Buckworth Solicitors - Introduction to start up law
Introductionto Startup Law
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Introduction to Startup Law1question@buckworthsolicitors.co.ukCONTACTST. 020 8834 1616T. 020 7969 1867E. email@example.comW. www.buckworthsolicitors.co.uk“An Introduction to Start-up Law” ispublished by Buckworth Legal ServicesLimited trading as Buckworth Solicitors,Berkeley Square House, Berkeley Square,Mayfair, London W1J 6BD.Buckworth Solicitors is a bodyrecognised and regulated by theSolicitors Regulation Authority in theUK with registered number 559537including for any incidental servicesrelating to investments, insurance andmortgages.The content of this booklet is a generalsummary of a number of areas of law.It is not intended to be, and shall notconstitute, legal advice. You are stronglyin relation to your business and arenot permitted to rely on any statementcontained herein.Any recommendation of a third partysupplier made by us herein or otherwiseis made by us in good faith but does notconstitute a representation that suchsupplier is suitable for your business.Accordingly Buckworth Solicitorswill not be responsible for any lossessuffered by you arising from your use ofany such supplier.disclaims any liability for losses,damages or other expenses incurred byany person as a result of reliance on anystatement in this booklet.Copyright 2012. All rights reserved.No part of this booklet may bereproduced, stored in a retrieval systemor transmitted in any form or by anymeans, without the prior written consentof Buckworth Solicitors.I am Michael Buckworth, the Founder and Managing Partner ofBuckworth Solicitors.of serving the booming UK start-up market.advice and documentation. Hourly rates tend not to represent a gooddeal for clients. Furthermore they discourage clients from speaking tolawyers and building a close working relationship with them.We base our charges around the provision of documentation and aregenerally happy to give advice for free.The purpose of this “Introduction to Start-up Law” is to provide start-upswith a helpful, easy-to-understand resource to which they can refer asthey begin or continue their entrepreneurial journey.I hope that this resource is useful and informative. To the extent that youhave any questions or advice on any aspect of start-up law, please sendus an email or give us a call.Good luck with your business!“We charge solely on the basis of
2 www.buckworthsolicitors.co.uk1 Letter from MichaelBuckworth3 Commonly Used PhrasesA translation of commonly usedstartup jargon4Legal StructuresA summary of the legal structuresthrough which businesses can beoperated6 An Introduction to SocialEnterprise StructuresThe special entities created forsocial enterprises8 Customer AgreementsThe key terms to include inagreements with customers9 Privacy PoliciesWhat they do and why all onlinebusinesses have them10 Employment ContractsThe must have informationfor startups looking to take onemployees12 Intellectual PropertyRightsGetting it right from the startis easy. Getting it wrong is anightmare14 Shareholders’ AgreementsA corporate pre-nup. Not soromantic but much more sensiblein the long run16 Seed EnterpriseInvestment SchemeThe best thing to happen tostartups in a decade. Why youjust can’t ignore SEIS18 Enterprise InvestmentSchemeThe big brother of SEIS andalmost as punchy. The way toattract investors using HMRC’smoney19 Business PlansHow to write the perfect businessplan20 About BuckworthSolicitorscan help entrepreneursContents
Introduction to Startup Law3question@buckworthsolicitors.co.ukCommonly Used PhrasesEntrepreneurs and lawyers use “start up jargon”. This is adictionary for the uninitiated.Articles of association: theconstitutional documents of acompany which are created onincorporation. If you set up acompany yourself, tick the boxto use the standard CompaniesAct articles. These are perfect forstart-ups and will probably onlyneed to be changed in the contextof an investment round.Drag along: this is a termfor a provision often found inshareholders’agreements.Itrefersto the situation where a buyer whohas acquired a certain percentageof the share capital of the company(often 90%) is able to force theremaining 10% shareholder(s)to sell their shares to him at thehighest price at which he acquiredany other shares. The rationale forthis provision is that a buyer whobuys 90% of a company probablywants 100%.Convertible debt: this describesa loan structure that can orwill convert into equity (seeexplanation of “equity” below)in certain circumstances. Thesetend to be the occurrence of aninvestment round, a sale or listingof the Company or the insolvencyof the company, in each case priorto the loan being fully repaid.Debt: a short hand for loans andraise money by way of debt orequity (see explanation of “equity”below). Debt simply refers tothe fact that the company hasborrowed funds from a third party.Equity: a short hand for shares.An “equity investment” is asubscription for shares. “Holding10% of the equity” means holding10% of the issued shares of acompany.Intellectual property rights:this covers patents, copyright andrelated rights, trade marks andservice marks, business namesand domain names, rights in get-up, goodwill and the right to suefor third parties passing off theirbusiness as yours and rights indesigns, database rights, rights toShareholders: these are holdersof shares in a company limited byshares and who together own thecompany in proportion to theirshareholdings.Pre-emption: this is used to referto two separate concepts thatshould not be confused. The mostcommon usage is in the contextof share transfers. Here, a pre-emption provision requires aselling shareholder who has anoffer to purchase his shares fromto sell his shares to the othershareholders on the same termsand at the same price as offeredby the third party buyer. This givesthe remaining shareholders theability to retain ownership of thecompany and, for example, to stopa competitor purchasing a stake.Occasionally, people will referto “pre-emption rights”. In thiscontext they probably mean rightscontained in statute and in thearticles of association stating thatany new shares to be issued bythe company to third parties mustto its existing shareholders.The procedure for doing this isrelatively involved and so oftenthese pre-emption rights arewaived by the shareholders.Tag along: this term refers to aprovision found in shareholders’agreements that requires a buyerof a stated percentage of theshares of a company (often 75%)to offer to buy the remainingshares at the highest price and onthe same terms as he purchasedthe 75% shares. This grants theoption (but not the obligation) tothe remaining shareholders to exitwith the majority.
4 www.buckworthsolicitors.co.ukFor Profit Businesses:Legal Structuresto use. Fortunately, in the UK a limited company is cheap andIntroductionThere are a variety of legalstructures through which abusiness can be operated. We lookhere at incorporated structuresbusinesses.There are two main reasons foroperating a business through anincorporated entity (as opposedto operating a business as aadvantage of the limited liabilitynature of some incorporatedentitieswiththeresultthat(absentthe directors committing criminaloffences or the shareholdersgiving personal guarantees of thebusiness’s liabilities) the founderswill not be personally liable onan insolvency of the business.The second (which is applicableto companies but not to limitedliability partnerships) is to havethe business taxed separately toits owners.Most common types of entitiesPrivate company limited byshares: this is a company witha share capital. Shares in thecompany construe an ownershipstake and are purchased eitherat their nominal value or at apremium (i.e.atnominalvalueplusan additional amount). Ordinaryshares generally carry three rights:the right to a vote at a meetingof the shareholders, the right toreceive a dividend (a distributionin the capital of the company(which is generally relevant whenthe company is wound up or itsassets sold). Crucially the liabilityof shareholders is limited to theamount unpaid on their shares.Limited liability partnership(LLP) this is a special kind ofpartnership structure which isrecognised as a separate legalentity from its members for thepurposesofenteringintocontractsand carrying on its business andhas limited liability. Unlike alimited company, however, an LLPis not taxed as a separate entitybut each limited partner is taxedaccordance with his proportionalLLP must be set up by two or morepeople with a view to carrying on
5Introduction to Startup Lawquestion@buckworthsolicitors.co.ukTaxation of companies and thereliefs availableCompanies have to paycorporation tax each year. In thetax year 2012/13, this is chargedallowable expenses) at 20% up£300,000. Thereafter corporationtax is charged at 24%. Oncecorporation tax has been paidon any income, that income canremain in the company and (undercurrent tax law) will not be taxedagain unless and until it is paidout.Companies with a turnover inexcess of £77,000 in tax year2012/13 are required to registerfor VAT. Companies with aturnover below that threshold arenot required to register, but mayif they wish. VAT is chargeableat 20% on provision of VATablegoods and services and is payableto HMRC in arrears. Companiesregistered for VAT are permittedto offset VAT they have paid (inputtax) from VAT they have charged(output tax).Subject to meeting certainentrepreneurs’ relief is available tofounders of a company when theysell their shares. Entrepreneurs’relief reduces the capital gains taxpayable on any gain arising on asale of shares to 10%.As discussed later in this booklet,SEIS and EIS reliefs may beavailable to investors investing incompanies. These reliefs includeincome tax relief up to a maximumof 50%, capital gains tax relief upto a maximum of 100% and lossrelief.Ongoing costsLimited companies are requiredon an annual basis: a returnto Companies House, annualaccounts (or, if the Company isdormant, a dormant return) and acorporation tax return.If the company has employees, itmust deduct PAYE and accountto HMRC monthly for suchdeductions and its own employer’sNIC liabilities.When new shares are issued and/or directors are appointed orCompanies House.The cost of this compliance isare made on time, the fees payableto Companies House should notexceed £50 per year. Accountancyfees will vary depending on thecomplexity of the company’sbusiness but in general should bein the region of £1,000 to £2,000.Where the company is dormant,accountancy fees should benominal.annual returns but they are notlimited partner will be requiredinto account his proportion ofthe earnings of the LLP. The feespayable to Companies Houseshould be similar to those of acompany.Choosing a legal entityBefore choosing a legal entity,you should consider the followingquestions:(i) Is my business sellinga packageable product,software or service or isit a means for me (and myfellow founders) to sellour time, experience andknowledge?(ii) Will the business needinvestment in the future?(iii) What is my exit strategy?(iv) Is there any reason whyI would want to be taxedof the business?As a general rule, limitedcompanies are ideal structuresfor businesses that want tobring on board investment, orcommercialise a mass marketproduct or service. Bringing ininvestment is effected (relatively)simply by issuing shares; selling astake in the business (or the entirecompany) is achieved by a saleof shares. In addition there are aavailable on the issue and sale ofshares.Investing into an LLP is morecomplex whilst selling thebusiness of an LLP is generallymore challenging and often lessGetting the structure right up frontis important as changing it latercan be complicated.“Limited companies are idealstructures for businesses that want toseek investment…”“Companies must pay corporation tax
6 www.buckworthsolicitors.co.ukAn Introduction to SocialEnterprise Structuresand cons of each approach.IntroductionA social enterprise is a businesscarried on for a social purpose.Social enterprises can be operatedvia a number of structures.The desire to pursue a socialpurpose impacts on the structure,the main, social enterprises aimwhich they were set up, rathershareholders.One of the most important thingsto consider when setting up asocial enterprise is what legalstructure to choose. It is vital toconsider which structure will offerthe best protections for the socialpurpose, how the structure willimpact on the business’s ability towhat tax breaks will be available(if any) and how stakeholders canbe incentivised.A social enterprise can operate viaone of a number of legal structures.These include an unincorporatedassociation, a company limitedby shares or by guarantee, acommunity interest company, anindustrial provident society ora limited liability partnership.Further, a charity can be operatedthrough a number of structures.Sole traders, partnerships andunincorporated associationsHowever, those responsible forrunning the business will bepersonally liable and exposed tothe full risks and liabilities of thebusiness. For this reason, they tendnot to be practical structures forbusinesses operating in the publicliabilities.Common legal structuresCommunity interest company(CIC): CICs were originallyestablished as a social enterprisestructure for businesses witha social purpose which did notwish to become a charity. The CICstructure requires the businessto offer safeguards to protect itscommunity purpose. This is donevia the imposition of an assetlock. The asset lock is containedin the articles of association ofthe CIC and operates to protectthe community purpose. Assetscannot be distributed to theCIC’s shareholders (except inlimited circumstances whichinclude offering limited returnson investment and reasonableremuneration to directors andemployees). Upon a winding up ofthe CIC, the assets must be appliedand not to repay creditors. TheCIC cannot transfer any assets forless than market value apart fromto another CIC, other asset lockedcompany or charity.structure which protects thecontinuation of the social purpose”
7Introduction to Startup Lawquestion@buckworthsolicitors.co.ukcharity structures and can offerlimited returns on investmentto investors and reasonableremuneration for directors.They are regulated by the CICRegulator which offers a lightertouch approach to regulation thanthe Charity Commission. The CICmust satisfy a community interesttest both upon incorporation andthroughout the CIC’s lifespan.Further the CIC must providea community interest reporteach year setting out how thecommunity interest has beenpursued.Limited company: businessesan asset lock without restrictingthe possibility of operating thecan use a standard limitedcompany structure and replicatethe asset lock provision in thearticles of association. However,unlike CICs, the shareholders ofsuch companies can amend thearticles to remove the asset lockat any time. This gives addedthe community interest beingpursued at risk.Industrial and provident society(IPS): IPSs are societies which cantaketheformofeitheracommunityother than its members) or a co-operative society (Co-op) (set upIPSs offer members an equalstake and an equal say in themanagement and pursuance of thepurpose for which the society wasset up. They are regulated by theFinancial Services Authority andare registered under the Industrialand Provident Societies Act 1965.An IPS can be a charitable entity.However, IPSs are currentlyexempt from regulation by theCharity Commission.Charities: a social enterprise canbecome registered as a charityif it has been set up for a purelycharitablepurposeanditmeetsthestringentrequirementsofcharitieslegislation(includingfallingwithinone of the increasingly narrowpurpose and being operated forbe an asset lock in place to ensurethat all assets are applied solelyfor the charitable purpose. One ofregistered charity is that charitiesare entitled to a number of veryFinancingwith limited returns available toinvestors). Social enterprises aregrants. Grant funding is availableto social enterprises whateverthe legal structure. However,structures containing an asset lockand/or restrictions on investmentreturns and salaries are oftenviewed as more suitable for grantfunding.ConclusionInvestors are generally seeking agood rate of return which is morestructure.“Structures containing an asset lockare often viewed as more suitable forgrant funding”
8 www.buckworthsolicitors.co.ukCustomer AgreementsThe cornerstone of any business is the contract with itscustomers. This document limits the liability of the businessand requires the customer to pay.Forms of contractCustomer contracts come in threemain formats: terms of business,terms and conditions on websitesand formal written agreements.The nature of the business willoften determine which format ismost appropriate. Regardless ofform, the provisions are largelythe same.Key provisionsOtherthan“boilerplate”provisions(clauses dealing with governinglaw, waivers, notices, severanceetc.) which are very important toinclude in any contract, there arethree main provisions that arevital.Limitation of liability: anybusiness will want to limit itsliability if things go wrong. Everybusiness is exposed to liability. Byway of example, a tech businessproviding a website could as amatter of English law be liableto its customers if the websitetemporarily stops working. Wherecustomers are business users, thecompany might face a claim foroffers travel booking services, thebusiness could face a claim froma customer who was unable toretrieve his booking. In each ofthese cases, the business will wantto exclude its liability for any lossor damage incurred as a result ofthe website not working.Businesses offering advisoryservices could be potentially liableforhugelossesarisingfromaminormistake. This kind of businesswill want to limit its liability toa manageable level (generallywithin the limits of its professionalindemnity insurance).In the UK, businesses cannotexclude liability for death andpersonal injury, gross negligenceor fraud. In addition, some typesof business (including lawyersservices) cannot exclude all theirliability for negligent advice. Thesedealt with by insurance.Payment: most (though not all)businesses operate to make aset out what customers willbe charged, when they will becharged and when the charges willbe payable. Failure to set thesematters out in writing can resultin disputes and arguments withcustomers over what and whenthey are required to pay. Further,in the absence of clear provisionsconcerning payment, a court mayrefuse to give judgment in favourof a business pursuing a client fornon-payment.In parallel with paymentprovisions, businesses shouldconsider and detail theircancellation policy. Particularlywhere cancellation of an ordercould result in the businesssuffering loss, clear provisionsshould be drafted to set out whatfees will be payable in the event ofcancellation.Termination: theoretically, failureto provide for termination and/in a business being unable to stopperforming a service withoutbeing in breach of contract. Thiscan be problematic if the servicebusiness no longer wishes toprovide the service for otherreasons. Similarly, if a customerconsistently breaches the contract,provisions, it may not be possibleto terminate the provision ofgoods or services.Businesses should always includedetailed termination provisions incontracts with customers.Other mattersDepending on the nature of thebusiness, other provisions may beappropriate. Often it is necessarygoods to be provided, particularlywhere payment is conditional onperformance.“In the UK, businesses cannot excludeliability for death or personal injury”
10 www.buckworthsolicitors.co.ukEmployment ContractsComplying with employment law is vital if a business is toavoid employee claims. The employment contract is the mainagreement between employer and employee.The law discriminates betweenemployees and contractors.The most important differencebetween them is that the companywill deduct from salary paid to anemployee amounts in respect ofincome tax and national insurancecontributions under PAYE. It willalso pay employer’s nationalinsurance contributions. Thecompany will pay fees due to acontractor gross and will not payemployer’s national insurancecontributions. There are complexrules that determine whether arelationship is one of employmentor contractor: simply labelinga relationship as a contractorEmployment law regulates therelationship between the companyand its employees. It sets out theemployment conditions, rights,responsibilities and duties of theparties.The employment contract mapsout the employment relationshipand each of the parties’ rightsand obligations under it. Whilstthe contract does not need tobe in writing, it is advisable tohave a comprehensive writtencontract in place as evidence ofthe terms agreed. Furthermore,employees are entitled to awritten statement with particularsof the employment to be providedto them within two months of thestart of their employment with thecompany.General provisions: allemployment contracts shouldinclude the commencement date,job title and place of work such ashome of the employee.Notice periods: the employmentcontract must set out the noticeperiods that each party must givein order to terminate the contract.The statutory notice periods for anemployeewithbetweenonemonthand two years service is at least 1week’s notice, and after such timean additional 1 week for eachcontinuous year of employmentup to a maximum 12 weeks (for 12years of employment).Payment in lieu: the companymust consider whether they wantto offer payment in lieu of notice.This allows an employer to pay anemployee a lump sum rather thanletting the employee work outtheir notice period. If so, this mustbe stipulated in the employmentcontract.Salary: every employee is entitledto receive at least the nationalminimum wage. The employer isonlyentitledtomakedeductionstoan employee’s wages if required bystatute such as PAYE contributionsor if the employee has consentedto such deduction or it is an agreedterm under the contract. Eachemployee must receive a payslipeach time payment is made.Hours: the employment contractmust stipulate the employee’sexpected hours of work. Accordingto the Working Time Regulations1998 an employee may not workfor more than 48 hours per weekwithout the written consent ofthe employee to opt-out of thisrestriction. The contract mustmake the employee aware thatthey may be expected to workover their contracted hours, withor without remuneration for over-time.Holidays: the Working TimeRegulationsstipulatethataworkerwho works full-time is entitled to5.6 weeks paid holiday per yearwhich can include public holidays.In the UK there are currentlyeight public holidays per year.The employer can decide to offerlonger paid holiday entitlementand can allow any untaken holiday(usually up to ten days) to becarried over into the next year.Disciplinary and grievanceprocedures: information ondisciplinary and grievanceprocedures should be set out inthe contract of employment. Forexample an employee must notifythe employer in writing with anygrievances. Further, an employeeis entitled to be accompanied by“Employees are entitled to writtenparticulars of employment within twomonths”
Introduction to Startup Law11question@buckworthsolicitors.co.ukat a disciplinary or grievancehearing.Pensions: the company mustconsider whether to offeremployees a pension. Aside fromthe State Pension offered by theState to employees who havecontributions, the company maywish to offer its employees aprivate pension. A company isnot obligated to offer a privatepension but it should be clear inthe employment contract whetheror not one will be offered.Sickness and sick pay: if anemployee is absent from workdue to sickness, the employer isrequired to pay Statutory SickPay for a period of up to 28 weeksfor any period of sick leave. Someindividuals do not qualify forStatutory Sick Pay for example ifthey do not earn enough to paynational insurance contributions.The Statutory Sick Pay can besupplemented with contractualsick pay which will be equal tothe employee’s normal salaryinstead of Statutory Sick Pay, orthe employee can receive theirnormal salary less the amountfor SSP. However any entitlementto contractual sick pay must beincluded as a term under thecontract.an employermay wish to include a term inthe contract that governs theemployee’s duty to protect theinformation of the companyduring and after termination ofemployment. During employmentthe employee will have aninformation of the Company. Aftertermination of employment theemployee will still have an impliedduty, but this will be limitedto protect information that isto a trade secret.Restrictive covenants: whilst theemployee is bound by a limitedimplied duty to protect the tradesecrets of the company aftertermination, the company maywish to consider incorporatingexpress contractual restrictivecovenants as a further safeguardagainst any potential harmfulconduct of the employee aftertermination. However, thegeneral position is that restrictivecovenants are unenforceable asthey are considered a restraint ontrade unless the restriction canbe proven reasonable in order toprotect the legitimate businessinterests of the company. The testfor whether a restraint on tradeis deemed reasonable dependson an assessment of the length oftime, scope and geography of therestriction. Restrictive covenantscan be used to protect interestssuch as trade secrets, businessconnections and the stability of theemployer’s workforce and includenon-compete, non-solicitationbusiness connections, and non-dealing covenants prohibitingdealing with customers.
12 www.buckworthsolicitors.co.ukIntellectual Property RightsFailing to secure ownership of crucial IP at the very start ofa business can be a very expensive (if not terminal) mistake.Fortunately, getting it right is relatively straight forward.For many businesses, ownershipof rights in designs, graphics,content and code is crucial. Theserights are known as “intellectualproperty rights” (IP). The mostimportant aspects of IP formost businesses are copyright,trademarks and patents.Copyright arises automatically oncreation – no formal registrationis required. Copyright protectionapplies for a limited period oftime and allows owners to preventthe use or adaptation of theircopyright content.Trademarks arise by virtue ofregistration with a registry (whichin the UK is the IPO). Trademarksare granted for a period of timeand allow the trademark holderto prevent competing businessesfrom using his trademark.Patents are also granted byregistration and are designedto offer a limited period ofprotection to innovative productsor processes.For startups, the priority shouldbe on ensuring that all IP is ownedand controlled by the business.The following are 5 commonproblems faced by new businessesand some suggested solutions.Ownership ofIP created by anemployeeUnder Englishlaw, intellectualproperty rights created by anemployee during the courseof employment automaticallybelong to the employer. However,show that the employee did in factcreate a disputed IP right duringthe course of his employment.The fact that material embodyingintellectual property rights wasor using the employee’s privateresources, or that the materialembodying the intellectualproperty rights is not related tothe employee’s normal duties,may give rise to arguments thatthe rights belong to the employeerather than his employer.The Solution: inclusion inemployee’s employment contractof the following clause:The Employee acknowledgesthat all Employments IPRs,Employment Inventions andall materials embodying themshall automatically belong tothe Company to the fullest extentpermissible by law. To the extentthat they do not vest in the Companyautomatically, the Employee holdsthem on trust for the Company.Ownership ofIP created by aconsultantUnder Englishlaw, intellectualproperty rights created by aconsultant during the course ofthe consultancy automaticallybelong to the consultant.The Solution: inclusion inconsultant’s consultancyagreement of a similar clauseproviding for the automaticassignmentofallIPtothecompanyon creation.Moral rightsMoral rightsare statutoryrights relatingto copyrightworks. Copyrightapplies to software and computerprograms automatically byoperation of law. These rightssurvive assignment of thecopyright works to a third partywith the result that the third party(and any subsequent assignee)is limited in what it can do withthe work. The two main moralrights of concern are the right towork and the right to object todefamatory treatment of the work.An employee cannot enforcemoral rights against his employer,“Businesses should take steps toensure they own any IP created byemployees and consultants fromday 1”
13Introduction to Startup Lawquestion@buckworthsolicitors.co.ukbut he can enforce them againstan assignee of the employer. Ifan employer wants to assign thecopyright in a work to a third party,that third party may be preventedfrom adapting the work. Thiscould affect the value and sale ofthe copyright.The Solution: inclusion inemployee’s employment contract(or agreement with contractor) ofa waiver of moral rights by way ofthe following clause:The Employee waives all his presentand future moral rights which ariseunder the Copyright Designs andPatens Act 1988, and all similarrights in other jurisdictions relatingto any copyright which forms partof the Employment IPRs, and agreesnot to support, maintain or permitany claim for infringement of moralrights such as copyright works.Disclosure ofinventionIf any personreveals how aninvention works,it is highly likely that the inventionwill no longer be patentable. Thisis because an invention mustbe “novel” to be patentable andwhatsoever destroys this novelty.The Solution: inclusion inemployee’s employment contractof the following clause (in additionprovision):The Employee agrees to keepInvention unless the Companyhas consented in writing to itsdisclosure by the Employee.Right to obtain apatentOnly the inventorowner of aninvention isentitled to obtain a patent for it.The Patents Act does not grantownership of any invention madeby a consultant to the company.The Solution: an agreementto assign future rights shouldbe included in the consultancyagreement. It should be as preciseas possible in identifying the rightsto be assigned.The agreement should alsoprovide that the consultant must(on request and on condition thatthe company will pay the costs)apply for the patent itself and onbeing granted the patent assignit to the Company for a nominalconsideration.ConclusionAs a starting point anyone creatingIP for a business should sign anagreement containing appropriateIP protections. This appliesequally to employees, contractors,developers and founders. GettingIP ownership right is relativelystraightforward. It should be apriority of any startup reliant oncontrolling and owning its IP.
14 www.buckworthsolicitors.co.ukShareholders’ AgreementsWhere money is involved, even the best of friends can fall out.Agreeing ownership and management structures up frontreduces the risk of irreparable disagreements.A shareholders’ agreement is anagreement between the ownersof a company agreeing how thebusiness will be run, who will beresponsible for decision-makingand what will happen if and whenone or more shareholders wishesto exit the business.A well-drafted shareholders’agreement should set out in clearunequivocal terms what happensin the event of a shareholderwishing to sell his shares and howdisputes between shareholdersare to be resolved. Failure to dealwith these issues in the earlystages of a company’s life can spelldisaster further down the line.When thinking about puttingtogether a shareholders’agreement, founders andstakeholders should consider anddiscuss the following questions:Control: will the managingshareholder (if there is one)retain control of the board anda majority shareholding? If so,will there be any matters onwhich the unanimous consent ofthe directors/shareholders willbe required? Can the managingshareholder be removed as adirector or forced to sell some orall of his shares?Capitalisation and business plan:is the amount of any investmentall shareholders been involvedwith producing the businessplan and have all shareholderstaken responsibility for it? Is thebusiness plan realistic?Further capital and dilution:have the shareholders discussedand agreed how additional capitalwould be raised if required? Whowould provide additional capital?By loan or equity? If by equity,are all shareholders comfortablewith having their shareholdingsdiluted?Accountability: who will run thebusiness on a day-to-day basis?Where some shareholders will be“silent”, are mechanisms agreedfor them to be kept informedabout the performance of thebusiness? What documentationwill they receive and when? Is thispractical? What powers do theyhave if they feel that the businessis being poorly run?Risk allocation: have theshareholders discussed theallocation of risk amongst them?Are some shareholders better“Failure to consider and documentownership and managementstructures in the early stages canspell disaster”
15Introduction to Startup Lawquestion@buckworthsolicitors.co.ukprotected on an insolvency thanothers (e.g. they have securityover company assets) or do someshareholders have preferentialhave theshareholders agreed theremuneration of directors (ifany), the extent of managementfees paid to a shareholder (if any)and the dividend policy of thecompany?interest: have the shareholdersagreed what work shareholdersare permitted to do for othercompanies? Does this includecompeting businesses? Doesthe shareholder owe a duty ofAre non-compete, exclusivityand non-approach provisionsappropriate in respect of anyshareholder?Dispute resolution:notwithstanding the above, isthere a mechanism by whichdisputes will be resolved?Will this mechanism operateif a shareholder (or group ofshareholders) refuses to take partin any process? What happensif a shareholder breaches anyprovisions of the Shareholders’Agreement?Exit: have the shareholders agreedtheir exit strategy? When doshareholders wish to exit? Willall shareholders exit at the sametime (e.g. by sale or listing of thecompany)? Is there a mechanismto force all other shareholders tosell their shares if an offer for thecompany is made? Do pre-emptionrights kick in if a shareholderwishes to sell his shares? Is therea mechanism for valuing thecompany for the purposes of asale?Insolvency: to the extent possible,are the assets of the businessoperated by the companyprotected from an insolvencyof the company? Do any of theshareholders have preferentialrights on an insolvency of thecompany?Key provisionsThere are a number of provisionsthat should be considered inthe context of all shareholders’agreements and will appear inmost.Transfer provisions: in the eventthat a shareholder wishes to sellhis shares, the common approachto the other shareholders. Forfounded, it might be appropriateto state that no founder can sellhis shares. Some businesses alsoseek to prevent sale of shares tocompetitors.Restrictive covenants: it iscommon for founders to agree notto set up a competing businessand not to solicit any client oremployee of the company eitherduring or after the end of hisinvolvement with the company.Mandatory transfer: someshareholders’ agreements containprovisions that contemplate thecompany (or other shareholders)buying some or all of a leavingfounder’s shares at a pre-agreedvaluation. This can be structuredas a simple mandatory buy back oras a reverse vesting.Management provisions:shareholders’ agreements containprovisions setting out how boardand shareholder matters willbe decided, and allocating somedecisions to the board and othermatters to the shareholders.In addition to it being easiermanagement matters when thecompany has no value, the otherWhen a company has no value,more structures are available asshare issues and transfers are lessterm tax liabilities.property: there should be anobligation on all shareholders toinformation, trade secrets andintellectual property of a company.In addition these assets should beof the company. It is common tosee provisions in shareholders’agreements designed to providethis protection. In particular,where the company is relianton its intellectual property, onewould expect to see an IP transferprovision assigning all IP createdby any shareholder now and in thefuture and relating to the businessof the company to the company.“When a company has no value,more structures are available asshare issues and transfers are lessterm tax liabilities”
16 www.buckworthsolicitors.co.ukSeed Enterprise InvestmentSEIS is one of the most generous tax incentive schemes forinvestors in years. Entrepreneurs should be rushing to takeadvantage of it.The Seed Enterprise InvestmentScheme (SEIS) is a tax reliefscheme for investors investing instartup companies. The rationalebehind SEIS is to encourage highnet worth individuals to invest inhigh risk start up businesses on afull risk basis.SEIS offers investors generousincome tax, capital gains tax andloss reliefs. Under SEIS an investorcan invest in a qualifying companyup to a maximum £100,000 perannum and a qualifying companycan raise a total of £150,000 underSEIS.Whilst the scheme was createdin order to incentivise andfacilitate investment into startupcompanies, complicated andtechnical rules apply both for theinvestor and the investee company.Tax reliefs availableincome tax and capital gains tax.Income tax relief: an investor isentitled to 50% income tax reliefon the amount invested in sharesin a qualifying company up to anannual limit of £100,000. The reliefwill be set against the investor’spersonal tax liability for the taxyear in which the investment wasmade. Therefore, if an investorinvests £100,000 in tax year 2012-2013 and his tax liability for thatyear is £50,000, he can set therelief against his tax liability andreduce his tax liability to zero.Carry-back facility: an investorwho invests in shares in one taxyear is permitted to carry back thetax relief to the previous tax yearin respect of all or part of the costof the shares as if the shares hadbeen acquired in that previousyear.Capital gains tax relief: aqualifying shareholder can beentitled to up to 100% exemptionfrom capital gains tax on a disposalof the SEIS qualifying shares ifa claim for income tax relief hasbeen made on the shares and theyhave been held for at least threeyears.Loss relief: if the SEIS shares aredisposed of at a loss, the loss canbe set off against income made inthe year in which the shares weredisposed of, less any income taxrelief already given.Capital gains re-investmentrelief: capital gains re-investmentrelief is available for chargeablegains made from a disposal of anyassetintaxyear2012-2013ifsomeor all of the gain is invested intoSEIS qualifying shares in that sameyear. Note the SEIS investment canbe made prior to the disposal ofthe asset. The relief can be claimedon a maximum investment perinvestor of £100,000. This relief isonly available for tax year 2012-2013 and is incredibly valuable fortax liabilities and capital gains taxliabilities in the 2012/13 tax year.It is important to keep in mindthat should an investor disposeof SEIS qualifying shares beforethe expiry of three years from thedate of the investment, the reliefwill be withdrawn in its entirety.The relief will also be withdrawnshould either or both the investeecompany and the investor fail tomeet any of the requirements ofthe scheme as summarised below.Investor requirementsThe investor must subscribe fornew, full risk, ordinary shares.There must be no arrangement inplace to protect the investor fromany normal risks associated withan investment into a company.The shares cannot have anypreferential rights and must benon-redeemable.The investment must be made forgenuine commercial reasons andnot for tax avoidance purposesand the shares must be paid forupfront in full before the sharesare issued. The investor must not“SEIS offers investors generousincome tax, capital gains tax and lossreliefs”
17Introduction to Startup Lawquestion@buckworthsolicitors.co.ukdispose (or agree to dispose) ofsome or any of the shares prior tothe end of the period of three yearsfrom the date of the investment.The investment must not be part ofa reciprocal arrangement wherebythe investor will subscribe forshares under SEIS in return foranother person subscribing forshares in a company in which theinvestor or a person connectedwith the investor has a substantialinterest.The investor cannot be a personconnected with the company.The investor cannot hold 30% ormore of the share capital or votingrights and cannot be entitled tomore than 30% of the company’sassets. When considering whetheran investor holds a substantialinterest HMRC will take intoaccount the shareholdings ofthose deemed associated withthe investor. Associates includespouses, civil partners, businesspartners, parents, grandparents,children and grandchildren butnot brothers or sisters.The investor cannot be employedby the company during thethree year investment period.An investor can however be apaid director of the companyso long as he is paid reasonableremuneration. When consideringwhether remuneration is“reasonable” HMRC will considerwhat is reasonable remunerationfor a director in the same line ofwork and similar circumstancesand any expenses claimed mustalso be deemed reasonable.Company requirementsOnly a qualifying company canissue shares under SEIS. In orderto be a qualifying company,all investment funds must beapplied towards progressinga new qualifying businessactivity within three years of therelevant share issue. A qualifyingbusiness activity includes a newtrade carried on at the date theinvestment is made and or anypreparatory activity, includingresearch and development, whichtakes place with a view to carryingon a new qualifying trade at a laterdate. The qualifying trade mustbe the sole purpose for which thecompany was set up.The concept of a qualifying trademaking activities with a fewexceptions.The company must carry out aqualifying trade throughout theterm of the investment. The trademust be less than two years old atthe date of the investment and theissuing company must not havecarried on any other trade priorto starting the qualifying trade forwhich funds are being raised.From the date of incorporationuntil the end of the relevantthree year investment period thecompany must be independent.This means the company cannotbe a 51% subsidiary or under thecontrol of another company.Money raised and used to buystocks or shares in a companyor payment of dividends toshareholders will not be deemedspent on a qualifying activity.However if the money is used tobuy stocks or shares in a 90%qualifying subsidiary which thenspends the money on a qualifyingbusiness activity then the investorwill still be entitled to relief.At the time the shares are issuedthe company must be resident inany previous investment underany venture capital trust or EISinvestment. The company mustless. Immediately before theshares are issued the companymust have no more than £200,000gross assets.ProcedureA company can apply foradvance assurance from HMRCto see whether it meets all therequirements to qualify forinvestment under SEIS.Once the share issue has beenmade, and 70% of the investmentmonies have been spent, thecompany can apply to HMRC for aof the share issue. Once HMRC hascompany can then issue the SEISinvestor with a claim form (SEIS3)so that he can claim his relief.The investor claims relief bycompleting a Self Assessment taxreturn for the tax year in which theshares were issued. If an investorholds a form SEIS3 but has yet tobe issued a tax return, the investorcan request a change to their PAYEtax code or any self assessmentpayment due. An investor canalso claim retrospectively forany relief where it is too lateto amend a Self Assessment orwhere he is claiming capital gainsreinvestment relief. Relief can be31stJanuary following the tax yearin which the SEIS investment wasmade.“The company must be tax resident
18 www.buckworthsolicitors.co.ukEnterprise Investment SchemeForinvestorsinlarger,more-establishedcompanies,EISoffersa 30% income tax relief and no capital gains tax to pay on asale of shares in the investee company.EIS, like SEIS, is a tax relief schemefor investment into startupcompanies. The scheme offers30% income tax relief and capitalgains tax relief to investors inqualifying companies. Under EIS,an investor can invest up to amaximum £1,000,000 per annumin a qualifying company and aqualifying company can raise atotal of £5,000,000 per annumunder SEIS, EIS and other similarschemes combined.A company which has initiallyraised money under SEIS musthave spent at least 70% of themonies raised prior to raisingfunds under EIS and any moneyraised by the Company underEIS must be spent on a qualifyingbusiness activity and within twoyears of the date of the investment.Tax reliefs availableIncome tax relief: an investor isentitled to 30% income tax reliefon the amount paid for his sharesup to an annual limit of £300,000(30% of £1,000,000). Just like withSEIS, the relief can be carried back.Capital gains tax relief: as withSEIS, a disposal of EIS qualifyingshares will be tax free if a claim forincome tax relief has been madeon the shares and they have beenheld for at least three years.Loss relief: if EIS qualifying sharesare disposed of at a loss (afterthe end of the period endingthree years after the date of theinvestment), the loss can be set offagainst income made in the yearin which the shares were disposedof or income from a previous year,less any income tax relief alreadygiven.Capital gains tax deferral relief:any capital gains tax liabilityarising from a disposal of an assetcan be deferred by investing thegain in shares of an EIS qualifyingcompany on condition that thegain is invested one year beforeor within three years after thegain arose. There is no investmentlimit under this relief so long asthe investment does not exceedthe maximum amount a companycan raise per annum. The sharescan be disposed of at any time asthere is no minimum or maximumperiod for holding the shares andthe tax liability will crystaliseupon disposal of the shares. Unlikeincome tax relief, this relief isavailable to persons connectedwith the company.Investor requirementsExcept for the following theinvestor requirements for EIS arethe same as for SEIS.The investor (and/or an associateof the investor) will not be eligiblefor income tax relief if he isemployed as a partner, director oremployee by the company withinthe period of two years prior tothe date the shares were issuedand three years after that date(or the date the qualifying tradebegan if later). However, there isan exclusion to the above rules foran investor who acts as a ‘BusinessAngel’. For these purposes aBusiness Angel is a director whodoes not receive, nor is entitledto remuneration and who has notpreviously been involved in thecompany’s trade at the time theshares were issued. The BusinessAngel can subsequently becomea paid director without losinghis relief, but any remunerationmust be reasonable in thecircumstances. The director canalso invest after becoming a paiddirector and receive income taxrelief on that investment so long asthe investment as a paid director ismade either within the three yearinvestment period of the initialEIS investment before the investorbecame a paid director, or theshares are issued before the end ofthe three year investment periodin relation to qualifying sharesissued to the investor under SEIS.Company requirementsSimilar requirements to those setout above in relation to SEIS apply,except as follows.Immediately before the shares areissued the company’s gross assetsmust not exceed £15,000,000and immediately after the shareissue the company’s gross assetsmust not exceed £16,000,000. Thecompany cannot own a subsidiarythat is not a qualifying subsidiaryand there must not be any sucharrangement or plan in place todo so at the time the shares areissued. The company must have250 employees or less.
Introduction to Startup Law19question@buckworthsolicitors.co.ukBusiness PlansHaving a coherent, defensible and realistic business plan is apre-requisite to securing investment.A business plan must be wellthought through and defensible.together like a jigsaw and must beThe constituent partsThere are three parts to a businessplan: the vision, the business caseequally important.The vision sets out the idea, whythe founders are able to monetisethe idea, what the founders bringto the business beyond the ideaitself and how the founders intendto grow the business to provideThe business case explains whythe world needs the idea, whatproblem it solves and the potentialmarket for the idea. This sectionis the most factual and foundersmust have an understanding of themarket in which they will operate,theircompetitorsand the potentialopportunities and pitfalls they willencounter in seeking to exploit themarket.the most important section, butthey can only exist in parallel withthe previous two sections. If thereis no realistic market for the idea,If the founders have not correctlymarket, any assumptions in therealistic.Getting help with business plansThe author of a business planneeds to have an understandingnot just of the idea, but of theexpectations of investors. Oftenthe best business plans are notwritten by the founders butby a detached third party withexperience of fundraising andof the expectations of investors.Founders need to be deeplyinvolved as part of the process, butthe input of an experienced thirdissues early on.
20 www.buckworthsolicitors.co.ukAbout Buckworth Solicitorsbased in Central London. They charge solely on the basis ofOur practice areasWe provide advice on a range oflegal issues including:models: we assist clients withputting together business plansand work with our accountingforecasts. We leverage ourexperience of working withlarge numbers of startup clientsand investors to create strongdefensible business plans.Incorporation and set up: wecan incorporate companies andother legal structures (includingfor clients not resident in the UK),agreements and advise ontransfers of businesses from soletraders to companies.Website/software launch: weprovide tailored privacy policiesandtermsandconditionsaswellassoftware as a service agreements,licence agreements and developeragreements.Employment: we providecontracts and policies and adviceon whether a relationship shouldbe treated as one of employmentor contractor. We also adviseon avoiding and dealing withemployment disputes.Commercial transactions:we assist clients with draftingcustomer contracts, negotiatingsupplier agreements as wellas franchising, licensing andoutsourcing agreements.Intellectual property: we assistclients with ensuring that theirbusiness owns intellectualproperty rights created byemployees and third parties.We also advise on trademarkapplications for clients.Property: we negotiate new leasesand the acquisition and disposalof leases. We also advise on rent: we adviseclientsonmergersandacquisitionstransactions, fundraisings andjoint ventures.Investment and funding: inaddition to negotiating anddocumenting funding rounds, weoffer a funding report productinvestors. The report is madeof recent deals in the client’sbusiness sector detailing theinvestee company, the investors,the size of the investment and thedate of the transaction. The secondis a tailored list of investorswho match the criteria of thecompany and who are active in thecompany’s business sector.Our value added services forclientsIn line with ourpolicy of not charging for advice,we provide clients with regularVideos we provide videosexplaining areas of law relevantto startups which can be foundon our youtube page which isaccessible from our website.Seminars we hold monthly legalseminars which are free to attendand are open to all.
Club Workspace is a fastgrowing network of creative,co-working business clubsacross London.Our Clubs are designed for both collaborative anddrop-in working. All of our Clubs host workshops,seminars and networking events that are tailoredfor an audience of small businesses, entrepreneursand startups. Members are invited to them all!We have three simple membership packages:• Three days, one Club• Everyday, everywhere• Your desk at Club.Or if you want to work in a different way, let usknow. We also have a great new range of optionalextras from printing and lockers to mailboxesand meeting rooms.For more information or to join Club Workspacevisit the website, call 020 3176 4006 or firstname.lastname@example.org@clubworkspace for news and eventsclubworkspace.co.ukClub locations:Clerkenwell Workshops EC1RThe Leathermarket SE1Kennington Park SW9Opening December 2012:Barley Mow W4Enterprise House SE1Buckworth Solicitors recommends
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