An Investor’s Tips for

Structuring an Emerging Market Start-Up — Part I

At Digital Spring Ventures we think that smart structuring is important for any start-up. For emerging market businesses with outbound plans, a well thought out structure that works for your ambitions — and needs — is even more critical.

Andrew Dalton
Nov 18, 2019 · 7 min read
Illustration from Undraw

Step 1: Set up “a” company early on

Get an operating company

Clear allocation of ownership

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

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

Step 2: Build the structure to power your future growth

Illustration from Undraw

Pick the right jurisdictions

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

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

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

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

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.

Digital Spring Ventures

Stories from the DSV team & portfolio companies.

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