This post is part of Acuity’s Master Class Series, dedicated to shedding light on financial and other influential industry topics.
Entrepreneurs are known for breaking boundaries and taking risks, but when it comes to startup legal matters, proceeding with caution is the smartest approach. Acuity recently sat down with Brian Gordon, a Partner in our Atlanta office, to discuss the legal side of startup funding.
Q&A Lightning Round With DLA Piper
Q: First off, tell us a bit about DLA Piper and what you offer to local startups.
DLA Piper is a global law firm, helping our clients with legal needs all around the world. Our Atlanta office represents businesses of all types (from private equity and venture capital funds to Fortune 100 companies) throughout the world on regional, national and international matters. DLA has a long history representing emerging technology companies; we love representing these clients as they seek to raise money and need creative legal solutions to grow their business.
Why do startups need to educate themselves about the legal side of funding?
The choices that early stage companies make at the beginning can have drastic effects down the road. Every company is different, and it’s important to get sound legal direction right from the beginning. Think through the key facets of your business and what potential roadblocks you will face in the fundraising process or eventual sale. For example, should your startup operate a C Corp or an LLC? This choice should be strategic as it can have major implications for the future of the business.
Do founders NEED to talk to an attorney when determining their business structure?
In an ideal world, yes. Your business entity will drive a lot of the conversation during the fundraising process. For example, most institutional investors like to invest in C Corps, so if you started out as an LLC, you’ll hit a roadblock when you go to raise money. Switching business structure costs time and money down the line, so why not just start out the right way? Also, it makes the most sense to lock down a team of advisors who understand your expected path and can help you anticipate what will happen if things don’t go as planned. Your CPA can help with this, but they are typically more focused on the immediate consequences of business structure and less on the overall ecosystem of fundraising and M&A. Seek legal advice early whenever possible.
What are some of the biggest legal pitfalls you see when people are setting up their company or raising funds?
I would say people trip up in a two main areas. First is equity raising. An early stage company needs to be extremely careful when managing and tracking their cap table. During these very early stages of a business, entrepreneurs will make big promises to get their big idea moving forward. Unfortunately, they often don’t fully understand the consequences of those promises nor do they have the documentation to back it up.
Second is intellectual property. Early stage entrepreneurs need to make sure that whatever intellectual property is being developed for and by the company is owned by the company. This strategy needs to be fully outlined and documented. Make sure your founders sign their IP to the company and that employees have the appropriate assignment provisions. All too often, a company will go out to raise money only to realize they have no idea whether they own their intellectual property. It’s a painful realization and difficult to fix retroactively.
So those are two key pieces of the puzzle: making sure you know who owns the company and making sure the company owns its assets. For most early stage companies, the key asset is intellectual property.
Any tips for founders looking to manage their cap table?
Managing a cap table and equity compensation takes research, planning and expertise. Most startups will outsource this task. At the end of the day, no matter who is managing it, the entrepreneur needs to have a solid understanding of how their cap table impacts their ownership and dilution. They should also make sure that it’s based on fundamental signed documents. Bottom line – get help. Your future investors and wallet will thank you.
What’s the one thing you wish founders knew before diving into the funding process?
Do your research and have realistic expectations. The biggest disconnect I see is people assuming it will be easy to raise capital – that all it takes is cold calling a few VCs who will be more than willing to put money in at a high valuation. It just doesn’t work that way. Getting investment takes a lot of groundwork. It takes more than hitting a certain revenue number – there has to be a good fit between the investor and the investment.
What do startups do when they are low on cash? What should they prioritize first?
It depends. Ideally, startups should engage legal counsel sooner rather than later. But legal priorities aren’t going to be the same for every company. Some startups will need to get a patent on file, others may need to focus on agreements and rights to the IP they’re commercializing. There’s not a one size fits all approach. It’s a good conversation to have with your legal advisor – what should we prioritize now and what can we put off until we raise money?
Any advice for startups looking to match with a law firm?
Know that, in the end, it all comes down to the relationship. You need to feel confident that whoever you choose will be available to offer sound advice when you’re down in the trenches. Match with a law firm that has the resources you need such as national, global, industry or startup expertise. Make sure they are incredibly transparent about what you’re buying and the associated costs – there should be no surprises.
Any closing words of wisdom, Brian?
Startups – keep detailed records and documents. With tools like Dropbox, DocuSign, and others, there’s really no excuse NOT to. Whether you’re preparing to raise funds or sell your business, making sure your documents are all in one place will make diligence a little easier.