This article first appeared in the Union Leader in May 2020
UNDOUBTEDLY, the coronavirus pandemic has had a disastrous effect on the economy, and small businesses everywhere are hurting. With that said, it is helpful to remember that, historically, some of the most significant innovations and successful companies have come out of an economic downturn or other universal struggle, and this situation likely will be no different.
Inevitably, new companies will be borne out of this crisis, whether due to layoffs, as a necessary response to shifting customer needs, or simply because the increased time at home will provide new opportunities for creative thinking and innovation. When starting a new company, particularly for the first time, taking the following preliminary steps will help founders ensure that the company is built on a solid foundation: (1) determine what restrictions and obligations the founders may be subject to, (2) properly organize an entity, and (3) put early agreements, particularly those regarding ownership of the company, in writing.
Before starting a new venture, it is important to consider what restrictions may be imposed by any current or former employer. Many companies require employees to sign an agreement that restricts how confidential information (including, most notably, trade secrets) and developments are used both during and after the term of employment. Non-competition and non-solicitation obligations are also often included in such employee agreements.
Whether these restrictions and obligations still apply in the context of a layoff will depend on the specific contractual language, but most contractual restrictions will apply if employment is terminated for any reason, not just for cause. These considerations are particularly relevant if the new venture has any overlap with the business of such employer.
Properly forming and organizing a new entity will start the new venture off on the right track. Among other significant benefits, forming an entity will provide the founders with liability protection and tax advantages. When forming an entity, one of the first considerations should be whether to form a limited liability company, corporation or another type of entity, and it is worth getting the input of legal and tax advisors (most of whom are still fully operational, albeit remotely) to better understand the legal and tax implications of that decision.
A full set of organizational documents will establish rules for the operation of the business, flesh out how decisions regarding the company are made, and confirm how owner contributions and distributions work, among other things. To the extent that the founders have worked on developments relating to the company’s business before the entity was actually formed, those developments should also be assigned into the company. Finally, the company’s assets should not be intermingled with any founder’s individual assets, and a separate bank account should be opened for the company.
Particularly in instances where a company has more than one founder, it is recommended that agreements pertaining to the company, especially ownership of the company, be put in writing. Written agreements provide clarity and force a discussion of potential issues before they actually arise, when it can be much harder to come to an agreement.
Similarly, rather than talking about ownership of the company in terms of percentages, which can shift over time and be misleading, agreements should refer to ownership in terms of concrete amounts of equity, such as shares of stock or units of membership interest. Founders should also consider whether transfer restrictions or repurchase rights should apply to such equity under certain circumstances; for example, if one founder can no longer actively contribute to the company.
Entrepreneurs and innovators are already rising to the challenges presented by the coronavirus and are pivoting to pursue new business ideas. Keeping these considerations in mind will help ensure that new companies start off with a good framework and continue in the right direction, long after the coronavirus subsides. Years from now, hopefully those companies will be added to a long list of successes that have emerged from recessions and similar challenges.
Emily B. Penaskovic is a corporate attorney at Cook, Little, Rosenblatt & Manson, where she advises entrepreneurial clients on a variety of business matters, including entity formation, capital raising, contract negotiations, and corporate governance. Emily is also on the board of directors of the New Hampshire Tech Alliance. Emily can be reached at email@example.com