As early as possible, of course.
In your journey as a startup founder or entrepreneur, it is so crucial for you to get things right – and avoid making legal mistakes. But I admit that it may not be practical for most startups. Engaging a lawyer unnecessarily can add up to costs especially when you’re bootstrapping and running the business with your limited savings.
There are a number of things that you don’t need a lawyer for. The ideation and business planning stage or even setting up a company (so long as you set up the correct legal entity and hire a good company secretary!) to get the first version 1.0 (aka minimum viable product (MVP)) out for your product or service.
When exactly should I hire a lawyer?
When you are negotiating an agreement – of any kind. And of course, before you sign any document. Here’s why.
#1 – The odds are usually against the founders
It doesn’t matter if you’ve read countless articles to sample templates obtained from the internet, if you’re a first time entrepreneur, you may likely have to deal with people with more experience in the ecosystem. It could be a venture fund to an angel investor or a manager in charge of the new company that you want to onboard for your pilot project. The person you’re interacting with may have seen and even have negotiated so many similar agreements – and they know exactly the ‘important’ or ‘pressure’ points and what are the key terms.
Also, when you have a co-founder, you need to have a founders agreement or shareholders agreement when you form a company. The terms of this agreement are so important. It sets out the foundation of your business vehicle – and you need to get it right. In my experience, co-founders leave business all the time for various reasons from a change of life situation or to take up a better opportunity elsewhere. If you don’t have anything in writing (eg, vesting schedules), it’ll be hard to clawback the shares if the departing co-founder refuses to return the shares to the remaining party.
#2 – You need someone to cover your back
One thing that differentiates a seasoned entrepreneur from a first time entrepreneur is that the seasoned entrepreneur tends to have a good team of advisers from legal counsels to accountants advising him on his business journey. In my work as a startup and venture lawyer, I usually get asked to give legal advice from startups only when term sheets have been signed. You are in the strongest position during the initial negotiation stage – so it will be harder to make changes especially once the term sheet has been signed.
Of course at times concessions need to be made so that you can make the deal work, but you need to know exactly the consequences of the concessions that you’ve made. Founders tend to agree to terms that are not in their favour – because they thought that it was “normal” or “standard” terms based on sample documents they may have found on the internet.
Once the term sheet has been signed, it may be harder to get the terms changed as the investor is ready to sign the definitive agreements (eg, subscription and shareholders agreement) which contain more comprehensive terms (based on the earlier term sheet).
For example, reserved matters clauses tend to be a long list that may end up restricting the founders from running the business smoothly – as the founders are forced to seek the investor’s approval, again and again, every time the management decision falls within the list of the reserved matters.
#3 – Agreements like term sheets can be legally binding
There’s this default assumption that term sheets are not legally binding. This common assumption is a bad misconception.
Terms sheets can be legally binding.
Even if you’ve just signed a term sheet, you may have committed yourself or your company to some obligations (eg, confidentiality or exclusivity (or ‘no shop’ clause)) – or be exposed to liability.
Of course you can break the agreement – but there are strong reputational risks which means you can’t just walk away when you receive an offer (even though the terms may not be in your favour)
In the next post, I will share more on ways on how to choose a good startup lawyer.