Lawyers at Fox Williams act for companies of all shapes and sizes, including early-stage startups with founders of varying levels of experience. While most founders are hard-pressed for time and cash, obtaining the right legal advice at the appropriate juncture can minimise headaches, and potentially even dealbreakers, in both the short term and the long term. Major events in the life of the startup that could be helped with legal expertise include dealing with due diligence requests on a new investment round and co-founder or senior employee exits.
Five common startup mistakes
Below are the five most common legal mistakes made by startups and tips on how legal expertise, sooner than later, can make all the difference;
1. Neglecting your company books
Understandably, many founders regard maintaining their company records as a purely administrative task and, therefore do not make it a priority. However, it is important to ensure that your company’s statutory books (for example, its register of members, register of persons with significant control and register of directors) are in order. This is because, in addition to being required as a matter of company law, those registers are evidence of the matters set out in them and, therefore, can be critical to establishing the key corporate details of a company, such as its shareholders and directors.
Most investors conducting due diligence on your company will ask to see these statutory books to ensure their understanding of the key corporate details of your company is correct, which in turn helps them confirm the price at which they will invest. Naturally, a cap table and Companies House filings are important to the investor’s diligence exercise but are generally not sufficient for an investor to get comfortable as to the share capital position of a company; the statutory books are key to this analysis.
If your statutory books are inaccurate, out-of-date or simply don’t exist, this can give rise to a number of potential issues in the context of a transaction such as a delay to the deal timetable and post-completion claims from investors. Therefore, it is advisable to ensure these are correct and up-to-date in advance of undertaking an investment round.
Where a lawyer can help: While you will need to guide us as to the factual position of such matters, we can provide advice on constituting, reconstituting and updating your statutory books.
2. Waiting to plan how to allocate equity interests to co-founders and employees
It is common for startups to incentivise founders and employees with equity interests in the business. For founders, that equity often takes the form of shares issued upfront, whereas for other employees, it is often preferable to grant options over shares instead, using a tax-advantaged scheme if possible.
As your company will hopefully gain value over time, it is generally sensible to grant those equity interests early in the company’s life cycle, to minimise possible tax complications for both the company and the individuals in question.
Getting those share issuances and option grants right is of the utmost importance. As mentioned above, there can be tax issues if this is not done properly. In addition, you need to consider what happens to those shares or options if your co-founders or employees are not performing well or decide to leave the business.
Where a lawyer can help: Our experts can assist with this process, including providing advice on whether shares or options are more appropriate, whether there are tax-advantaged schemes that the company and employees can benefit from, and the terms of any equity awarded (e.g. voting rights and good/bad leaver provisions).
3. Adopting model articles of association without due consideration
Your company’s articles of association are, in essence, a public rulebook as regards the company’s corporate governance (such as rights attaching to shares and provisions relating to convening board and shareholder meetings). Companies sometimes, but not always, supplement their articles with a shareholders’ agreement, which can set out further provisions relating to corporate governance if it is preferable for those terms to be documented privately. In contrast to a company’s articles, a shareholders’ agreement generally does not need to be filed at Companies House.
Many founders will opt to use ‘model articles of association’. These are the standard, short-form, articles of association which you can elect for your company to adopt as part of the Companies House incorporation process.
In some cases, the model articles will be perfectly adequate. However, you will need to consider whether you are comfortable relying on their fairly basic provisions, which do not deal with matters such as departing founders (meaning any departing founder-shareholder will be entitled to retain all of their shares, even if they leave to work for a competitor) and may not account for your company’s unique dynamics as regards its shareholders and directors.
Where a lawyer can help: We can help you consider whether producing a bespoke set of constitutional documents is appropriate in the circumstances and can produce those documents once we understand your needs.
4. Not protecting intellectual property
More often than not, a substantial part of the value in a startup is attributable to its intellectual property (IP), including trade names, brands, logos, patents, trade marks and software.
As such, ensuring that all material IP is owned by the company and suitably protected is crucial. Most potential investors will factor this into their due diligence process.
If, for example, material IP has been created for the company by a third-party consultant or contractor but no IP assignment exists (meaning, most likely, the company does not own the IP), obtaining a suitable IP assignment may become a condition to securing investment. It is not always straightforward to obtain such an assignment (e.g. if the consultant requests payment for the same or cannot be located). Therefore, it is important to ensure IP ownership and protection is dealt with at an early stage and ideally as soon as, or even before, the IP is created.
Where a lawyer can help: We can assist with ensuring your commercial agreements and employment contracts contain suitable IP provisions, as well as providing advice on ways you can protect your IP.
5. Not putting it in writing
We appreciate that in some cases a verbal contract or an agreement made over email can provide flexibility for your startup and will be cheaper than instructing lawyers to draft a contract – at least in terms of upfront costs, but almost certainly not in the event that an issue develops as regards the performance of that verbal or informal agreement.
However, most of the time, it is sensible to put your agreements with employees, consultants and commercial counterparties in writing. As your startup grows over time, it is common for misunderstandings or miscommunications to arise and for relationships to change. In such a case, you will want to be able to point to a formal written agreement which clearly sets out the responsibilities and rights of the parties involved.
In addition, potential investors performing due diligence on your company will want to ensure that the business’ most important relationships are properly documented. If the terms of your relationships with key employees, consultants and commercial counterparties are deemed inadequate by the investor, or simply haven’t been documented, entry into new or amended written agreements can become completion deliverables, meaning they could potentially delay the transaction timetable.
Where a lawyer can help: We can help you document the terms of both new and existing business relationships. Our Employment team can produce a tailored contract or consultancy contract on market standard terms, dealing with key terms of employment or engagement and matters such as post-termination restrictive covenants (including non-compete clauses). Further, our Commercial & Technology team can assist with pulling together commercial contracts, including drafting service level agreements, licence agreements, SaaS agreements, agency agreements and more.
Conclusion
Given our wealth of experience with start-ups and investors alike, our lawyers can provide pragmatic and cost-efficient advice to founders on these (and many other) topics to help overcome the common startup mistakes.
We are always happy to have a conversation with you about your business and any specific matters that may arise over time – not just when a matter has reached a critical point.
We recommend you contact us as soon as you become aware of a material, or potentially material, matter (such as a dispute or investment), as obtaining advice at an early stage can be critical to how the matter develops.
If you would like more information, please contact a member of the team or speak with your usual Fox Williams contact.
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