PRE-INCORPORATION PLANNING - HR

Planning for a new company starts before that company is incorporated as a corporation or organized as a limited liability company. Whether only one entrepreneur is involved or a small group of like-minded individuals are starting the work of developing an app, taking an idea and expanding it into a business plan or bringing to life a new type of service or product, a number of important issues have to be addressed before a new company is formally created. (Let’s call the business to be created “Newco”). In this initial blog we’ll examine one of the more important pre-incorporation issues: the entrepreneur’s relationship with his or her current employer:

Often, when Newco is still just an idea or a dream, the team members who will eventually create and grow Newco are employed at different jobs working for different employers. The entrepreneur and team members may be currently working, either as employees or as independent contractors, for companies other than Newco. Nothing slows a start-up down faster than a law suit brought by a current or former employer. If you are currently employed, you need to look at any agreements you may have signed which may limit your freedom to pursue your business idea. Even without a written document, there are legal doctrines which control your activities with regard to your current employer. First of all, if you’re currently employed, as an employee or contractor, and particularly if you want to keep your day job, you should think about whether you signed an Employment Agreement with your employer. You should carefully read the Agreement, if you have one, and determine if it obligates you to work full time for your employer and not be involved in any other business activities, even if you intend to pursue Newco at night on your own time. If you’re thinking about leaving your employment to pursue Newco full time, you need to figure out when your Employment Agreement ends, so you can leave. Many Employment Agreements are “at will”, which means you can leave or be terminated at any time for any, or no, reason. Some Employment Agreements allow you to quit or be fired for specified reasons. Other Employment Agreements have a concrete term, with a definite end date.

If you intend to keep your day job while working on Newco, you owe a duty of loyalty to your employer. This duty exists whether or not you are party to a written Employment Agreement. There’s no precise definition of the duty of loyalty, but clearly you can’t overtly takes steps which a reasonable person would consider to be detrimental to the interests of your employer. The level of loyalty is higher for an employee than for a contractor but to the extent that “improper” activities are involved in getting Newco off the ground, functionally, the duty is the same. The duty of loyalty exists while you remain an employee, and it includes steps which may occur while planning Newco and your exit from your current employer. Having a duty of loyalty doesn’t mean you aren’t allowed to plan and start your new venture, but it does mean things like not taking proprietary information, computers and office equipment belonging to the employer with you. It may mean you can’t take cost and pricing information and customer lists with you. You need to be careful about convincing suppliers, vendors, customers and other employees to cut their ties to the employer and move their relationships to Newco. You need to be careful about doing or saying anything which denigrates your employer.

In addition, you will want to confirm whether you (or any team member) signed a Non-Compete Agreement. This Agreement may be a standalone document or it may be a provision in your Employment Agreement. A Non-Compete is just what it sounds like: a restriction on your ability to compete with your current or former employer. It usually includes a description of the duties you can not perform, the customers you cannot solicit, the geographical territory in which you cannot be active, and/or the length of time the restrictions are in place. Non-Competes are probably not enforceable in California, but they may be if you’re in a different state or expect to have employees in a different state. You have to consider if Newco’s business is competitive with your current employment, whether your duties at Newco will be competitive with your employer, whether the restrictions in the Non-Compete are reasonable and whether the Non-Compete serves what would be considered the legitimate interests of the employer. People change jobs all of the time, but even in California, where Non-Compete provisions are generally unenforceable, there can still be legal liability based on other documents and doctrines, if you “improperly” directly compete with your former employer. A former employer has other weapons at its disposal. You may have signed a Confidentiality Agreement, a Trade Secret Agreement and/or a Non-Solicitation Agreement. The two former documents (which again may be independent documents or provisions embedded in an Employment Agreement) explicitly restrict and prohibit your ability to take and utilize at Newco proprietary or confidential intellectual property (“IP”) that belongs to your current employer, in addition to the limits created by the duty of loyalty. IP can include information in your head which you learned during your employment. You can’t unlearn information and know how, but you may be restricted in your ability to use confidential information, and you certainly cannot copy and take documents and materials which describe, discuss or constitute proprietary employer knowledge. The contents of the IP may further be restricted by copyright registration, patents and other vehicles or because they constitute enforceable Trade Secrets. The Non-Solicitation Agreement prevents you from talking your colleagues into leaving their employment to join you at Newco. Of course, they can leave of their own free will. The types of restrictions described in this paragraph usually stay in place for a period of time after you’ve left your employment, so they don’t disappear just because you’ve left the employer. The length of time the restrictions survive needs to be reasonable

In summary, once you are considering leaving your current employment, or staying and working on Newco during your off hours, you need to be acutely aware of any restrictive agreements you may have signed. In preparing to found Newco, you have to be careful that you do not physically take any files, hard drives or other material belonging to your employer which contain confidential information. You need to be aware that restriction terms you’ve agreed to, generally survive the period of your employment. Of course, the reason many entrepreneurs strike out on their own is that they want to create something completely different than the products and services being provided by one’s employer, or they want to do it differently or better. But to the extent there’s overlap – your employer is building mousetraps but you think you can build a better one, a cheaper one, or one with more appeal, you need to be very careful that you are not violating any agreements you signed in the past and that you’re not improperly using Trade Secrets or other IP that may belong to your about to be former employer. Otherwise, if Newco really represents, or becomes, a competitive threat to your ex-employer, or if your ex-employer is just nasty, you may find yourself in court before Newco has raised any money and before it has made any progress toward becoming viable.

There’s a lot to think about long before Newco is more than an idea in your entrepreneurial head. Remember that every situation is different, and anyone wishing to engage in the tech and start-up world should seek their own legal advice, tailored for their unique circumstances.