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Tips for Startups - Part 2 of 2 : A Pre-nup for Your Startup

Startups
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In the second part of our two-part series, we are taking a deeper dive into one of our Top 10 Legal Tips discussed in Part 1.  If there are any other topics you want us to write about, please let us know.

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You might be lifelong friends from school or newly connected from a networking event – a million dollar idea is formed and you are off to begin a new venture.  Not so fast! The honeymoon period is always sweet but what happens if things go south?  Save yourself some headache down the road and avoid making lawyers rich by thinking ahead about some of these issues below and documenting them in the Founders/Shareholders Agreement:

1. Align the vision

A good place to start is to agree on the overall goal and vision of the business. If the founders cannot agree to this then there is no point in continuing. Do you want to revolutionize the transportation market? Change the way charities fundraise? Maximize profit on second hand fashion? Why, what, when, where and how.

2. How big is your piece?

Perhaps the default positon is an equal split among the founders but does that reflect reality?  What is the level of contribution and commitment expected from each founder?  Every member will bring in a unique set of skills – whether it is technical, business, networks or otherwise – have an honest conversation early and allocate a value for that skill.  Decide upfront how the vesting of the shareholding should work.  For instance, it may not be ideal for all the shares to be allocated upfront; instead, consider using a vesting structure where founders will get a certain percentage of shares upon each milestone reached.

3.  Who does what and what do you bring to the table?

Define your roles clearly and set performance targets based on those roles. This holds everyone accountable. Founders may also be required contribute cash or assets into the business.

4. If someone leaves then what?

Be prepared for someone’s exit, including your own. Should that co-founder’s piece be split up evenly/proportionately between the remaining co-founders? Perhaps there would be a “right of first refusal” for the co-founders.  If that is the case, how much should the co-founders pay?

5. Money for food?

How will co-founders be compensated? Dividends are unlikely in startups so specify the salary to be given to each co-founder.

6. Day to day decisions vs Reserved Matters 

Day-to-day decisions will likely be made by the CEO. However, where significant risk or direction of the company is at stake, shareholders may want a say in that decision – these items are sometimes termed as “Reserved Matters” whereby unanimous, majority or some other agreed percentage of shareholder approval for the entry into certain types of deals (e.g. sale of the company, incurrence of debt above a certain level or disposal of assets beyond a certain level etc.).  This power may lie with the board of directors (though for a start-up, this would likely be the shareholders themselves).

7. Breakups happen 

This is a touchy topic but if there are irresolvable internal conflicts then the best outcome for the company is a fast resolution. Should there be a formal procedure to be followed to resolve a conflict?  If someone needs to leave, are they allowed to keep vested equity?

If you want to discuss any of the above in greater detail, contact us and a KorumLegal Consultant will be in touch. 

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Posted by Gerry Wong

Gerry is a consultant of KorumLegal. He has a keen interest in start-ups and legal technology. He is the organizer of a Hong Kong based meetup group – LegalTech Hong Kong 1.0.

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