It's one of the many paradoxes of launching a startup; on the one hand, you need to set all your legal structures right in order to get your first money, be it funding or revenues. On the other hand, you seldom have the resources to hire a lawyer for that purpose before venture funding or revenues come in.
A lot of entrepreneurs seem to choose the easy solution of the aforementioned problem — that is, just forget about it for a few months (sometimes years) and hope for the best. Make no mistake though, more often than not this decision does go back to bite you in the back quite soon.
Another, more constructive solution is to try and put something together yourself, DIY-style. There are a lot of things that don't necessarily require a law firm that charges hundreds of euros per hour. The tricky thing, however, is to figure out where you do need to involve that external expertise to avoid screwing everything up.
We've sat down with Karola Kassai, founder of the startup law firm KassaiLaw, to dig deeper into how you could minimise your legal budget at the very early stage of your startup's existence — without setting it up for failure later on.
The earlier you start thinking about the legal fundamentals for your startup, the better, says Kassai.
“A very important thing to do early is outline the responsibilities of the different founders, and what they expect from each other,” she said. “What you shouldn't do, is to say without any specific ground, okay, we own the company 50/50, and that's it. That's the most common issue that further down the line it turns out that somebody thinks that they do much more, and this ultimately leads to a conflict. I don't think I have seen a company owned equally by two founders where this didn't become a debating point eventually. Debates can arise regardless of the structure of the cap table, of course, but they can be somewhat eliminated by a clear common understanding of the long-term intentions of the founders.”
A good practice here is to put together a basic shareholders' agreement that would outline what's expected from every founder long-term. How many hours will they put in? What are the responsibilities of the CEO, CTO, and COO? Who has invested actual money in the company?
Based on that agreement, it's easier to determine the initial shares of equity the co-founders receive. There are different calculation tools, manuals, and questionnaires available for free online that can offer a general idea of how this can be approached.
Secure your IP
Another important thing to think about from the get go is the intellectual property (IP) — starting from the name of the new company.
“Do a basic search to determine whether you can actually use the name you've come up with,” Kassai said. “Is someone else using a similar one? Is it possible to get a trademark? The relevant local databases are usually available online for free, but we see very often that founders don't do any of these checks, and ultimately have to rename their startups. The later they have to do it the more painful it can be, depending on the intensity of previous marketing activities or public appearances.”
In addition to that, make sure you've got documents that prove that the company owns all pieces of IP contributed by external parties, including things like logo, other designs, code, and so on.
“It's almost never done right,” Kassai said. “A founder would often tell us that they had a friend or an intern who created a certain design, but don't even know where they are now and how to reach them. ‘But they made it for us, so it's totally fine to use it, right?’ Well, not legally. Serious VCs would only invest in a company where the IP is absolutely straightened out, since that's basically what they invest in. They check these things as part of due diligence, and don't accept this kind of risk at all.”
Be careful with templates
“You cannot cut the corners here,” Kassai said. “You have to read through these documents, customise them, remove whatever is not applicable, and then add all kind of additional points relevant for you. And after that, make it a habit to regularly check back and make sure everything is still up to date, as startups tend to pivot and change the ways they sell their products and services.”
But then, what can go wrong with a generic template downloaded from the Internet, we asked? No one reads those things anyway, right?
“It usually requires an unsatisfied customer,” Kassai said. “But if you get one, they're going to attack you for sure. They usually want their money back, or maybe some kind of compensation or even report you to the relevant authorities, not to mention that in more extreme cases you risk being subject to a lawsuit. They'd often refer to the legal documents on your website and say that you stated something that was deceiving and untruthful. It can actually get very ugly, especially with fintech companies.”
Although the international mindset is something entrepreneurs talk a lot in terms of the market, startups often think within their borders when looking for the first investors. Attracting international investors early on, however, is a great way to broaden your perspective and make the future geographic expansion smoother.
One reasonably easy thing to do from the beginning is to translate all your legal documentation into English — or use English as the main language if that's allowed by your local regulations.
“We usually prepare everything in two languages, it really saves a lot of time, effort, and money in the long term,” Kassai said. “If all of a sudden there is a due diligence request, then who pays for the translation? Obviously, somebody has to. And how much time does it take if you have a lot of documentation already that's never been translated?”
Another benefit of having the legal documentation available in English is that it makes it easier to establish an entity in your VC's country. While this may not be required for very early-stage deals, investors often don't want to be exposed to foreign regulations and/or have LP-related geographic restrictions.
“So all the contracts, shareholders' agreement, investment agreement, whatever adds up to the corporate structure, all the IP assignment agreements — all this better be available in English,” Kassai concluded.
When and where to look for help
“You shouldn't ever try and structure your funding round without at least talking to a lawyer,” Kassai said when asked about where she draws the line on the DIY legal stuff.
“The investment agreement, shareholders' agreement, and other related documents are like a huge puzzle,” she said. “And in 99 percent of the cases, founders don't really understand what they sign, because one piece of the puzzle here adds to another one, 15 pages later on. So I would definitely never recommend signing a deal with any kind of investor without legal representation.”
This doesn't necessarily mean that all investors are evil and will definitely try to push for unfair deal terms.
“If you think about it from their perspective, they're taking a huge business risk,” Kassai said. “Lets face it, there is a good statistical chance that you are going to fail anyway, and they put a lot of money into you. So for them, it's basically throwing that out of the window, and they are aware of that. But of course, they would like to ensure that at least they have a chance to get that money.”
This, unfortunately, may go against the founders' best interest, as most early-stage investors may push for terms that would put them in a position where they can veto any major decision about the company. This happens in almost every case, Kassai said, and many businesses have failed because of issues arising from this approach, which risks the founders were not really aware of at the time of signing.
An important thing about getting legal advice is that it doesn't necessarily mean paying a huge amount of money upfront.
“You can also go to a law firm for an hour or two hours of consultation,” she said. “This is an amount you should be able to pay, and it would allow you to at least quickly go through some of the more obvious red flags.”
Pre-fundraising legal checklist
To sum things up, here's a quick legal checklist to go through before starting a fundraising journey, courtesy of KassaiLaw.
- A shareholders' agreement signed by the founders
- Cap table: list of owners and percentage ownership interest
- Minutes from board meetings, shareholder meetings and all written resolutions properly documented
- Organizational documents: articles of association, certificate of incorporation, etc.
- A copy of past investment agreements, if any
- Trademark on the name (or at least making sure that you can obtain a trademark) and if you already have, a list of trademarks, patents, copyrights and domain names (or any relevant applications)
- Secured and documented IP rights for all the fundamental things like design and code
- Current business plan, any financial projections and most recent financial statements
- Copies of agreements that are of material importance to your company
- Copies of agreements with non-competition or non-solicitation clauses, agreements on exclusivity or similar
- Proper employment contracts with the management and other employees
- Proper regulatory licenses/registrations for the business activities, if relevant