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Legal Issues for Technology Startups

Executive Summary

Ignoring legal issues can stifle the growth or even destroy the potential of promising high-tech companies. A business must address legal issues in a practical manner at the outset to build a strong foundation and create every opportunity for it to achieve its full potential.

The primary legal issues that founders of technology startups should consider include: 

  1. Choosing the right business structure
  2. Protecting intellectual property
  3. Building a strong foundation
  4. Raising capital
  5. Building the right relationships
  6. Interacting with the public​​​​​

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Choosing the Right Business Structure

The type of business organization is very important when starting a new business because it will have important legal implications, including how the business is taxed, the ways in which it can raise capital, and the personal liability of the individuals controlling the business. The most common business structures are sole proprietorships, partnerships and corporations. 

Sole Proprietorships: an unincorporated business with an individual as a sole owner who is personally responsible for all obligations of the business and receives all profits derived from its ownership. 

Partnerships: a relationship between two or more individuals, corporations or other entities carrying on a business in common with a view to a profit. The rights and obligations of partners as among themselves are usually set out in a formal partnership agreement, though, absent an agreement, the relationship is governed by presumptive rules set out in Ontario legislation. 

Corporation: This is the most common organization for a technology startup. Corporations have separate and distinct legal personality from its shareholders and management and have all rights, powers, and privileges of a natural person. Corporations can also hold property, carry on business and enter into contractual relationships. 

Protecting Intellectual Property

Intellectual property refers to creations of the mind, such as inventions, literary and artistic works, designs and symbols, names and images used in commerce. The forms of intellectual property most relevant to tech startups are patents, trademarks, copyrights and industrial designs. Patents provide a time-limited, legally protected, exclusive right to make, use and sell an invention. Trademarks are any combination of words, sounds or designs used to distinguish the goods or services of one person or organization from those of others in the marketplace.

Copyrights protect literary, artistic, dramatic or musical works (including computer programs) and other subject-matters such as a performer's performances, sound recordings and communication signals.

Industrial designs are distinctive attributes of a product that are judged solely by eye and include either features of shape, configuration, pattern or ornament or a combination of these features.

The importance of intellectual property to technology startups, ensuring confidentiality, assigning intellectual property to the corporation and maintaining rights over work done by employees, contractors, and third parties are critical. Additionally, changes in policies based on geographic location should be considered when formulating an intellectual property strategy.[2]



Building a Strong Foundation

Founders who do not set out clear legal rights and obligations for themselves and for other stakeholders at an early stage risk losing value and increasing conflict, potentially jeopardizing the future of their business. Some of the agreements that technology startups typically use to formalize the rights and obligations of stakeholders are listed below.

Articles of Incorporation: sets our a corporation's purpose, regulations, and share structure. Filed with the government. 

Shareholders Agreement: a private document providing commercial terms of the arrangement between shareholders, including details on the key terms of investment.

Founder Restriction Agreement: contains provisions regulating the use of the founders' shares. 



Raising Capital

Businesses commonly raise capital by equity financing, debt financing or a combination of both. 

Equity: a method of raising capital through the issuance of additional shares in the capital of a corporation or units of a limited partnership or trust. 

Simple agreement for future equity (SAFE)allows investors to convert a cash investment to equity when the business raises capital through an early round of equity financing. SAFEs are typically short and easier and more convenient to use than other forms of investment, including convertible notes. 

Debt Financing: a method of raising capital by borrowing from shareholders, partnerships or third parties such as banks and other financial institutions or debt investment funds. 

Government funding and grants: There are many different opportunities for start-ups to take advantage of government grants, funding and tax benefits for various projects. There is often a large amount of supporting documentation required in an application process. Project milestones and timelines are very important in this process and it is recommended start-ups implement a project management system. 

Building the Right Relationships

Employment contracts are crucial because it will ensure that the startup (the employer) and its employees clearly understand the terms and conditions of employment, and can minimize uncertainties in the event of a dispute.

Whether an individual is an employee or an independent contractor depends on a number of factors reflecting the relationship between the business and the individual. 

It is best that intellectual property rights are clearly defined and a formal agreement regarding the ownership of intellectual property is clearly defined. Generally, these agreements will stipulate that the business will own the rights to all intellectual property created by the employee or contractor and that the employee or contractor will cooperate to ensure those rights are protected. 

Interacting with the Public

Often, the main interaction between a tech startup and the consumer is through its website or mobile app. This means that commonly the only agreements between the startup and the consuming public will be the terms of use and privacy policy found on its app or website.

A tech startup’s terms of use agreement outline the terms and conditions required for people using its website or app, while its privacy policy sets out how it will collect, use and share personal information gathered from the user. It is integral that comprehensive policies are drafted to address any number of possibilities that may occur when the public engages with an app or website. Well-drafted policies will reduce uncertainty in the event of a dispute with a user, and can limit liability for the business, its employees, officers, and directors.

 

Each province in Canada (other than Alberta) levies a sales tax on most sales of property and services provided within the province. Several provinces (including Ontario) have harmonized their provincial sales taxes with the GST to form a single Harmonized Sales Tax (HST). The tax regime for the GST and the HST is generally the same. The HST uses the same registration number as the GST and is reported on the registrant’s GST return. The combined federal and provincial components of the HST result in a combined rate of 13% in Ontario. Quebec’s provincial sales tax mirrors, but is not harmonized with, the federal GST. When selling to the public, businesses may be required to register and remit HST and GST. 


 

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