Best Practices For Startup Legal Structuring in 2022

March 24, 2022
TABLE OF CONTENTS

Best Practices For Startup Legal Structuring in 2022

March 24, 2022

Whether you've been dreaming of starting your own company for years or if the idea came to you in your sleep — like Mendeleev's periodic table — you need to wrap your business idea up in a secure legal structure. Once you have validated your business idea and concluded that it's commercially viable, it's time to register your business. The location–the jurisdiction–that you choose will have lasting impacts on your business, particularly when attracting clients and seeking external capital. Overlooking the importance of picking the right jurisdiction could land your business in trouble down the line.

Don’t listen to your friends or rely solely on internet forums–get legal advice that knows startups inside-out.

When incorporating your startup, you have to analyse the following:

  • Where is your core market?
  • Who are your ideal investors, and where will you find them?
  • Where will your core team be located?

If you are based in Montenegro, working on a price comparison platform you plan to incorporate in the Cayman Islands, with your target audience for sales being elderly English women, and your dreams of investments coming from certain "a-some numbers, maybe a sixteen-z" fund…your business plan might not work so well.

What to consider when choosing a country to register your business:

  1. The perception your customers have of your corporate location.
    Customer opinions matter; without customers, you don't have sales. People also hold opinions about different countries (rightly or wrongly), which affect who they buy from. So, make sure you choose a reputable country of incorporation. For example, a B2C SaaS startup with a head office in the British Virgin Islands might look suspicious and garner less customer trust. In contrast, consumers will likely consider a business based in the EU more trustworthy.

  2. Your relationship with your investors
    Investing is based on trust, risk, and the overall relationship between the investor and the project they're investing in. If you are considering sourcing investments for your organisation, and want to obtain outside capital, think hard about the type of investors you want to attract. Each angel investor or VC has their area of innovation they're most interested in; smartech, healthtech, edutech, traveltech, the list goes on.
    Each investor will also have some geographical preference or areas of interest. Different jurisdictions will offer different methods of protecting their investments, as well as tax laws, legal frameworks, and costs applicable when investing. For example, Investor A prefers the US for its Silicon Valley lifestyle, Investor B prefers the EU for its unity of regulations, and Investor C prefers Asia with its skilled yet affordable workforce. All investors will be wary of protecting their assets, no matter their business interest or where they invest their money, so be sure to consider what type of investors you wish to work with in the future and where you're likely to find them.
  1. Your core team
    Your core team is vital to moving your business forward. A disgruntled or dysfunctional team can ruin work ethic and dampen entrepreneurial spirits, threatening the business's success. Avoid all of this by setting up your core team to succeed. Start with finding a location that can satisfy your human resource needs and provide startup-friendly governance, first-class legal and business infrastructure and good quality of life. Your dream team only lasts as long as their happiness and productivity are alive. A location that promotes a happy business and happy workers is key.

  2. Your startup's unique needs
    Every startup will be slightly different - what exactly does yours need to hit the ground running? Consider those needs, from intellectual property business and legal structures to tax optimisation and corporate management tools. Now ask yourself, does the jurisdiction I want to register the company in serve these needs, or will it create barriers and unnecessary complications? Work out which countries have IP box regimes, are tax-friendly to your business, and will help ensure that your rights are protected both in the Apple App Store and Google PlayStore and in court.

Which jurisdictions are best for incorporating a startup?

You've covered your basics – customers, investors, team and business needs – but what else is there to consider? Here are five more things to consider when choosing the best jurisdiction for your startup:

  1. Whether share transactions (share issuance / secondary sales / reasonable KYC for shareholders) are likely to be smooth. In the UK, you can do almost any actions with your shares online and have the changes reflected in the registry within a couple of days (which unfortunately shall not work in many European countries where all the documents should be submitted in person and translated into the local language);

  2. Whether the operating cost can be reduced and accrued funds are enough for operations. Here, Cyprus allows various solutions to establish a business that meets the required level of substance recognised by the authorities, which allows applying relevant tax benefits. Many other EU countries provide virtual offices, accounting, etc.;

  3. Whether opening and operating bank accounts is quick and easy or might take years. The recent growth in the number of UK fintech (neobanks and banking apps) has resulted in increased access to e-banking business solutions in this particular jurisdiction;

  4. Whether tax and IP preferences are available for tech companies. From an IP box regime in Cyprus and R&D tax relief in the UK to a special tax regime attracting tech companies to Estonia, different countries offer tax and IP schemes to make tech businesses feel comfortable;

  5. Whether the country in question proposes additional benefits for the founders. For example, Estonia implemented an e-residence program, which allows obtaining such status in several days and registering a company promptly (and grants potential access to the Schengen Area)

Here's a table that compares some of the most popular jurisdictions for registering a startup.

Read more: How to Choose a Residence Country as a Digital Nomad Entrepreneur.

Incorporation is done. What's next?

Your major business operations begin as soon as you've chosen jurisdiction and have all the paperwork and company registration done. You must now attract clients — either B2B or B2C — and need to ensure all the activities are correctly regulated. It is vital for SaaS / Marketplace businesses to have Terms & Conditions, Privacy & Cookie Policies, and Licence & Publishing Agreements covered. The list of the required documentation depends on the type of business and is adjusted case-by-case.

What do founders need to know before they start fundraising?

When it's time to fundraise, many businesses consider attracting outside investments. The more effort put into the legal structuring for the startup, right at the beginning, the smoother the fundraising process will be. Both angels and VCs pay special attention to corporate and IP issues. A good investor will check to see if the cap table is "broken" or not. They will also check:

  • if the founders' interests, options, loans to the company and vice versa are regulated;
  • if trademarks and patents protect the key IP of the business; and
  • if there is a clear mechanism of IP assignment from employees and freelancers to the company. 

Once you get a green light for funding, the work isn't over. Funding can trigger a new set of issues, depending on the financing (advanced subscription in any form or equity investment). Some investors prefer standard documentation by YCombinator or SeriesSeed, while others will develop super customised and unique bundles for their deals. Different legal matters should be solved at different stages of the fundraising process, from negotiating a term sheet and carrying out due diligence to preparing transactional documentation describing business and investor rights and obligations and regulating various post-closing issues.

How to Choose the Best Jurisdiction for Your Business

It can be a complicated process, and there's a lot to cover, but if done properly, your startup has the best chance of registering, operating, and growing. 

As soon as you've decided to start a business, you should tick the following boxes to be safe and sound from a legal perspective:

  1. Registration stage (captable, certificate of incorporation (or equivalent), Articles of Association / Bylaws, Founders / Shareholders Agreement, Share Option Plan / Share Option Agreement)
  2. Operations stage (Terms & Conditions, Privacy & Cookie Policies, Licence & Publishing Agreements, Contractors & Partners Agreements, Employment / Contractor Agreements, NDAs & IP Assignment)
  3. Growth and Fundraising Stage (all from stages 1 and 2 + convertible loan / SAFE, or Stock Purchase / Share Subscription Agreements, Shareholders Agreement and related corporate documents).

If you need help with any legal matters arising at these stages or are just starting and don't know where to begin, Book a Legal Discovery Session with our Head of startup legal, Daria Zhuk, to get started. 

In this session, you'll receive an overview of the best startup legal structuring practices that apply to your case, whether at a registration stage or later ones like operations or fundraising. Based on the session, we'll be able to create a custom Legal Roadmap that will include the legal tasks to complete to meet your current business goals. Our Virtual Legal Officers then, we'll be able to choose and assign relevant legal providers to work on these tasks and manage their workload.

Disclaimer: the information in this guide is provided for informational purposes only. You should not construe any such information as legal, tax, investment, trading, financial, or other advice.

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Daria knows the ins-and-outs of venture deals after working in the VC industry, and now she helps startup founders solve their complex legal issues, all via the Legal Nodes platform. When she's not out for a run or sailing on her favourite Platu25, you'll likely find her discussing the best ways to structure a deal with her clients.

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