Entrepreneurs are often portrayed as rule-breaking rebels who have a great new idea to introduce to the world. They may be singularly focused on how best to create and sell their product or service – regardless of what the law, or even their customers, may think at first. While this kind of behavior is a great way to focus energy into a product that customers or clients want to buy, it might not be the best way to create a company that investors want to buy.

If you ultimately want to build a company to sell, keep in mind that investors are looking for a company with great enterprise value – the sum of the parts of your brand and customer relationships, intellectual property, and other assets. Critically, if you cannot document what these parts are – or, some of these parts have negative value – then your company will be worth less than what you have actually created.

While some companies may be so appealing to investors or acquirers that they may be willing to overlook some omissions or errors, most transactions include some haircut or loss of value for sellers as a result of poor documentation, compliance, or risk management. The best way to prevent this from happening is by taking time early in your lifecycle to set things up the right way. After all, it’s much easier to do things right the first time, than to spend time and money to go back and correct the problem.

Organization: Choosing the Right Entity Type

One of the first legal decisions you make when starting a company is what type of entity to organize under, and in what jurisdiction. This will not only impact you when you sell the business, but also as you operate it up to that point. Some questions to ask yourself:

• Do I want anyone else involved in the business with me?
• Which do I care more about: the ease and expense of setting up and maintaining the entity, or the ease and expense of selling the entity?
• Do I want to pick an entity type that works for me now, and potentially reorganize as I’m nearing the point where I want to sell?
• What’s the likelihood that I want to sell only a portion of my business? If I want to sell IP but keep client contracts, for example, how easily could I do that under my planned structure?

In the United States, the main entity types are:

1. Sole proprietorship: A business owned by a single individual with no distinction between the owner and the business.
2. Partnership (general, LP, LLP, LLLP): A business owned by two or more partners (individuals or entities).
3. Limited liability company (LLC, LC, PLLC): A business which provides limited liability to the owners.
4. Corporation (including PC): A business treated as a single, separate legal entity, providing limited liability to owners.

If you’ve already organized your company but are worried about its suitability for selling, don’t panic. Reorganization is always an option, though it may involve additional costs and effort.

Pro Tip: Keep electronic copies of all original organizational documents filed with the jurisdiction. This can save you time and money when acquirers, investors, banks, or clients request them.

Navigating Jurisdictional Requirements

As your business grows, you may find yourself operating in multiple states or countries. It’s crucial to stay on top of where your company or its representatives are engaging in activities. Different jurisdictions have varying thresholds for when a business must register to operate there.

Failing to register in required jurisdictions can lead to complications during due diligence with potential acquirers. Regularly review your activities and consult with a legal expert if you’re unsure about registration requirements in new areas of operation.

Protecting Your Intellectual Property

For many companies, especially in the tech sector, intellectual property (IP) forms a significant portion of the company’s value. Ensuring that your company actually owns the IP it relies on is crucial for a successful sale. Here are some key considerations:

1. Employee IP: Generally, work performed by employees for your company, using company-provided assets, or during working hours is owned by the company. Consider including specific language in employment agreements to clarify IP ownership.

2. Contractor IP: This is a higher-risk area. Contractors often use their own equipment and may work on similar projects for multiple companies. Always include an IP-assignment clause in contractor agreements or use a separate IP-assignment agreement.

3. Avoid “Work for Hire” Language: Be cautious with “work for hire” language, especially in states like California where it can lead to contractors being classified as employees for certain purposes.

4. Third-Party IP: Be aware of any third-party IP you’re using, from stock photography to complex data or patent licenses. This is particularly important for software companies.

5. Regular Audits: Implement regular monitoring of your IP portfolio and the processes by which it’s developed or acquired.

Maintaining Consistency in Legal Documentation

As your business evolves, so too will your legal agreements. It’s important to maintain consistency across all your legal documents. Here are some strategies:

1. Master Forms: Develop a single master form for each type of agreement (employment, contractor, IP assignment, master service agreement, etc.).

2. Version Control: If changes are made to master forms, consider amending existing documents to match, or implement a system to track which version of an agreement is in use with each party.

3. Document Management: While full-fledged contract management systems might be overkill for small businesses, even simple spreadsheets can help track and manage contract complexity.

When to Consult Legal Experts

While many aspects of legal compliance can be managed independently, especially in the early stages of a business, there are times when professional legal counsel is invaluable:

1. Initial Setup: Getting expert advice on how to properly establish your company and its policies can save significant time and money down the road.

2. Complex Transactions: When entering into complicated deals or partnerships, especially those involving significant IP or cross-border elements.

3. Fundraising: Any time you’re taking on outside investment, professional legal guidance is crucial.

4. Compliance Checkups: Periodically having a legal expert review your practices can help catch any issues before they become problems.

5. Pre-Sale Preparation: As you start seriously considering a sale, having a legal team audit your company can help identify and address any potential roadblocks.

Conclusion

For many businesses, hiring legal counsel can seem like a painfully expensive undertaking. However, with proper planning early on in your company’s lifecycle and by taking simple steps that any business owner can manage, you can head off issues that might otherwise arise at the time of a sale.

Remember, an ounce of prevention is worth a pound of cure. While it’s not necessary to break the bank with attorneys for every decision, strategically consulting expert counsel at key junctures can have significant financial benefits down the road. By establishing a solid legal foundation, you’re not just protecting your company—you’re building a more valuable, more saleable business.

In the next post in my “Built to Sell” series, I’ll explore human resources strategies critical for building a valuable, saleable company. I’ll discuss how to assess your staffing needs, choose the right hiring methods, ensure regulatory compliance, and effectively manage your team. I’ll also discuss the importance of proper documentation, streamlined onboarding and offboarding processes, and balancing transparency during potential acquisitions.