Last night my Pivotal Tribes meetup group hosted an evening with myself and two other corporate lawyers forming a panel to discuss a range of legal issues relating to corporate and commercial deals with an audience of startups and entrepreneurs.
The other panelists were Louise Eldridge and Dan Johnson, two experienced and multi-faceted lawyers with good reputations amongst London’s startup community. The idea of the event was rather than have the usual format of one lawyer as the fount of all knowledge reading through a powerpoint, to instead have a collaborative panel of relevant lawyers discuss a range of issues openly and interactively with the audience in order for people to gain genuine insight and useful knowledge.
The following represents a basic summary of some of the main points that I can recall from the event:
It was highlighted how often disputes arise because shareholders never put anything in writing to regulate their relationship. The effect of this is that views diverge over time, things are not properly considered at the outset of a business relationship and people’s circumstances change leading to shareholders falling out with no previously agreed written provisions to fall back on. Shareholders agreements can be very straightforward and a lawyer can help formalise one from a list of previously agreed points whilst also advising on other issues that need to be discussed and agreed between the parties.
Leaver provisions and vesting schedules
The panel discussed the importance of having ‘good’ and ‘bad’ leaver clauses in a shareholders agreement with carefully worded definitions to ensure that, depending on the circumstances, departing shareholders can be bought out for an equitable amount in relation to their contributions and impact on the company. Valuations in such clauses can range from par value (the nominal amount that the shares were subscribed for at the outset) to the fair market value at the time of exit to be determined in accordance with a pre-agreed formula. In addition, vesting schedules are becoming more common whereby founders and shareholders are issued with further shares depending on certain milestones being achieved and targets met with venture capital firms sometimes implementing reverse de-vesting provisions whereby the shareholders that are being backed have shares clawed back if they are not performing.
Combined limited company and LLP structures
The panel highlighted the benefits but also the limitations of trading through a company limited by shares. One of the difficulties, partly caused because of the weight of legislation in this area, is trying to use a company’s share capital to reward and retain staff. Limited liability partnerships, due to their tax transparent nature and light body of regulation, are much easier to operate and use in order to bring more people into the business on a more permanent basis. As a result combined limited company and LLP structures are increasingly used whereby the company is the holding entity owned by the founding shareholders and retaining all ownership of assets, while underneath is a wholly owned LLP that is used as a trading vehicle and makes it easy to bring in partners (and have them exit) without having to worry about the burden of employment and tax related legislation while being able to better reward them as members of the LLP.
Registering and protecting intellectual property
Specifically in relation to patents and software patents the audience wanted to know whether it was worth it for an early stage business to register intellectual property rights. The panel’s judgment was that not only are patents very expensive and difficult to register, but by registering you have to very openly disclose the inner workings of your technology while then having to be able to continually defend your patent against future infringements. All in all very time consuming, distracting and expensive with the overall result being that patents are only really of benefit for very large companies with deep pockets. The audience discussed how software was already automatically protected by copyright and that companies primarily protect their source code through very strict security and confidentiality which is easier to effect now software operates through the cloud. The panel also mentioned how important it is to ensure that all your business relationships are governed by some sort of commercial contract that will include provisions regarding the ownership and protection of intellectual property rights.
One of the audience discussed how he is currently building his business by contracting through a much bigger player in the market who is able to open doors for him and help him create sales opportunities. The relationship currently works as an informal consultancy or supply of services scenario, although the panel discussed how if possible it would be better to operate the joint venture through a LLP entity (with both businesses having a relevant share) so as to get more long term value and reward from the business as well as increasing the smaller player’s influence and control through provisions in a LLP agreement such as an entitlement to monitor the accounting records.
Cross border deals
For international businesses the panel discussed how companies should ensure that they have contracts in place that are governed by UK law and to also check double taxation treaties so as to ensure your company is not subject to a crippling tax liability.