From our experience advising growth companies, there is often a common but understandable trend of entrepreneurs overlooking legal formalities in the early stages. The journey of any start-up will have high and low points, but there are a number of risks that can easily be avoided by dealing with certain issues from the start. The Leathes Prior Technology team has set out some of the most important of these below;
1. Think carefully about your corporate structure
The corporate structure of any business is fundamental to its operation and management. Although there are various corporate vehicles that can be used to run your business (such as limited liability partnership or as a sole trader), most growth businesses are typically run through a limited company structure. If this is the case, you will need to consider certain key matters, including how shares are held in the company, which individuals will be appointed as directors and the company’s constitution.
Understandably, founders can easily overlook the company’s governing documents, such as its articles of association and shareholders’ agreement. Founders often believe that their time is better-spent on product delivery and growth, rather than legal formalities. However, by adopting a longer-term view, entrepreneurs can better protect their investment; in particular if things go wrong further down the line.
Articles of association will set out the constitution of a company, dealing with various matters from the composition of the board of directors to the rights that attach to the shares. For growth companies, it is important to consider any restrictions on the issue and transfer of shares, and what happens if a founder wants to leave the business. Without bespoke Articles, in the event of a dispute, there is scope of ambiguity which can be time-consuming and expensive.
A shareholders’ agreement is a private agreement between the shareholders of a company in order to properly govern their relationship moving forwards. This document may include a policy on the payment of dividends and any specific “reserved matters” that require the consent of a certain number of the shareholders.
Dealing with these formalities early on should set a defined path for the development and expansion the business, with clear guidance in the event that there is a break down in relationship between shareholders.
2. Record your business plan
For some founders, a business plan is a collection of mental notes or informal assorted scraps of paper. For others, business plans are considered too vague or headline to have any meaningful use. However, a business plan can add real value to an early-stage growth company and, in particular, assist founders in focussing their minds on short and longer-term aims.
For example, in the short-term, how will the company be funded? How many staff are needed? Where will the business operate from? What scope is there to accelerate the growth of the business? As a matter of long-term strategy, founders may also consider preferred exit plans, to give focus to their overall objectives.
Founders should also take account that any potential investors or funders would usually expect a clear business plan as a matter of course before being prepared to finance the business.
Remember that business plans should be sufficiently detailed and realistic, with evidence to back-up any assumptions or forecasts, where possible.
3. Protect your intellectual property
For most tech-based growth companies, the development or use of unique intellectual property (IP) will be core to the value of the business. Whether IP subsists in a company’s source code, product design, branding or engineering, there are various ways to protect against unauthorised use by third parties.
However, the starting point for any business with potentially valuable IP is to understand what exists and who has ownership. For example, was the IP created by the founders before the company was set up? Was it created by a freelancer without any consultancy agreement? It is often the case that IP has been developed by one or more of the founders in a personal capacity.If so, it should be assigned (i.e. transferred) to the company, as otherwise if that founder leaves, then he or she may be able to prevent the company from using it in future. Likewise, any investor or funder will normally require evidence that core product IP belongs to the company.
Once the company is comfortable that it owns the IP, the next steps will be to consider if and how to protect it. There are different ways to protect different types of IP. For example, if you have developed a key logo or trade name for the business, then you may want to consider registering them as trade marks. Alternatively, if you have a designed a physical product, then it can be protected by way of registered design right.
Failure to formally protect IP (through registration, where possible) does not automatically mean that the company does not have any rights, but the company will have a reduced ability to prevent third parties from using that IP. As such, if the foundations of the business are built on specific IP, and it is not properly protected, there is a risk that the business itself will be devalued.
4. Prepare bespoke employment contracts
One aspect commonly overlooked by entrepreneurs in early-stage growth companies putting employment contracts in place with staff. For tech-based companies, this can present particularly high risk, as employees are likely to be developing IP as part of their job role (and not always during regular working hours). In these circumstances, founders will want to ensure that the IP properly belongs to the company and that the employees cannot claim that they own the IP in a personal capacity at a later date (for example, when the business has grown in value) or otherwise make use of it in another business which competes with the company. As such, employment contracts should contain specific IP provisions confirming that anything they develop for the company during their employment belongs to the company, to avoid any doubt over ownership.
Equally, it would normally be appropriate to include business protections in employment contracts for key staff. Without proper employment contracts, employees can leave the business and set up in competition, or approach customers or suppliers without recourse. This has the potential to cause financial and reputational damage, which will distract the founders from their other management responsibilities. With that in mind, you can mitigate the risk by including tailored restrictive covenants in your employment contracts for key staff, which look to prevent your employees from setting up in competition, or actively soliciting your clients, after they leave your employment. These should be specific for particular job roles, in order to increase the likelihood of enforceability, rather than standard form across the organisation. For example, if an employee does not have any customer contact, then a restriction on approaching customers is probably not going to be appropriate.
For early-stage growth companies that have limited cash reserves, granting share options is often an attractive way to incentivise key members of staff. For more information, see our article here.
5. Formalise commercial terms
Once a business has developed its minimum viable product (MVP) to take to the early-stage market, then some thought should be given to the terms on which the product or services are being sold. Depending on the nature of the business, these could take the form of standard terms and conditions of supply, or software licence agreements with customers.
Preparing commercial terms for sale will avoid customers seeking to impose their own terms and conditions, which are likely to be much less favourable to you, and should give comfort to allow you to finalise contracts quickly and easily. Likewise, considering the terms of sale may assist in flagging any potential issues that you have not yet dealt with. For example, what is the duration of the contract? In what circumstances can you or your customer terminate? What payment terms will apply? These are all key commercial factors that will impact on your customer relationships, and provide clarity in the event that the relationship with a customer breaks down. If your business is licensing software, then you will also need to take into account use and protection of your IP.
Leathes Prior can assist with all of the above and more. For further information please visit our Technology page, call us on 01603 281158 or email us directly on firstname.lastname@example.org.
Note: The content of this article is for general information only and does not constitute legal advice. Specific legal advice should be taken in any specific circumstance.