Launching Your Startup? Legal and Commercial Considerations for Beginners

The global startup ecosystem is growing at fast pace. In Africa, it is faster than ever before. There is ever increasing innovation, and investors are ready to put in good capital to bring the next big innovation into profitability. This is largely influenced by growth in the global information technology space which, according to a report by Business Wire[1], is expected to grow from $7.9 trillion in 2020 to $11.9 trillion in 2025 at a compound annual growth rate (CAGR) of 9%.

This is largely driven by small and mid-sized startups together with those that transform themselves into huge global brands and commercial behemoths. It is instructive to note that the general projection and perception is that, even with the growth and the financial gains already seen, the startup climate is still at its infancy. This is even more so in Nigeria where the growth in the startup climate has become more pronounced by increased investor activity in the space.

In the first half of 2021, Nigerian startups raised $1.270 billion in venture capital funding, the largest in Africa, which, according to reports, is five times more than traditional FDI which stood at $232.73 million.[2] At the end of 2021, startups in Nigeria raised about $1.7 billion in disclosed transactions being about 60% of total VC funding in Africa.[3] The effect of this increased activity, growth and development is that it has created momentum for the creation of even more startups, innovating across sectors, even as investors still have their tentacles fixed on Africa.

What will be done in this article is to introduce founders to the starting point of them setting up their business and also to simplify the understating of some of the legal and commercial labyrinths they will face. Some pointers will be given on what startup founders can do to navigate the terrain. Thus, certain essential legal and commercial considerations for startups, before and after they have launched their venture, will be looked at.

What are Startups?

Simply put, a startup is a company, usually a private company, with high-growth potential, creating innovative products and services, looking at rapidly expanding across markets. Usually, startups aim to create unique and irreplaceable products and services. Their goal is to create new products, through research and innovation, that changes the way markets carry out particular activities and use particular products. An essential feature of a startup is that they are usually technology companies or companies that utilise technology-based solutions in creating their products and services.

Today, startups are found in all sectors of the economy, including but not limited to finance, healthcare, real estate, transportation, commerce, energy, media, law etc. Their products and services are positively disruptive, changing how things are done and creating needs and wants that were otherwise non-existent.

Startup founders face a lot of challenges in setting up shop. The first set of challenges they usually face are questions on how they can scale their idea into profitability. This makes them consider several things: from raising finance either by approaching VC funds or individuals who may want to invest in their idea or venture; to protecting their idea and intellectual property to avoid their theft or sabotage; to the formation of appropriate corporate structures; to compliance with regulatory requirements. These considerations are numerous and the legal and commercial issues that arise at the initial stage are a myriad of mazes on their own. I will attempt to address some of these issues in this little article.

Let’s jump right into it.

The Legal Considerations

Company formation: In setting up your startup, you must do so with the appropriate legal structure. One of the distinguishing features of a startup is its ability to raise finance to scale its business. This can either be done either through debt or equity. In today’s venture capital climate, most fund raises are done through equity capital or through alternative instruments, like convertible notes and simple agreements for future equity, that ends up granting equity in the business at the end of a particular term. This cannot be done through the appropriate structure, which is usually a company that has the capacity to both grant and receive shares.

In Nigeria, the usual structure is to register a startup as a private company limited by shares, also referred to as a private limited liability company “Ltd”. Asides, the advantage mentioned above, with regards to accommodating new investors, the “Ltd” ring fences the liability of the founders and investors, limiting it to the capital contributed to the company by them. This means that upon liquidation of the company they will not become personally liable for the startup’s liabilities. Another advantage is that it also has its own legal personality, meaning that it can enter into contracts, purchase properties and own things, and can also sue and be sued in its own name. This concept is known as corporate legal personality.

The idea of corporate legal personality also allows for the possibility of several corporate structures being formed in taking advantage of the laws of several jurisdictions. This is especially seen with regards to the use of a holding company “HoldCo” structure for startups.

Intellectual property protection: Startups are valuable entities. One fundamental indicator of their value is their intellectual property (IP) assets and portfolio. Intellectual property essentially is the most fundamental valuable asset of a startup and they must be properly protected. Intellectual property, in the case of a tech startup for instance, refers to the source codes of its several applications, its trade name, its domain name, its logo, its designs, its products looking at the software upon which a software patent may be obtained. Essentially, it refers to every creation of the mind in the startup whether or not it is of immediate value.

IP, therefore, refers to copyrights, trademark, patents, industrial designs, geographical indications, trade secrets etc. Startups must take measures to protect these assets, either by registration with international and local agencies, or by contracts with its employees, partners, contractors, investors and other counter-parties they deal with.


The use of contracts (Founders/Shareholders Agreement, Employee Contracts and IP Assignment): Another consideration that startups and founders must pay attention to is with regards to the use of agreements in protecting the startup. First is with regards, to founders of the company entering into a Founders Agreement. This agreement spells out the role of the founders, their shareholding structure, their rights in the company. This agreement can also be used to gain long-term commitment of the founders to the startup, to ensure confidentiality, to prevent the circumvention or sabotage of the startup or startup idea by any of the founders, and to prevent the theft of intellectual property.

The shareholders agreement which is one entered into with the shareholders of the startup, whether or not the shareholders is a founder, contains clauses similar to those in the Founders Agreement and affords similar protection to a startup. The employee contract, on the other hand, is one entered into with the employees of the company spelling out the roles, rights and responsibility of the employee, it must also contain clauses relating to confidentiality, non-circumvention and non-solicitation of other employees, clients and, in some cases, contractors.

There must also be IP assignment agreements between the founders. This can be in a separate agreement or it can be inserted as clause in the founders or shareholders agreement. Similar clauses should also be inserted in employee contracts to make sure that the startup takes ownership of the work the employee is being paid to create for them.

Data protection and data privacy: Protecting the data of users and ensuring their privacy is an essential legal consideration that startups must have in mind in their business undertaking. So many startups and large companies have run into liability in this regard and have either entered into large settlements or paid heavy fines for data privacy breaches, and it does not matter whether or not the breach is intentional. In solving this problem, Startups must, therefore, spell out terms under their terms of use and data privacy notices of how they are going to collect and handle the data of their users in compliance with extant laws.

Retaining the services of a lawyer: In rounding up the conversation on legal considerations, the startup must also retain the services of a skilled lawyer specialised in advising startups. What the lawyer does is advise the startup through the various stages of its startup lifecycle– from formation, through the different stages of finance, regulatory compliance, strategic collaborations and partnerships, expansion, and to exit. So while you are focusing on building and growing your business, you need a lawyer who would advise you on keeping the corporate process tidy. There must be a budget for this. The importance of a startup lawyer cannot be overemphasised.

The Commercial Considerations

Getting the right team: The survival of a startup usually depends on its team. All startups must possess the right people with the right skill sets and motivation. What then does the right team look like for a startup? This begins with looking at the founders of the startup. The people with the big idea to create the product and the company. They must possess the necessary motivation and intelligence to accomplish their vision. They must also possess the right skills. In a tech startup for instance, asides the CEO of the startup there must be a technical co-founder who possess, who possess the right skills to lead the technology development of the company and to also hire team members with the right qualifications. There must also be a team member or department in charge of finance who will be on ground to prepare necessary documentation, especially at the stage where it is looking at growth and expansion and may need outside capital.

Creating the right team also involves hiring the right people with the right ethics to work at the startup.

Creating a product people are willing to use: If there is no product, there is no startup. If people are unwilling to use the product, there won’t be profits and therefore they will be no startup. The startup must therefore create what people are willing to use to solve their problems or gain some satisfaction from.

The startup can begin by creating what is known as a minimum viable product (MVP). This product is essentially a prototype or an imperfect expression of the product is looking at creating. Once the MVP is introduced to the market and people are willing to use them and pay for them, it means that they will be willing to use a more excellent version of it. One of the importance of an MVP is that it tells investors that the product is good, that it solves a problem and if people are willing to pay for its use, it has potential to generate profits in the long term.

So it is not just about creating a product, it is about creating a product that people are willing to use and pay for in the long-term.

Gaining traction: Another commercial consideration a startup must have in its back pocket is to strive to achieve traction. What does traction mean? This essentially means that the startup must achieve consistent growth on those that sign up to use the product. It must keep building momentum in its growth process. What this means is that the startup company can repeatedly acquire customers. Investors are usually unwilling to invest in a company that has no traction.

How then can a company achieve traction? There are no cut-size-fits-all answers here. There are, however, several recommendations which ranges from: community building, targeted marketing, creating events and speaking at conferences, etc that may help build traction. Essentially, it is about creating opportunity to increase user adoption of the product and retaining those users long-term.

Documentation: For a startup to be investment ready, investors usually ask for several documents during due diligence. Most startups find it difficult to get many of these documents during this process because they can either not find them or they are missing. As a startup grows, it must create an internal structure and system for warehousing documents.

Some of these documents include incorporation documents, certificate of registrations, IP certificates, licenses, agreements, receipts, financial projections, business plan. It also includes interactions with customers generally especially in cases where they enquire to use the product. You never know what the investor may ask for, so it would be best to keep records of everything. A single document may be all that is needed to make deal.


Conclusion

The startup is not really a game as people describe, but it possesses the features of a battle. It is, essentially, a value creating venture for the investors, founders, and users. Today, it stands as the vanguard commercial innovation. This essentially means it is fast-paced, intense and could be heart wrenching. It also means that there are “land mines” that comes with the terrain. This means that while looking at creating and generating value, startups must be take essential care and precautions to protect themselves and their investors.

The above legal and commercial considerations is a simple guide that will help you as a startup or startup founder begin the process of value creation and growth.

All the best on your journey.

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[1] Business Wire, “Information Technology Global Market Report 2021: IT Services; Computer Hardware; Telecom; Software Products – Forecast to 2025 & 2030 – ResearchAndMarkets.com

< https://www.businesswire.com/news/home/20210909006056/en/Information-Technology-Global-Market-Report-2021-IT-Services-Computer-Hardware-Telecom-Software-Products—Forecast-to-2025-2030—ResearchAndMarkets.com> accessed 06/12/2021.

[2] Business Day, “Nigeria’s Venture capital deals now five times of FDI” https://businessday.ng/business-economy/article/nigerias-venture-capital-deals-now-five-times-of-fdi/ accessed 06/12/2021.

[3] Nigerian startups raised 60% of African tech funding in 2021 – US < https://punchng.com/nigerian-startups-raised-60-of-african-tech-funding-in-2021-us/> accessed 10/01/2021