8 Legal Documents that will save your Startup a**
Launching a Startup is a process inherently filled with passion and opportunities but also uncertainty. You have a big idea and are working round the clock to make it happen. You are sacrificing your time and money for the pursuit of this dream, and yet there are a trillion factors that might bring the whole enterprise to fail.
Some of these factors may be external and out of your control. Some may have to do with flaws in the business model, target market or execution choices. Ultimately, some of those factors might just be unavoidable pitfalls that could have not been avoided, given the initial starting point.
Having said this, it would be foolish to stack the odds even more against yourself, especially when you can avoid it. Getting the basic legal agreements in place is one of those “boring” practices that will prevent your dream-fulfilling enterprise from turning into a failed experiment — even before you raise your first round of funding.
Ah… and as a little bonus, I added a link to a fun “founders’ equity calculator” tool at the end of the article. Enjoy!
1. Founders’ Pledge
For proto-startups still at the ideation stage: This document protects both the founders and the organization if things turn out badly, which happens more often than you might suspect!
Beginning a business may be incredibly exciting, you have an incredible idea and a dream to change the world. All of the other founding members of your startup might be your best friends or even family, yet it’s as still critical to guarantee that you plan for a worst case scenario, even if you are (and you very well should be) convinced of your success.
Without the correct legal documents, you’ll quite possibly find yourself with a founder that you simply can’t take away — even after they demonstrate not to be acting within the company’s best interest.
The provisions of the Founders’ Pledge define you and your co-founders’ duties as administrators and founders of the business. They outline reasons for the potential termination of founders, how to proceed in the event of a director leaving the company, as well as as other clauses safeguarding the company’s property and interests.
The founders pledge, however, is not particularly strong as a legal document, so once you begin moving away from the idea-stage and towards your first funding round, you ought to think about the more “serious” Founders Service Agreement. This document, in fact, encompasses a much wider range of provisions.
2. Founders Service Agreement
For startups wishing to raise funding: This agreement sets out how you and any co-founders should work to develop your business and what to do if a dispute arises.
Once you are on the brink of do your initial funding round or have started to turn around some real revenue, you ought to upgrade your Founders’ Pledge to a Founders’ Service Agreement.
It is essentially a hybrid of the Founders’ Pledge and an employment contract that you simply cannot do away with. It has several of the identical provisions from the Founders’ Pledge referring to the duties of a founder, as well as grounds for potential termination and protection of the company’s interests. However, it includes sections that you would expect to find in an employment contract — like your regular payment, the work expected to be done each week/month, your vacation claim, or alternative absences.
On top of all this, it will normally also establish a vesting schedule for your shares as a founder. In essence, this ties the number of shares that you will eventually own to the amount of time that you work for the company. For instance, if you had a thirtieth of the share capital with a thirty-month vesting amount, you’d vest one percent of the shares monthly, till all of your shares are fully owned and there aren’t any longer any conditions connected to them.
While vesting may seem against your interests as a founder, it’s in essence a protection for founders against one another. If you don’t have vesting provisions, you could find yourself with scenarios such as one where a co-founder leaves and takes away a great deal of equity. This basically renders your company “uninvestable” as there simply isn’t enough equity to shuffle around and keep founders, staff and investors aligned.
3. IP Assignment
Make sure you’ve got an Intellectual Property ( IP) Assignment with everybody who’s worked on your product or company without a proper contract regulating the terms — this ensures your company owns their contribution to your startup, and not them.
When you initially begin building your business, there’s typically lots of individuals helping out with your product and other intellectual property. These can be potential co-founders or team members, advisors or maybe contractors that you simply hire (for example freelancers for your website).
The IP that they produce, whether or not it’s clearly for your business, doesn’t essentially belong to you unless you’ve got an IP Assignment in situ. There are several samples of founders that got sucked into costly battles over their IP due to lack of clarity on IP ownership. This can easily make your startup completely uninvestable.
An IP Assignment ensures that any work they are doing for your company, whether or not it was actually after your company was formally incorporated, belongs to your company. There’s occasionally a payment involved with this, that is commonly either a nominal figure or what was initially agreed for the contracted work e.g. the freelancer’s payment to build your web site.
Ideally, you ought to ensure you’ve got An IP Assignment agreed in writing with every agency or individual who has worked on your product to avoid any potential disputes within the future. This applies whenever the IP Assignment is not already part of a formal work contract between the parties — and irrespective of whether or not you think their contribution to be material.
4. Employment Agreement (with vesting provisions)
If you are a Startup at its inception, hiring is usually not even on the cards. At best you could possibly have some contractor agreements with individuals or agencies that are working on a project for your venture — and that aren’t part of the co-founding team.
As you begin to grow, it’s necessary to make sure that everybody who really does work as your employee, is provided with a proper Employment Agreement. This is often for two reasons: 1) it provides you with a degree of protection and clearly defines each of both his and your roles and responsibilities and 2) The taxman is cracking down on “bogus self-employment”, as they call it, that might incur you a fine and/or extra liabilities.
An Employment Agreement designed for startups covers everything you would possibly expect, e.g. salary, vacation and job roles and responsibilities. However a very important extra feature for startups is the ability to assign share options to your staff as a part of their contract.
Often early stage startups don’t have a beefy bank account to pay out big salaries, thus a part of your employee’s remuneration is from having options on your startup shares.
An option is basically the right to acquire shares in your company at a price set today, with the idea that, in the long term, these shares will be worth much more, in line with the startup valuation.
What’s more, it outlines a vesting period for these options too. Vesting ties the number of options that your worker earns to the amount of time that they work for the startup. For instance, if that they had options on 3% of the share capital with a thirty-month vesting period, they would vest 0.1% of these shares monthly, till all of the choices are totally unconditional and there aren’t any longer any conditions attached to them.
5. Advisor Agreement
An Advisor Agreement may seem like superfluous paperwork, but it’s actually very useful if your business has a mentor, consultant or coach.
In startups, having the right people around and asking for expert advice is crucial. Once you begin to interact with your advisors, you should not forget to have an agreement with them. This is particularly important if you are giving them some form of financial benefit for providing advice.
Depending on the kind of person you’re dealing with, the remuneration can be in terms of equity, money or a mixture of the two. However it’s most typically equity.
Advisor Agreements define what your expectations are of the consultant, for instance, in terms of their role in assisting with networking and introductions. Additionally, it will include clauses to ensure that any data they acquire within the role will be treated as confidential.
It further covers what happens if they leave, or are terminated from post, and (if they’re compensated with equity) their vesting for their equity.
Vesting, as mentioned before, ties the number of options that your consultant earns to the length of time that they work for your startup. For instance, if that they had 3% of the share capital with a thirty-month vesting period, they would vest 0.1% of these shares monthly, till all of the options become totally unconditional.
6. Consultancy Agreements
An agreement between your company and anyone operating for it as a contractor and not a regular company worker.
Consultancy agreements are to regulate the work of contractors that aren’t a part of the management team, long term advisors or staff. They’re principally used for shorter term engagements of a few weeks or months. Since the contractors working under a Consultancy Agreement aren’t treated as staff, they don’t need to be included in the payroll and neither you nor them have to pay national insurance contributions.
A standard Consultancy Agreement should outline the contractors’ roles and responsibilities, their invoicing and payment terms and assigns any property they produce to your company.
It’s important that you don’t treat contractors with the same method as staff. They should not, for example, have a fixed timetable at the workplace. Otherwise they would technically be classified as staff and you’ll become liable of paying social insurance and supply them with other worker related benefits.
7. Non Disclosure Agreement
An agreement between the business and anyone not presently engaged by the business (such as an employee) which obliges them not to not disclose any data from the business that they may receive from it.
When you enter business discussions with potential advisors, partners or prospective members of staff you might want to consider making then sign a Non Disclosure Agreement (NDA).
Let me start by saying that I don’t really believe in NDAs and that in most circumstances, they just hamper your startup inception rather than help. However, in certain circumstances and especially when you start to develop your business into a proper corporation, they might be useful in certain fields.
An NDA is a commitment that the person receiving sensitive information regarding your startup would not disclose that information to anyone else. They’re often seen in sectors like life sciences, where a substantially amount of the worth of the company is in their intellectual property.
In practice, NDAs are almost always “half-unenforceable” and a great majority of potential advisors or investors won’t sign them for numerous reasons.
Usually, you’ve got way more to gain by openly discussing your plan with others than attempting to keep it secret. It’s execution that matters, not ideas.
8. Article of Association (and Share issue/transfer documents) + BONUS TIP FOR FOUNDERS & FUN EQUITY TEST TOOL
Underpinning all of the above documents are the shareholders’ agreements that define the company’s Capitalisation (Cap) Table. A Cap table is the structure of the company’s equity makeup or, in other words, the list of the company’s shareholders and their share of ownership. Individual shares define the units of ownership of the company entity and their function is listed in a fairly standard pair of documents: the Articles of Association and the Memorandum of Association (where the latter exists, such as in the UK).
The Articles of Association is a document that defines the company’s internal constitution. It often complements the Memorandum of Association, which regulates the company’s external affairs. In the UK, these documents have to be filed with the registrar of companies (Companies House) during the process of incorporating a company and tend to be a fairly standard pair of documents that most companies don’t really need to customise much — if at all. They provide the rule book which links Shareholding, Voting Rights, and Dividend Rights with the company ownership and management.
Incorporating a company may not be a hard process, especially in countries like the UK. Assigning shareholding and issuing shares might also not be an issue, especially when you are a single original founder or a couple of friends getting started. However, as your path takes you towards your first serious revenue, asset acquisition, or investment round (which means your company will start to have a value), things might become more complex to manage. It is therefore very important to define your structure before getting too close to any of those milestones.
Initially, when you start a company, you would have to create a few shares each with a nominal value. These shares (or at least some) will have to belong to the owner(s) in whatever ratio you prefer or have agreed. If you want to onboard someone as a founding member early on, the normal process would be to transfer some shares to this person.
You can do this without much problem because your company does not really have any substantial value, and any share of 0 is also 0. Therefore, there are no Tax implications in doing this and you can issue more shares, keep them in the company, distribute them, split them and reassign them without worrying too much. You would just need to sign either a Share Issue Certificate or a Share Transfer Certificate or agree on a Share Splitting Resolution when doing so. Then you need to record everything when due on the relevant company registrar in your country.
Bear in mind, though, that who owns shares owns the company and that you should be careful at planning how the whole structure will develop once shares and options are issued and distributed. This becomes particular important later on because investors won’t like a confusing ownership structure and you can’t reclaim back shares once they’ve been fully assigned.
Furthermore, you can’t keep issuing shares at will once you have a certain company value because each time you do this you would diminish the value of each share — and to make things worse, once your company has some sort of valuation, transferring shares bear Tax implications!
Lastly, you might not be able to survive the early departure or dismissal of a founding team member who has already been assigned shares without any vesting period — remember we discussed before how to avoid this?
Ultimately, if you give out too many share too early, you might end up with a messy cap table, or giving away too much equity too soon. You might find yourself, your co-founders or your early investors squeezed out by future dilutions (that is the diminishing of individual ownership share as new company shares are issued). In most of these scenarios, your company would become uninvestable. Alternatively, you might find that you and other founding team members lose interest as any hope of future gains are lost with the shrinking of your total equity share.
For all that we’ve seen so far, it is fundamental that you plan carefully how to distribute your equity and to use vesting conditions when onboarding co-founders, early team members, consultants and early investors.
Some startup like to have, for instance, an unassigned pool of shares to distribute to early investors, accelerator programs and team members without needing a dilution until late rounds. They might then use the legal documents we mentioned above to assign shares through options and an attached vesting period. This “option pool” typically ranges from a 10 to 20% of the company’s total share stock.
Besides this, it might be worth considering whether you would like to include in the company records and in the relevant Share Transfer Certificates any clause allowing a buy-back option for the company in case of dismissal or unjustified early departure of a team member or advisor.
To help you reflect on how much equity to distribute amongst founders and co-founders, I wanted to share a little online tool you can have fun play with. It’s a free and only gives you a rough indication and ideas, but it’s quick and fun and it can start making you think about early equity division “rationally” rather than “emotionally”. You can check it out on foundrs.com
Remember that when it comes to building a startup company “fairness” must be viewed in a broader context than the here and now. It is also critical to think through these issues in the early days (ideally before launch) while rational minds prevail.
If you are UK-based and want to have a chat about how we help startups grow and get funded, please feel free to join my organisation’s Meetup group: meetup.com/SiliconRoundabout — Come say hi! Also, a big shout out to our partner SeedLegals for providing most of the information on what I wrote above.
Director of Silicon Roundabout — The biggest Startup Hub and Tech Community in the UK
CEO of AGÀPE Properties — The first UK Property Investment and Multi-Let Management Company accepting cryptocurrencies