We fully agree: Especially early on, legal should be as light touch as possible. It should be targeted to hedge the major risks, so that you’re enabled to invest more time and money in go to market, product, talent, and more.
So, we’re putting together this guide to help you–a Venture Capital-track Software as a Service (SaaS) company–understand the roadmap of some of the essential things to do.
Please note this is generalized and doesn't include things unique to your business (e.g., regulatory, clean-up, unique facts, which may be hard to identify without a lawyer). Of course, if you can afford it, the best legal outcomes are achieved by working with a lawyer! That said, let’s jump in.
If you're a VC-track business, choose the Delaware C Corporation as your operating entity, as opposed to an LLC or sole proprietorship—that's because almost all VCs will expect it, and in fact, can't invest in you as a sole prop. At the same time, there are many other investment limitations to being an LLC.
Most commonly, startups "authorize" 10,000,000 shares, "reserving" 10-15% of that for the Equity Incentive Plan (Aka Option Pool), which you should budget to carry you through your raise.
If you don't start with a C Corp, it's usually changeable, but may carry heftier administrative overhead the longer you postpone the conversion; you will likely have to convert your LLC into a C Corp before your first raise, since LLCs have certain tax and equity grant characteristics that make them less attractive to VCs. The longer your operating history, the costlier it is to transfer contracts, IP, realize any tax consequences, and generally transition your business. A totally vanilla, no operating history conversion could cost $3-5k, and in some cases, it's easier to just dissolve the old LLC and start over!
We personally recommend Clerky over Stripe Atlas because its lifetime pricing offers high-leverage value, and it has a bigger menu of actions you can take post-formation.
Make sure founders buy their stock at fair market valuation! You need to work this out yourself, with the help of an accountant or part-time CFO, but often, barring written term sheets, revenue, goodwill, or other assets, it's just "par value" at the time of incorporation—that's the price per share indicated on your Certificate of Incorporation, usually a fraction of a penny. Your Board should formally consider these things and make any grant of stock at FMV.
If you issue stock at below fair market value, the IRS may take objection and take the position that you received a benefit by buying your stock at a discount, and that you or your startup may owe taxes on the spread between that fair market value and your actual purchase price.
Make sure founders have actually executed a Restricted Stock Purchase Agreement (RSPA) and, if your stock has a vesting schedule, in the vast majority of cases for startups, founders will file their 83(b) elections with the appropriate IRS office! That should happen within 30 days of the Board consent that approves the grant–not 30 days from the RSPA itself.
An 83(b) Election is a personal tax decision that cannot be done or undone after the 30 days from when you purchased your stock! It tells the IRS that, for tax purposes, you want to treat your stock's value as if it has all vested today, even though it vests over time. If you miss this deadline, there are few fixes, and you can expect to spend several thousand dollars in legal fees, plus have to live with a slightly muddier paper-trail in future diligence.
www.file83b.com is a gem! Drop us a line for a promo code.
Make sure you are in compliance with Delaware Annual Taxes each year. Read this article here to better understand your tax obligation, noting that there are multiple ways your tax obligation may be calculated, and you don't necessarily owe an exorbitant fees—often this number can be as low as $400. Talk to an accountant!
Your company may no longer be considered to be in good standing if you fail to make timely payment, or worse, could be subject to additional penalties and fines.
Check out the team at Shay CPA!
For Employees
Your Proprietary Information Invention Assignment Agreement (AKA PIIAA or CIIAA) will ask employees to assign IP, sometimes including previous IP. Those employees just have to disclose any prior inventions they are not assigning to the company; that disclosure lives in the schedule.
If you're Transferring IP from a previous entity, check the Transfer Agreement included in the Cooley Go incorporation documents, which may be appropriate to use as a starting point.
For Consultants
Consultants should still assign their IP to your company! This is particularly true if they are working on anything sensitive. The Cooley Go US Consulting Agreements include standard IP assignment language.
Not sure how to classify your service provider? See Properly Classify Service Providers as Employees or Contractors; Hiring
If you're a VC-track startup that hasn't assigned IP from your service providers to the company, you should do so immediately, and probably talk to a lawyer to make sure that the IP assignment language you are using properly captures work done in the past—it is sometimes not enough for the language just to say so, and may require additional compensation to the assignor in order to make that assignment good!
Failing to do this at all will likely raise eyebrows when your company is being due diligence'd as part of your next raise, and because IP is so important to startups, it is critical to get right! Some deals do get killed because investors don't have comfort around a sensitive piece of IP being rightfully owned by the company.
If you or a new team member was employed by a third party while working on your new company, consider (1) reviewing your employment agreement for any non-compete or non-solicit language, considering whether that language is applicable to your current business, and (2) whether you used company time or resources to develop IP for your new startup, in which case (and in some cases even without such case) your previous employer may have claims to your IP. Seeking a waiver or release may or may not be the strategic choice, depending on how strong of a case they/you have, how litigious they are, and your own risk appetite vs. trying to fly under the radar.
Also, be mindful that interfering with your previous employer's existing business relationships or contracts may create exposure for you personally.
Failing to seek a waiver or release with respect to non-compete can result in your previous employer seeking damages, including, for example, in the amounts of any profits you made, business they lost, or otherwise, if your new business activities fall within the defined scope of that non-compete (noting that in some states, the enforceability of such provisions is more limited); the same analysis applies to non-solicits, and damages may, for example, be composed of cost of replacing solicited employees, or otherwise.
Failing to get a waiver or release with respect to IP that your employer (1) has a claim to or (2) has sufficiently deep pockets and appetite for litigation to try to fight you for, could be very damaging to your new startup when it comes time for investors to diligence your company when preparing to invest in you.
If you're setting up an Equity Incentive Plan, check with Carta who may be able to generate those docs in-platform (including Board and stockholder consent, both of which are required to properly adopt the plan)! You need this Plan in order to be able to issue Options (and will also need a 409A valuation to do the same if you want to have a better shot of avoiding IRS penalties—the 409A valuation is also included in some Carta packages). You'll also want to generate a Form of Option Agreement and Form of Restricted Stock Award as part of this package.
If you don't properly adopt the plan, all your issuances may be deemed invalid, and you may be forced to treat them as having a much higher exercise price / fair market value if you have to re-issue them later. If your plan documents are not well-considered, there also may be a number of gaps in how option grants and equity grants are governed, resulting in unfavorable outcomes when dealing with employees who are vesting stock or options from the Plan.
Usually, at this stage (if not earlier), it starts to make sense to invest a bit in a form that's not generic to SaaS companies, but contemplates risks and needs specific to your business.
Many SaaS companies will develop a Master Subscription Agreement (or something with a similar name) template or Terms of Service for self-service online use–that’s especially true if your customers check out / self-service online (as opposed to through a sales motion, in which case you more likely need a separate MSA). Use that template as much as possible (your customers may try to get you to use their form--that will cost you way more). Once executed, that same MSA can ideally be used to execute any number of Sales Orders without renegotiating the Agreement, facilitating more upsells.
If you have limited budget to update this template, try to focus on optimizing the following provisions, which play some of the highest leverage roles in risk allocation & mitigation: Indemnification, Limitations of Liability, IP assignment and Exclusion of Warranties.
Depending on which template you originally used as your template, you may be sending out agreements that don't cap liability (AVOID THIS), and that make promises about what kinds of risks you will offer your customers, some of which may not be fair or reasonable. If you signed their forms, that is even more likely to be the case. So, if something goes really wrong (and we hope it doesn't), you may be left holding the bag.
If you used a generic consulting agreement for a SaaS company, you may also be inadvertently assigning company IP, rather than just giving out a license to use it.
More immediate business risks are straightforward—the inability to terminate a contract, your customer's get a right to get a refund, or not getting paid on the terms you expected.
If your customers typically aren’t comfortable signing “clickwrap” agreements on self-service (in other words, if they commonly want to negotiate your terms, or expect you to use theirs), you might consider investing in a more thought out form that takes a more middle-of-the-road position, so that you’re not spending lots of time (and money) sifting through asks that are quite reasonable to begin with. Especially because more mature customers tend to have longer sales cycles, shortcutting some of the legal negotiations with more neutral MSAs (which would override your Terms of Service if correctly drafted) may serve to lower transaction costs, shorten sales cycles (at the cost of some legal protections).
There's generally no statutory requirement in most US states for businesses to have a Privacy Policy. Common bodies of law that may be applicable to startups and addressed by a privacy policy include (1) General Data Protection Regulation, or GDPR (very roughly meaning you have European "data subjects", customers, or an effort to solicit clients there) or (2) California Privacy Rights Act (very roughly usually meaning you have $25m+ revenue or collect data on 50,000 households, or derive a lot of your income from selling PII).
That being said, a Privacy Policy can add legitimacy and trust to your stakeholders—just make sure its contents are consistent with your data practices & behaviors.
One of the major ways to mess up a Privacy Policy (especially when it is not required in the first place) is to say you're doing something you're not, or say you're not doing something you are, in which case a user can make a breach of contract claim against you, or even a claim under a statutory right established by a law like GDPR, CCPA or otherwise.
Speaking in big generalities: SAFE rounds are (much) cheaper in terms of transaction costs (AKA legal fees) and time, they defer the often difficult problem of setting a valuation, and defer having to actually give out substantial control promises today (e.g. board seat or control-favorable preferred stock)--rather, they just promise to give these things later.
However, if you do multiple rounds of SAFEs with different terms, it’s possible you and the founding team are bearing disproportionately high dilution. Also, the more you raise on SAFEs, the bigger your next priced equity round will likely have to be.
tl;dr: SAFEs are easier / cheaper / punt on difficult things and make lots of sense if (1) investor is up for it, (2) the raise is smaller, (3) you're not going to give out a bunch of SAFEs with different terms, and (4) you feel like your next priced round will be big enough that new money is assured it'll have enough of the cap table (~20-25% excluding SAFEs). If any of these aren't true, I'd consider a priced round more.
Securities Filing(s)
Any time your company issues securities (of which SAFE instruments should be treated as such), your attorney needs to find relevant "securities exemptions" at both the Federal and State levels (so called Blue Sky laws), which exemptions may require filings at the Federal and/or State level; these are exemptions to the general rule that you must otherwise register your company's securities any time they are sold, which would be an extremely costly and time-intensive process that is not practical for the vast majority of startups absent these exemptions. Note that sometimes these filings must occur prior to the sale of sales.
Consents
Your Board of Directors should authorize the financing in order to (a) comply with statutory law and (b) document that this Financing was properly diligenced by the leadership of the company and considered to be in the company's best interests, among other reasons.
Other
Foreign investors may require special securities filings or language/provisions in their transaction documents.
This is a technical area of the law that is very fact-specific, depending on factors that include the size of your round, the nature of the buyers, the jurisdictions where they live, and more. The more investors lack a pre-existing relationship with you; the larger the size of the round; the more jurisdictions where purchasers live (and depending on the rules of those jurisdictions), failure to make the applicable securities filings may or may be treated as violations of securities law.
Further Research here.
Lots of things can cause the IRS to determine–in the event of an audit or otherwise–that the fair market value (FMV) of your company has increased, which, in turn, has effects on how much you need to issue your stock for, or else owe penalties and/or backtaxes. One such event that’s likely to cause the IRS to consider your company’s FMV to have changed is the receipt of a written term sheet. That’s why it’s important to–as soon as possible, but certainly before receiving a written term sheet, having material changes in revenue and especially profitability, or other valuation factors–conduct a cap table tie out. This is a way of auditing your cap table in fact represents what you think it represents, so that you can avoid having to make very costly fixes after your cap table has changed.
This is not a complete list, but a great place to start. For every grant of stock, or options, confirm there is:
This is a great time to get started with a cap table solution that can help you track what grants you’ve made–you have confidence in your cap table, and the onboarding process can be a forcing function to make sure you captured many of the key points.
An added benefit is that if you intend to issue options, you’ll need a 409A–and many cap table solutions offer a 409A valuation as part of their packages to startups.
Check out a service like Pulley.
Good time for a double check that all your IP is duly assigned to you, that your service providers are developing original works / not infringing on others.
If your name is super important to you, a trademark registration can cost ~$1-1.5k, but you can't necessarily trademark a name--it might not be unique enough, specific enough, or already taken by a similar provider; it should already be in commercial use. You likely don't need to worry about this now, but adding "TM" to your name may help you start accruing benefits.
Note that these benefits only apply to jurisdictions where you've actually applied, like in the US, and for the "classes" of trademarks you apply for—e.g. consumer applications, b2b SaaS services, etc.
If you are a SaaS company, note that software is hard to patent, and may not generate ROI for you at this stage.
Failing to obtain trademark registration doesn't necessarily mean you won't accrue enforcement rights over time—it just gives you a leg up and an easier time convincing a court to help you if it does become an issue in the future.
Many protections afforded by copyright law happen the moment you publish an original work of authorship in a tangible form. You do gain some additional benefits from registration, but it’s atypical for Silicon Valley software companies to pursue an investment in this practice early on, especially because different code can often accomplish the same result without infringing on a copyright.
Like copyrights, patents are less powerful tools for software companies for a variety of reasons, including the fact that it’s often easy to achieve a similar deliverable using a different software. Most software startups will not invest in patent protections for that software early in their tenure, if at all. For life sciences companies, hardware companies, and others operating outside of pure software, this question may differ.
You should be able to defend the Board's position on valuation in case the IRS ever comes knocking. In almost all cases, you want to issue stock (or set the exercise price of options to purchase stock) in an amount equal to that fair market value.
A 409(a) valuation can often provide a safe harbor to challenges, and enable certain kinds of stock option grants as well--more on this shortly.
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