Startup Legal Basics
The complete legal guide for startup founders. Protect your company, your equity, and your future from day one without spending a fortune on lawyers.
In This Guide
Why Legal Matters Early
Legal problems are like technical debt—cheap to fix early, exponentially expensive later. A $500 founder agreement today prevents a $500,000 lawsuit when you raise your Series A. The stakes are too high to wing it.
The Real Cost of Legal Mistakes
| Issue | Cost to Prevent | Cost to Fix Later |
|---|---|---|
| No founder agreement | $500-2,000 | $50K-500K+ (litigation) |
| Missed 83(b) election | $0 (just paperwork) | $100K+ in extra taxes |
| No IP assignment | $1,000-3,000 | Deal killer (no investment) |
| Misclassified workers | $200/contractor | $5K-50K per worker + penalties |
| GDPR violation | $2,000-5,000 | Up to 4% of revenue |
The Due Diligence Reality
Every investor will conduct legal due diligence before writing a check. They will find every mistake, every missing document, every informal agreement. Legal issues are the #1 reason deals fall apart at the last minute. VCs have seen founders lose 50% of their company to a departed co-founder with no vesting. They wont make that mistake with you.
When to Get Serious About Legal
Day 1 Essentials
- + Founder agreement with vesting
- + IP assignment from all founders
- + Basic incorporation docs
- + 83(b) elections filed
Before First Hire
- + Employment agreement template
- + Employee handbook basics
- + Contractor agreements
- + Equity incentive plan (option pool)
Before First Customer
- + Terms of Service
- + Privacy Policy
- + Customer contract template
- + Cookie consent (if applicable)
Before Fundraising
- + Clean cap table
- + All agreements signed
- + IP assignments complete
- + Corporate minute book
Choosing Your Entity Structure
Your entity structure affects taxes, liability, fundraising ability, and exit options. For most venture-backed startups, there is only one real answer: Delaware C-Corp. Here is why.
Entity Comparison Chart
| Factor | C-Corp | S-Corp | LLC |
|---|---|---|---|
| VC Compatible | Yes | No | Rarely |
| Stock Options | Yes (ISOs) | Limited | Complex |
| Unlimited Shareholders | Yes | Max 100 | Yes |
| Foreign Investors | Yes | No | Yes |
| Pass-Through Tax | No | Yes | Yes |
| QSBS Eligible | Yes | No | No |
Why Delaware?
- Court of Chancery: Specialized business court with expert judges, not juries. Faster, more predictable outcomes.
- Established case law: 200+ years of corporate law precedent. Lawyers know exactly what to expect.
- Investor expectation: VCs strongly prefer Delaware. Many will require you to redomicile before investing.
- Flexibility: Delaware law is founder-friendly with maximum flexibility in corporate governance.
- Privacy: No requirement to disclose shareholders or directors publicly.
When NOT to Use Delaware C-Corp
- Lifestyle business: If you never plan to raise VC or sell, an LLC in your home state is simpler and cheaper.
- Real estate: LLCs offer better tax treatment for real estate investments.
- Solo consulting: An LLC provides liability protection without corporate overhead.
- Profitable from day one: If you are immediately profitable and want to distribute cash, S-Corp or LLC avoids double taxation.
QSBS: The Hidden Tax Benefit
Qualified Small Business Stock (QSBS) allows you to exclude up to $10M (or 10x your basis) in capital gains from federal taxes—potentially saving you millions at exit. Requirements:
- + C-Corporation with less than $50M in assets
- + Stock held for at least 5 years
- + Active business (not investing, real estate, etc.)
- + Original issue stock (not purchased on secondary)
The Incorporation Checklist
Incorporation is more than filing paperwork. You need to properly issue stock, document decisions, and create the legal foundation for your company. Miss a step and you will pay for it during due diligence.
Complete Incorporation Checklist
Formation Documents
Founder Setup
Ongoing Compliance
Critical: The 83(b) Election
When you receive stock subject to vesting, the IRS treats it as income when it vests—at the higher future value. An 83(b) election lets you pay tax on the stock NOW, at its current (low) value. The difference can be hundreds of thousands of dollars.
- Deadline: 30 days from stock grant. Miss it and there is no fix.
- Method: Certified mail to IRS. Keep the receipt forever.
- Risk: If you leave before vesting, you paid tax on stock you do not own.
Incorporation Costs
| Item | DIY | With Lawyer |
|---|---|---|
| Delaware filing fee | $89-189 | $89-189 |
| Registered agent | $50-300/year | $50-300/year |
| Legal setup (docs, review) | $500 (Stripe Atlas, Clerky) | $3,000-10,000 |
| Foreign qualification | $100-800 | $100-800 + fees |
| Total Year 1 | $750-1,500 | $3,500-11,000 |
Founder Agreements & Vesting
More startups die from co-founder disputes than from running out of money. A founder agreement is not about distrust—it is about clarity. Define everything upfront while you still like each other.
What a Founder Agreement Must Cover
Equity & Vesting
- + Equity split with rationale
- + Vesting schedule (typically 4yr/1yr cliff)
- + Acceleration triggers (single/double)
- + What happens if founder leaves
Roles & Responsibilities
- + Who does what
- + Decision-making authority
- + Time commitment expectations
- + Outside activities allowed
Intellectual Property
- + All IP belongs to company
- + Prior IP disclosed and licensed
- + Invention assignment
- + Non-compete scope
Exit & Disputes
- + How to remove a founder
- + Buyout terms for departing founder
- + Dispute resolution process
- + Drag-along/tag-along rights
Understanding Vesting
| Term | Meaning |
|---|---|
| 4-Year Vesting | Stock vests (becomes yours) over 4 years |
| 1-Year Cliff | No stock vests until 1 year of service; then 25% vests immediately |
| Monthly Vesting | After cliff, stock vests monthly (1/48 per month for 36 months) |
| Single Trigger | Vesting accelerates on acquisition (rarely given to founders) |
| Double Trigger | Acceleration requires acquisition AND termination (more common) |
Why Founders Need Vesting Too
Many first-time founders resist vesting—"We are committed!" But vesting protects everyone:
- + If a co-founder leaves after 6 months, they should not own 50% of the company forever
- + Investors require it—no VC will fund a company where a departed founder owns half
- + It creates accountability and commitment
- + It is fair to the founders who stay and do the work
Equity Split Considerations
There is no formula. But consider these factors when splitting equity:
- Idea contribution: Ideas are worth less than execution. Maybe 5-10% premium, not 50%.
- Domain expertise: Irreplaceable knowledge or relationships matter.
- Full-time vs part-time: Part-time founders typically get significantly less.
- Cash investment: If one founder funds the company, consider a note or extra equity.
- Opportunity cost: What each person is giving up (salary, other opportunities).
- Future contribution: Who will do most of the work going forward?
Intellectual Property Protection
Your IP is often your most valuable asset. Make sure the company owns everything it needs and that you are not infringing on anyone else. IP issues can kill deals and attract lawsuits.
Types of IP Protection
| Type | Protects | Duration | Cost |
|---|---|---|---|
| Trademark | Brand names, logos, slogans | Indefinite (with renewal) | $250-2,000+ |
| Copyright | Code, content, designs | Life + 70 years | $45-125 to register |
| Patent | Inventions, processes | 20 years | $15,000-50,000+ |
| Trade Secret | Confidential business info | As long as secret | $0 (just protection) |
IP Assignment: The Critical Document
Every person who creates anything for your company must sign an IP assignment agreement. This includes founders, employees, contractors, and advisors. No exceptions.
Must Include:
- + Assignment of all work product to the company
- + Waiver of moral rights
- + Disclosure of prior inventions (carve-outs)
- + Agreement to assist with IP filings
- + Confidentiality obligations
- + Work-for-hire acknowledgment
Startup IP Checklist
The Prior Employer Problem
If a founder worked on similar technology at a previous employer, you may have a problem. Most employment agreements include broad IP assignment clauses. Review these carefully:
- + Get copies of all founders prior employment agreements
- + Have a lawyer review for IP and non-compete clauses
- + Document that no prior employer IP was used
- + Consider reaching out to prior employers for releases if unclear
Employment Law Essentials
Employment law is a minefield. Get it wrong and you face lawsuits, penalties, and back taxes. The rules vary dramatically by state, so know your obligations where your employees work.
What Every Offer Letter Must Include
Compensation
- + Base salary or hourly rate
- + Pay frequency
- + Bonus structure (if any)
- + Equity grant details
- + Benefits summary
Terms
- + Start date
- + At-will employment statement
- + Reporting structure
- + Work location
- + Exempt vs non-exempt status
Required Attachments
- + Confidentiality and Invention Assignment Agreement (CIIA)
- + At-will acknowledgment
- + Arbitration agreement (if using)
- + Employee handbook acknowledgment
Exempt vs Non-Exempt Employees
Misclassifying employees as exempt when they should be non-exempt is one of the most expensive employment law mistakes. Non-exempt employees must receive overtime pay.
| Exempt (No Overtime) | Non-Exempt (Overtime Required) |
|---|---|
| Salary at least $684/week ($35,568/year) | Paid hourly or salary below threshold |
| Executive, administrative, or professional | Most other roles |
| Primary duty is management or specialized work | 1.5x pay for hours over 40/week |
State-Specific Requirements
Employment laws vary dramatically by state. Know your obligations wherever employees work:
California (Most Strict)
- + Daily overtime (8+ hours)
- + Meal and rest break requirements
- + Non-competes unenforceable
- + Pay transparency required
- + Higher minimum wage
New York
- + NYC has unique requirements
- + Salary range disclosure
- + Paid family leave
- + Specific harassment training
- + Wage theft protections
Remote Work Complexity
When employees work remotely, you must follow the employment laws of where they work, not where your company is located. Each state where you have an employee may require:
- + State tax registration and withholding
- + Workers compensation insurance in that state
- + State-specific employment posters
- + Compliance with local minimum wage and leave laws
Contractor vs Employee
Worker misclassification is one of the most common and expensive startup legal mistakes. The IRS and state agencies are cracking down. Get this wrong and you will owe back taxes, penalties, and potentially benefits you never paid.
The Classification Test
| Factor | Employee | Contractor |
|---|---|---|
| Control over how work is done | Company controls | Worker controls |
| Set work hours | Company sets schedule | Flexible/project-based |
| Tools and equipment | Company provides | Worker provides own |
| Multiple clients | Works exclusively for company | Works for multiple clients |
| Payment structure | Regular paycheck | Project or milestone-based |
| Training provided | Company trains | Already has skills |
| Duration | Ongoing/indefinite | Defined project or term |
The Cost of Misclassification
If you misclassify an employee as a contractor, you may owe:
- + Back employment taxes (FICA) - typically 7.65% of wages
- + Penalties and interest (can double the amount owed)
- + Unpaid benefits (health insurance, 401k, etc.)
- + Unpaid overtime if they were non-exempt
- + State penalties (California: $5,000-25,000 per violation)
When Contractors Make Sense
- Specialized project work: A defined project with clear deliverables and end date
- Expert consultants: Someone with specialized skills you do not need full-time
- Agencies: Working with a firm that employs the workers
- International workers: Often easier to engage as contractors (use EOR for employees)
Contractor Agreement Essentials
Customer Contracts & ToS
Your terms of service and customer contracts define your relationship with users and limit your liability. Good contracts prevent disputes. Great contracts make disputes you can win.
B2B vs B2C Contracts
| Element | B2C (Terms of Service) | B2B (Master Agreement) |
|---|---|---|
| Acceptance | Click-wrap or browse-wrap | Negotiated and signed |
| Liability cap | Typically unlimited exclusion | 12 months of fees typical |
| Indemnification | User indemnifies company | Mutual indemnification |
| SLA | Usually not included | Often required (99.9% uptime) |
| Data processing | In privacy policy | Separate DPA often required |
Key Terms of Service Clauses
Protective Clauses
- + Limitation of liability
- + Disclaimer of warranties
- + Indemnification
- + Arbitration clause
- + Class action waiver
- + Governing law and venue
Operational Clauses
- + Account terms and termination
- + Acceptable use policy
- + Payment terms
- + Modification rights
- + Intellectual property rights
- + User-generated content license
B2B Contract Negotiation Tips
- Start with your paper: Always send your contract first. Starting from their paper puts you on defense.
- Know your walkaway points: Unlimited liability and broad indemnification are typically deal-breakers for startups.
- Cap liability appropriately: 12 months of fees is standard; never agree to unlimited.
- Protect your IP: Never agree to clauses that give customers rights to your underlying technology.
- Get mutual indemnification: If you indemnify them, they should indemnify you too.
Enterprise Must-Haves
Enterprise customers typically require additional documentation:
Privacy & Data Protection
Privacy law is getting stricter everywhere. GDPR, CCPA, and new state laws create real liability. Even if you are small, you need a privacy policy and data practices that do not expose you to fines.
Major Privacy Regulations
| Regulation | Applies To | Max Fine |
|---|---|---|
| GDPR (EU) | Any company with EU users | 4% global revenue or 20M EUR |
| CCPA/CPRA (California) | $25M+ revenue or 100K+ consumers | $7,500 per intentional violation |
| COPPA (US) | Services directed at children under 13 | $50,000+ per violation |
| State Laws (VA, CO, CT, etc.) | Various thresholds | $7,500-20,000 per violation |
Privacy Policy Must-Haves
GDPR Quick Compliance
If you have any EU users, you likely need GDPR compliance:
- Lawful basis: Have a legal reason to process data (consent, contract, legitimate interest)
- Consent: Must be freely given, specific, informed, and unambiguous
- Data minimization: Only collect what you need
- Right to deletion: Must delete data on request (with exceptions)
- Data portability: Provide data in machine-readable format
- Breach notification: Report breaches within 72 hours
Data Security Basics
Technical Measures
- + Encryption at rest and in transit
- + Access controls and authentication
- + Regular security updates
- + Secure development practices
- + Vulnerability scanning
Organizational Measures
- + Employee training
- + Access on need-to-know basis
- + Incident response plan
- + Vendor due diligence
- + Data processing agreements
Fundraising Legal Basics
Raising money triggers securities law. Get this wrong and you face serious legal consequences—potentially criminal. Use standard documents, work with experienced counsel, and never take shortcuts.
Common Funding Instruments
| Instrument | Best For | Key Terms |
|---|---|---|
| SAFE | Pre-seed, Seed | Valuation cap, Discount, Pro rata rights |
| Convertible Note | Pre-seed, Seed, Bridge | Interest rate, Maturity, Cap, Discount |
| Priced Equity (Series A+) | Series A and beyond | Valuation, Board seats, Preferences |
| Revenue-Based Financing | Profitable companies | Multiple of investment, % of revenue |
SAFE vs Convertible Note
SAFE (Preferred)
- + No interest accrual
- + No maturity date
- + Simpler document
- + Lower legal costs
- + Founder-friendly
Convertible Note
- + Interest accrues (6-8%)
- + Has maturity date (12-24 mo)
- + More complex
- + Some investors prefer
- + Creates debt obligation
Key SAFE Terms to Understand
- Valuation Cap: Maximum valuation at which SAFE converts. Lower cap = more equity to investor.
- Discount: Percentage discount to next round price (typically 15-20%). May be in addition to or instead of cap.
- Pro Rata Rights: Right to invest in future rounds to maintain ownership percentage.
- MFN: Most Favored Nation clause—if you give better terms to later investors, earlier investors get those terms too.
- Post-money vs Pre-money: Post-money SAFEs include SAFE amount in valuation calculation (more dilutive to founders).
Securities Law Basics
Selling securities requires registration with the SEC unless you qualify for an exemption:
- Reg D 506(b): Unlimited raise from accredited investors + up to 35 sophisticated non-accredited. No general solicitation.
- Reg D 506(c): Unlimited raise, general solicitation allowed, but must verify accredited status.
- Reg CF: Up to $5M/year through crowdfunding platforms.
- Accredited Investor: $200K+ income ($300K joint) for 2 years, or $1M+ net worth excluding home.
Pre-Fundraising Checklist
Common Legal Mistakes
These mistakes kill deals, trigger lawsuits, and cost founders millions. Most are completely preventable with basic awareness and good habits.
No Founder Agreement
Without vesting and clear terms, a departing co-founder keeps their full equity stake forever. This can make your company uninvestable.
Fix: Sign a founder agreement with vesting before writing any code. All founders should have 4-year vesting with 1-year cliff.
Missed 83(b) Election
Without an 83(b), you pay taxes on stock as it vests—at potentially much higher valuations. This can create a tax bill of hundreds of thousands.
Fix: File 83(b) within 30 days of receiving any stock subject to vesting. Set a calendar reminder. Use certified mail.
No IP Assignment
If the company does not own its IP, it is worthless. Investors will not fund a company that does not clearly own its technology.
Fix: Every founder, employee, and contractor signs an IP assignment agreement before starting work.
Handshake Equity Deals
Oral promises about equity are unenforceable and create disputes. "I promised him 10%" means nothing without documentation.
Fix: Every equity grant must be in writing, approved by the board, and properly documented in the cap table.
Misclassifying Workers
Treating employees as contractors to save money creates massive liability—back taxes, penalties, and potential lawsuits.
Fix: Use the IRS classification test. When in doubt, hire as an employee. Use the contractor relationship correctly.
Ignoring Securities Law
Selling equity without proper exemptions is securities fraud. It can result in investors being able to demand their money back.
Fix: Use standard documents (SAFE, convertible notes). File Form D. Only raise from accredited investors.
No Operating Agreement or Bylaws
Without governance documents, there is no clear decision-making authority. This creates chaos during disputes or exits.
Fix: Adopt bylaws at incorporation. Follow them. Document all major decisions in board resolutions.
Giving Away Too Much Equity Early
Equity given away too freely early on leaves nothing for employees and investors. Advisors should not get 5%.
Fix: Follow market standards: advisors 0.25-1%, early employees 0.5-2%, reserve 10-20% for option pool.
When to Hire a Lawyer
You do not need a lawyer for everything, but some situations require professional help. Know when to DIY, when to use templates, and when to call counsel.
When to Use Templates vs Lawyers
Use Templates (Clerky, Stripe Atlas)
- + Basic incorporation
- + Standard SAFEs
- + Employment offers
- + NDA templates
- + Basic contractor agreements
Quick Lawyer Review ($500-2K)
- + Customer contract review
- + Employment agreement tweaks
- + Advisor agreements
- + Lease review
- + Privacy policy customization
Full Legal Engagement
- + Priced funding round
- + M&A transactions
- + Litigation or disputes
- + Complex IP issues
- + Regulatory compliance
Finding the Right Startup Lawyer
What to Look For
- + Experience with startups at your stage
- + Familiarity with standard VC documents
- + Reasonable rates or deferred fee arrangements
- + Responsive communication
- + Partner-level attention for key matters
Red Flags
- + No startup experience
- + Wants to rewrite standard documents
- + Cannot explain things simply
- + Billing surprises
- + Slow response times
Typical Startup Legal Costs
| Matter | Cost Range |
|---|---|
| Incorporation (Clerky/Stripe Atlas) | $500-1,000 |
| Incorporation (lawyer) | $3,000-10,000 |
| SAFE round (using template) | $0-500 |
| Seed round (priced) | $15,000-30,000 |
| Series A | $30,000-75,000 |
| Trademark registration | $1,000-3,000 |
Deferred Fee Arrangements
Many startup-focused law firms offer deferred fee arrangements for early-stage companies:
- Deferred payment: Fees are deferred until you raise funding. Typically up to $25-50K.
- Discounted rates: Reduced hourly rates for early-stage companies.
- Fixed-fee packages: Incorporation and early setup for a flat fee.
- Equity for services: Some boutique firms will take equity (be cautious—this can be expensive).
Recommended Reading
Books
- Venture Deals by Brad Feld & Jason Mendelson—The definitive guide to term sheets
- The Entrepreneurs Guide to Business Law by Constance Bagley—Comprehensive legal overview
- Legal Guide for Starting & Running a Small Business by Fred Steingold—Practical basics
Resources
- YC SAFE documents: Standard SAFE templates
- Clerky: Automated legal docs for startups
- Stripe Atlas: End-to-end incorporation
- Orrick, Fenwick, Cooley: Major startup law firms
Related Guides
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