What Legal Precautions Should I Take Before Pitching My Startup Idea to Investors?

An idea can turn into a unicorn business if the right amount of funds can be raised at the right time with the right set of terms. Formation of a startup is the second most important step; the first important step remains pitching the idea to the investors. A little financial help from the investors can help the business to turn the most brilliant ideas into a reality. This article explores the legal precautions that the startups should usually take before pitching their idea to investors in order to uphold their interest and growth.

1. Non-Disclosure Agreements (NDAs)

An NDA is a legal contract that binds the parties to keep the information confidential and in concealment. Whilst pitching an idea to the investor, it is possible that the investor may disclose the idea or implement it himself. To avoid the same, an NDA can be signed before making the pitch. However, in some cases NDA forms may backfire due to the reluctancy of various investors to sign them. Thus, NDAs should only be included in the scenario where it is absolutely necessary. NDAs are most effective when you're sharing highly sensitive, detailed technical specifications, proprietary algorithms, or trade secrets that aren't easily discernible from a high-level pitch. They are more common in later-stage discussions or with strategic partners.

Another alternative for NDAs is sharing only relevant information by focusing on the problem, the solution, and the market opportunities.

2. Intellectual Property Protection

Intellectual property rights are the exclusive rights provided over the usage of the work to the creator of that work. Intellectual property includes copyright protection, trademarks, patents, trade secrets, and geographical indications.

• Patents: In case the startup idea involves a novel innovation, process, or design, the inventor shall consider filing for a patent before the disclosure of the same. The patents remain valid for a period of 20 years. One may even opt for ‘provisional patent filing’ in order to secure an early filing date without meeting all the requirements of a provisional patent. It must be noted that the ‘provisional patent’ expires within 12 months if not followed by the complete and formal patent application.

• Trademarks: These are the marks that distinguish the goods and services of one entity from those of other entities. It protects brand name, logo, sound, slogan, tagline, etc. Registration of a trademark would ensure that the no one else is using the same brand identification mark. This does not only set the startup apart but also provides a reassurance to the investor with respect to the uniqueness of the business.

• Copyrights: Copyright is the protection that subsists in original literary, artistic, dramatic, and musical works and in cinematographic films and sound recordings. Formal registration, although advisable, is not mandatory for the copyright protection. The reason being that copyrights automatically subsist once the creator has translated his idea into a tangible form of expression. Registration of the copyright can serve as crucial evidence for protection of computer programmes, software codes, marketing material, scripts, app design, etc.

• Trade Secrets: Trade secrets, as the name suggests, constitute confidential business information. They are not liable to registration but can be protected via strict internal policies, NDAs, limited access, etc. Trade secrets can be protected for an indefinite period, i.e., unlike patents and copyrights, they do not have an expiry date and would continue to be a secret as long as the information is not being made public by the interested entities. Thus, startups cannot directly protect them through registration but can create agreements that provide the terms and conditions for non-disclosure of such information.

3. Incorporation of the Company

A company comes into existence only after it has been registered under the Companies Act, 2013, with the Registrar of Companies. Before pitching the idea to the investors, incorporation of the company should be carried out. It does not only increase the confidence of the investors in the idea but also projects the seriousness of the founder with respect to his notion. Under the Companies Act, 2013, different kinds of companies have been provided, for instance, private limited companies, one-person companies, and not-for-profit companies. One may check the characteristics of each kind and proceed with the most viable option according to the affairs that the business might be engaged in.

4. Clean financial and legal records

A startup shall at least maintain basic accounting records before pitching an idea to the investors. Mandatory legal compliances should be obeyed. A startup may even get itself recognized under DPIIT (Department for Promotion of Industry and Internal Trade), as it provides tax exemptions for 3 years along with other benefits.

5. Legal advice from an Experienced Legal Counsel

It is essential for any startup to actively take legal advice from a legal counsel who specializes in this behalf. It would help the startup to comply with the Indian laws to avoid any mishap. Furthermore, legal guidance is of paramount importance whilst entering into agreements. An experienced legal counsel would help the startup to gauge the profitable deals with favorable terms and conditions.

6. Founder Agreement

Before involving any third party, the startup shall have a clear Founder Agreement to regulate the internal working. A Founder Agreement shall cover all the important aspects from equity split to exit clauses. This would help in keeping the functions divided and would prevent conflicts.

7. Preparation and understanding of the term sheet

A term sheet is a non-binding document that outlines the key terms of the proposed investment. The term sheet usually outlines the provisions relating to the valuation of the company, equity dilution that is proposed/accepted, voting rights of the investor, board seat, etc. A proper perusal shall be carried out of the term sheet, preferably by the specialized attorney, before engaging in any permanent deals.

In conclusion, pitching an idea to the investors can be stressful. It might be a make-it-or-break-it moment; thus, it is important to keep a few things in mind before proceeding with deals at early stages. Legal precautions, such as safeguarding one’s intellectual property and asking for legal guidance before signing a term sheet, are essential to protect the ideas in the long run. This does not only protect the startup from being taken unfair advantage of but also shields them from unfavorable dealings. Taking sensible legal precautions at the early stage itself provides them a solid foundation and successful partnerships.