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Launching a startup? Here are some key legal issues

24 May 2017

As a founder you may, and often will, have limited resources.  Legal issues may not seem so important or pressing and fall to the bottom of the list.

For your startup to succeed, you need to be able to monetize your ideas and hard work while complying with the law and protecting yourself under it.  If this is your first time you may not be across some of the potential legal pitfalls (and liabilities) in connection with launching a business.  You may be aware of some but not all ways you can use the law to protect your venture and interests.  Or it could be you are not sure which legal issues to deal with in what order.

No two startups are alike, but as you prepare to launch you should consider the following key legal issues.

Business formation and founder arrangements

There are many reasons why forming a business entity for your startup, rather than operating informally, should be a priority. Doing so will protect the founders from liability, allow the startup to own property and open bank accounts, have different classes of shareholders (holding common and preferred shares) and carry on business both in and outside of Hong Kong.

Consider this: all issues related to ownership of the business, as well as intellectual property, will be settled in accordance with the law unless the founders have already taken affirmative steps to address them. For example, where two or more people are involved with developing a business concept, it is possible that they will be considered partners if there is no agreement otherwise, even if that was not their intention.

You and your co-founder(s) should form your company early and ensure that arrangements among you are properly documented, providing answers to at least the following questions:

  • What is the overall goal and vision for the business?
  • What cash or other assets will each founder be contributing to the business?
  • Who gets what percentage of the company? Is the percentage ownership subject to vesting based on continued participation in the business?
  • What are the roles and responsibilities of the founders? What time commitment to the business is expected of each founder?
  • If one founder leaves, does the company or the other founder have the right to buy back that founder’s shares and if so, at what price?
  • How will key decisions and day-to-day decisions of the business be made?
  • What circumstances would result in removal of a founder as an employee of the business?
  • How will a sale of the business be dealt with?

Intellectual property and confidentiality

Your business’s most valuable asset will likely be its intellectual property. Trademarks protect its name and branding, trade secrets protect certain kinds of confidential business information, and patents protect any inventions your startup will use. In Hong Kong and Australia all of these require registration to enjoy protection from outsiders. Copyrights protect creative works such as songs, literary works and computer code, but they are automatically protected and normally do not need to be registered.

If you are like most startups, you will also need to design a website and register a domain name for it. Like all other intellectual property created for the startup, steps will need to be taken to transfer ownership of your domain name to the startup itself. While there is no one-size-fits-all solution for registering intellectual property, as a rule, you should arrange for a trademark search and companies search to be carried out to ensure that no one else is already using the name you want to use for your startup.  

To avoid disputes and ensure everyone knows what their role and responsibilities are, you will need suitable written agreements in place with all of your co-founders, employees, and contractors to ensure that the startup – not the individual creator – owns all intellectual property created in connection with services performed for the startup.   In addition, you should have a standard non-disclosure agreement for third parties to sign that prohibits them from disclosing and/or using your confidential information.

Fundraising/securities issues

This is an area that is littered with potential legal pitfalls but might not be a concern if you are bootstrapping your business. However, if you are like many startups in Hong Kong and Australia, you will be looking to tap into the burgeoning local and international angel investor scene, and so caution is warranted. 

Hong Kong’s longstanding legal restrictions on raising capital from members of the public complicate the process of approaching potential investors, but it is possible to raise the capital you need without breaking the law whether you are intending to issue convertible bonds or shares. In both Hong Kong and Australia you can raise money on a private placement basis or from professional investors. 

You should always speak to an experienced startup lawyer before undertaking any fundraising activities, even if you are just raising money from family and friends. Aside from ensuring that your fundraising complies with the law, getting advice before striking a deal can avoid unrealistic expectations on the part of investors and unwittingly tying a below-market valuation to the business. 

Employees and contractors

You are probably already aware that employees and contractors are treated differently under the law, with employees given greater protection.

Before hiring employees or engaging contractors to perform services for your company (such as app development), speak to a startup lawyer about what each employee or contractor will be doing, who is responsible for what, how they will be remunerated and, most importantly, who will own any intellectual property they might create in the process. To protect your business, contracts governing these relationships should contain non-competes, non-disclosure and work for hire provisions.

In addition, startups usually incentivize early-stage and key employees with some form of equity participation such as share options. When structuring these arrangements, it is useful to have a lawyer’s input on what strikes the right balance between the company’s interests and making sure the terms are both fair and likely to incentivize these key people.  

Contracting generally

Wherever possible you should use written contracts when dealing with third parties. Oral agreements may be enforceable, but proving what was agreed upon can be complicated (read: expensive).

If limited time or resources prevent you from preparing standard written contracts, you should send out a binding letter of intent or, at the very least, a follow-up email to everyone concerned to document the key terms of your agreement. That way, if a dispute arises, you will have some evidence of what was agreed.

Who’s got your back?

Every entrepreneur needs an experienced lawyer that he/she can turn to from time to time. We will be able to identify and help you brainstorm a way through all of the significant legal risks you encounter and press you to negotiate reasonable protections in every deal you do.  If you don’t have much deal-making experience, we've got your back in negotiations to help you get the best deal possible.

The above list only sets out the basics of what you should know when launching a startup.  Failure to obtain sound legal advice on the key issues at the outset could lead you down the wrong track and be expensive to get right. Our team is here to ensure you stay on course with the right tools to move forward.  We value and build long term relationships.

If you are starting up, feel free to contact John Koh or Michael Chong on +852 3197 0091. 

This alert is for information only and is not legal advice.