Startups

  • Incorporation – What, Why, Where and How

    Over the next while I’ll be posting on some of the more common questions I get from clients. Please feel free to leave a comment if you have something to add. Today, it’s the basics of incorporation.

    What is incorporation and why do I need to incorporate my business?

    Incorporation is the process that legally creates a corporation – a form of organization that is probably the most common form for technology businesses. There are many reasons for this, but the three most important are probably the tax advantages one gets from incorporation; the corporation’s independent, perpetual existence; and the corporation’s limited liability. The latter two mean that a corporation is a separate legal person, distinct from its owners, and that in general the owners do not have anything at risk other than their investment in the corporation. For obvious reasons, these characteristics facilitate operating, financing and selling businesses.

    Not every business needs to incorporate – sole proprietorship and partnership, for example, are popular vehicles in many contexts.  But the typical life-cycle of a technology business involves activities and relationships with third parties that make incorporation the best choice in most cases.

    Where do I incorporate?

    Incorporation is done in Canada under one of our many provincial and federal incorporation statutes. These statutes used to be quite different in important respects, but in recent years they’ve mostly been conformed and they’re now very similar (though there are still some differences that can matter for specific needs).  In Ontario, the Business Corporations Act is probably the most common statute used, but many businesses based in Ontario are incorporated under the federal Act, called the Canada Business Corporations Act (“CBCA”). Generally, because of cost and duplication of effort considerations, most businesses in Canada incorporate under their home province’s statute or under the CBCA.  Here is a recent paper from Wilson Vukelich, co-authored by my friend Jordan Dolgin, explaining some of these considerations.

    How do I incorporate?

    Incorporation is a pretty simple process. There is a government fee to pay and forms to complete, but that’s about it. Here’s a slightly dated but still useful outline.  And here’s Industry Canada’s guide to incorporating under the CBCA, and a couple of guides for Ontario. There are a few services now that will do your incorporation online. Or you can consult a lawyer, who can do it for you.

    What about the company’s name?

    I usually advise clients to defer picking a name until the dust has settled on choosing the brand. Most of the clients I work with will change their vision of the brand several times before they settle on their final choice. As a result, I usually suggest quickly locking down relevant domains on any possible choice, but staying with the default numbered name (eg., 1234567 Ontario Inc.) until the choice is settled and the brand is ready to be used in public. Once you’re ready to pick a name there is a search process that must be undertaken to ensure that the name can be used as the corporate name.

    Picking the name is obviously a longer discussion, but before it’s settled it’s a good idea to do an exhaustive search, including in trade-mark registries, for similar names. And if the business is carrying on business or identifying itself to the public under a name other than its corporate name (eg. a brand name different than the corporate name), that name should be registered under the Business Names Act.  Finally, trade-mark registration, while costly to the typical startup, offers some advantages, and should be considered at some point.

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  • Startup ABC’s – Pre-Startup IP Issues

    (This post is a condensation of a conversation Rick Segal and I recently had in a session at StartupEmpire’s StartupSchool)

    I think many people would be surprised to hear that there are important steps you need to take for your new business before – even well before – you start it. But it’s true. The single most common request I’ve had over the past year from startups is to help them deal with intellectual property ownership problems created because of pre-startup work relationships. Indeed, in the last year I’ve seen one startup abandoned because of this issue and one exit scrapped. And many other problems have been worked through, with varying degrees of success and difficulty. All of this is a shame because these are generally easy – at least relatively – problems to address if you get at them early.

    What’s the issue?

    Generally, your employer expects that work you create on the job belongs to them. After all, you’re getting paid for it – this is only fair. Where your work product is protectable by copyright, the Canadian Copyright Act echoes this principle in Section 13(3), which says:

    Where the author of a work was in the employment of some other person under a contract of service or apprenticeship and the work was made in the course of his employment by that person, the person by whom the author was employed shall, in the absence of any agreement to the contrary, be the first owner of the copyright, but where the work is an article or other contribution to a newspaper, magazine or similar periodical, there shall, in the absence of any agreement to the contrary, be deemed to be reserved to the author a right to restrain the publication of the work, otherwise than as part of a newspaper, magazine or similar periodical.

    I’ll make two points about this. First, putting aside cases where the work is an article or other contribution to a newspaper, magazine or similar periodical, the copyright in work “made in the course of employment” belongs to the boss. Second, because this is triggered by employment, it applies only to employees – this means that in Canada the copyright in work created by a person who is not an employee – we generally call these people ‘independent contractors’ – is owned, in the absence of any agreement, by the independent contractor.

    What the Copyright Act says is only the beginning, though. Many employers – probably almost all in the tech sector – are not content to leave this issue to the Copyright Act. They prefer written agreements with their team members, generally because (i) there are intellectual property rights created by their employees (such as inventions, trade secrets and others) that are not addressed by the Copyright Act, (ii) they also work with people who aren’t employees, and are therefore not covered by the Copyright Act, and (iii) there are other aspects to the business relationship, like confidentiality, payment, non-solicitation, and many others, that should also be addressed in a written agreement.

    As a result, one of the first things one gets from a potential new boss is their form of employment agreement or consulting agreement, and sometimes also a separate IP ownership, confidentiality and non-solicitation agreement. Sometimes the provisions of these agreements that deal with IP ownership are very similar to the words used in Section 13(5) of the Copyright Act – they state that the company owns work created “in the course of employment”. But usually they go further than this, and claim for the company not only work that is created in the course of employment, but other work as well.

    Here’s an example. One pro-company formulation of this concept that I see quite often says that anything created by the worker during the calendar period they were working for the company (whether during business hours or not – whether in the office or not – whether using company equipment or information or not – even whether working on a project requested by the company or not) is owned by the company. While this is an extreme example, I see troublesome language in these contracts all the time. And I’ve seen many problems in these contracts caused by drafting errors – even very serious ones (these problems are not, I’m sad to say, rare, and can often make it very difficult to sensibly interpret a contract). I’m not saying, of course, that there aren’t cases where an approach that might at first blush seem extreme isn’t appropriate – but those cases are pretty rare, at least on the ‘net.

    Why is this an issue for tech startups? Well, code, visual design and written work is often the subject of copyright. And all of these forms of work – as well as others that are potentially copyrightable – are often developed by and for tech startups, especially those active on the Web. But if the individual creating that work was working for someone else when the work was created, the chances are pretty good that the Copyright Act or a written agreement between that individual and that someone else raises questions about who actually owns that copyright. And if you don’t settle those questions early – preferably before the work is created – you could have problems – potentially very serious problems – later on.

    How? Here’s an example that mashes together a few cases I’ve worked on recently: A client approached me wanting to sell his business. The main asset was an app. The key team members had written the code in the evenings and on weekends while they were employees of another company. The work was outside of their employment with that company, but to be sure about their position, they approached their supervisor to tell him what they were doing on their own time, and the supervisor verbally acknowledged that that side project was not the property of the company. Fast forward, and the team has left their former employer and is now in their own company, working on the app full-time, and is approached by a potential buyer. The buyer does some basic due diligence and learns that the core of the app was built while the key team members were working for the former employer. The team produces their old employment agreements, and discover that they contain copyright ownership language that seems to be very much in favour of the employer. I say “seems to be” because what’s more, the agreements are not well-drafted – people reviewing the documents can’t say for certain who owns the copyright created during the team’s employment, or since. Worse yet, the buyer is a competitor of the former employer and suspects that when the employer learns about the deal it might want to interfere just to slow down the competition. Cue litigators. Cue sick feeling in your stomach.

    How Do You Deal With This?

    There is only one sure way. Before you sign an agreement giving someone else rights to what you create, review it carefully. If you’re not sure about your position, have it reviewed by a lawyer. If you still have concerns about your ownership of Project X, clear them up with your boss in writing. And if Project X isn’t yet on the horizon, raise it as soon as it is – ideally, before you start working on it, but certainly before you start creating meaningful work product.

    For a variety of reasons, people are often reluctant to raise these issues with their boss. First, they don’t want the boss to know they’re living another life or planning a departure – it’s important, for promotions, bonuses and the like, to be seen as loyal and committed. Second, they don’t want to be seen as a complainer – someone who “can’t see the big picture” and gets bogged down in “unimportant detail”. And of course, sometimes Project X will compete with the employer – the worker has figured out an approach that they think is better – and breaking that news to the boss is trouble for a variety of reasons.

    I think some of these concerns are often misplaced. Many people understand now that no one is just one thing in the world of work. And the best employees often have a lot more than just one thing going on at any one time. Smart employers seek out creative people, and are not surprised when their creativity takes them in new directions. And smart employers know that someone who is particular about detail and principled about setting correct expectations before they start work will behave that way on the job too.

    But only you can decide what the right approach is in your situation. Just be aware that keeping your head down now could create serious problems later on. And keep in mind also that written agreements with your boss sometimes also contain language requiring you to keep your boss informed of even your outside projects.

    Last, you should keep in mind that every member of the team you might be putting together is in the same position – you need to vet all of them to make sure no one is coming aboard with a problem.

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