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Five Legal Documents Every Start-Up Needs

Whether it is a video game start up, a social networking enterprise, a content aggregator, or anything in between, every start-up needs a few basic legal documents to allow it to function effectively. This post outlines five basic documents that every start-up needs, and how each of these can save your start-up from significant costs, aggravation down the road and possibly avoiding a commercial litigation situation.

Articles of Incorporation

It is generally a very good idea for start-ups to incorporate. There are many advantages to incorporation, but a few of the main ones are:

  • Limited liability – A corporation is a separate legal entity from its owners, and individual shareholders are generally not personally liable for debts incurred or other actions taken by a corporation.
  •  Tax Benefits  – Incorporating can lead to significant tax benefits, including due to the fact that corporations are taxed separately from their owners, often at a lower tax rate.
  • Greater Ease in Raising Capital – Raising money as a corporation is often far easier than as a partnership or sole proprietorship, partly due to investors’ comfort and familiarity with this type of ownership structure and the ease with which an ownership interest in the corporation can be transferred (often a matter of simply selling shares).

While a number of documents need to be prepared to incorporate a company, the most important of these is the Articles of Incorporation. The Articles essentially act like a corporation’s constitution, setting up the ground rules that will govern how the company functions. They cover things like the appointment of directors, procedures for board meetings, and the rights and restrictions that will attach to each class of the company’s shares. Every corporation in B.C. must have corresponding Articles of Incorporation, and the initial shareholders of the corporation must agree to be bound by the Articles when taking their first shares in the company.

Decisions a company’s founders make regarding how to structure a company’s Articles can have a significant consequences down the road in relation to issues like how their shares are treated for tax purposes, and how easy it is to issue new shares to investors. While it is possible to amend the Articles later on, this can sometimes be a difficult process, especially when some shares are owned by arms-length investors who object to the changes, so ensuring your company has well-drafted articles in place from the beginning may save you significant expenses and aggravation in the long run.

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Shareholders’ Agreement

A Shareholders’ Agreement is a contract between the company’s initial shareholders that goes beyond the matters addressed in the company’s Articles and sets out their agreement on other issues that have the potential of leading to conflicts down the road. Some matters that are often addressed in Shareholders’ Agreements include restrictions on the transfer of shares, rights of first refusal if other shareholders decide to sell their interest in the company, and general procedures for resolving disputes between shareholders when conflicts arise.

A Shareholders’ Agreement can offer a company’s founders protections well beyond those found the company’s Articles, and can be one of the most important agreements that a company’s founders will enter into when their company is incorporated. If you will be incorporating a start up with one or more partners, entering in to a well-drafted shareholders’ agreement can go a long way to ensuring the company operates smoothly and that, if problems or disputes between shareholders develop down the road, they are resolved efficiently while minimizing legal expenses.

Employment Contract/Consulting Agreement

Once a start-up is in the position to hire employees it is important that each employee have a written employment contract. While it may be tempting to rely on an oral contract or brief, informal written agreement with your employees, this approach can be risky. Proving the terms of an oral contract can be difficult, and informal agreements are often vague, and do not cover many important aspects of the employer-employee relationship. If a dispute between management and an employee occurs regarding something that is not adequately addressed in an oral or informal contract, it will ultimately be up to the courts or an arbitrator to resolve the matter. Going through this process can be time-consuming, expensive, and expose your company to significant risk and uncertainty. Having a written employment contract in place that clearly sets out what is expected of both the employer and employee can often avoid the need for such lengthy legal proceedings and save a company significant legal costs and aggravation.

One example of how an employment agreement can help in this manner is severance pay. Without an employment agreement that clearly addresses the amount of severance an employee who is laid off is entitled to, it will ultimately be up to the courts or an arbitrator to determine this amount if the parties can’t otherwise agree. Such awards can vary widely depending on the circumstances, and subject a company to significant risk. A written employment agreement that sets out the severance an employee is entitled to beforehand can solve this problem, saving the company considerable time and legal expenses, and adding all-important certainty to the process.

For start-ups that are hesitant to bring on a new employee, another option may be hiring a worker as an independent contractor. Hiring an independent contractor often involves less of a commitment and can have  many advantages for a company. For instance, independent contractors are generally not entitled to severance, employers are not responsible for withholding their income taxes or making CPP and EI contributions on their behalf, and they are generally exempt from employment standards legislation.

However it is important to keep in mind that the courts and government agencies such as the CRA will conduct their own assessment regarding whether a worker is an employee or an independent contractor. Depending on their overall assessment of the employment relationship they may find that even if a worker is referred to as an independent contractor and has entered into a consulting agreement, the nature of their situation is such that at law they should be considered an employee, with the corresponding obligations on the part of their employer. It is generally a good idea to obtain legal advice before entering into a consulting agreement to avoid this potential problem.

Intellectual Property Assignment Agreement

A start-up’s intellectual property is often its’ most important and valuable asset, and protecting it is crucial. While intellectual property created by a company’s employees during the course of their employment generally belongs to the company, this may not always be the case, especially if those employees are independent contractors or are also co-founders of the company. Disputes over who owns a company’s key intellectual property can have a crippling effect on a company’s operations, and investors often want to ensure that a company has “clean” ownership of its intellectual property before investing in a company. A well-drafted intellectual property transfer agreement will ensure that all intellectual property created by the company’s employees is transferred to the company, and prevent unnecessary disputes relating to its ownership, as well as the associated legal expenses and headaches.

Non-Disclosure Agreement

Individuals considering investing in a company often want to have a closer look at a company’s operations and finances before investing. A company’s management may understandably be hesitant to reveal such information without assurances that it will be kept private by the potential investor and not revealed to its competitors. A Non-Disclosure Agreement solves this problem by preventing the individual signing it from disclosing any information they obtain about the business any other party, allowing a company’s management some assurance that the information they disclose will not be disclosed or made public. It is worth keeping in mind that sometimes such investment discussions can come up on little notice. In such situations having a Non-Disclosure Agreement already drafted and ready to go can be a lifesaver and allow the process to move forward smoothly.

You may have noticed that one key thing that all of these documents have in common is that they are meant to save your and your company time, aggravation and legal expenses in the long-run. For founders, making effective use of well-drafted agreements in the nature of those above can prevent or minimize the disruption and expense associated with many potential disputes that may arise during the life of a company, and allow it to operate with minimal expense and aggravation.