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IP Corporate Attorney

3 Ways Your Startup Lawyer and Accountant Need to Collaborate

Blog post written by Michael Leventhal, Intellectual Property and Corporate Attorney, MC Squared Law and Consulting

Here’s a horror story: The lawyer for an Internet startup set the company up as an S-Corp. In two years, the business grew from nothing to grossing $5 million a month. Now, the owners wanted to take an investment, add a profit-sharing plan, and do other things that an S-Corp is not permitted to do. Converting to a C-Corp at this point meant a $5 million cash flow hit that could have been avoided had their lawyer and accountant been consulting from the get go.

If you want to get your startup off the ground, you need a strong relationship between your lawyer and accountant.  Several critical early stage issues require both perspectives and a collaborative flow of communication.  Here are three: formation, intellectual property, and sharing the wealth.

Startup FormationStartup

You’ve got an idea, and, maybe, some interest.  You need to form a legal entity to protect yourself, take in financing, and do business.  What’s it going to be?  Your lawyer should be asking questions, including these:

  • How many founders are there?
  • What is the potential size of the business?
  • Are you looking for investment?  What kind?
  • Where are you located?
  • What is your vision of the future of the company?  For example, are you in it forever?  Or do you want to build it and sell it to a bigger company?  Or go public?

The answers to these questions help determine the best legal form—LLC, C Corporation, S Corporation, as well as where you should incorporate—California, Delaware, somewhere else.  Lawyers seek the best form for legal protection, flexibility, and ease of operation.

Your accountant should be looking at a number of different issues, particularly taxes.  While I often like a California LLC for California companies, I want your accountant to be scrutinizing issues such as the gross receipts tax.  When does this issue offset the advantages of our preferred form?  Your accountant may not like the C Corporation because of the dreaded Double Taxation, and with good reason.  Sometimes, however, that’s the best form because investors won’t invest in anything else.  I’m not a tax guy.  Your accountant isn’t necessarily looking at issues such as flexibility or exit strategy.  To get the best solution, you need each perspective in the room.

How important are these choices?  Angel investor Stan Tomsic, a partner at ACODA Technology & Investments, says, “When we go through the process of due diligence, some of the most critical areas we address are making sure the company’s corporate house is in order, the intellectual property of the organization is well established, and the financials are accurate and make sense. We like to see experienced lawyers and accountants involved, especially those we are familiar with, who we know will provide sound advice.  We won’t write a check until we are satisfied with these areas.”

Intellectual Property for a Startup

So, you’ve created your entity—or you’re still figuring that out—and the basis of the business is its intellectual property.  Patent attorney Michael Zarrabian, a partner at Myers Andras Sherman & Zarrabian LLP, reminds us that, “You need to bring the IP into the company.” Smart investors will never put money into a company that doesn’t own the very thing they are betting on.  Zarrabian talks about the ways to get the IP into the company and get compensated for it.  “You can create a new entity just to house the IP, and then you have to decide whether it’s a domestic company or offshore.  Then, you would license the IP in to the new company in exchange for royalties or equity.  The license fee can vary.  Or, you can grant all rights to the new company in exchange for stock.”

While investors like to see the IP owned by the company, it doesn’t have to be that way.  Having your accountant at the table on this one determines which of the possible arrangements is going to be best for the inventor/owner from a tax perspective.  Your accountant’s input is critical.

Sharing Startup Wealth

You want the people who have been important to the creation of the idea, or will be important to the execution of the plan, to have a piece of the company.  How do you give it to them?

Your lawyer is watching out for voting control; protecting you from giving out ownership that hasn’t been earned yet; keeping an eye on too much dilution too early; looking for securities issues if the option strike price is too low.  Your accountant is on top of providing definitive answers to the tax side of the equation.  Brian Rabinovitz, president of Proactive Professional Solutions, Inc., points out that “any company looking to compensate employees or service providers, or otherwise provide equity for non-cash transactions, should consult with its attorney as well as its accountant about all of the possible accounting and tax ramifications.  The reason is that the Company should be aware of the accounting and tax treatment of the equity transactions and understand that there could be negative effects if the transaction was not well thought out.  Valuations could be incorrect and not understood, which could lead to financial statement and tax problems for the company, as well as tax problems for the employee or service provider.”

You also need your accountant and attorney working together to answer questions such as these: Is it better for the company to issue stock or options?  How about stock with a reverse vesting mechanism?  Should an option recipient file the 83(b) election?  When does that have to happen?  How does a low strike price affect your company’s financials?

An entrepreneur has a lot of ground to cover.  You need to keep your attention on turning the idea into a real technology/product/service.  You already know you need a lawyer and an accountant.  What most startups overlook is putting them together as a team.

Intellectual property and corporate attorney Michael Leventhal is a futurist, entrepreneur, and owner of MC Squared Law and Consulting.  He works to help companies grown in high tech, digital media, entertainment, Cleantech, and New Space.  You can reach Michael at 310-702-4048.

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