Top 10 Legal Pitfalls for Startups September 2019

1. Not forming an entity soon enough

Liability Protection Matters What are you before you form a corporation or LLC? In a partnership, every partner is liable for everything, and every partner can bind everyone else Launching before getting liability protection in place is doing it backwards Even if you are a poor student now, a judgment in Massachusetts lasts for 20 years

2. Choosing the wrong entity

Entity Choices Sole proprietorship Partnerships Corporations LLCs Non-profit and “benefit” entities

Decision Points Consideration LLC “C" Corporation Tax Pass-through entity Entity is taxpayer Losses Losses pass through to owners Losses carry forward, used by corporation Seeking investors? Many investors don’t like pass through characteristics of LLC, unlikely to invest in LLC Investors very comfortable investing in C Corp, likely to require that entity is a Delaware C Corp before they will invest Incentivizing with equity? LLC can issue “profits interests,” which are partnership interests with no initial capital account. Equity incentive compensation is simpler in C Corp.

Consequences of Wrong Choice? Forced conversion down the road Tax event at time of conversion Pass-through income without cash to pay taxes Unnecessary double-taxation

3. Not paying attention to basic tax obligations

Will the Taxman Cometh? Effect of pass-through taxation Employment taxes Withholding – not your money! Employer share Self-employment taxes Timing for employers Timing for individuals

4. Not minimizing annual corporate fees

Don’t Get Caught Up With the Number of Zeroes Annual fees higher in Massachusetts than Delaware, but … Delaware corporate fees can be based on “authorized par value,” which puts premium on minimizing annual taxes using the Delaware formula (minimum = $175) In a start-up, you can always authorize more shares later 20% of 5,000 = 20% of 5,000,000. Don’t be impressed by a big number alone Not an issue with LLCs

5. Equity granting: too much, too soon, too many

When Should You Grant? Watch out for unlicensed brokers and “finders” Don’t issue fully vested shares to anyone (including yourself) Ask: why are they getting equity? Leave a “cushion” Anticipate the “divorce” Be careful about promises regarding ownership share Promising “percentages” Future “dilution” Watch out for unlicensed brokers and “finders”

6. Failing to make an 83(b) election

Why does this Matter? Grant date valuation for restricted stock grants Risk of forfeiture required Alternative is taxation at time of vesting = tax based on appreciated value 30 day deadline for IRS to receive election form

7. Not paying your employees

Paying Employees Minimum wage is now $12.00 (rising to $15) All employees MUST be paid There is no such thing as a volunteer for a for-profit company Equity is not pay You must pay a minimum of bi-monthly Triple damages!

Employee or Independent Contractor? MA law is very strict about who is an IC Employee unless all three conditions are met: The individual is free from control and direction in connection with the performance of the service, both under his contract for the performance of service and in fact; and The service is performed outside the usual course of business of the employer; and, The individual is customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the service performed.

Intern Factors? Extent to which the intern and employer understand that the internship is unpaid Extent to which the internship provides training similar to an educational environment, including clinical and other hands-on training Extent to which the internship is tied to the intern’s formal education program by integrated coursework or academic credit Extent to which the internship accommodates the intern’s academic commitments by corresponding to the academic calendar Extent to which the internship is limited in duration Extent to which the intern’s work complements, rather than displaces, the work of paid employee​ Extent to which the internship is conducted without entitlement to a paid job at the conclusion of the internship

8. Failing to get the IP to the right place

Types of Intellectual Property Copyright Patent Trade Secret Trademark What it Protects Original work of authorship fixed in a tangible medium of expression New, useful, non-obvious invention (composition, method, article of manuf.) Secret and commercially valuable information Words, names and other indicators of the source of goods and services Examples Music, books, movies, software code Device, software, drugs Coke recipe, software algorithm, customer list Apple, Louis Vuitton Duration Author’s life + 70 year Work made for hire 95/120y 20 years from filing date No Filings - Cost to obtain, maintain, and enforce Copyright Office Low $35 - $55 to register USPTO High $8-20k to file, incl. attorney’s fees Highly dependent on nature of TS $225 per class to register Protect against Reverse Engineering Yes Protect against independent invention Require Disclosure

Ensure Company Ownership of IP Ensure the company has clear title to IP Assign to company as soon as reasonably practical Have associated parties sign an NDA & IP Assignment Departed founders who contributed to IP should also sign IP assignment Be careful about: Class work Overbroad outbound license University ownership…

University Rights In general University owns the IP if it is (i) within the scope of university employment or (ii) developed with significant use of university resource Promptly disclose any potentially patentable invention and copyrightable software to technology office University owned IP Managed by technology office; royalties for inventors

9. Overdisclosing your idea (and missing deadlines)

Not Just a Bad Business Move 12 months to file patent application from date of initial public disclosure (publications, sale) 12-month time limit only kicks in if disclosure enables duplication of invention, but be careful Can file a provisional patent application or full patent application Best to file before public disclosure (rest of the world is much more strict than US) Disclosure without NDA also eliminates possibility of trade secret protection

10. Being careless about NDAs

Many Varieties of NDAs No such thing as “standard” form Vary based on the setting Employees & founders Advisors & consultants Potential investors Potential business transactions Departed contributors Just because appropriate for one setting doesn’t mean appropriate for other settings

Pay Attention to NDA Details Who is disclosing/generating information? Unilateral or mutual obligations? How is “Confidential Information” defined? Any exceptions? Purpose of use/grant of license (be careful) Duration of obligations Non-compete and non-solicitation – often inappropriate for students (but protections under new MA law) Residuals Obligation to return

Questions? To meet with the Startup Law Clinic or learn more about its services, visit sites.bu.edu/startuplaw