Avoiding common legal landmines for your climate startup
When you’re eager to get up and running, it can be tempting to rush through the somewhat complicated legal aspects of starting a business, especially when so much of it can be easily done online. But if you don’t read the small print and make sure you’re building your business on a solid foundation, you could run into major issues down the line.
Chintan Panchal is a founding partner at RPCK, a law firm serving social enterprises, including startups and the impact investors who often partner with them. We sat down with him to discuss the costly mistakes founders tend to make, and how you can stay on the right side of the law.
Frequent mistakes - and how to steer clear of them
1. Choosing the wrong structure
Forming your business is very straightforward - you can either handle it alone, or use a service like LegalZoom or Clerky. It’s tempting to just pull something off the shelf so you can get started, but if you don’t choose the right structure, it can come back to bite you.
For instance, if you’re planning on raising venture capital, you likely don’t want to form an LLC - generally speaking, venture funds find it more complicated to invest in LLCs, and it’s the same with S-Corps. And if you're planning on building a cash-flowing business, you may not want to form a C-Corp, because of the “double taxation” that comes with this kind of entity.
Meanwhile, if you believe you're a high growth business, you should be aware of Qualified Small Business Stock (QSBS). Obtaining and maintaining this status can give both you and your investors very favorable tax treatment on an exit, potentially doubling the cash in your pocket. But in order to qualify, you’ll need to have been set up correctly from day one, and have operated in compliance with specific tax rules as you’ve built your business.
To avoid the trap of picking the wrong structure, either put in some research elbow grease or get advice. This could be from a lawyer - though it doesn’t have to be an expensive one - or you can call upon your networks to get guidance from founders who’ve been down this road before. The key is ensuring that the sources for your information are sound, and that you’re asking the right questions.
2. Jumping into a partnership too soon
Business partnerships are easy to get into, and a hundred times harder to get out of. If you enter a partnership prematurely, without taking the time to learn whether you’re a good match, it can result in an ugly breakup down the line. These disputes are often very difficult to untangle, and can have exorbitant legal costs attached.
So if you find someone you want to work with, often the best advice is to start small. Do a couple of projects together or have a consulting agreement first - essentially, do the business analogue to casual dating before you rush into a marriage. You might be sharing half of your company with someone, so you want to be as confident as you can in the assumption that you have a shared vision, that your capabilities complement one another, and that you can resolve issues (that will inevitably arise) in a constructive manner. Draw up a partnership agreement - this can be expensive, and might seem tedious when you’re working at an entrepreneur’s rapid pace, but many who don’t end up regretting having skipped it. The process of building a partnership agreement will document the understanding you had going in (details can get hazy years into the future without something to look back on), is a great way to raise and think through partnership dynamics together (especially ones you haven’t focused on yet), and is a great way to gain legal certainty of your own rights and responsibilities in the business.
3. Falling for the ease of internet contracts
Raising equity is a legally distinct type of transaction - a securities transaction - and to be in compliance with the law, you need to understand what that means and what it requires of you. But because it’s so easy to pull documentation off the internet, many founders believe they can just pay for it first, and worry about it later.
In a nutshell, all securities transactions in the US need to be registered with the SEC, or fall under a handful of clearly laid out, well-defined exemptions to this rule. Even if you’re exempt, there’s still necessary documentation that the SEC requires. It may not be complex or expensive to comply, but fixing (or dealing with the consequences of) prior mistakes or failures to comply can become quite costly and distracting. .
4. Paying for introductions
A lot of people out there will happily charge you for introductions to investors, and according to the law, most instances of this kind of activity would be considered broker-dealer transactions - meaning the introducer is acting as a “broker” when they are paid for an introduction that results in an investment transaction. Beware, however, because if they don’t have the proper registrations and licenses and you raise capital based on that introduction, you may have - perhaps unwittingly - entered into an unregistered broker transaction.
This can have significant negative consequences for your business. In an unregistered broker transaction, one of the investor’s potential remedies is to ask to unwind the deal, meaning you’ll have to repay their investment. If you’ve already spent or invested the money, they can take you to court, which in many instances has ended in significant damage - even bankruptcy - for your company.
Don’t get caught in a jam - be aware of what you’re getting into. If anyone approaches you offering to make introductions, or to help you raise capital in exchange for a fee, don’t take them up on it before doing your homework first. They might claim to be a registered broker-dealer - check resources like FINRA’s BrokerCheck (https://brokercheck.finra.org/) to be sure. But remember, your fellow founders will often introduce you to VCs for free.
5. Not recognizing the value you create
In the course of growing your business, you’ll create assets (both tangible and intangible), so you need to understand the tax and regulatory implications of doing so. For instance, say you need to change your business’s structure in order to raise capital - these assets will mean your balance sheet is likely more complex, making the process more complex as well.
You’ll also need to take steps to protect the value you’ve created - if you’re a multinational business, you’ll need to think about the countries you operate in and what that means for your assets like intellectual property, as US patent, copyright and trademark laws don’t necessarily or automatically extend to other jurisdictions. These laws can be complex, so you can either do the research yourself and hope you get it right, or speak to a lawyer whose job it is to know this stuff.
6. Choosing the wrong lawyer
If you hire the wrong lawyer, you could end up following bad advice, and creating a lot of operational headache and cost for your company. A few tips for finding the right advisor: look for someone who has deep experience supporting your specific kind of business, knows the terrain you're operating in, and cares about getting you where you want to go.
Many people rely on brands to address the complexity and difficulty of finding the right fit - and brands do mean something. But it’s just as important - if not more so - to find the right person, who will be working with you. Remember, when you’re hiring a firm - you’re not getting hundreds of folks working on your matter, and you might not have found the right person from withing the hundreds of folks who may work there. Or the right solo/small firm among the hundreds of options out there. Look for someone who truly knows the ins and outs of your specific field, and is aligned with your mission and vision.
Choosing a lawyer is also a question of having the right firepower at the right time. There might be moments that call for a slick Wall Street marquee firm, others when you need someone with specific government experience, and times when you’ll need a smart, corporate generalist with a broad toolkit like a Swiss Army knife.
Finally, make sure you also like your lawyer as a person and enjoy working with them - after all, you’re going to be in the trenches with them. Referrals from someone you know will go a long way.
Chintan is the founder of RPCK, a mission driven law firm, which aims to create positive impact in the world by both propelling visionary founders and investors forward, and by helping build the community and structures that support them. Chintan is an entrepreneur himself, having founded RPCK nearly 14 years ago. He is also an active impact investor, and teaches innovative impact finance at Oxford Univerty’s Said Business School.
The information provided in this Insight does not, and is not intended to, constitute legal advice; instead, all information, content, and materials are for general informational purposes only.