Legal structure, documentation and intellectual property. Solicitor and ‘entrepreneur in residence’, Michael Buckworth, looks at three areas that all startup founders need to get right
I advise founders to speak to a lawyer at the very start of their journey. There are so many potential pitfalls that can be avoided by getting the right advice upfront. However, there are three topics that come up time and time again, and these are as follows:
1. What legal structure should I use?
The country in which you choose to set up your business will have its own tax and corporate rules, so it’s important to be aware of those. However, in general terms, you have a choice as to whether to set up in business as an individual (as a ‘sole trader’) or operate through a company.
To set up as a sole trader, in most countries all you need to do is notify the tax authority that you’re self-employed. You then pay taxes on the profits that you make from your business, mots often at the end of the year. It’s nice and easy, and quick to get up and running. However, there is a downside: if something goes wrong, you’re personally liable for any losses. Other negatives of being a sole trader are that it is far harder to build a scalable business – you can’t raise investment by selling shares so you would have to borrow money instead – and many businesses don’t take sole traders as seriously as they take companies.
A company is a separate legal person owned by its shareholders. It can enter into contracts, borrow money, employ people, and sell shares in itself to raise money. In most countries, there is a type of company structure that has limited liability. This means that (in most circumstances) the company can go bust, but the personal assets of its shareholders and directors are protected. This is a big bonus for entrepreneurs embarking on the risky enterprise of setting up a startup. The downside of companies is that they tend to be more expensive to set up and operate. You generally have to file accounts and returns with the regulator and comply with prescriptive rules when it comes to taking on new shareholders and raising investment.
How to decide which structure is right for you? My rule of thumb is that if you view your business as a hobby, something that will sit alongside your full-time job, work as a sole trader, at least to start with. However, if you plan to grow and scale a business as your key focus, go straight for a company.
2. What documentation do I need to have in place, and when?
Agreements have many purposes, but the most important is to exclude liability and limit risk – without an agreement in place with a counterparty, you have unlimited liability if something goes wrong. With that in mind, the most important document you will ever put in place is that with your customer. Your business faces risks as soon as it starts trading, so get your customer contract in place prior to launch.
One document that is often missed relates to the grant of ‘sweat equity’. Often, cash-poor entrepreneurs incentivise and remunerate co-founders and service providers by granting than shares in their company instead of cash. For tax reasons, shares may be issued upfront in contemplation of work that may well take place over an extended period of time. If that is the case, you need an agreement in place that regulates the work you require and provides a mechanism for clawing back the shares if providers don’t perform their obligations.
3. What do I need to think about in terms of intellectual property?
Everyone talks about intellectual property (IP), but what is it? IP refers to all the intangible stuff that is created as you go about setting up your business: your product name, logo, website design and content, social media images and videos, and any other visual or written work. Together with your product or service, these are important assets of your business, and you wouldn’t want anyone else to copy your IP and pass it off as their own.
Every person who contributes to your business is potentially a creator of valuable IP. However, in most countries, if that person isn’t an employee of your business, any IP they create belongs to them and not to you – even if you pay them for their work. Consequently, you need to ensure that any IP that they create is transferred to your business, and this is done by getting them to sign an IP transfer provision, either as a clause in a contract with them, or as a standalone document. My top tip to every entrepreneur is to get every contributor of IP to sign an IP transfer at the very beginning of the relationship – and this includes every co-founder.
Michael Buckworth is the author of Built on Rock: the busy entrepreneur’s legal guide to startup risk (Practical Inspiration Publishing, 2021). He is a Solicitor and the Founder of Buckworths, a UK law firm that works exclusively with startups and high-growth businesses. Michael is also an ‘entrepreneur in residence’ at London South Bank University and University College London.