This week is all about legal stuff!
That lovely subject that founders tend to try to avoid or don’t understand. It’s hard to blame them – there are far too many documents involved!
However, although they often get missed, making sure you have the right legal details in place is critical to setting up any startup. Not being much of a legal expert myself, I decided to bring in a real expert to share some valuable lessons.
In this article, Jonathan will walk you through all of the legal details you need to consider when starting a business, and share some expert tips on what to focus on first.
You can also listen to our entire conversation with Jonathan by tuning in to episode 18 of our weekly podcast “From the Factory Floor”.
The shareholders’ agreement – the cornerstone of any legal structure
Jonathan: “Before you start any business, you first need to develop a level of trust with your co-founders or business partners. Then you can mould the legal details around that.
The Companies Act in the UK doesn’t give you any formal legal protection between shareholders and directors, so the first legal detail you need to have sorted is an insurance contract between the shareholders called a ‘shareholders’ agreement’. It’s an insurance policy that is hopefully put in a drawer and never used.
However, if the founders fall out or want to move on, it allows the remaining founders to get those valuable shares back.
That’s essential because as the business grows, the last thing you want is one founder that’s not involved in growing the business still having shares.
The terms and conditions and the software agreements can all be tailored once you start trading, but the shareholders’ agreement is something you want to do from the very beginning – it’s the founding cornerstone of any legal structure.”
I think all founders are a little guilty of going on Google and trying to do this themselves, but it’s far better to have a good face-to-face relationship with someone who is experienced in all the legal aspects of your business – it will be money well spent!
All entrepreneurs like to roll the dice, but lawyers know the rules of the game, so always try to get a professional to help you with these details.
Alphabet shares explained
All founders can benefit from having a deeper understanding of how shares are structured from a legal perspective.
For example, “alphabet shares” is a term you hear a lot these days, but what exactly are they? Rather than using Google, I decided to ask Jonathan:
Jonathan: “In my opinion, if founders are on an equal footing, they should have the same class of share – an A share.
This means they have the same rights before any investors come into the picture.
The only other class of shares are the B shares that can then be issued to employees who aren’t on the board, that you might want to tie into the company.
However, the main reason why you would have different classes of shares is for capital rights on an exit.
For example, if the company sells for £10 million, the founders would get an equal share of the first £5 million, and then the people who came later in the journey, the B shareholders, get the share of the next £5 million.
You have to think carefully about when you give these shares away, because when you’re bootstrapping a business, founders tend to give shares away rather than cash and can end up giving away too much.”
When to think about IP
Another crucial legal detail for tech startups is making sure their intellectual property (IP) is protected.
I asked Jonathan to share some tips regarding IP for any new founders:
Jonathan: “Under English law, when you write code, the copyright is the same as a book – its copyright is vested in the individual if they haven’t formed a company. So, when you form your tech company, any valuable code needs to immediately be vested in your company by a deed.
It’s very easy to do and can be wrapped up in a shareholders’ agreement by a simple paragraph!
Ensuring your IP is vested in your company is vital because when you come to raise your seed round, the only real asset you’ve got pre-trading is your IP. That’s the first thing the investor looks at, and if you’ve got a whole raft of consultants or developers that have worked on it, you need to make sure that if you’ve paid them, that IP is all vested in the company.
If you start vesting your IP at the beginning, every project you do will be structured, and it’s easy to prove where that IP is vested.”
That is great advice from Jonathan. One of the challenges with an early startup is making sure they have someone like Jonathan sitting at the table when these deals are made, because everyone just wants to crack on. However, if you don’t get this bit right, you may regret it.
So, once the shareholders’ agreement has been drawn up and the IP vested, what comes next?
The onion of legal details
Jonathan: “Think of your company as an onion. At the core, you’ve got The Companies Act. Layered around that you have your shareholders’ agreement and your articles, then you go to trading where you start thinking about your terms and conditions.
That’s where you commercialise your intellectual property, write up your terms and conditions of sale, software licences, NDAs, etc.
These legalities will all be bespoke to you, so you really need to get your accountant, lawyer or someone like tsf.tech on the phone to deconstruct the nuts and bolts of what you’re trying to do.
If you’ve had proper advice, when it goes to the customer, you’re fully covered on your data protection, GDPR and escrow agreements (if anything happens to you as a business, the software is protected). All these things are never really thought about initially, but these layers of legal protection are crucial to get right.
After that, you’re onto your management team and your directors’ service agreements, along with your sales contracts. These can be standard, but the key thing in any commercial business is a restrictive covenant.
This means that if anyone leaves, they’re not going to steal your customers and all your intellectual property!”
So, don’t be seduced by cheap online, automated Google legal documents. When it comes to the legal side, there can’t be any shortcuts. Get yourself a good lawyer you can talk to – like Jonathan!
To have a chat with Jonathan, feel free to email him at firstname.lastname@example.org, or give him a call on 07842405414.
I hope you have found this useful.
If you have any questions or would like to hear more about legal details, check out episode 18 of our podcast “From the Factory Floor”. Alternatively, feel free to email me at email@example.com.