Every founder knows the thrill and triumph of seeing the first customer, collecting their first payment and first employee, and first investor. But, somewhere amidst the excitement and chaos of building a business, there is something important that is forgotten, ignored, or left for later. That thing is none other than the legal foundation of the startup.
While it is understandable that legal formalities may not be the top priority when building a business especially at the beginning legal issues rarely appear in isolation. There is always context around legal problems, and that context is often a significant event for your business. That is why, as you build your startup, it is helpful to ask yourself five important questions regarding your legal foundation before your next big business event.
Legal Questions to Ask Yourself Before Your Next Big Business Event
- You and your co-founders started the business together have you ironed out the details?
- Is your business actually owning what it claims to own?
- Your first investor has shown interest in it, are you investor-ready?
- Your first ten employees can create ten legal challenges for you are you prepared?
- As you scale, have you evaluated the legal requirements of expansion?
Let us elaborate:
1. You and your co-founders started the business together have you ironed out the details?
Most startups begin with an idea and a couple of friends who believe in the idea more than anything else. As a startup grows, its various aspects get split between the co-founders, and for many startups, the process stops there. The uncomfortable discussions on ownership, control, and other founder-specific matters are left for a later date. But what happens if one of your co-founders decides to sell their shares? What happens if one of your co-founders wants to raise funds while the others disagree? What happens if one of your co-founders wants out?
A carefully drafted Founders Agreement can help address some (or many) of these issues by outlining the decision-making process, ownership, and voting rights, restrictions on transfers and ownership in case of resignation, intellectual property ownership, and a dispute-resolution mechanism, among other things.
2. Is your business actually owning what it claims to own?
The intellectual property of a business is usually its most valuable asset. While it is true that much of it is created by the business itself, it is critical to ensure that what your employees create actually belongs to the company. This applies to trademarks, copyrights, and patents and the legal documentation around it must be thorough to avoid unpleasant surprises later. In addition, make sure that your employment agreements are also properly worded to ensure that any intellectual property created by your employees belongs to the company.
3. Your first investor has shown interest in it, are you investor-ready?
Fundraising is exciting, but a large part of it involves due diligence on the part of the investor to understand the company they are investing in. This could involve various legal documents, including incorporation documents that establish the nature and the jurisdiction of the company, shareholder-related documents, employment agreements of the key personnel, intellectual property-related documents, and agreements and contracts that the company is either a party to or is bound by.
It also includes understanding any disputes that the company is involved in or is facing. For foreign investors, there are additional requirements under FEMA and RBI that apply when dealing with foreign exchange in India, including sector-specific permissions, pricing approvals, and reporting requirements. In short, legal preparation begins long before an investor shows any interest, so it is always a good idea to undertake these preparations in advance of an investor reaching out with a due diligence request.
4. Your first ten employees can create ten legal challenges for you are you prepared?
While the hiring process of startups is often informal, there are several legal formalities that should be met while hiring including documentation such as employment agreements, non-disclosure agreements for proprietary information, and internal guidelines and processes. Additionally, there are numerous statutory requirements, including Sexual Harassment Prevention (POSH) and various filings for tax and other purposes, as well as documentation for employee exits.
Ensure that your employee-related documentation and statutory requirements are met as your startup grows and hires more people.
5. As you scale, have you evaluated the legal requirements of expansion?
A startup that began its journey in one city may soon find itself operating from multiple states or countries. As new products are launched, and new services are introduced, various new considerations come into play. That is why it is important to take legal advice before launching new products, moving into new markets, and hiring new people legal counsel can advise you on the various requirements that apply when these events occur.
Why Should you Address Legal Matters at all?
Most new founders believe that legal support is something that is only relevant later in a startup’s lifecycle. But how does it help to have carefully drawn organizational documents when the ownership structure of the company is disputed three years later? How does it help to keep an updated list of your share capital when a funding round requires the company to restructure its shareholding? How does it help to have carefully drawn IP assignments when the product is already in the hands of the customer?
A practical legal checklist for every founder
Here is a quick legal checklist for you to go through before your next big business event:
- Is your business structure optimal for its current and prospective needs?
- Are your founder-related documents updated?
- Is the intellectual property of the company registered and protected?
- Are employee and consultancy-related documents updated?
- Are the company’s contracts properly reviewed prior to execution?
- Is the company prepared for investor-related due diligence?
- Have you considered FEMA requirements, if any?
Final thoughts: Build Your Business, But Do Not Leave its Foundation Behind
While it is true that a startup’s success is largely driven by the people, product, and execution its legal structure is unlikely to be the reason for its failure. Founders spend most of their time and effort on everything else, and the last thing they want to do is spend time and money on lawyers and paperwork. But a solid legal foundation will help you understand and navigate the challenges at each stage of your startup’s development, so that you can focus on what you do best building the startup.
Author: Sarika Aggarwal (Head – Advisory & International Relations)
