Andrew Dalton

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Nov 18, 2019 · 7 min read

Step 1: Set up “a” company early on

It’s not uncommon to find a group of people who have been working together on a product or business idea for quite some time that have not yet set up a legal entity to secure their business. However, whether your start-up is based in Vientiane or the Valley, establishing a basic corporate structure from early in a business’ life should be a top priority for any founder who has evolved from the Starbuck’s table-for-one stage to developing his or her great idea with a team.

Get an operating company

While it doesn’t mean you need to create a multi-layered, multi-jurisdictional behemoth group structure just yet, putting in place your first simple “operating” company now will likely save headaches in the future and put you on the right track for success. Indeed, while getting your early-stage business neatly bundled into a sparkling new company may cost you a small amount of time and money, once you’re “incorporated”, a whole host of advantages are readily available, such as:

Clear allocation of ownership

Due to (quite properly) focusing on product development and running on a bootstrapped budget, in the early stage of a business promises are often quickly made (and sometimes differently remembered) around who owns what from the outset, what later joiners will receive, and how service providers and freelancers might be rewarded with shares rather than cash.

While equity incentivization is an industry-wide practice that investors strongly encourage, if not administered and recorded properly, issues including ambiguity around exact ownership of a business can arise. A lack of clarity as to who holds what economic rights sows seeds for future division and discord amongst founders, team members, and even early investors. Worst of all, it can even result in distraction from the job in hand — building the business.

While it’s not always essential to actually issue shares (indeed options over shares subject to vesting and differing “leaver” treatment are often a better solution as your team and business grows) — or even strictly necessary to already have a company in place to clearly record ownership agreements — it’s in everybody’s best interests to clearly agree ownership from the outset in writing. Having a basic corporate “capital table” to work from is usually the clearest, easiest and most robust way to administer this as the number of stakeholders grows.

Intellectual property protection

There will likely be a multitude of people working for your start-up at different times, whether as employees, external contractors or, at an early stage, even friends and peers under no formal contract. While it will sometimes be clear that certain innovations, product features or code may be attributable to certain team members, many others will likely be the result of collaboration and improvement by a changing composite of people over time, some of whom may not stay with the business in the long term.

From an investor’s perspective, any lack of certainty as to formal ownership (or at least usage rights) of the product or any critical intellectual property being created or used by your business not only undermines your professional credibility but may diminish valuation or, in extreme cases, even investability of the business.

As such all business-critical intellectual property must belong to the corporate structure that investors are putting their hard-raised dollars into. The automatic vesting of intellectual property into an “employer” company cannot be guaranteed under local law in many jurisdictions, so the simplest step to protect your businesses is to have all people involved in product development in any capacity whatsoever sign an agreement at the outset with the company assigning all intellectual property to the entity.

Other benefits

Trading through a company from the get-go has a host of other benefits for a start-up: your ability to conclude contracts on market terms with certain counterparties may be improved (be it customers, suppliers, landlords or lenders); taxable losses arising particularly during the R&D/pre-revenue stage may be more easily protected and carried forward in some jurisdictions than if you incorporate later; and banks and certain types of corporate clients will find it easier to digest working with a corporate SME rather than a disparate group of individuals.

Step 2: Build the structure to power your future growth

The simple single company approach outlined above will likely be adequate in many jurisdictions to get you through the angel/seed stage where invested capital is likely to be small and largely local, and revenue generation limited. However, as your company starts to grow and capital requirements increase, for start-ups in many emerging economies, it will be valuable to consider if it’s time to think more carefully about your optimal structure.

Pick the right jurisdictions

Generally speaking, it makes sense to have your operating company in your “home” jurisdiction, regardless of whether it’s Nigeria, Vietnam or Ukraine. With team members to employ, working space to rent and basic corporate bank accounts to be opened, it’s usually necessary (and sometimes a legal requirement) to have a local entity that counterparties can easily understand and be comfortable with.

However, for start-ups in many emerging markets, local shortages of Series A and particularly Series B capital and beyond will push founders to look beyond their home market for investors.

At the same time, businesses — especially B2B models — looking to expand beyond their home market will also need to consider the needs of their future international counterparties.

Typically, both cross border investors and multinational corporates will prefer or even need to deal with a company in another “appropriate” jurisdiction that can be inserted as a parent “holding company” above your existing domestic operating company.

There are a few considerations to factor in when choosing the right country for your holding company:

Familiarity and reputation of the jurisdiction

People are more comfortable with what they know; investors are no exception. If, for example, your business is based in Thailand and you believe your funding will likely come from the Asia-Pacific region, the smart choice is likely to be Singapore as it’s considered to be the most blue-chip and hence most popular jurisdiction for holding companies in that region. Likewise, for a Kazakhstani start-up looking to raise capital in and do business across the Central Asian region, it likely makes most sense to incorporate a holding company in Cyprus, as it is acknowledged as a top-class business destination across the CIS.

The same rules largely apply to international corporate counterparties as to investors.

However if you anticipate selling your products to US enterprise clients or global corporates with highly-sensitive legal, tax and compliance teams you would be well advised to make sure that your chosen holding jurisdiction is considered to be adequately blue-chip (e.g. Western European).

If your key customer targets will be the Microsofts and Oracles of this world, a counterparty based in Luxembourg or the Netherlands is far more likely to be comfortable than an entity based a far-flung exotic island nation, tarred by reputational damage around aggressive tax structuring and inadequate transparency.

Tax efficiency

For start-ups in many emerging markets, tax regimes may be relatively punitive and/or uncertain for international investors in tech companies. Both tax efficiency and tax certainty for these investors can be achieved by having them invest through a holding company in a more developed but relatively low-tax jurisdiction, which has concluded a favorable double taxation treaty with the country of your operating company.

However, not all double taxation treaties are born equal, so it’s important to understand both the specific terms between the two countries and also to verify that “claiming relief” under the treaty in question is a well-worn path that has been successfully claimed by comparable structures.

The legal and judicial system

Appropriate holding jurisdictions are typically those that boast a long convention of stable legislation and adherence to the rule of law, where the risk of corrupt practices, unpredictable court judgments and unforeseen dramatic changes in law are mitigated by a robust legal system, incorruptible courts, and typically parliamentary democracy.

Having a holding company in a stable jurisdiction with a strong history of the rule of law is particularly comforting for investors into emerging market start-ups.

Additionally, holding the business’ intellectual property in a holding company situated in a stable jurisdiction ensures that the key assets of your business are insulated from the risk unpredictable or corrupt practices that may affect entities in less robust or developed jurisdictions. Your likely investors will typically already be exposed to technology/business model risk as well as possibly EM economic and currency risks, and adding (or removing) another dimension of risk can fundamentally impact the willingness of non-domestic investors to invest.

Adequacy of corporate law system

The corporate law of some jurisdictions allows for the creation of “preference shares” with preferential liquidation returns attached, while others do not. Since some form of liquidation preference protection is an industry standard in many parts of the world and an essential deal term for early-stage investors, incorporating a holding company in a jurisdiction where this is not expressly permitted is a major obstacle.

Likewise, shareholder’s agreements (another key investor protection) are of question enforceability in some jurisdictions, while strict restrictions on the permitted number of shareholders in a private company exist in others. It is, therefore, essential that a jurisdiction with the appropriate corporate law regime is chosen for your business.

In Part II we look closer at nominee arrangements, banking and structures designed to power a successful exit.