Article by: Lim Seng Siew, Director of OTP Law Corporation
The Start-up and the Lawyer
The life journey of a start-up is fraught with much uncertainties. Where is the next round of funding coming from? How do I make sure that I am complying with the law when I employ my first employees? Is the area of business that I want to get into regulated? Am I fair to my new investors without being unfair to my employees and my initial investors?
In a series of articles, we hope to help you answer some of these and other questions. As a start-up, we understand that cash is often tight. Endless important issues demand a start-up’s limited resources. To assist, we will be having free templates that a start-up can use to cover the important basics. We also have plans to add to this introduction with a series of simple-to-understand articles. They are an important resource to help you think about typical issues a start-up may face. As a generic set of documents, they are not (and cannot be expected to be) tailored for specific issues that you may be facing. For these issues, you probably need to speak to a lawyer, whether as a formal engagement or catching up over a cup of coffee.
First off, start-ups are not just tech companies, although tech start-ups have unique characteristics. If you have a new business model or idea, you are a start-up. Even lawyers who want to practice law in a ‘non-traditional’ way is a start-up. In this day and age, almost everyone you meet either has founded a start-up, is involved in a start-up, or wants to start a start-up.
Next off, standard documents intended for elsewhere may not be suitable for Singapore. One example is the SAFE (Simple Agreement for Future Equity) financing documents introduced by Y Combinator in 2013. It is very popular in the USA for its start-ups. SAFEs are intended for funding raised from family and friends, (ie pre-series A funding) based on a deferred issuing of equity. It is not a debt. However the concept of deferred issuing of equity in Singapore is different from that in the USA. Therefore using SAFE financing documents in Singapore is very ‘unsafe’. Instead we have an equivalent in Singapore called CARE (convertible agreement regarding equity). More about CARE later.
Typically, we help start-ups put in place the basics of corporate governance that investors expect to see. These will include the company’s constitution, a shareholders’ agreement and/or a co-founders’ agreement. Sometimes we also advise on the corporate or group structure, especially when risk management is one of the primary concerns of the start-up.
When the start-up is ready for business, we can help prepare or vet supplier’s contracts, employment letters, the start-up’s office/employee manuals, customer’s contracts and T&Cs of your product.
The Cradle: Starting a Start-Up
One key characteristic of tech start-ups is that they aim for ‘hyper-growth’, becoming a very very large company in a very very short time. Think Google and Facebook. To achieve this, tech start-ups need four key ingredients: a great idea, a great product, a great team, and great execution. There is a fifth ingredient that no one has any control over, luck. I will leave it to the start-up gurus to deal with these ingredients.
Instead, I will be touching on the boring bits of a start-up, that is its legal mechanics. You don’t need to know the details, but you need to know the basics. You concentrate on building and growing your business. Let the professional accountants and lawyers handle the details. That is what we are trained in and that is what we do, day in and day out. What I have to say applies to all start-ups, tech or non-tech.
If nothing else, my first advice is keep things simple. Use standard stuff where possible. Keep the paperwork organised. Know what you are doing but you don’t need to know the details.
My next advice is incorporate. Don’t run a start-up using your own name. If things go wrong (and they can), you don’t want your family home and your bank account to be taken by creditors.
Incorporation means setting up a company under the Companies Act. The company is a legal entity separate from the founders. You and your co-founders will be shareholders of the company. Some of you may be directors. The shareholders are ‘owners’ of the company. The directors are the people responsible for the important decisions in the company. Some directors will be working directors. Working directors will handle the day-to-day decisions and the operations of the company.
It is possible for your start-up to take other forms; such as partnerships or LLPs. But remember my first advice. Keep things simple and use standard stuff.
After deciding to set up a company, your next decision is how many shares (ie equity) to each of the founders?
It is always good to talk when relationships between the founders are good. Don’t delay. If relationships turn sour, things left unsaid and undocumented will always get blown way out of proportion and take on an entirely different meaning.
Having said that, what would be a fair distribution of the initial shares (ie equity allocation) among the founders?
Many start-up gurus say “Execution has a greater value than the idea.” Of course you have other gurus who ask “What valuable company is nobody building?”, implying that good ideas are rare. My take on this? It’s all about balance. A good idea with bad execution has zero value. Good execution of a bad idea is exactly the same.
So resist the urge to give away too much shares to the founder who came up with the idea. Give him a fair number as recognition that the original idea came from him. But remember that all founders pulling together in the same direction to grow the company is also important. So if one or more founders in a start-up has a disproportionate number of shares, will all the founders be pulling in the same direction? Maybe or maybe not. Most likely not because of the disproportionate rewards some will have.
Do take into consideration the contributions of the individual founders; ie Who developed the application? Who raised the initial funding? Who spent sleepless nights rallying the team together? Value all of these but don’t overvalue each of them. However this means that the discussion about each founder’s contribution cannot start too early when each founder’s role and contribution, hence his value, is not yet clear. Discussing a theoretical contribution is of little value.
So the bottom-line, discuss equity allocation when each founder’s value becomes clear. It doesn’t have to be equal equity allocation to each of the founders but the difference should not be too large to ensure that all founders pull together in the same direction. Think Google again. When Google IPOed, Larry Page and Sergei Brin had almost equal number of shares.
Another important advice, once it has been agreed and why the shares were allocated the way they were allocated, document them in a founders agreement.
If you have plans to raise funds from family and friends, consider using CARE (convertible agreement regarding equity). CARE is part of a suite of model agreements called “VIMA” or Venture Capital Investment Model Agreements launched in October 2018 by the Singapore Academy of Law (SAL) and the Singapore Venture Capital and Private Equity Association (SVCA). Depending on the details, the funds raised can be treated either as equity or as debt.
After the documents have been signed, keep them safe. You do not want to have to scramble to find the documents (or discover that they are missing) when venture capitalists are knocking at your door and doing their due diligence. Telling venture capitalists that key documents are missing will not instill any confidence in the founders ability to manage the start-up.
In the next part of this series, I will be dealing with the First Baby Steps of a Start-Up.