Dan Martell - 5 Major Startup Legal Issues And How To Avoid Them

00:00:00.000 Hey there.

00:00:00.500 Dan Martell here, serial entrepreneur, investor,

00:00:02.400 and creator of SAS Academy.

00:00:04.160 And in this video, I'm wearing my legal shirt.

00:00:07.120 But I'm going to teach you how to avoid the five major startup

00:00:11.080 legal issues that I see come up over and over.

00:00:13.800 And be sure to stay to the end where

00:00:15.280 I tell you how to get access to my Fundraising Like a Pro.

00:00:17.920 If you've got legal issues, or you're thinking you may,

00:00:20.320 you're probably going to raise some venture capital

00:00:22.080 to eventually grow your business.

00:00:23.360 I'm going to share with you how the three phases of fundraising

00:00:27.000 work with you at the end.

00:00:30.000 So, I do not play a lawyer on TV or the internets.

00:00:44.680 This information is provided for informational purpose only.

00:00:48.600 It is not legal advice.

00:00:49.520 If you need some legal advice, I would highly recommend you reach

00:00:53.060 out to an attorney.

00:00:54.840 That being said, I have built five companies myself,

00:00:57.800 raised venture capital for the last two,

00:00:59.640 helped hundreds of entrepreneurs raise hundreds of million

00:01:02.060 dollars in funding and have been involved

00:01:03.740 in over 100 plus financings where I reviewed docs

00:01:07.820 and signed contracts, et cetera.

00:01:09.740 So I've seen all the challenges from like the ghost founder

00:01:12.800 running around with all this equity

00:01:14.160 that nobody really understands why they have,

00:01:16.340 to legal issues, being sued, co-founder infighting,

00:01:20.540 you name it, I've seen it.

00:01:22.460 And what I want to share with you today

00:01:23.560 are the five top reasons that founders get in trouble

00:01:27.300 how to just overcome them so they're not an issue for you

00:01:30.300 and your startup.

00:01:31.300 Number one, wrong entity.

00:01:33.380 I'm just going to throw this out.

00:01:34.480 I am, again, not a lawyer.

00:01:35.780 I'm Canadian on top of all that.

00:01:37.820 And we don't have LLCs in Canada.

00:01:40.540 We just do everything from my understanding as corporations.

00:01:43.480 So if you're building a company that's going to give equity

00:01:47.020 to other investors or teammates, et cetera,

00:01:50.260 then just set it up as a corporation in Delaware.

00:01:53.220 Don't mess with it.

00:01:54.200 It's super simple.

00:01:55.160 There's two documents that they give you.

00:01:56.700 Most founders don't even deal with the second one.

00:01:58.740 Again, I'm not getting into the legal construct

00:02:00.780 of how to do it, but I'm just saying

00:02:02.140 if you want to do it right, start off vanilla,

00:02:05.580 Delaware Corporation, make it a corporation.

00:02:08.140 I don't care what people are saying about LLCs

00:02:10.140 and tax efficiencies, et cetera.

00:02:11.640 If you want to build a real venture-backed SaaS tech company,

00:02:16.860 that's how you do it.

00:02:17.680 Just keep it simple, easy peasy.

00:02:19.660 Number two, IP ownership.

00:02:22.360 Intellectual property.

00:02:24.100 You've probably seen the movie The Social Network where the

00:02:28.100 Winklevoss twins end up walking away with hundreds of millions

00:02:30.940 of dollars from Zuckerberg at Facebook.

00:02:33.440 That is the kind of challenges that could come up if you're

00:02:36.840 engaging with especially contractors to build technology

00:02:40.520 for you and eventually you're gonna wanna sell that company

00:02:43.680 because if they worked on it and you didn't have the right IP

00:02:47.060 ownership agreement then they might have a claim to that

00:02:51.120 outcome.

00:02:51.620 So the simple solution to solve this

00:02:54.180 is in every employment contract, in every subcontractor

00:02:57.960 agreement, et cetera, et cetera.

00:02:59.760 There's a very clear IP assignment, IP ownership

00:03:03.600 clause that makes sure that as they're doing the work

00:03:06.780 are assigning you the IP of that work.

00:03:09.700 And this is true.

00:03:10.540 I've seen this many times where I've had companies

00:03:13.640 get a contractor to build something

00:03:15.400 and they use a framework that they built for other clients.

00:03:18.340 And it wasn't very clear that the core framework was their IP,

00:03:22.500 and they were just customizing it for their solution,

00:03:24.660 for your solution.

00:03:25.760 And we just got to make sure that that is clear.

00:03:28.060 So it's in the contracts.

00:03:29.560 It's in the agreements.

00:03:31.280 And you just make sure that that's their day one.

00:03:33.160 Because if not, and you go to raise money,

00:03:35.120 you might have to go back and get people

00:03:36.800 to sign documents that they may not want to sign, which usually

00:03:39.680 costs a little bit of money.

00:03:41.160 So real quick, IP ownership.

00:03:42.860 Just make it part of the agreements, and you'll be fine.

00:03:45.420 Number three, not setting up vesting.

00:03:48.360 So vesting is essentially saying that I'm gonna give you

00:03:50.860 10% of the company, but you only get allocated that

00:03:54.020 over a period of time.

00:03:55.400 Typically it's four years and there's a one year cliff,

00:03:58.400 meaning that if in the first 12 months they don't perform

00:04:01.400 and you don't think that they're doing what they said

00:04:04.240 they would do and your expectations are not being met,

00:04:06.300 you can let them go and they get no equity.

00:04:08.940 So the mistake that a lot of founders make is say like,

00:04:10.980 oh, I'm gonna bring on this biz dev guy and he says he wants

00:04:13.520 you know, 5% of the company,

00:04:14.920 and they just give the person 5% of the company,

00:04:17.320 they work for a few months, do some things,

00:04:19.920 beat the bushes as one guy told me.

00:04:21.960 I had a guy, I'm not gonna tell you his name,

00:04:24.500 but I had a guy run around with 1% equity

00:04:26.800 in my company, Flowtown,

00:04:28.660 and he literally spent four months beating the bushes.

00:04:31.700 This is what you tell me all the time,

00:04:32.780 beating the bushes, I'm drumming up business,

00:04:34.440 and I'm just like, dude, you haven't gotten us

00:04:37.420 any new deals, and it's done,

00:04:39.620 but for some reason, I didn't know this,

00:04:41.480 I allocated 1%, and when we went

00:04:43.380 to raise our fundraising, we need to figure out

00:04:46.220 how to convince this guy to sell us back that equity.

00:04:49.780 So we were able to pull it off, but it could have been

00:04:52.220 a lot worse than it was.

00:04:53.520 And so to me, nobody should get allocation.

00:04:56.900 Even if you go to raise your next round of funding,

00:04:59.060 there's even a thing called founder vesting,

00:05:00.900 where the investors investing in the new round might say,

00:05:03.140 hey, you guys each have 50% today with the new round

00:05:07.800 of funding, maybe you guys each maintain 35%.

00:05:10.580 We think that maybe we allocate 10% and the other 25%

00:05:14.660 is vested over a four-year period.

00:05:16.500 Just because you never know how people are going to react

00:05:19.020 as you grow, can they grow with the organization?

00:05:21.340 And if you don't have a way to throttle back somebody's equity

00:05:25.280 allocation, what happens is you go to build this big business

00:05:29.160 and this person doesn't perform or leaves,

00:05:31.220 and they're running around with all this equity

00:05:32.800 that you can't use to incentivize the next key hires

00:05:36.480 you need to make.

00:05:37.280 So that's why vesting, to me, should

00:05:38.740 be part of the negotiation conversation

00:05:40.980 at the very early days of building out your team.

00:05:43.420 Number four, not complying with securities law.

00:05:46.540 Now, if you haven't heard of a thing called accredited,

00:05:49.860 and there's a bunch of other securities laws that, again,

00:05:52.580 not a lawyer, don't play one, but go educate yourself.

00:05:56.380 The biggest one where I see founders breaching

00:05:58.740 is raising money from non-accredited investors.

00:06:01.060 So you hear this thing all the time, friends and family 0.98

00:06:03.320 and fools, OK? 0.97

00:06:04.760 The reality of it is you can't sell somebody a security 0.99

00:06:09.440 if they are not an accredited investor.

00:06:11.220 Now, this definition of what's an accredited investor

00:06:13.920 changes all the time.

00:06:15.040 There's been some new changes around the crowdfunding space,

00:06:17.760 et cetera.

00:06:18.260 So I don't know what it looks like in today

00:06:19.780 when you're watching this, but all I'm going to say

00:06:22.200 is you need to make sure that they are accredited.

00:06:25.380 And here's where people are like, well, how would I get caught

00:06:28.160 if nobody knows?

00:06:29.520 Here's where I've seen it happen recently

00:06:31.820 to one of my clients is they had a disgruntled investor

00:06:36.920 and then the investor went to their lawyer

00:06:38.920 and their lawyer said, well, you weren't even accredited

00:06:41.020 and then came back to the corporation.

00:06:43.060 So you have it that way where the investor's like,

00:06:45.100 hey, where's my money?

00:06:45.940 You're like, I'm a startup, I'm building this thing,

00:06:47.700 we're still trying to figure it out.

00:06:48.540 And they're like, this is crazy, I don't get it anymore,

00:06:50.440 I want my money back.

00:06:51.280 And you're like, you can't have your money back.

00:06:52.400 And then they go see a lawyer and then boom, you're busted.

00:06:55.480 There's that or maybe an accredited investor knows

00:06:58.420 there's people on the cap table,

00:07:00.040 on the capitalization table that were not

00:07:02.340 and they could use that as well. 0.90

00:07:03.620 So to cover your butt, make sure that everybody's accredited 0.94

00:07:06.800 investors. 0.90

00:07:07.220 To do that, you can just get them to sign a release statement

00:07:09.460 saying that they are.

00:07:10.900 Again, I'm not a lawyer.

00:07:11.980 I'm just telling you what I've seen my lawyers do.

00:07:15.000 And that'll help you get past that.

00:07:16.380 But just make sure you comply with all security laws.

00:07:19.960 I don't know if you saw recently, well, even Elon Musk

00:07:23.020 got himself in trouble in a huge, like, I think it was like a,

00:07:25.120 I mean, in the grand scheme of things, it's not a lot of money,

00:07:26.920 like a $10 million fine for tweeting something

00:07:29.880 he shouldn't have that violated this.

00:07:32.500 So even somebody as smart as Elon can get himself in trouble. 0.99

00:07:35.140 So just make sure you cover your butt. 0.99

00:07:37.480 Number five, not doing due diligence. 0.99

00:07:39.980 If you're raising money from an investor,

00:07:41.800 it is your responsibility as a founder

00:07:44.400 to find out who this person is.

00:07:47.160 What, how have they acted in the past?

00:07:50.020 What is their vision for your startup

00:07:52.180 and where do you want to go?

00:07:53.180 And is it aligned?

00:07:54.280 Because if it's not, you're going

00:07:57.180 to find yourself in a really bad situation

00:07:59.780 as you raise your next rounds of funding.

00:08:01.520 I have a client right now going through this right now

00:08:04.520 where she has an investor that was kind of like,

00:08:09.320 you know, aggressive in their terms

00:08:12.260 and she felt at the beginning

00:08:14.120 that maybe this person was off

00:08:15.400 and now that they're pivoting a little of the business

00:08:18.340 and moving in a different direction

00:08:19.460 and they're about to close their next round,

00:08:21.000 the new investors want certain terms that are very fair.

00:08:24.880 Like I would say if it was aggressive, they're very fair,

00:08:28.300 but the old investor is not willing to sign off on them.

00:08:31.100 And because of that, they might actually

00:08:32.920 block that next round of funding.

00:08:34.360 So you need to make sure that if you're raising money

00:08:36.760 from an investor that you understand who they are,

00:08:39.500 do your due diligence, talk to previous investments

00:08:41.720 that they've made to the founders, the CEOs,

00:08:43.640 see how they acted when things didn't go right.

00:08:46.500 That to me, I don't want to talk to the people

00:08:48.760 that you invested that are like hockey stick growth people.

00:08:52.300 I want to talk to the ones that failed,

00:08:54.480 were complete craters, and I want to know

00:08:57.480 how you treated them because that to me is gonna tell me a lot

00:08:59.940 about who you are than the successful ones.

00:09:02.720 So to avoid the five major startup legal issues,

00:09:05.760 number one, don't set up the wrong entity.

00:09:08.560 Number two, ensure you set up the right IP ownership assignment.

00:09:12.520 Number three, not setting up vesting.

00:09:15.760 Number four, not complying with security laws.

00:09:18.960 Number five, not doing your due diligence.

00:09:22.600 So if you do those five things, you're gonna be sailing smooth

00:09:25.840 when it comes to legal issues in your startup.

00:09:28.340 And as I mentioned at the beginning of this video,

00:09:29.540 I wanna share with you an incredible resource

00:09:31.380 called Fundraising Like a Pro Training.

00:09:33.980 You can click the link below to get access for yourself in it.

00:09:36.760 I break down the fundraising process

00:09:38.580 into three distinct phases.

00:09:40.980 I share with you exactly how to get intros to investors

00:09:44.020 because if you didn't know this, they don't wanna meet you.

00:09:46.400 They wanna be introduced to you.

00:09:48.120 And I talk about why it's so important to do

00:09:50.540 pre-marketing for your fundraising.

00:09:52.760 So click the link below so you can get access to that training.

00:09:55.300 And if you like this video, be sure to click the like button,

00:09:57.900 subscribe to my channel, and if there's somebody you care

00:09:59.740 about that you think I can serve,

00:10:01.180 feel free to share this video with them.

00:10:02.980 As per usual, I wanna challenge you to live a bigger life

00:10:05.580 and a bigger business, and I'll see you next Monday.

Dan Martell - February 11, 2019

5 Major Startup Legal Issues And How To Avoid Them

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