents can give you a sense of what is involved in formation and also provide a baseline for your final agreements.  However, there are still many things here that you should discuss with your attorney.  There is no such thing as a one-size-fits-all set of formation documents.  Each company will have individual needs based on the structure of the organization, the people involved, etc.  For example, you should at least consider the following:

1. These documents assume that your startup is incorporating in Delaware and is located in California.  State laws of formation differ and your state may have different requirements that will have an impact on the documents.
2. These documents are founder-friendly in that they give a lot of control to the entrepreneurs who form the company.  That is great for the entrepreneurs but may become problematic if you have other investors or third parties involved who want to share in that control.
3. You may need to consider an additional agreement for the founders to cover other contingencies that affect their relationship.  Remember that everyone is happy to be in business together at the beginning.  But a little planning up front will help to resolve disputes later.
4. If you sign a restricted stock agreement, you will likely (in almost all circumstance) file an 83(b) election.  This must be filed at the time you sign or within 30 days in order to enjoy the benefit of recognizing tax on the value of the shares of the fair market value (which should be $0.00 at the time of grant because they are given at fair market value).  The alternative is that you will be taxed at each stage of vesting - if the company increases in value, you could be stuck with a tax bill each time without any liquidity (i.e. no cash is paid to you at vesting from the stock).

The bottom line is that forms like these give some more power to entrepreneurs in taking control over the formation process.  And because they come from reputable organizations, you can have a piece of mind that you might not find with other online sources.  But with this new control comes the responsibility to make sure that you understand what you are getting into.   A good startup attorney can walk you through the pros and cons of these documents so that you can feel confident that you are setting up a strong organization.

Will new gTLDs make the Internet too confusing?

Do you remember when the Internet took off in the 1990s and you could find a company simply by adding ".com" to the name and  - voila! - there was the Web site.  That worked well until all of the common names or phrases were taken because every business, organization, charity, or individual was lumped together in the same place.  Then came ".org" and ".biz" and other extensions, each of which is called a "generic top level domain" (or gTLD), to try to bring some order to the Internet universe.  You had to separately register you name on each of those with ".info" and ".net" and then link them together with a redirect.  Ah, how simple the world was back then. Indeed, while most people do not think much past the basics "open" gTLDs that we have used for the past 10 years, ICANN has rolled out the likes of ".mobi" for mobile devices, ".aero" for the aerospace industry, ".travel" for the travel industry, ".jobs" for companies to post openings, and several others.

Now, the Internet Corporation for Assigned Names and Numbers (ICANN), the group that is in charge of controlling how Internet addresses are handled, is pushing through with a new plan to allow literally hundreds of new top level domains starting early next year.  This would allow for some more specific "community" gTLDs like ".boston" or ".sports" or even individualized company-specific names like ".redsox" or ".dunkindonuts".  Since the naming convention will any string of between 3 and 63 characters, which will now include characters from other languages, there could be millions of possibilities.

What does this mean for trademark owners who have been diligently protecting their name through the various iterations of gTLDs that have come out over the past decade?  It is hard to tell at this point.  There will be some protections for trademark owners, but this may mark the end of the now commonplace occurrence of business owners buying their name in each domain - that just might not be possible anymore.  That is why many companies were critical of the new plan when it was announced last year.

There certainly will be more to come on this in the next several months.  Trademark owners in particular will want to investigate whether a company-specific gTLD makes sense for their business, and I am sure that multinational corporations like IBM and Coca Cola will shell out the $185,000 fee currently proposed for new applications.  There is clearly a need to clean up the conventions of finding information on the Web.  But I would expect that ".com" addresses will continue to be required minimums, particularly for small businesses, while there will be more experimentation with the new names for some time to come.

Where should you incorporate your business?

I was involved in a discussion today with an entrepreneur who was planning to incorporate his business but was wondering where to do it. He is located in California and was asking whether he should stay there or incorporate somewhere like Delaware or Nevada. I have written before about the whether or not you want to incorporate, but the location of your incorporation is another discussion you should have with your attorney. You can choose to incorporate your business in any state, though you will typically want to file in your home state (the state where your operations are located) unless you have a compelling reason to choose elsewhere. Filing in a different state does not excuse you from the filing requirements and corporate taxes of your home state. If you are located in California, you are going to have to pay California taxes and fees either as a domestic California corporation or as a "foreign corporation", which is a corporation filed in another state.  In addition, you will likely have to pay for a registered agent in the state you choose if you do not have an office there.  So choosing another state because it has lower fees doesn't necessarily work.

There are many companies that choose to incorporate in Delaware even though almost none of them are actually based there. In fact, approximately 60% of the Forture 500 companies are incorporated in Delaware. There are two main reasons for this: (1) the Delaware corporate laws are generally favorable to management, and (2) Delaware has created a special Court of Chancery whose jurisdiction is to hear nothing but business law cases. See, in other states, your business case could be heard by the same judge who just heard a criminal matter, or a domestic dispute, or an environmental action. The Delaware Court of Chancery's focus on corporate law provides a certain amount of predictability and consistency that you may or may not find in other states.  However, many large and small companies will choose for a variety of reasons to incorporate in their home state (for example, even large tech companies such as Apple Inc. and Microsoft Corporation are incorporated in California and Washington respectively).

Nevada is also mentioned on occasion, primarily because it has liberal rules with respect to privacy, very pro-business laws, and a beneficial tax policy (read: no corporate, franchise, or income taxes). It has also developed a court similar to Delaware's, but because it has not been around nearly as much, it has much less established case law.  New York is a state that is often used as the governing state law in commercial transactions, but getting through the incorporation process there can be onerous.  And some states have laws that you might prefer to do without.  California, for example, has a very strict policy of not enforcing non-competition agreements other than in connection with the sale of a business.

Again, you should consult with an attorney who can help you sort through these issues.  I often have this discussion wtih new clients as part of a free initial consultation, so the cost should not get in your way.   But you need to have this conversation to prevent making mistakes that will cost you much more in the long run.  The bottom line is that unless you find factors that outweigh any deficiencies of your own state's laws, you will generally be better served in your home state.