Starting your business is exciting. The journey of taking it from an early-stage idea to a fully formed and functioning business is a wild ride, but there are a few things that you should and should not do when you’re getting started.
Contents
1. Not choosing the right jurisdiction for your business
2. Not having a Founders’ Agreement in place
3. Not protecting your Intellectual Property (IP)
4. Not being ready for investors’ due diligence and term sheet negotiations
1. Not choosing the right jurisdiction for your business
If your primary place of business is in a jurisdiction that is not deemed “investor grade”, you’ll need to consider creating a holding company in a more investable jurisdiction. What makes a jurisdiction investable? Typically, it is a place based on common law where standard investor terms and protections are recognised, enforceable and have a track record of startup investing.
Other factors to think about when choosing your jurisdiction include:
- Can a company issue different classes of shares?
- Can a company issue options under a share incentive plan?
- Can a company issue convertible instruments?
- How straightforward is the process to transfer shares in the company?
- Does the law offer a good level of legal protection for investor and founder rights and is there a track record of cases and enforcement?
- What is the tax environment like?
- Is it easy to set up a bank account?
- Is there history of VC firms accepting it as an investable jurisdiction?
2. Not having a Founders’ Agreement in place
When you’re in the early days of starting up, it might be hard to imagine things going wrong, but sometimes they do.
- Your idea might hit a speed bump
- Your co-founder might sidestep you on something you thought you had agreed
- Is everyone clear about what you are each bringing to the table and what you get in return?
- Have you set clear guidelines on how you will run the company and make decisions?
- What happens if your idea isn’t successful?
- What happens if a founder leaves the company?
You should always have a plan in place to document how you will operate and what happens if things don’t go to plan. A Founders’ Agreement also typically includes vesting for the founders, so if one leaves before doing what they agreed to do for the minimum period of time, a portion of their shares would be returned to the company. How you and your co-founders work together in the early days of your startup is a key driver of how successful your company might be in the future.
The existence of a Founders’ Agreement may also be a key factor that potential investors will consider when assessing the governance and risk of your startup. As much as investors are investing in your business, they’re also investing in you and will want to see that all founders work well as a team. Being organised and efficient gives investors confidence in your startup.
3. Not protecting your Intellectual Property (IP)
Intellectual Property rights can deter competitors from stealing or copying your idea or developing something similar. It also makes taking legal action against anyone who steal or copies your idea much easier.
Your IP might not seem that valuable when you’re starting up, but it could be in the future which is why it’s important to protect it early on. Starting up you should seek advice to:
- Identify the types of IP your company has
- Identify any problems you might have (for example, if somebody has developed a similar idea)
- Make sure any IP is owned and controlled by your company and put the right protections in place – one of the simplest ways to do this is to put in place an IP assignment agreement with every employee and consultant that works with your startup
You’ll probably need to protect a range of different IP rights to ensure you have all bases covered. The type of rights and how they can be protected vary from jurisdiction to jurisdiction. IP rights also change over time which is why it’s important to regularly re-evaluate what IP you have and what protections you need.
4. Not being ready for investors’ due diligence and term sheet negotiations
When you’re securing funding from a VC or other investor it’s important that you’re organised before you start pitching. Investors will want to have in depth knowledge of your startup’s legal structure, equity ownership, intellectual property position, governance, and team agreements.
It’s a good idea to gather all documents related to these areas in a “dataroom” (a shareable folder or set of folders) so you’re ready to share them with interested investors right away.
To move the process along, investors will want to know about any:
- Unsigned or missing document
- Large outstanding liabilities
- IP infringement issues
- Litigation or court judgments against your venture
- Employee-related problems.
Going through this exercise (and gathering your “dataroom”) may also help you identify any gaps or issues you have and fix them before you kick-off this process.
Negotiating a term sheet with your investors is also a key part of the investment process. This is a short, negotiable document that sets out the key commercial terms of investment agreed between the company and the investor.
5. Not having an exit plan
It’s a natural part of starting and growing a business to plan an exit. And it’s something that you as a founder (and certainly your investors) will think about at some point. What’s your goal after you’ve made your business a success? What does success look like? Do you have a general idea for potential exits to make a financial return for you and your investors?
The most common exit is a sale, which might be through a merger or acquisition. However, there are different routes and options depending on how successful the business is.
Not every company needs to sell to give a return to founders and investors. If a company has proven its business model is successful and profitable, you might be able to IPO – the holy grail for most startups!
Alternatively, though it’s less appealing to think about, your startup may also run into trouble and you might have to shut it down. Typically, this when you run out of cash before proving your business model. The approach to wind up your business will depend on the financial position of your business and whether a bank or creditor has rights to the company’s assets. It’s a complicated and lengthy process, but you should keep it in mind as a possible outcome.
