Every year, founders should invest some time in corporate housekeeping matters. This post highlights some common legal concerns for technology and CPG startups. It’s not exciting stuff, but a basic understanding of these laws can help you work more efficiently with your lawyer. The earlier you address these matters, the cheaper it is to fix any issues that may arise.
Please reach out if you have questions about any of these issues.
Contents:
TAX
Delaware Tax Deadline
The franchise tax Delaware entities is due March 1st, not April 15. If you miss the deadline, they tack on a late fee. Filing on time will save you a few hundred bucks.
Delaware Franchise Tax Calculation
Delaware allows you to calculate your franchise tax using two different methods. First, Delaware sends a tax bill using the default “Authorized Share Method”, which can result in taxes of around $60,000. You can recalculate your tax using the “Assumed Par Value Capital Method,” which will usually reduce the tax down to $600 or so.
S Corporations
If you operate an S Corp, be sure you understand the S Corp requirements. These include:
- 100 or fewer shareholders
- a single class of shares
- distributions should be pro rata among shareholders
- no corporate shareholders, etc.
If you accidentally violate the S Corp requirements, you can lose S Corp status. The IRS will retroactively tax you as a C Corp as of the date of the inadvertent termination of S Corp status. It is possible to reclaim S Corp status after such a mistake, but they involve an expensive IRS “letter ruling” process.
QSBS: First $10M Tax Free
If your company’s stock meets the Qualified Small Business Stock requirements, then the first ten million dollars can be shielded from federal income tax on an exit. This is a huge benefit to both founders and investors. However, there are numerous requirements, including:
- that the company be a corporation (not an LLC taxed as a partnership),
- that you hold the stock for at least 5 years, and
- that your company does not make any significant stock repurchases within certain time periods.
I recommend discussing these rules with your lawyer, and making sure your company is on track to receive these substantial tax benefits. You need to start preparing for your exit at least 5 years in advance.
TRADEMARKS AND INTELLECTUAL PROPERTY
Trademarks
Have you registered the trademark for your brand name and logo? Are you launching any new brands this year? If so, discuss a trademark “clearance search” with your trademark lawyer to confirm your proposed brand names are available. If they are available, you will likely want to file an “intent to use” trademark application to get the process started early.
Are you monitoring the marketplace for any infringing activity? Your trademark lawyer can set up a “trademark watch” for you to track potential infringers. If you tolerate infringers, you may weaken your trademarks, or lose your trademark rights altogether.
International Trademarks
Are you expanding into international markets? I recommend early filing for international trademark protection. Foreign trademark squatters may register your trademark and ransom it back to you at a huge markup (often $60k+). You can save money by securing your own international trademarks before squatters get to them.
Trade Secrets
A trade secret program can be a valuable tool for maintaining intellectual property, but it must be run correctly. At a minimum, all of your employees and contractors must be signing NDAs (or documents likes PIIAs that include equivalent NDA terms).
Patents
Are you developing new technology? Early patent filings are often critical, and you can lose patent rights altogether if you wait too long to file.
EMPLOYEES
Employee Intellectual Property
Have all your employee signed a proprietary information agreement to confirm that any IP they create at work will be owned by the company? Have all your contractors signed appropriate consulting agreements? Intellectual property assignment from all service providers is a critical component of your IP protection strategy and will be scrutinized by investors or acquirors in due diligence reviews.
Employee Misclassification
Do you have any contractors or consultants that might be considered “employees?” Classification of service providers as employees or independent contractors is based on a number of facts and circumstances that often require careful consideration, and there are significant penalties for misclassifying an employee as a mere contractor.
Note that interns must be paid at least minimum wage or receive course credit.
Non-competes Are Prohibited In Some States
Many states limit or prohibit non-compete agreements, such as: California, North Dakota, Oklahoma, D.C., Colorado, Illinois, Maine, Maryland, New Hampshire, Oregon, Rhode Island, Virginia and Washington. If you have employees in these states, your employment agreements should be reviewed to confirm any non-compete language is appropriate and enforceable.
File to “Qualify” In States Where You “Do Business”
If you formed a Delaware corporation, but you have employees and business activities in other states, then you may need to “qualify to do business” in those states. This involves a short filing, and generally involves a small fee ($300-1,000).
How much “business” do you need do in a state before you’re required to file? The threshold varies by state, and is generally poorly defined. It’s worth discussing with your lawyer.
Additional Laws for Growing Companies
As you hire more employees, federal law imposes additional obligations. The table below is only a high-level summary of the laws that kick in as your head count increases. The details should be discussed with legal counsel.
| # | Law | Details |
|---|---|---|
| 15 | ADA | Forbids discrimination against the disabled. (Americans with Disabilities Act). |
| 15 | Title VII | Prohibits discrimination on the basis of race, color, religion, sex, and national origin. (Title VII of the Civil Rights Act of 1964). |
| 15 | PDA | Forbids discrimination on the basis of pregnancy, childbirth, or related medical conditions. (Pregnancy Discrimination Act). |
| 20 | ADEA | Forbids the discrimination against people over 40, and may require you to give such employees additional time to consider their separation agreements. (Age Discrimination in Employment Act). |
| 20 | COBRA | Employees who lose coverage under group health plans must be given a continuation option. |
| 50 | FMLA | Mandates 12 weeks leave in any 12-month period for certain circumstances. (Family and Medical Leave Act). |
| 50 | Affirmative Action | Requires the development of Affirmative Action Plans for employers with $50,000 or more in federal contracts. |
| 100 | Federal WARN | Requires certain notices before mass layoffs. |
EMPLOYEE EQUITY
Vesting
Equity issued to employees is typically subject to vesting schedules (e.g. vesting monthly over 4 years, with a 1 year cliff). If you have key employees who are fully vested, consider making a new equity grant with vesting requirements to incentivize long-term service.
409A Valuation
All employee options must be issued with an exercise price that is no less than “fair market value” as of the date of grant. A “409A Valuation” is commonly used to determine fair market value. The 409A Valuation will no longer be valid after one year, or upon the occurrence of an event material to the value of the corporation. Consider whether your 409A Valuation needs to be refreshed before making new option grants.
TERMS OF SERVICE AND PRIVACY POLICY
Website Terms
Your website should have a TOS and privacy policy that accurately reflects your business practices. If you have not updated these policies recently, they should be reviewed with counsel.
Software EULA
All of your software products should have a written user agreement (e.g., End User License Agreement, Terms of Use, etc.). If your agreements haven’t been updated recently, they should be reviewed.
DMCA Policy
If you operate a website that hosts third-party content, you need a DMCA “notice and takedown” procedure. If someone posts infringing content to your website, the DMCA will protect you from liability, but only if you’re closely following the safe harbor rules.
Data Security Policies
Are your data security policies complaint with Europe’s GDPR and California Consumer Privacy Act (CCPA)? If you deal with health information, are you HIPPA compliant? If you provide services to children under 13, are you COPPA compliant?
California Consumer Privacy Act (CCPA)
Do you either (a) generate more than $25M in annual revenue or (b) process personal information (defined broadly) of 50,000 or more California users? If so, the California Consumer Privacy Act likely applies to you, and imposes substantial rules on how you handle consumer data.
MISCELLANEOUS
Website ADA Compliance
Is your website compliant with the ADA rules? E.g., does it use high contrast colors, captions on videos, appropriate alt text on images, forms that are accessible without a mouse, etc.? Plaintiff’s lawyers file thousands of ADA lawsuits each year against companies whose website fail to comply with these accessibility rules.
Significant Contracts
Do you have any significant contracts that need review? Are any of your contracts set to renew unless you provide advance notice of termination?
Loan Covenants
Have you reviewed your loan covenants and ensured you are in compliance?
Insurance Policies
Do you have appropriate insurance policies? Do your venture capital investment contracts require you to obtain Directors and Officers insurance? Do you have workers’ Comp insurance? Do you need to consider intellectual property litigation insurance?
Board Meetings
Are you holding proper board meetings, and keeping proper minutes? Are all of your equity grants being approved by the board?
Fundraising and Exits
Are you planning to raise capital this year? Are you considering selling your company? Discuss timing and strategy with your lawyer well in advance of any term sheet.
Disputes
Are you aware of any disputes or potential disputes that may escalate into litigation? Discuss these with your litigation counsel as early as possible. A good litigator can help you resolve the dispute before it explodes into litigation, or atl east position your company for the best possible outcome in the event of litigation.
CONCLUSION
A good corporate lawyer will help you keep an eye on all of these issues. Please reach out if you are the founder or CEO of an emerging tech or CPG company, and have questions about any of the above.