Startup Law Presentation

The Law Firm of Ekaterina Mouratova, PLLC
Presents
10250 Constellation Blvd., 23 Floor
Los Angeles, CA 90067
222 Broadway, 19 Floor
New York, NY 10038 Tel.: (212) 203-2406
Fax: (212) 279-9743
Email: info@mouratovalawfirm.com
www.mouratovalawfirm.com
http://nystartuplawcenter.com

Defining Success
 Implement legal and financial structures that do not impede your ability to
raise capital in a timely and expedient fashion, grow the business or execute
a sale or IPO process
 Optimize for attracting capital and talent and facilitating liquidity
 Key questions--What is company’s timeline? Capital needs? Plans to issue
equity to employees and other advisors?
 Allow potential investors/acquirers to focus on the merits of the business
and the quality of the team, and not be distracted by background noise

 Most M&A exits of startup companies do not
result from an orchestrated, investment-
banked process, but instead opportunistically
arise.
 The bonanza deals are virtually always
companies that are “bought, not sold”
 Buyers approach, and transactions can
happen fast (sometimes as quickly as a few
weeks)
Being Opportunistic

Choose the right form of business entity - LLC vs. S vs. C-Corp
Make Sure Your House is in Order Formation

Business is a separate legal entity from its owners. It is best suited for single or
multiple-owner company needing limited liability protection and single-level
taxation.
Limited Liability Company

 Liability is limited to the extent of owner’s investment, his/her personal assets
are protected
 Profits and losses may be allocated differently than owners’ contributions upon
agreement between them
 Capital can be raised through the sale of company interest
 The entity does not pay taxes separately from its members. The income,
deductions and credits are applied to the members in portions set forth in an
LLC Agreement and they report it on their personal income tax returns. But the
members are taxed on allocations, not distributions of the profits, meaning they
own taxes even if they decided to reinvest the profits rather than take it for
themselves.
Pros:

 Can be difficult to raise capital – the sale of membership interests in
an LLC can create concerns/challenges for investors (not everybody
wants to became an LLC member). Venture capitalists may have
inner-restriction about investing in LLC or simply do not want to
deal with LLCs.
Cons :

The corporate entity can have an unlimited number of shareholders, thus best
suited for multiple-owner business seeking both limited liability and
established procedures for management and funding.
Corporation

 Limited owner liability for business debts and lawsuits (only
liable in certain situations when owner’s activities are egregious)
 Capital can be raised through the sale of stock rather than
looking for a bank or personal loans
 Lawsuits are brought against corporation rather than the owners
or managers and liabilities are limited by the company’s assets
 Tax deductible fringe benefits, including health insurance and
retirement plans
Corporation
Pros:

 Many administrative formalities in managing the company
(mandatory shareholders and directors meetings, documentation
of every major decision and maintenance of records)
 Expose shareholders to double-taxation – when a corporation
earns income, it pays taxes on the earnings as an entity, and if a
corporation later distributes dividends to the shareholders, they
are taxed again on such dividend income (double taxation may be
mitigated by expenses and losses and by distributing income in
form of compensation, but only to those who perform actual work
for the company)
Cons:
Corporation

Generally it is a closely-held company, which is best suited for smaller business
seeking to avoid double-taxation imposed on a corporate entity, but preserve
limited liability and established procedures for business operations and funding.
S Corporation

 All advantages of a regular corporation, plus
 Only one level of taxation (the company does not pay taxes on
income, only shareholders pay taxes, but they own taxes on business
income even if the profits are not distributed (for example,
reinvested in the business).
S Corporation
Pros:

 May not have more than 100 shareholders and cannot publicly
trade its shares
 Non-resident aliens cannot be shareholders
 Generally, another corporation, an LLC or a partnership cannot
be a shareholder
 Administrative duties can be complex for small owners to set
up, operate and dismantle the company
S Corporation
Cons:

 Delaware, Delaware, Delaware…If in doubt, Delaware is the right
locale for organization.
 Investors insist on Delaware.
 Well-developed and predictable body of law
 a separate Court of Chancery which reviews only corporate claims
 directors and officers of DE corporations are awarded a greater
protection from liability
 Complying with procedural formalities is efficient in DE
Where to incorporate

The owners usually are comprised not only of the founders, people who
contributed financial or intellectual capital, but also frequently of key
management personnel that are identified as being necessary for the success of
the venture.
 Determine the percentages of ownership so that ownership share is aligned
with the value of contribution
 Establish management rights and voting provisions
 What happens if a founder leaves either voluntarily or non-voluntarily?
 Inheritance rights, Buy-back provisions, Valuation and Terms of Payment
 Confidentiality, Non-compete and “Assignment of Invention” Provisions
Founders Issues
Splitting the pie
Who are the owners?

Should Founders Stock be subject to vesting?
When individuals form a new business, they invest ideas, assets, and
labor. Accordingly, many founders believe their stock should be theirs
no matter what happens in the future.
On the other hand, most founders also agree that a cofounder who
leaves the business shortly after it begins should not continue to own a
part of the business that will require substantial future efforts to grow
and be successful. Accordingly, to earn the right to participate in the
future rewards the recipients of stock should continue working for
some period of time.
Founders Stock Vesting

If the founders expect to seek venture capital financing in the future,
they should also recognize that the venture investors will have similar
concerns.
Venture capitalists invest in people as much as in ideas and
technologies.
The typical venture capitalist will spend as much time evaluating the
team as the product and will want to make sure that incentives are in
place to keep the team intact.
It can be a good strategy for founders to impose a reasonable vesting
schedule up front to guarantee certain degree of commitment to
venture capitalists and other team members.

If Founders Stock is subject to vesting
what the vesting terms should be?
Vesting can be
• Time-based
• Performance-based
There are arguments in favor and against each

What is reasonable?
A typical vesting schedule is a four-year vesting with a
one-year cliff. This means that 25% of the shares will vest
one year from the vesting commencement date, with 1/48
of the total shares vesting every month thereafter, until the
shares are completely vested after four years.
The vesting commencement date can be the date of
issuance of the shares, or an earlier date, in order to give
the founder vesting credit for time spent working on the
company prior to incorporation and/or issuance of the
shares.

An individual who receives stock in
connection with the performance of
services is normally taxed at ordinary
income tax rates to the extent that the value
of the stock when received exceeds the
amount paid for the stock.
Tax Treatment of Unvested Stock

If the stock is subject to a substantial risk of
forfeiture, however, the taxable event
(including the measurement of taxable
income) is normally delayed until the risk
of forfeiture lapses.

A substantial risk of forfeiture exists if the
recipient’s right to full enjoyment of the
stock is conditioned upon the future
performance of services.
Therefore, if stock issued to founders is
subject to repurchase by the company upon
the termination of employment, the stock
will be treated as subject to a substantial
risk of forfeiture.

Under these rules, if a founder is issued
stock that will vest over a period of time, he
will recognize taxable income on each
vesting date equal to the difference (if any)
between the fair market value of the stock
on the date it becomes vested and the
purchase price paid.

For example,
$0.05 per share - the value of the stock on the date
of issuance
$1.00 per share – the value of the stock at the end
of the first year
The stockholder recognized ordinary taxable
income at the end of year one.

The income tax will be due even though the stock is still
held by the stockholder and is usually totally illiquid.
Further, on each monthly vesting date occurring thereafter,
the stockholder will recognize additional ordinary taxable
income measured by the then current value of the shares
that become vested minus the amount paid for those
shares.
Moreover, this income will be treated as if it were wages
paid by the company in cash, and (assuming that the
founder is an employee) it will be subject to income and
employment tax withholding from the employee’s cash
salary or other sources.

What is an 83(b) election?

Section 83(b) of the Internal Revenue Code gives an
alternative to recognizing taxable income upon each
vesting date
By timely filing a Section 83(b) election, the stockholder
is electing to pay tax at the time the stock is purchased in
an amount equal to what would be due if the stock were
not subject to vesting. If the founder pays full market
value at the time of the purchase, no tax will be due
because the value of the stock on that date will not exceed
the purchase price.

An 83(b) election must be filed with the Internal
Revenue Service within 30 days (no exception
under any extraordinary circumstances) of the
initial purchase of the shares.
Once this election is made, subsequent vesting of
the stock will not be taxable.

Thus, the filing of a Section 83(b) election both
allows
• a deferral of tax (tax due only when stock is
ultimately sold at a profit); and
• enables all appreciation in the stock’s value to
qualify for capital gains tax treatment instead of
ordinary income

IP Concerns for Businesses
• Protect Investment
- Naming and Branding
- Content
- Innovations
• Avoid Liability
- Third Party IP infringement claims
- Clear agreements with partners
Intellectual Property

• Trademark
• Copyright
• Patent
• Trade Secret
Types of Intellectual Property Protections

is any word, letter, name, slogan, symbol, design, logo, shape, image,
sound, color or combination thereof that is used or intended to be
used in commerce. In short, it is a brand name.
A trademark

Copyright law protects the “original work of authorship fixed in tangible
mediums of expression”.
In order to be protected the work must be;
1) created by the author seeking to register it (created independently);
2) original (not copied from somewhere in whole or in part);
3) creative (not a plain compilation of information);
4) fixed in a tangible mediums of expression (not merely an idea or plan to
create in the future); and
5) non-utilitarian in nature (copyright protects only expression, not function.
Functions are protected by Patent law).
Copyright Law

Literary works
Musical works
Dramatic works
Pantomimes and choreographic works
Pictorial, graphic and sculptural works
Motion pictures and other audiovisual works
Sound recordings
Architectural works
Vessel hulls
Certain software
The works that can be copyrighted include:

Patent is a property right granted to the inventor of a new, useful and
nonobvious process, machine, manufacture, composition of matter or
improvement thereof.
There are three types of patents:
• Utility Patent – new and useful process, machine, article of manufacture or
composition of matter, or any new and useful improvement thereof
• Design Patent – new, original and ornamental design for an article of
manufacture
• Plant Patent – distinct and new variety of plant.
Patent

• Useful
• A sufficiently developed idea (no requirement to have actually made
an invention, but must provide an “enabling” disclosure)
• Novel
• Non-obvious
To obtain a patent the invention must be:

A trade secret – proprietary information that is under an obligation to be kept
secret.
Almost any confidential, not-publicly known information used in the conduct of
one’s business may be protected as a trade secret. For example, a trade secret may
consist of formulas, manufacturing techniques and product specifications,
customer lists and information, information related to merchandising, costs and
pricing, internal company’s practices, and any new business-related ideas.
A trade secret

• Derive economical value from not being generally known or readily
ascertainable
• Be the subject of its owner’s reasonable efforts to keep it confidential
When to Use Non-Disclosure Agreements
• Disclosing a new product to a potential investor
• Giving access to business information to employees and/or partners
• Contractual relationship with third-parties, which may have access to
confidential information (e.g. independent contractors, suppliers, distributors,
etc.)
• Anytime the information you are disclosing, if used by others, would lessen
your competitive advantage
A Trade Secret must:

• Assignment of inventions – all employees, consultants, contractors
• Check agreements with former employers
• Make sure you are not violating smb else’s IP
• If use IP of a third-party, obtain proper licenses
• Confidentiality agreements with all employees, consultants, contractors
• Patents, trademarks, copyright, domain names – make sure filings are in
order
Make Sure Your Company Owns What It Believes It Owns

Know state and federal employment laws concerning working hours and
minimum wage
Know the difference between employees and independent contractors and
properly classify people who work for your business
Employment matters

 Generally, an individual is an employee if the employer
controls the manner of his work and means used to achieve
results. With an independent contractor, an employer may only
control or direct the result of the work and not the way it is
performed. For example, an employee works from the
employer’s space using employer’s technology; an independent
contractor organizes his working conditions himself and
delivers the final product to the employer. The employer does
not control the time, place, and method of independent
contractor’s performance.

 The employer pays commissions or per-job
fee to the contractor rather than hourly fee
as he pays to the employees. The contractor
should be compensated for work completed,
rather than for hours worked. The employer
also does not provide fringe benefits
(medical and life insurance, participation in
the pension plans, etc.) to the contractors.

 The independent contractors usually have some indicia of an independent
business, such as business cards, websites, their own support personnel and
consultants, such as accountants, lawyers, etc.
 The employer cannot restrict the contractor from performing the services to
others during the same time he is working for that employer.
 The contractor must be able to make important business decisions by himself,
e.g. whether to hire assistants, what equipment to use, where to do the job, etc.

What do your job ad and offer letter say?
Make sure every employee is “at will” employee

 Set aside approximately 20% of equity for future employees at
the early stage
 Restricted Stocks vs. Options
 Cannot grant equity without proper documentation
 Make sure Equity Compensation Plan is implemented
 Make sure all grants are in compliance with tax laws
 Subject to vesting
Equity Compensation

Debt vs. Equity
There are two basic choices for financing – debt or equity. Most
startups during their lives do both.
Debt is borrowed money usually secured with collateral.
Equity, on the other hand, is contributed capital in exchange for the
company’s ownership share.
Getting Funded

 Personal Assets - whatever cash resources founders can muster –
savings, home equity loans, credit cards.
 Co-Founders - find others who share the company’s dream, can
work without compensation and provide needed skills & cash
investment.
 Friends & Family - are often easiest to raise capital from, but must
be authentic about the potential loss of 100% of funds given.
 Vendors - sometime start-up vendors are willing trade all or a
portion of their services for equity.
 Strategic Alliance and Joint Ventures – a collaborative
arrangement with an established company that has complementary
needs or objectives.
Sources of Funds

 Angel Investors - wealthy individuals or small angel networks can be approached for
financing. There are also some great sites like AngelList and Gust that have created
networking sites with startups on one side and angel investors on the other.
 Crowd Donations Sites - sites like KickStarter and IndieGoGo have made it easier to
raise capital via donations from a crowd, without giving away any equity in business.
 Venture Debt - similar to bank loans, there are loans from venture debt companies.
 Small Business Grants - sometimes free state and federal grants are available if a
startup is helping to solve a bigger problem (e.g., healthcare, education, energy).
 State and Federal Financing Programs – a variety of loans and subsidies are
available for small businesses from the government.
 State Tax Credits & Programs - be sure to look for any state tax credits that may be
available for startups, to reduce tax bills or offset salaries from new jobs created.

 Make sure you have valid securities law exemptions for all
equity issuances
 Were Federal and Blue Sky filings completed?
 Are your investors accredited?
 Make sure you’ve used good corporate governance when
dealing with related party transactions
Complying with the law

10 most common mistakes startups make

We guide companies through all stages of development
 The idea stage - new and early-stage entrepreneurs get inspired, learn the
basics and best practices of building companies, develop their skills, validate
their ideas with experts, and begin to build their team and product.
 The launch stage - entrepreneurs establish and formalize the company,
develop their product, get feedback from customers, and prepare for the next
step.
 The growth stage - a startup proves their utility, receives recognition, and
scales up. This usually requires funding and other resources to drive growth.
 The exit – a startup merges or get acquired by a bigger company or
conducts IPO
The Startup Ecosystem

To facilitate the startup stages, every ecosystem needs strong
supporters like:
(1)Advisors
(2) Government
(3) Talent

 all checks and balances are in place
 all possible case scenarios are foreseen
 the company has a strong foundation for future
development
 we have taken a leadership position in a community by
establishing our own Startup Law Center where people can
obtain professional advice, share resources, and network
with like-minded individuals
 frequently speaking at startup events, leading or mentoring
various startup programs, and generally "paying-it-
forward".
(1) As trusted advisors we ensure that
supporters like:

The U.S. Government created multiple opportunities for startups to
flourish. Some of them include:
 Strong protection of IP
 Multiple tax benefits for companies at the early stages of development
 Federal and State grants and other funding programs
 Long-term bank and government loans with low interest rates
 Free access to all government resources and benefits
 Predictable, reliable and transparent legal system
 Legal protection of investment and from unfair business practices
 Immigration benefits for business owners and their families
 Prestige of having a U.S.-registered company in the eyes of foreign investors
(2) Government
supporters like:

• U.S. attracts talented professionals from all over the
world.
• Our clients have access to a comprehensive body of
resources and professional network that we
developed during the years of legal practice
• We cooperated with various groups and
organizations to facilitate the opportunities for
partnership or collaboration.
• We established relationship with vetted qualified
professionals who may be needed to bring a
business idea from conception to implementation
(3) Talent
supporters like:
(3) Talent

 Accounting and book-keeping
 Marketing and advertising
 Financial analysis and planning
 Market research and strategy development
 Talent acquisition
 Investor and funding guidance
 Many other business matters
Our referral partners can help with

Lawyers are different. Industry & business focused lawyers vs.
matrimonial, criminal, personal injury and other attorneys.
Hire the lawyer who is the right fit for the task .
Recruit your legal advisors with experience in business, corporate,
securities regulations, and intellectual property.
Make sure your attorney explains your options and expected
costs/benefits up front
How to Choose A Lawyer

 Ask your attorney to prioritize items of the proposed legal work
 Ask how your account will be staffed
 Pay attention to cultural fit
 Ask whether a lawyer has resources you need or will need soon
 Hire the lawyer who has result-oriented and value-generating approach.
Results are the only thing that matters, you do not want surprises down the
road.
How to Choose A Lawyer

QUESTIONS?

222 Broadway, 19 Floor 10250 Constellation Blvd., 23 Floor
New York, NY 10038 Los Angeles, CA 90067
Tel.: (212) 203-2406
Fax: (212) 279-9743
Email: info@mouratovalawfirm.com
www.mouratovalawfirm.com
http://nystartuplawcenter.com

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