With DIY Incorporations (say, through LegalZoom), BEWARE …
You might end up with a DUI (“Don’t Understand Incorporations”).
According to the LegalZoom website, over 3 million satisfied customers have used its popular legal document service. At LegalZoom, they even “guarantee your satisfaction.”
Perhaps LegalZoom should redraft its guaranty. We continue to encounter more and more companies that have used LegalZoom or similar DIY incorporations, only to realize later that their corporate formation or legal structure is defective. In some cases, the deficiencies can be cured, albeit at some cost and with more headaches that could have been avoided by doing it right in the first place. In other cases, the deficiencies can be toxic. Read our article: Founders Holla to learn more about how startups can go awry – and how to prevent that from happening.
DIY Incorporations: Read the Fine Print
We of course appreciate that entrepreneurs are drawn to services such as LegalZoom with good intentions – to save money and time. But we wonder whether many entrepreneurs know enough about LegalZoom to make an informed choice.
So what is LegalZoom, really? Perhaps this question is best answered in the disclaimers that appear in small print at the bottom of LegalZoom’s webpages:
“LegalZoom provides access to independent attorneys and self-help services at your specific direction. We are not a law firm or a substitute for an attorney or law firm. We cannot provide any kind of advice, explanation, opinion, or recommendation about possible legal rights, remedies, defenses, options, selection of forms or strategies.”
“LegalZoom does not endorse or recommend any lawyer or law firm who advertises on our site. We do not make any representation and have not made any judgment as to the qualifications, expertise or credentials of any participating lawyer. The information contained on this site is not legal advice.”
Let’s try to put these disclaimers in plain English: You are basically on your own to work through LegalZoom’s online questionnaire and take your chances that the documents that you generate will work for your company now and into the future. Or you can pay LegalZoom to connect you with an unknown “independent attorney” that may not have meaningful experience working with startups and that may not be interested in forming a long term relationship with you to be in your corner if you encounter problems down the road.
We think the takeaway is clear: you simply get what you pay for with these legal document services.
DIY Incorporations: How Hard Can This Legal Stuff Be?
Even if you had a great night’s sleep and started the day with a strong cup of coffee, do you really have the time, knowledge, focus and skill set necessary to structure, organize and document the formation of your new company? (Not to mention continually maintain its structure).
Will you complete all of the tasks necessary to form your company properly? What documents do you need to protect your new company’s “secret sauce” and to help ensure that the stock is owned by the people really working for the benefit of your company? We often come across founders who have worked with a legal document service to make the initial state filing to form their company. They then receive a notebook or CD with various legal documents that remain incomplete for months and sometimes even years. You have a business to build and it is not surprising that your attention might be diverted. However, it is difficult, expensive and sometimes impossible to remedy these administrative and legal matters after the fact, especially if a legal dispute has arisen. (Do you want to know how to get things done the right way, the first time? Read more, here.)
Does your new company have a group of founders with differing levels of involvement and equity ownership? Are stock repurchase agreements in place? Have you entered into contractual relationships to protect your company’s trade secrets and other intellectual property? For example, it is very important to address appropriate ownership and intellectual property protections in the event that a founder leaves the company.
When reviewing a do-it-yourself company, we often find: (i) an inadequate capital structure that does not allow for future equity issuances or stock incentive plans; (ii) a lack of documentation regarding the equity ownership of the company (e.g., no stock ledger, no governance approvals, no stock certificates, etc.), with promises to founders, employees and consultants regarding their equity stakes in the company; and (iii) no attempt to protect the company’s intellectual property by, for example, signing up proprietary information and invention assignment agreements with founders, employees and consultants. In addition, the corporate records likely do not establish the proper governance relationships, with no clear indication or appointment of the corporate officers and Board of Directors.
Can You Really “Fix It Later”?
Some companies may experience good fortune and avoid any future shareholder, governance or other disputes that challenge the legal structures or commercial arrangements that they have attempted to put in place. Other companies may realize too late, however, that their do-it-yourself legal documents have problems, and it then may be a very complex and costly exercise to unwind and cleanup the prior legal matters.
For example, even at the early stages of a corporate formation, it is not a cheaper solution to unwind and fix prior do-it-yourself legal work. We often have to redraft and refile the organizational documents, because they are poorly prepared (and therefore are incomplete or unclear) or lack the basic legal terms that are required. Like the famous Fram oil filter commercial once noted, if you do not pay for the proper legal solution at the outset, then you eventually will need to engage qualified counsel down the road to get your legal matters on the right track.
It all comes down to the type of company that you want to create and build. You should consider the appropriate legal foundation that will allow your company to, as applicable, raise money, distribute equity, develop important technology, sell products and services, etc., while managing appropriately your company’s legal risk and exposure. When starting your company, you should invest the necessary time, focus and resources in the initial organization and structure of your company as you position the company to be successful.
Have you had any experiences with do-it- yourself legal document services? If so, let us know! How did you get your startup on the right track afterwards?