How to navigate UK startup legalities: Pandemic edition

How to navigate UK startup legalities: Pandemic edition

Editor's note: The COVID-19 pandemic and last-minute Brexit deal have added a lot of uncertainty and anxiety to the lives of many UK-based founders, which wasn't all that easy and smooth to begin with. This post by Tudor Musat, legal associate at SeedLegals, aims at providing some hands-on advice for entrepreneurs to make sure they can stay on top of their legal arrangements.

  1. Where should I begin if I want to make sure my legals are in order?

Starting a new venture can be hectic at the best of times, and as you solve the day-to-day challenges of your business it is easy to lose sight of the bigger picture. While every company has its own special needs, the legal basics inevitably fall into three main categories:

  • Corporate records and filings, which includes the various registers that the company must keep such as their shareholder register, their cap table and the periodic submissions of information from those registers to Companies House.
  • Team agreements that help you retain, remunerate and incentivise your co-founder and employees in line with the law.
  • Integrity of your product, both externally (think privacy policy on your website) and internally (the ownership of your software/design/content).

Once these bases are covered, not only will you be protected from many legal risks – you will also have an investment-ready structure that you can confidently present to angel investors and funds as you reach out to them within a funding round.

  1. What reporting requirements do I need to keep in mind to be on top of my corporate records compliance?

There are routine yearly corporate filings that a company must make. They include the Confirmation Statement (CS01 Form) to let Companies House know whether anything has changed since incorporation (first Confirmation Statement is due no later than one year and 14 days since your company was registered) and annual accounts  — which are separate from your HMRC filings. Your first set of accounts must be sent to Companies House within 21 months after your company is registered.

Separately, there are also the ad hoc filings required to notify Companies House of important changes, such as a new share issue (which requires filing an SH01), a new person with significant control of the company (owning more than 25% of the company’s shareholdings), a change to the composition of the board of directors, or a change in the company’s articles of association. These should normally be filed within 14 days of the change, whether online or by posting a prescribed form — here’s a link with a helpful summary from Companies House itself.

  1. I don’t employ anyone yet — does this mean I don’t need to worry about “team agreements”?

If your business is just you and your co-founder(s) at the moment, it is essential that all of you are clear on your respective roles, metrics, level of commitment and any individual restrictions that will help protect your company. It is a good idea to sign a founder agreement early.

Chances are, there are or will be external advisors coming on board to help push your business to that next milestone, or just share their expertise more generally. You will be looking to define their responsibilities, make sure they keep your information confidential and your IP protected — and you may want to reward them with cash and/or equity (such as share options).

Plus, when your team expands and you start employing others, you’ll need up-to-date terms of employment to comply with the law and incentivise your workforce — you can read about this and other team agreements that may be relevant to your business here.

  1. Someone helped me create my software product/design my logo or website, and I have paid them for the work – am I safe?

The single most valuable thing one can do to protect a product, is to check and put in place, agreements with the people behind the code or product: it is not a given that a company owns the works created by an employee, and the default rule if third-parties are involved is that they own the output — and not their client who paid for the work in the first place. Their client merely has a licence to use it.

Taking software as an example, the company only owns the code produced by an employee if the development of that code formed part of that employee’s duties. It may not be enough that their job title is “developer”: you want to make sure that there is a detailed job description in place in their employment agreement, to ensure that any code you have asked your employee developer to write is caught by that description.

When it comes to third-party developers, you will want to have a record of an agreement (even if it’s an email chain!), and that agreement must have a so-called intellectual property assignment clause. In other words, to change the default ownership rule, the developer has to agree that your company – and not them — will own the copyright in the code. This is most often achieved by a consultancy agreement.

If you are reading this at a stage where the employee or outsource developer in question has already delivered the code without any explicit agreement, all is not lost: assuming you can still reach them, it is a good idea to sign a standalone intellectual property assignment that transfers the ownership of the already existing code to you.

  1. Any other legal pitfalls around software development?

One other thing to keep in mind when structuring a relationship with your software developer is the extent to which they’re allowed to use open-source software (“OSS”) – that is, software that’s been made publicly available for everyone to use. It’s worth asking your developer from the outset which OSS they are using, and if their answer contains acronyms GPL or GNU – and particularly if it’s AGPL – you may be better off picking another developer. The reason is, those OSS are very restrictive (also known as “copyleft”) in that their terms of use tend to require you to then publish your own code for everyone to use.

Since it is not always easy to verify whether the code you have been delivered contains bits of open source, it is important to ensure that your agreement with the developer contains robust warranties and indemnities which you can rely on should you later find yourself in the midst of a copyleft dispute.

  1. Do I need to display any legal information on my website?

Nobody is really signing paper contracts every time they ship a package to a customer anymore, so if you sell or advertise anything through your website, chances are you already have your terms of business there.

And if you’re dealing with individual customers, it is virtually certain you are handling their personal data — even if it is something innocent, like their email addresses for your monthly newsletter or even their IP addresses obtained through cookie files. That is why you should not overlook your privacy policy, also usually found on the website. Privacy regulations are constantly evolving — who can forget GDPR? — and there were more changes this month, so it’s a good idea to keep an eye on these developments and build a policy that’s right for you.

  1. How do I obtain investment and extend my runway during a pandemic?

Managing to raise funding for your company may be difficult at the best of times. But, it becomes more fraught than usual when you’re also faced with an uncertain economic climate, as is the case currently due to the pandemic. If you find yourself in the situation of being mid-round, it’s probably best to close it now with the investors that you do have committed, and issue those shares rather than wait any longer for more investors to join the round. It’s also sensible to allow for Instant Investment in your funding round, and it’ll be easy to top-up the round afterwards.

However, opening a new funding round is still very possible and we’re seeing many companies proceed smoothly with funding rounds even in this climate. According to SeedLegals data from more than 15,000 companies on our platform, we’re already seeing term sheet numbers rising substantially compared to earlier in the year, valuations remaining largely unaffected by Covid and round closings remaining stable. As such, while there was a dip in investor appetite during the spring lockdown, the angel investors and investment funds in the community have bounced back and are again willing to invest at normal rates. You can find more information on our data analysis here.

Even if you can’t get investment for a full funding round now, there are alternative funding avenues available for you. These include:

  • SeedFAST (Advanced subscription agreement) – the investor invests now, and that investment will convert into shares at your next funding round. This is a great way to bind investors that are ready to pay, to a round that you’re planning in the future. This avenue is especially advisable if you have a Friends & Family investor or one which can invest now and negotiate terms afterwards — they will get a subscription letter and can be attached to the Shareholder Agreement that comes into place as part of the future funding round.
  • SeedNOTE (Convertible Note) – a short-term debt that converts into shares at a later date, and more often than not carries an element of interest. This is particularly attractive to investors who are not looking for any form of SEIS/EIS tax relief.
  • Instant Investment – a bridge investment consisting of a cash injection, usually by your existing investors between funding rounds. Bridging in this way is an incredibly useful tactic, and works well especially if you are looking at a runway extension or some fast cash. This will be most useful if you have a previous investor who is willing to invest again in your company by topping up the last round.
  1. Should I grant my investor a board seat as part of my funding round?

As part of your funding round, investors may often ask for a board seat, known as an Investor Director position, in order to have a say in the strategic decision-making through which the board steers the business. The decision of whether to grant one or not may be a difficult one, given it might influence how willing your investors are to invest in this funding round. According to SeedLegals data, we see that in smaller funding rounds, founders rarely need to offer their investors a seat on the board (32% of the time), whereas raises nearing £1 million or above often require Investor Directors (67% of the time).

The likelihood of companies granting board seats to investors also varies depending on the profile of your investor. Smaller raises will typically be funded by friends and family or crowdfunding backers, who are less likely to have the financial or technical expertise which would add input to the board. Larger raises which contain angel investors and especially Funds and VCs will often make a director seat a condition of their investment, given their continuing interest to look after their investment and how it’s used by the company.

Ultimately, keep in mind that the most important aspect to consider when granting an Investor Director seat is whether they bring added value to your board by their expertise and experience, as well as whether their interests are aligned with the company’s or could contain conflicting interests. Remember also that a half-way house solution may be the granting of an Observer seat on the board, which has full visibility over the board’s discussions, but cannot vote.

  1. What government funding assistance can I obtain and what grants/loan schemes are available for companies?

The government has set up a number of schemes designed to assist start-ups who are having difficulty raising funds or staying afloat during this time.

These include:

  • Coronavirus Business Interruption Loan Scheme (CBILS) — a scheme through which private lenders provide term loans, overdrafts, invoice/asset finance up to a maximum of £5 million and receive a government-backed guarantee for the loan repayments. To be eligible the company must be a UK-based SME with annual turnover of up to £45m, generate more than 50% of its turnover from trading activity, and not be classed as a “business in difficulty”. More details here.
  • Bounce Back Loan Scheme (BBLS) — provides loans of up to £50,000 to companies who have been negatively impacted by the pandemic, generate more than 50% of their income from trading activity, and have been established by the 1st of March 2020. More details here.
  • Resilience and Recovery Loan Fund (RRLF) — provides term loans between £100,000—£500,000 to charities, social enterprises or limited companies which have Social Objects in their articles who have a minimum turnover of £400k. More details here.
  1. What can I do if my company cannot afford to keep paying all its employees?

If your company is seeing a reduced amount of business due to the pandemic or if you’re looking to extend your runway, it’s useful to look at what the government is providing to companies who need to reduce their employment costs:

  • Furlough Scheme — HMRC launched their Coronavirus Job Retention Scheme (Furlough Scheme) in an effort to avoid business closures. This scheme allows all UK employers a grant of up to £2,500 per employee, to cover 80% of the wages of employees where the employer cannot cover employee costs due to the pandemic and as such they have been asked to stop working but have not been made redundant.

Image credit: Romain Dancre on Unsplash

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