5 legal tips for start-ups – The importance of laying a proper legal foundation
29 Oct 2018
Many highly successful start-ups are bedeviled by legal disputes, often between founders or funders, which could have been easily avoided. The story of McDonalds is one example. It was founded by brothers, Richard and Maurice McDonald, who were ultimately allegedly short-changed by Raymond Albert “Ray” Kroc, who joined the business after its establishment but took all the glory (and the money). How? Because they did not put legal agreements in place to regulate their partnership.
It is understandable that entrepreneurs are focused on growing their businesses and not on legal matters. Who wants to worry about what might go wrong when one’s focus is on building a business or implementing a great idea? Quite apart from this, it is not exactly exciting (especially for your typical entrepreneur) spending time on matters such as contracts and company structures.
However, some of the greatest pitfalls that face start-ups, if not at the outset, then later down the track, arise from the failure to lay a proper legal foundation. These five tips should assist.
1. Limit your liability
It is critical to ring-fence the assets and liabilities of the business from those of the founders’ personal assets and liabilities. Put differently, take steps to protect your own assets in the event of your business failing. Establishing a limited liability private company is usually the quickest and most cost-effective way of doing this. This can be done by purchasing a “shelf company” (a company which has already been incorporated, but which has not yet commenced trading), or incorporating the company oneself through the offices of the Companies and Intellectual Property Commission.
2. Agree on founding documents
A shareholders’ agreement and memorandum of incorporation are foundational documents for any start-up. These documents set the “rules” and provide a structure for a company. They can be flexible and can be adapted as the business grows. As between shareholders in the business, a shareholders’ agreement regulates the parties’ rights and obligations and, by way of example, should cater for voting rights (how decisions are made) and eventualities such as where one shareholder wants to exit and sell his or her shares to a third-party.
3. Negotiate and prepare clear contracts
Start-ups need to be flexible to adapt and grow. However, whether your business renders services or sells goods, it is critical that the terms and conditions of its offering (which may change from time to time) are clearly communicated to consumers. If your business offers an online subscription service, the terms of the subscription offering should be presented to consumers and agreed to by them before rendering the service in question. In the case of the sale of goods, the terms and conditions of sale should be clearly explained, and you should ensure that they comply with consumer legislation such as the Consumer Protection Act. As regards suppliers, make sure you negotiate the best terms possible for your business, and make sure that your suppliers put those terms in writing.
4. Ensure statutory compliance
Keep records! One of the most common mistakes made by start-ups is the failure to maintain basic company secretarial and other statutory records. These are vital to ensure that your business complies with its tax obligations, with the requirements of the Companies and Intellectual Property Commission (such as filing annual returns) or ensuring that cross-border transactions are approved by the South African Reserve Bank. A failure to maintain proper records can also prove to be very costly if the business grows and wishes to obtain investment in the future. Most investors will want to conduct a due diligence on the business before investing any funds, and statutory compliance (or non-compliance) is a key consideration.
5. Ask for help
Don’t be penny wise, pound foolish. Engage the services of an accountant and attorney to assist with book keeping, tax returns and legal compliance. This will serve to avoid any penalties for non-compliance, late and incorrect statutory filings. It should, hopefully, also help to ensure that your start-up has a solid legal foundation from which to grow.
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