Five Contracts That Every Startup Should Have From the Beginning and Why

Originally published by Leiza Dolghih.

If you have a winning idea about a product or a service, and you intend to share this idea with others in order to build a business, you must have legal agreements that prevent those persons from taking your idea and leaving you in the dust.  It is really that simple.

Without legal agreements, anyone who learns about the product or service your startup is building, can take it and make it their own.  Remember Winklewoss – Zuckerberg Dispute over the legal rights to Facebook? In that case, both parties had the funds to battle it out in court.  However, most of the startups do not have the luxury of unlimited litigation funds to resolve disputes over the ownership of a product or an idea, especially in the early stages of the business.

So, what agreements must a startup have and how do they help protect the budding company’s business?

1. Operating Agreement – If you have several owners or co-founders of the company, an operating agreement (for LLCs) or a similar agreement (for corporations), is a must.  It records each owner’s equity contribution and the percent of ownership, explains the mechanism for resolving disputes between the owners, specifies how the company will make major decisions if there is a disagreement between the owners, clarify how an owner can exit the company, and limit the owners’ ability to sell or transfer their interest in the company to third parties.  In short, this is THE document that will govern any disputes that may arise between the owners.  Without the agreement, if the owners disagree about what direction the company should take, or whether to obtain additional investor funds, take out another loan, or hire more employees, the owners often end up in a stalemate or a lawsuit.
2. Employment / Independent Contractor Agreements – Every individual who is hired by the start up to do anything related to the startup’s business should have an employment or an independent contractor agreement that clearly states what they will be doing for the company and how they will be compensated.  Without such agreements, the startup can easily be dragged into a lawsuit by a former worker claiming they were not paid what they were promised or that they now own a portion of the company because they put in “sweat equity” into building the business. Without such written agreements, the company exposes itself to all kind of claims by former employees and contractors.
3. Intellectual Property Assignment Agreements – Every individual hired by the startup should sign an agreement assigning the intellectual property that they create for the startup to that company.  This is especially important with the independent contractors, who work for many different companies at the same time.  Without such an assignment, any of the individuals who have contributed to the creation of e.g., software code or marketing materials, can later claim that the product belongs to them, not the company.
4. Confidentiality Agreements – No startup, ever, should reveal their business ideas or trade secrets, which may include customer lists, software code, marketing strategies, or any other information that gives them a competitive advantage, to anyone without a confidentiality agreement.  This includes employees, investors, potential investors, vendors, board members, suppliers and manufacturers, and anyone else.  Such agreements do not prevent idea theft, but they act as a major deterrent and allow the company to enforce its rights in court and seek compensation (or an injunction) if a theft has occurred. 
5. Non-Competition / Non-Solicitation Agreements – Many startups dislike these agreements and some employees or contractors outright refuse to sign them.  These contracts, however, have immense value for the startups, as they provide an easy way to prevent former employees or contractors from taking the company’s confidential information to a competitor or opening a competing business using the startup’s proprietary information.  These agreements, when they are reasonable, can be implemented in a way that is fair to the employees but also serves to protect the company.

BOTTOM LINE:  Clear legal agreements help minimize the chances of litigation, which can quickly exhaust the company’s monetary resources and distract it from what really matters – building a business.  These agreements also help attract investors, who are more likely to invest in a company if they see that the company has taken the right steps to protect its intellectual property. 

Leiza Dolghih is a partner at Lewis Brisbois Bisgaard & Smith LLP in Dallas, Texas and a Co-Chair of the firm’s Trade Secrets and Non-Compete Disputes national practice.  Her practice includes commercial, intellectual property and employment litigation.  You can contact her directly at Leiza.Dolghih@LewisBrisbois.com  or (214) 722-7108.

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