Tuesday, February 15, 2011

Entity Formation | Do You Really Need an Attorney?

The early-stage startup community is about being lean and about being frugal. It's not 1999 anymore. Company founders have to be realistic about the amount of time they may need to stay in operation before getting funded and they have to stretch their bootstrap dollars as far as possible.

And the best place to save money is eliminating obvious overhead items, like legal fees, right?

I talk to a lot of entrepreneurs in the idea stage, pre- company formation. "How early do I need to engage an attorney?" I am often asked. "Do I really need an attorney to form my company, when I can get incorporated on Legal Zoom for a few hundred dollars?"

The answer to the first question is easy--start working with an attorney as early as possible. It will help you avoid a number of pitfalls to which first-time entrepreneurs especially are very susceptible.

As far as the second question, here's my take on it.

Legal Zoom will get you incorporated, that is true. And, by the way, you could incorporate your company yourself, too, for even less than the cost of Legal Zoom. And get an EIN online in 10 minutes (maybe even less). Some big law firms have been adding their entity formation forms to the public domain, so the forms are out there for the taking. Why?

Because the reason to retain a startup lawyer isn’t because they can file a standard piece of paper on your behalf. It’s because with the help of a good startup lawyer your business has a higher chance for success.

As far as Legal Zoom goes, keep in mind that they don’t actually issue shares. Founders should be issued shares as early as possible, while the value of the company is at its lowest. And the shares they are issued should be restricted shares that vest over time (4 years is fairly standard). They should also be subject to the company’s right of first refusal. In addition, the founders should transfer their intellectual property to the company at the time of the issuance of the shares and in consideration therefor.

In order to issue shares subject to these restrictions and conditions, the corporation needs to execute stock purchase agreements with the founders. Legal Zoom, on the other hand, will provide you with board resolutions authorizing the stock issuance and blank stock certificates, with the idea that you can issue those to yourselves.

At the time when the corporation issues shares to the founders, in addition to building in the provisions discussed in the previous paragraph, the corporation needs to make a securities exemption filing in California and the founders need to file an 83(b) election with the IRS. Legal Zoom does not handle any of that (because they haven’t issued the shares).

The bottom line is, when you retain corporate legal counsel, you are hiring an experienced advisor who will guide you and help you avoid underwater rocks. If you use Legal Zoom to incorporate, or if you incorporate yourself, you still need to go to an attorney to take care of other "formation" matters.

Inna Efimchik

Emergence Law Group  Emergence Law Group, specializing in assisting emerging technology companies in Silicon Valley and beyond, provides incorporation, financing, and licensing services as well as general corporate counseling.

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