Launching your business? There are essential legal agreements in place that every business should have, right from the outset.
While it can be tempting for founders to jump straight into the practical aspects of making their vision a reality, it often means that the legal aspects take a back seat. Many founders overlook the importance of establishing a strong legal structure during early growth. There are a wide range of legal issues that will need to be considered, ranging from choosing the appropriate legal entity, taking the steps needed to become “investor ready”, to protecting your business from various legal standpoints.
Building your business should be a well thought-out and measured process that requires a strong legal foundation and skipping this step can have potentially devastating consequences.
This article will focus on seven essential legal agreements that every business should have, right from the outset:
Memorandum of Incorporation (MOI)
An MOI is the most important constitutional document governing a company and sets out the rules governing the conduct of a company, as specified by its incorporators and shareholders.
Every company has a set of default rules or regulations in terms of the Companies Act, 71 of 2008 (“the Act”) that apply to the company, unless changed by means of its MOI. The Act imposes certain specific requirements for the content of an MOI, as necessary to protect the interests of shareholders and other stakeholders of a company, which are referred to as the “unalterable provisions”. As its name suggests, these provisions may not be changed by means of an MOI (unless the MOI sets stricter requirements or higher thresholds). The simplest and most cost-effective manner is to register a company with a default, standard form CoR 15.1A MOI, which basically models the unalterable provisions of the Act.
The Act also provides for several “alterable provisions”, which companies may accept or alter as they wish, as long as such changes are in line with the Act. In addition, the Act allows for a company to add provisions to its MOI to address matters applicable to that company not already addressed in the Act itself, provided that all provisions of the MOI must be consistent with the Act. A unique MOI will be able to take advantage of this by building in, among other things, added protection for the shareholders.
It is important, especially in the context of a start-up business, to have an MOI that is not only consistent with the provisions of the Act from a governance perspective, but one which ultimately gives effect to all the parties’ intentions. If the company is looking to attract investors, then agreeing on a bespoke MOI to regulate the rights, duties and responsibilities of all the shareholders and directors early on, is definitely the way to go.
When more than one founder is coming into a business or where a company is looking to raise funds from investors in return for an equity stake in the company, then a shareholders’ agreement is highly recommended. Having a shareholders’ agreement is a valuable resource for any business as it structures the relationship between the shareholders early on and provides the mechanism for how shareholders will interact with each other and how they can protect their interests. It further sets out the rights and duties of the shareholders and can regulate the process surrounding an exit by a founder. Unlike an MOI which is a public document, a shareholders’ agreement is a private document, the binding force of which stems from the normal principles of the law of contract. For that reason, a shareholders’ agreement is more difficult to alter and usually requires the unanimous consent of all the shareholders while an MOI, by default, can be amended by special resolution of the shareholders (i.e. if at least 75% of the shareholders agree).
Because a shareholders’ agreement is a private document, it is also useful in cases where shareholders intend to build in certain funding and exit strategies, which they do not wish to record in the MOI. Although an MOI may contain many of these provisions already, a well-drafted shareholders’ agreement will act as a much needed safeguard where the MOI lacks protection. It is therefore important to ensure your shareholders’ agreement is tailored to your company’s specific needs while still being in line with the MOI and the provisions of the Act (in terms of hierarchy, the MOI supersedes a shareholders’ agreement in the case of a conflict).
For early stage start-ups (pre-investors), it may make sense to have an MOI and a shareholders’ agreement combined into one document. We refer to this as a “Founder Agreement”. Due to the cost implications of having two separate documents and the need to ensure that they are consistent with each other, a Founder Agreement can be hugely valuable for start-up businesses who lack the initial legal resources but wish to take the first step in formalising their relationship. Seen as the “marriage” contract between the founders, a Founder Agreement addresses various key issues by focusing on the following principals:
● Commitment: the success of the business you have embarked on will take commitment from each of the founders and having a proper Founder Agreement in place will ensure that the founders need to stay operationally involved in order to keep their shares.
● Control: a Founder Agreement allows for directors to be appointed, with defined voting rights, and explains shareholder rights to intervene in the decisions of the company, thereby ensuring that the big decisions are always made by the right people.
● Economics: a Founder Agreement defines the ownership structure and ensures that the founders get the value created by the business by addressing the principles of an exit, how that can happen, and how profits can be distributed.
● Funding: a Founder Agreement will address how the company is to be initially funded, how loans are made to the company, how interest is managed, and how those loans are repaid.
Intellectual property (IP) assignment agreement
IP can be regarded as possibly the most important asset of a company. This is especially true for start-up companies, because it’s often the value of the IP that determines the long-term success and profitability of your business. When investors look at the potential value of a business, the IP often forms a big part of the valuation methodology.
As such, IP should be effectively managed to ensure that the business itself gets the best protection and the most out of the ideas. The creator of the IP will either be the founder or someone employed by the founder to develop and enhance that IP. It is important that the ownership of the IP is addressed through appropriate contractual arrangements so that ownership of all IP assets does not remain with the creator but is rather assigned to the company right from the outset. This not only ensures that the IP contributes to the initial valuation of the market value of your company but that it can be properly exploited by the company to generate future income for the business.
The term sheet
Although not an agreement in the strict sense, the term sheet is a document that outlines the terms by which an investor (angel or institutional), will make a financial investment in your company. The term sheet is crucial, as it usually determines the final deal structure with your investor – it outlines the terms by which your investor will make a financial investment in your company. Finding an investor can be complex and time consuming. Once you’ve found one with the right strategies and values, you may be tempted to rush through negotiations to access the promised cash injection. There can be serious ramifications if the details of the deal are not negotiated on a level playing field and a term sheet exposes the bare bones of the fundamental commercial terms of the investment. Due to its concise nature, the involved parties are less likely to miss essential details.
It is important to note that a term sheet is intended solely as a summary of terms for discussion and agreement between the parties. In other words, it seeks to cover the more important aspects of a deal without going into every minor detail as in the case of a binding contract. Except for the confidentiality provisions, nothing should create any legally binding obligations on the part of the parties until they execute the definitive written agreements.
Depending on the nature and the industry within which your start-up business operates, your company will at some point, be delivering specified services to its customers. This will be the basis upon which your company will earn revenue – the lifeblood of any company. A services agreement will not only define the services provided in detail, but it can also equip you with the negotiation tools to limit your risk if the services are not delivered to the customer’s expectations or in accordance with any warranties. Having a services agreement tailored to the company will also ensure that other crucial aspects which are not normally thought about, are carefully carved out, including exclusivity of the services provided, who owns the IP created in the course of providing the services and obligations to keep information confidential, to name a few.
Once your business becomes operational, it will need to employ a task force. It is important that the status of any employee is clearly defined in writing. Section 29 of the Basic Conditions of Employment Act,11 of 2002 (“the BCEA”) requires every employer to supply the employee with written particulars of employment no later than the first day of employment. For this reason, employers are advised to enter into a written contract of employment with every employee. Although there is no legal requirement (apart from section 29 of the BCEA) for an employer to provide a written contract, by reducing everything to writing ensures that there can be no arguments down the line regarding the terms of employment, termination, breach or any unlawful action.
The above is not an exhaustive list but serves to highlight the most important things to consider and have in place when starting your business. Obtaining the right legal advice and having the right legal agreements in place not only ensures that your business is adequately protected but provides you with the head start to fully focus on growing your business the way you intended.
By Ya-fan Wong, Associate – BSocSci LLB (UCT), Dommisse Attorneys. www.dommisseattorneys.co.za.