Legal Issues Every Startup Should Consider Before Fundraising
Once your startup is ready to seek investment, your checklist should also include legal issues that you need to consider. Let’s take a look at them and some key documents you’ll need.
The Indian startup ecosystem has evolved dynamically over the last two decades. Times have been exciting for Indian startups with a growing number of new and creative business models being formed.
To begin with, setting up a business, either alone or as a partnership is a lot of work. There are a number of steps you’ll need to follow in order to get it going. You need to create a business plan, make sure you have enough money to pull it off, a pitch deck that outlines your business idea, you need to be equipped with all the facts and of course, pick your partners very wisely or else you could fall flat on your face.
In the initial formation of a business, every founder is hyper-focused on building their startup and raising money through multiple rounds of funding. Take a look at the different stages of raising capital for your startup here. That said, we all aspire to build the next Facebook or Instagram, but starting a business is not just about the idea or the fundraising process but also an understanding of how to overcome business and legal challenges.
Before hiring an attorney or signing any legal documents with the help of any intermediaries, you must first understand the following legal issues and challenges faced by startups for fundraising before it’s too late.
Legal Challenges faced by SaaS Startups
Startups face a plethora of tax issues. There is no doubt that tax planning plays a central role in business decisions. Many startups tend to overlook the importance of proper tax planning during their early existence stage. It is essential for SaaS startups to be aware of their tax liabilities and the government and explore exemptions that are available to them.
Intellectual Property Rights
The most valuable resource you have as a startup is your intellectual property. This includes patents, trademarks, copyrights, trade secrets, inventions or designs. That’s a lot to protect. Don’t just assume that your idea is protected by law. Simply put, you must take the necessary precautions to protect your assets in order to protect your company's value.
No matter what business you are in, your employees will be the key to your success. Make sure your start-up business is primed for success with flexible and motivation systems in employment contracts. Much more than a job, an employment contract is a win-win relationship between the company and the employee, offering a lot more than just financial benefits. A legally correct employment contract can help employee motivation and it can give your company any protection from internal agency risks like disloyalty.
It is so important to have a Non-disclosure agreement in place regardless of the nature of your business. In order to protect its confidential information, a startup must enter into a Non-Disclosure with another company. Such an agreement will clearly outline how the confidential information is not allowed to be disclosed by the other party, and what would be the consequences of such a wrongful act.
When starting a startup, licensing is critical. A license is issued to an entity that has its own infrastructure, raw material and machinery. Some licenses will specify the quality of the product that should be maintained while some others specify the number of employees that must be employed by a company before it can get the said licenses. Getting a license is perhaps the most important requirement for a startup.
Depending on the business it may be necessary to obtain licenses and obey specific laws that govern certain industries, including consumer protection laws and data privacy laws. These laws govern areas such as how businesses must handle products purchased from them and return of defective products. These laws adhere to how businesses must deal with consumer complaints both internally and with external agencies, potential liabilities for faulty products or fraud, potential liabilities for consumer credit or loans extended to customers, securities trading regulations and requirements, etc.
Key Transaction Documents
You’ve worked on your business idea. You're not going to let a few missing documents put everything you've worked for on hold? Before you put together the paperwork for your fundraising round, let's walk through the key documents you'll need:
Certificate of Incorporation
The Certificate of Incorporation is a document that proves that a company is a legitimate entity. It provides a company with the legal right to issue shares and clarifies the tax structure of the business. It is the first step in filing your paperwork related to the formation of a private corporation under state law. Without it, no investor will put money into a company given the procedural and tax-related implications involved.
A shareholders’ agreement is a legal contract between the corporation & the shareholders, which defines their rights & obligations. This agreement states the duties of each shareholder of a company and prevents actions that will bring harm to minority stakeholders. Such an agreement helps in reducing internal conflicts within the entity, protects acts that are not in the interest of all shareholders & allows for unbiased decision making.
A term sheet is a non-binding list of propositions, aka ‘Deal structure’ by a venture capital firm at the initial stages of a deal. It outlines the key points of engagement between the investor and startup during and leading up to the investment. A typical sheet includes valuation, investment structure, management structure and changes to share capital.
Investors’ Rights Agreement
The Investors' Rights Agreement establishes the corporate relationship between a startup and its investors. Investors’ Rights Agreement gives investors the comfort of knowing that they are part of the decision-making process within the company and have rights beyond ownership. It helps investors feel comfortable knowing that their right to information and participation is protected.
To Wrap up…
The startup ecosystem is aiming for the stars, no doubt. Before you hit the road running, startups must assess the potential risks and uncertainties ahead of them.
Since each venture is unique, there is no fixed set of things that need to be done. But with all that available cash comes more risk and in some cases, increased legal risks. However, with legal guidance through every step of the process, you’ll be certain to build your business in the best possible way and protect your company’s assets.