Katarina Mihalikova, partner at Majernik & Mihalikova
April 13, 2021
There are so many matters requiring attention of startup executive. How to prioritize? What is the most important? Legal matters, even though often looked at with resentment, definitely belong to those deserving your attention at the very early stage of you entrepreneur’s adventure. Not only to make your life easier but also because a tidy legal background is a good indication for an investor that your company is worth investing in.
The brief guide represents some of the top legal issues to be addressed by startups.
Please note that his article is jurisdiction-wise non-specific, i.e. you should consult your lawyer in your specific jurisdiction for country-specific legal information.
It is very common among startups that projects have to quit before they even started. Lack of communication about “unpleasant” topics leads to disputes and misunderstandings between the founders at the very early stages of their projects.
Therefore, you should not put on hold discussion about:
(a) how much time should each of you commit to your project;
(b) whether founders can be active also elsewhere or their relationship with the company is exclusive;
(c) what are their respective responsibilities in the company;
d) what topics require joint decisions;
(e) what will be their shareholding stake;
(f) whether any reverse vesting (i.e. obligation to return the shares) shall apply if the founder leaves the company or does not perform as expected.
This could be an informal discussion at first, but it will help to outline the expectations and lay a foundation for a formal document reflecting the agreement of the founders. A detailed discussion early in the process will either help to ensure transparency of your future relationship or, in a less ideal but also enlightening scenario, will reveal the difficulties in communication between the founders.
To find the right corporate set-up is like reading the future. It is like deciding what car you will buy in 10-years time without knowing if you will be single or have 3 kids, if you will work as a mason or accountant and if there will be only electric cars or not. Nevertheless, you should try to draw a picture of things to come best you can.
There are two basic decisions you will make - choose the type of the company you wish to set up and choose how will you hold your stake in the company, whether directly or indirectly. It is very important to understand tax implications of the setup you choose. Hence, your first step should be to consult a tax expert; who can adjust the corporate set to a favourable tax regime. You certainly want your company to be a capital company, i.e. the type of company where the shareholder is not providing a guarantee for liabilities of the company.
For startup entrepreneurs, the top expectations from the legal form of the company are that it is flexible; this means that it allows shareholders to freely attach variable rights to shares (to profit, to vote, to participate on the registered capital). Once you establish the company, you need to care for it, i.e. perform necessary maintenance required in your individual jurisdiction (whether it is to convene regular general meetings or file tax returns).
Whether you are in software industry, or your product is an innovative hardware, you should bear in mind that the value of your company, through the optics of the outside world is in (i) your team and (ii) your intellectual property (“IP”). Therefore, proper protection of your IP is imperative. There are several angles of IP protection and if these apply to you, you should have them covered.
Be the proper legal owner of your IP. You wish your company to be proper legal owner of intellectual property protected against potential claims of authors/inventors. Therefore, you should have proper paperwork in place proving that company is sole proprietor of IP regardless of whether the IP was created by its employees, executives, or freelance individuals or corporations.
Conclude non-disclosure agreements. You do not want your contractors, employees or freelancers to walk away with your know-how and confidential information and share them freely. Therefore, you insert confidentiality clauses into your mutual contracts. Same goes for your suppliers, business partners or potential investors. It is prudent to conclude non-disclosure agreement with them, protecting your know-how, IP or other confidential information.
If possible, record your IP in public register. If you can record in public register, that you are rightful owner of intellectual property (invention, software, design, trademark or anything else) and it makes sense from tactical point of view, do it. Beware that this might be costly adventure, time wise as well as money wise. Generally speaking, you should be also checking if you do not breach someone else’s intellectual property, especially if you are in doubts. Again, be prepared that this will cost you.
Many legal practitioners agree that no one (at least in many European countries) complies with ALL regulations and rules. No one. There are so many regulations that any entrepreneur having an ambition to achieve this would have to employ a few people to get there. Best course of action here is to choose wisely those regulations that are the most important. Obviously, you should avoid any criminal activities. This goes without saying, therefore let us focus on the areas that definitely belong to the top tier:
You can be smart about structuring your corporation to achieve tax efficiency within the permitted framework, but it does not mean you should avoid paying taxes. Same goes for any social security or health insurance contributions applicable in your country. Beware of the deadlines for filing tax returns. Authorities have little understanding for people avoiding these basic entrepreneurs’ obligations.
Your employees are key to the success of your business. Therefore, they should be treated fairly and with respect. Also, make sure that formal attributes of the employment relation are captured properly, i.e. do not underestimate good labour contracts.
If you do business in a regulated industry (finance, insurance, healthcare, energy etc.) you might be required to meet higher regulatory requirements such as specific trade license or necessity to hire professional representative with certain education or set of skills etc.
Personal data protection is a by-product of an era in which data is hardest currency. Many business people detest GDPR and view it as an impediment of the business (sometimes rightly so). But in general, this is a topic which will grow on importance and it will not go away. Authorities impose high penalties for breach of GDPR rules and that is a risk to your business. If you want to handle this problem well, bear in mind that it is not a one-off thing where it is sufficient to produce the necessary papers, put them in the drawer and forget about them. It is a process, lively organism, developing every day and it deserves the committed attention of at least one person in the firm.
You should know your customer. Especially entrepreneurs building scalable businesses, selling all over the world should be cautious. It is easier said than done, especially if you for example sell software. You should be checking your customers and make sure that they are not blacklisted by UN, EU or US. Sometimes, to make an assessment if it is risk to sell your product to a specific client might be complicated and you will need to seek an advice of a specialized lawyer.
You should be transparent about your ownership structure and be able to prove it. It is still harder to open a bank account in many European countries. Bear it in mind if you decide to set up a company or holding company in jurisdictions where there are no official proves of ownership structure (e.g. Delaware). Aiming for minimum corporate governance, your company should always have
- registered address where it accepts regular mail,
- properly appointed statutory bodies,
- by-laws or any other documents required by law that are properly filed with public authorities (if applicable),
- its shareholders should convene for general meeting and
- it should meet other applicable statutory duties (filing tax returns etc.).
Downloading contracts from the internet may sometimes seem a good idea saving time and money. And sometimes it can well be the case, but rarely it will be a long term and systematic solution when building a professional firm. Each of your contracts should be aligned with other contracts – for example your end user license agreements should be in line with the license terms you have received from your component providers. When you sell through stores, your contracts with end customers should reflect the terms of Apple or Google you have adhered to. Your confidentiality clauses in different types of agreements should be aligned as well. The contracts with your authors/coders must be reflected in the terms of license you are granting.
It is like a giant puzzle where all pieces should fit together, and this is hard to achieve if each piece is from a different puzzle set. Hence building a stable and long-time contractual base is a project that will evolve and improve over the time.
Also, try to avoid the common mistake – when you successfully conclude a contract it is not the end, it is just the beginning. Contracts need care and administration, usually there are regular obligations you need to comply with (reporting, sending notices, various information obligations, automatic prolongation/termination, obligations surviving termination, competition ban etc). Therefore, you should aim to build up a system in which the contracts are monitored until they terminate and sometimes even beyond that.
This is a brief outline of the matters you should pay attention to and it is rather high level. Most of the topics would deserve much more coverage and so would the others we have not addressed here. But if you are diligent in the above, it might determine if you pass an ultimate test – get a quality investor on board or exit at good conditions.
// Katarina Mihalikova is a managing partner at Majerník & Miháliková, a law firm based in Bratislava, Slovakia, where she advises startups, founders, investors and VCs. She is a recognized member of the Slovak startup community and regularly mentors founders.
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