Five Top Legal Tips for Startups

Turning a start-up into a profitable business is a monumental task and is often riddled with potential legal landmines

Turning a start-up into a profitable business is a monumental task. The process is also riddled with potential landmines that can derail even the most dedicated entrepreneurs.

As New York and New Jersey business lawyers, we regularly work with entrepreneurs to address the legal obstacles that start-ups face. Below are several tips that we provided throughout last year:

(1) Buy-sell Agreements: Many startups fail to plan for the departure of one or more of its founders. In basic terms, a buy-sell agreement lays out an exit strategy for the owners of a business. In addition to addressing what happens when a partner wants to leave the business, it can also address a myriad of other events, including what happens when a partner retires, dies, becomes incapacitated, or even gets divorced. When a “triggering event” occurs, the agreement gives the company or its remaining owners the right to buy the departing owner’s interest. To help facilitate that process, the agreement details the price and terms of the buyout.

(2) Direct Listings: Startups should understand that an initial public offering (IPO) isn’t the only way to go public. In 2019, Slack Technologies, Inc., a workplace messaging platform, became the latest technology company to go public via a direct listing rather than an IPO. In a direct listing, also known as a direct public offering (DPO), companies sell their shares directly to the public. DPOs can be attractive to startups because they eliminate the use of underwriters and thus are often quicker and cheaper than going public via an IPO. Direct listings also allow early investors to cash in by allowing a company’s employees and investors to convert their ownership into stock, which is then listed on a stock exchange. Once listed publicly, the general public can purchase the shares, and existing investors can cash out at any time without waiting for a “lock-up”’ period to expire, which is required for IPOs. Despite the advantages, DPOs are not without risks. Startups must still satisfy SEC filings requirements and other compliance obligations.

(3) Capital Formation: Startups should explore all their options when seeking to raise capital. The Securities and Exchange Commission (SEC) continues to prioritize capital formation. In June, the SEC announced that it is looking to harmonize the regulatory framework for exempt private offerings with the goal of making it work better for both investors and businesses seeking to raise capital. It is specifically exploring whether there should be any changes to improve, harmonize, or streamline any of the capital raising exemptions, specifically: the private placement exemption and Rule 506 of Regulation D, Regulation A, Rule 504 of Regulation D, the intrastate offering exemptions, and Regulation Crowdfunding. Congress is also contemplating regulatory changes. The House of Representatives has passed bipartisan legislation, known as Crowdfunding Amendments Act (H.R. 4860), that would expand the availability of the securities exemption.

(4) Delaware Incorporation: When consulting with entrepreneurs and start-ups, we often suggest looking outside the states of New York and New Jersey. The most common recommendation is Delaware. Delaware is considered one of the most attractive locations to incorporate a business in the United States due to its corporate-friendly laws and well-established corporate law doctrine. Over the past several decades, there have been more companies incorporated in Delaware than anywhere else. In fact, more than half of public and Fortune 500 companies are incorporated in Delaware. As discussed in greater detail here, forming a Delaware corporation or limited liability corporation (LLC) is a multi-step process. Businesses must also then qualify to do business in New York and/or New Jersey if they wish to operate here.

(5) Sharing Office Space: While commercial leases were once the gold standard, many small businesses are increasingly looking to share office space rather than rent it.  For startups and other small businesses, sharing office space provides the benefits of a fully-functional office at a fraction of the cost. Because there is no multi-year lease term, it also allows for flexibility. While coworking may be innovative and cost-effective, the failure to appreciate its unique features and risks can lead to legal headaches down the road. Startups should carefully evaluate any coworking license, take steps to safeguard intellectual property, and ensure confidential data is secure.

As highlighted above, New Jersey and New York startups have a lot of business and legal issues to consider. For guidance, we encourage consulting with an experienced business attorney who can guide you through the process.

If you have questions, please contact us

If you have any questions or if you would like to discuss the matter further, please contact the Scarinci Hollenbeck attorney with whom you work, at 201-806-3364.