1. Top 10 Legal Pitfalls for Startups
September 2019

2. 1. Not forming an entity soon enough

3. 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

4. 2. Choosing the wrong entity

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

6. 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.

7. 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

8. 3. Not paying attention to basic tax obligations

9. 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

10. 4. Not minimizing annual corporate fees

11. 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

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

13. 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”

14. 6. Failing to make an 83(b) election

15. 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

16. 7. Not paying your employees

17. 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!

18. 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.

19. 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

20. 8. Failing to get the IP to the right place

21. 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

22. 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…

23. 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

24. 9. Overdisclosing your idea (and missing deadlines)

25. 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

26. 10. Being careless about NDAs

27. 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

28. 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

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