Start-Up Advice ~ Black & Associates: Business Law ~ New York



Start-Up Advice

The following is a brief discussion of some issues which commonly arise for start-up businesses. It is not meant to be a comprehensive discussion of the issues raised and should obviously not be relied upon as legal advice.

- Names
- Founders’ Agreements
- Nondisclosure Agreements
- Choice of Entity
- Publication in New York
- Trademark Registration
- Contractors and Consultants
- Noncompete Clauses in New York

Names. One of the early questions you need to answer when starting a new venture is the name of your product or service. This issue should not be difficult, but it invariably is. DO NOT USE ORDINARY ENGLISH WORDS WHICH DESCRIBE YOUR PRODUCT OR SERVICE. Why? Because someone is probably using the same words for their business. Result: there will be confusion. Another Result: you may not have the legal right to use the name you have chosen. If someone else is using that name for their business and the business is similar in any way to your business, that other person may have rights to the name which supersede yours. The first person to use a name for the same or similar type of business in a geographical area is the one who is entitled to exclusive use of that name in that geographic area. Now that so many businesses have websites viewable all over the United States, it is relatively easy for the first user of a name to obtain nationwide rights to the name. Consequently, DO NOT USE ORDINARY ENGLISH WORDS UNLESS THEY DO NOT RELATE TO THE BUSINESS YOU ARE DOING. Think “Apple” (for computers), “Amazon” (for books), “Google” (for search services), “Starbucks” (for coffee), etc., etc., etc. You do NOT need a name which announces what you do in order to be successful. Indeed, it almost seems the opposite is true. So use a name like “Frammix” for your product or “Zelodian” for your service. Everyone will likely remember it and you probably won’t have trouble with conflicting trademarks when the time comes to register your trademark.

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Founders’ Agreements. There are many issues that arise in connection with the agreement that every new business should have between, or among, the founders. We are always surprised to find that one essential provision is still controversial: vesting for founders. Think about it. The three of you decide to start a business and own one third each. Then one of you decides, after one month, to go to Nepal and commune with the yaks. Should that founder keep his or her one third of the business? (Of course not, is our answer.) Just as important is the means for resolving basic disagreements. What if the third founder just isn’t pulling his weight or, worse, is hurting the business with his actions or inaction? It’s best to think about this problem at the beginning. Don’t wait until the business has become a roaring success and it is too expensive to buy out the under-performing founder.

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Nondisclosure Agreements. Now here is a simple issue which is really not simple at all. Should I have a nondisclosure agreement? Will it protect me? Is it dangerous to sign nondisclosure agreements? Is there any economical way to deal with all of the nondisclosure agreements we are presented with every month? Every business should have a standard nondisclosure agreement and should in general insist on using its own agreement drafted by an attorney with significant experience in nondisclosure agreements. Nondisclosure agreements are generally enforceable. Obviously there are problems of proof in enforcing such agreements, but such problems are not insurmountable. It may actually be easier to prove a disclosure or misuse of information in the email age than in previous times. Consequently, it is highly advisable to insist that a nondisclosure agreement be signed by anyone to whom you reveal sensitive business information. Not only does that document protect your information for competitive purposes, but in cases where you have technical information which could be the subject of a patent application, the nondisclosure agreement may be sufficient to avoid a “disclosure” of your invention which in turn can make it non-patentable. On the other hand, there are many poorly-drafted nondisclosure agreements being circulated about which can cause you to become entangled in unnecessary litigation. For that reason, you should also have a nondisclosure agreement you are ready to sign which will protect others who give you confidential information. We have found that a “mutual” nondisclosure agreement can serve both purposes and shows the other party that you are willing to abide by the same terms you ask him or her to abide by.

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Choice of Entity. We recommend to most of our clients that they organize their business as a limited liability company. The reasons: (a) losses, even from borrowing, can generally be deducted by active owners, (b) employees and other service providers can be rewarded with equity which will give them capital gain when sold, (c) assets can be distributed to the owners without tax consequences, (d) there are no restrictions on the type or number of owners the entity can have, (e) in certain jurisdictions, S corporations are taxed at the state or local level, and (f) you can almost always convert a limited liability company into a corporation, but converting a corporation into a limited liability company usually attracts an unacceptable tax cost. For local businesses, however, that do not intend to rapidly expand or raise funds from investors, some tax savings can be achieved by organizing as an S corporation.

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Publication in New York. One of the costs of choosing the limited liability company for New York start-ups is the need to publish a notice in a New York publication. That law is, of course, one of the most idiotic ever perpetrated on the business community. It costs $1,350 to publish in Manhattan ($1,550 for non-New York LLCs), which adds significant unnecessary cost for limited liability companies (and partnerships) doing business in New York.

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Trademark Registration. Once you have chosen a name for your product or service (see above), you should consider whether to apply for a trademark registration for that name. There is little question that registration makes it much easier to sue someone who is using your name to compete with you or who is otherwise using it without your permission. Registration is, however, expensive. We usually estimate $2,500 including filing fees, although it can cost much more if there are difficult issues involved such as a similar name which is already registered. Even without registration, you obtain common law rights to the name which supercede the rights of others who start using the name after you do. Thus it is very important to search for conflicting uses of the name you have chosen, but not as important to apply for registration. Many of our clients decide to put off the application for trademark registration until they are “up and running” and have some indication that their business will succeed.

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Contractors and Consultants. Typically, young companies have few or no employees and instead rely mostly on contractors during the start-up phase. There is one overwhelmingly important reason to have a written agreement with every person who works for the company who is not an employee: the company will not own the intellectual property created by such persons unless there is an agreement to that effect. Obviously, that principle is doubly important for software and internet companies whose intellectual property is their main asset. Confidentiality and noncompete provisions are also important reasons for a written agreement with contractors.

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Noncompete Clauses in New York. New York courts do not favor employee noncompete clauses and if the employee is not in possession of valuable confidential information, such clauses are generally not enforced in New York. Unfortunately, there is no bright line test to tell whether a court will or will not enforce such an agreement. It is more likely to be enforced (a) if the employee is a high-level executive with intimate knowledge of the employer's trade secrets, (b) if the employee attempts to solicit the employer's customers, especially if the employer spent years and substantial funds developing such customers or if the employee solicits the customers before he leaves, (c) if the employee takes confidential information, especially a confidential customer list, from the employer, (d) if the employee was represented by counsel when he signed the noncompete, (e) if the employee was only asked to sign the noncompete when given a raise or a promotion, (f) if the employee has been employed for many years, (g) if the employer took special steps to protect its confidential information, including its customer lists, (h) if the employee is paid during the noncompete period or (i) any combination of the above. In some cases the court will reform the agreement itself to reduce the time period during which the noncompete applies or to reduce the penalties imposed for competing. If the penalty for competing is the forfeiture of benefits otherwise payable to the employee, that penalty is generally enforced in New York

 

 


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