In starting a legal technology company, clearly you’ve invested in the improvement of others’ lives, and the reformation of the attorney-client relationship. And, those are your primary concerns.
Nah, I’m just kidding. You want to gets paid, son!
In the majority of situations, you’re not launching a legal technology company by yourself, and so you’re seeking partners — of all stripes. But, your most serious partner is your cofounder, or cofounders — those initial team members with whom you will share a significant financial interest in your new organization. Because there can be no Simon without a Garfunkel . . . Wait, bad example.
The wisest distribution of cofounders is one in which individuals have specific skill sets. As addressed last time, the CEO would manage the business, the CTO would manage the product development, the COO or CMO might be in charge of growth, etc. But, the reason any of these people are joining a startup is NOT because it is a delightful journey paved with steady paychecks and Turkish Delight. No, no: they want to gets paid, too. By nature, this is a high risk, high reward enterprise. Getting in on the ground floor means you stand to hit it BIG, IF your company is successful. So, it becomes vitally important for you to establish the protection of your financial rights at the outset of your relationship to your new company, because if you don’t, you stand to lose BIG, IF your company is successful. Neither is this just a personal protective mechanism: potential investors will not view you as serious about your work (and thus unworthy of investment) if you haven’t created a formal partnership arrangement with your cofounder(s). Clarity reduces risk; and, investors, while quintessentially risk takers, are in the business of taking calculated risks — at least, those investors who are successful operate that way.
If you’re expecting your legal technology company to succeed widely, your financial interest in the company as a cofounder will probably be defined by a stockholder’s agreement. Even lawyers can refer to this document by different names, but it is essentially a stock grant to you as cofounder (co-owner, essentially). In a very basic sense, it’s an allocation of interest. And, not surprisingly, the first hurdle you will run into with your cofounder(s) is trying to determine who deserves what percentage. This is a difficult thing to figure, of course, because it’s almost entirely based on projection; and, issues of control often come to the forefront at this stage. But, once you and your fellow cofounders can agree on numbers, that’s really the major hurdle to overcome.
After you settle the shares out, it’s time to start with the boilerplate language that these sorts of contracts have, and then build out clauses that work for the individuals attached. In a stockholder’s agreement, there are definitions, as there are in every other contract, and those may become a battleground in some cases. Other issues to be determined include: stock-related rights (like voting rights), potential forfeiture clauses, positioning in the board of directors (other corporate roles are defined outside of the contract), the distribution of rights upon the death or disability of a principle and methods for dispute resolution. Much of this is standard operating procedure for contracts, just applied in the context of the stockholder’s agreement. Relevant issues not required to be addressed within the contract could be clarified by a side letter. The stock itself will often vest over time, at settled percentages, with acceleration clauses in place for a corporate sale, i.e. — if the company is sold during the vesting period, the sale will trigger a full vesting.
If you have an interest in corporate stock at this early stage, it’s important to file an 83(b) election with the IRS, in order to receive favorable capital gains treatment. In other words, you want the value of your stock to be determined at the point at which the stockholder’s agreement is signed, not later, when the shares may be far more valuable. If you don’t file an 83(b) election, and your company is successful quickly, you’re going to be paying a metric shit ton in taxes. You’ll have 30 days to file the election; so act fast. You should also write a check and pay for your shares, even if the total value of the stock is something like 50 cents. It’s never too early to establish an audit trail.
Because startups are about pace and acceleration, things change early and often. And, the nature of your agreements with the company and your cofounders will change over time, especially as you pick up investment, and financial interests become more fractured. But, it is important to lock in your basic rights sooner than later. And, even if you are a lawyer — as many legal startup founders are — you should still hire an attorney to draft and review your stockholder’s agreement for you. There are multiple traps for the unwary, and having an expert on your side is essential.
Jared D. Correia, Esq. is the CEO of Red Cave Law Firm Consulting, which provides business management consulting services to law firms and bar associations. Red Cave also advises startup companies and existing companies wishing to reach the legal vertical. Jared is a recognized subject matter expert on law firm management. He is a regular speaker for local, state and national bar associations and lawyers’ organizations and consistently writes for national legal publications, including this column for Above the Law. He prefers James Taylor and was in noticeably better shape before his kids were born.
