LEGAL AND TAX ISSUES, INCLUDING
Why, When, and How to Choose an Attorney
Many enthusiastic entrepreneurs are so excited about where
they’re going that they forget to consider where they’ve been. They’re
surprised to learn that there may be serious limitations imposed upon their
freedom of action arising out of their former employment. Some of these
limitations may be the result of agreements signed by the entrepreneur while
employed in her former position. Others may be imposed as a matter of law,
without any agreement or even knowledge on the part of the employee. These
considerations are among many that suggest that entrepreneurs obtain an early
consultation with an appropriate attorney.
Unfortunately, many people perceive engaging an attorney as
an unnecessary expense when beginning a new venture. However, the earlier you
can consult a professional, the more likely your business will avoid costly
mistakes. For example, without an attorney to advise you with regard to the
drafting of a partnership or stockholders’ agreement (described later in this
chapter), the remaining partners may have no way of retrieving the share of the
business owned by the estate of a founder who has left the business for a
“better opportunity.” Or the entrepreneur may be confronted by a large income
tax bill for his receipt of “sweat equity.”
The laws in the United States do not officially recognize
legal specialties. In practice, how- ever, the U.S. legal profession has become
highly specialized. Thus, most patent attorneys do very little else, and most
good litigation attorneys concentrate on litigating. The representation of
startups and small businesses has become a specialty as well.
An attorney experienced in the problems of startups will be
aware of the myriad issues that should be covered in a stockholders or
partnership agreement and the other unique problems facing entrepreneurs. He or
she will be able to advise among the various choices of legal entities
available to entrepreneurial enterprises as well as to advise with regard to
any residual obligations owed by an entrepreneur to previous employers. Most
general corporate lawyers, representing larger, more established enterprises,
are simply not as familiar with issues such as these. In addition, attorneys
who practice in the start-up world will be familiar with these companies’
unique cash-flow problems and may be willing to work out installment payments
or other arrangements to ease the strain on tight start-up cash flow.
More general than any obligation not to recruit fellow
employees is the obligation not to compete with one’s employer. Like most of
the obligations we’ve already discussed, this duty is derived from the
fiduciary relationship between employer and employee—specifically, the duty of
loyalty. How can we justify accepting a paycheck from our employer while we are
simultaneously establishing, working for, or financing a competing business?
The law imposes this duty not to compete on all employees,
officers, directors, and partners while their association with the employer
remains in effect. Unlike the obligation to protect proprietary information
discussed below, however, the non-compete duty does not extend to the period
after the termination of the relationship. To extend the obligation, the
employer must obtain the employee’s contractual promise.
We can analyze noncompetition agreements along many
different dimensions, like the scope of the obligation. In an extreme case, an
employee may have agreed not to engage in any activity that competes with any
aspect of the business his former employer engaged in, or planned to engage in,
at the time of the termination of the employee’s association with the company.
At the other end of the spectrum, the employee may have agreed only to refrain
from soliciting any of his former employer’s customers or (somewhat more
restrictively) from dealing with any of the same, no matter who initiated the
contact. We can also measure such agreements by the length of time they extend
beyond the termination of employment and by their geographic scope. Such
measurements are important because, in the employment context, many states take
the position that non-compete agreements contravene basic public policies, such
as encouraging competition and allowing each individual to make the best use of
his talents. A few such states (such as California) actually refuse to enforce
all noncompetition agreements. Most, however, purport to enforce only those
deemed reasonable, recognizing the employer’s interest in protecting its
business and goodwill. Only those restrictions that prevent likely harm to the
employer’s legitimate interests will be enforced.
Thus, a company could not enforce an agreement not to
compete throughout New England against a salesman whose territory extended only
to portions of Maine, New Hampshire, and Massachusetts.3 Furthermore, although
a manufacturer may be able to enforce such an agreement against an officer,
salesperson, or engineer who has either direct contact with customers or knowledge
of the company’s processes and products, it might not be able to enforce the
same agreement against a bookkeeper, whose departure would have little effect
on the company’s goodwill. Even the officer, salesperson, or engineer might be
able to resist an agreement that purports to remain in effect beyond the time
that the employer might reasonably need to protect its goodwill and business
from the effects of new competition.
Another factor that may affect the enforceability of a
noncompetition agreement is whether the employer agrees to continue part or all
of the former employee’s compensation during the noncompetition period.
Similarly, a noncompetition agreement that might be unenforceable against an
employee might nonetheless be enforceable against the seller of a business or a
major stockholder having his stock redeemed. Finally, some courts that find the
scope or length of a noncompetition agreement objectionable nonetheless enforce
it to the maximum extent they rule acceptable. Others take an all-or-nothing
Yet another potential complication arising out of an
entrepreneur’s previous employment is the possible use of information or
technology belonging to the former employer. Such information need not be
subject to formal patent or copyright protection to be protected from such use.
And usually, by the time an entrepreneur has developed a viable business, she
will have created a body of proprietary information of her own. At that point,
she will be forced to turn her attention to protecting that information from
use by competitors, employees, and end users who have failed to pay for the
privilege. Thus, an in depth discussion of intellectual property rights would
be advisable at this juncture.
Entrepreneurship and intellectual property (IP) go hand in
hand. Intellectual property refers to creations of the mind, such as
inventions; literary and artistic works; and symbols, names, images, and
designs used in commerce. Business intellectual property includes patents,
trade secrets, trademarks, and copyrights.
Patents protect inventions. Trade secrets cover proprietary
information, whether it’s in the form of a recipe, a customer list, or a unique
way of conducting business. Trademarks are key in differentiating a business’s
products and services from those of others as well as in franchising
arrangements. Copyrights protect authors’ original creations, including
literary, musical, artistic, software, and other intellectual works.
Investors need to be assured not only that a business has
considered IP but also that it has implemented a plan to protect the company’s
crown jewels. And because IP protection costs money, it is necessary to budget
for and manage it. There are few guarantees in the area of IP. Not every patent
application is granted; a name you’ve chosen for your company might not be
available or be registrable as a trademark for a variety of reasons. Sometimes
entrepreneurs must take risks. To do that wisely, entrepreneurs must understand
the IP environment, which is slow to change in its legal underpinnings but
continually being pushed to keep up with technological advances.
Even when it’s successful, however, protecting IP is not the
endgame. A patent, for example, doesn’t generate revenue—it’s just a document.
A patent taken out for a great new idea is nothing unless people are willing to
pay for that idea implemented in a product or service. Timing can play a
crucial role in IP, just as it does in exploiting an entrepreneurial
Finally, IP is everywhere. Just because a business isn’t
about technology, don’t be misled into thinking it won’t ever face IP issues.
Patents today cover non-engineering subject matter such as holders for floral
bouquets; trademark law is invoked in Internet search engines, pop-up ads, and
Web sites in general; and even users of another company’s products, for
example, can be sued for patent infringement.
Managing Patent Costs. Patents are expensive: Plan on
spending between $15,000 to $25,000 to prepare and file a patent application and
between $8,000 and $12,000 to prosecute the patent application. Prosecution is
what occurs in the two to three years following filing of the application as
you attempt to convince the Patent Office that the invention is worthy of a
patent in the face of inevitable rejections. Foreign patents can cost over
$10,000 per country in filing fees alone. But you have to put these costs in
perspective. Consider the price of a mold for a plastic part, for example, or
the cost of a marketing study undertaken by a consultant. Because of the
potential value of a patent, the cost of filing is often well worth it. If, for
example, Gillette’s patent for the five-bladed Fusion razor can really be used
to stop all competitors from introducing razors with similarly manufactured
five blades, the cost of the Gillette patent and even the cost of patent
litigation (typically $1 million or more) is well worth the protection
afforded, especially given the enormous cost of Gillette’s advertising
campaigns surrounding the Fusion razor.
On the other hand, some patents may not have enough
potential value to provide a return on the investment. Consider a patent for
aerogel used as an insulating liner in deep-sea oil-well piping. If other
insulating materials work as well or almost as well, the patent might not be
worth the cost—unless it is worth something to advertise ′′the only deep-sea
oil-well piping with aerogel!′′
The problem is that, at the time the patenting decision must
be made, the value of the patent might be hard to measure. Big companies
regularly file for numerous patents and have a yearly IP budget in the millions
of dollars. Entrepreneurial companies cannot typically afford those costs and
thus must be particularly adept at planning and managing patents and other IP,
all the while remembering the deadlines and the fact that the value of a given
patent is measured by its claims. Finally, don’t forget to make sure your new
product or service doesn’t infringe someone else’s patent.