"Health Check for Your Start-Up" - Avoiding Legal Pitfalls and Boosting Your Investor Readiness

"HEALTH CHECK FOR YOUR START-UP" - AVOIDING LEGAL PITFALLS AND BOOSTING YOUR INVESTOR READINESS

The article provides brief guidelines to crucial aspects that must be taken into consideration while starting a business to avoid legal pitfalls and boost early on investor readiness of the venture

One of the difficulties start-ups naturally face is a lack of essential resources such as professional advise and counseling to critical legal, tax and accounting questions, funding, mentorship, and business strategy consulting, among others. In the worst case, this can lead to an early-stage failure of the venture or in the best case, hamper the growth of the start-up which is vitally needed to scale its business early enough in a competitive market. This article tries to provide a brief guideline to some crucial aspects which should be taken into consideration while starting a business to avoid legal pitfalls and to boost early on investor readiness of the venture.

A. Does your start-up have the right setup and foundation?

As a starting point, early-stage businesses need to think about what kind of legal form and license suits their undertaking in terms of effective tax planning, limiting of liability of owners, efficient management and decision-making structures, governance role of shareholders and required sector specific legal forms such as limited liability partnerships mostly applicable to accounting, audit, tax, and legal firms.

Start-up should avoid informal setups and pursue a compliant and proper legally structured foundation based on orderly drafted establishment documents such as articles and memorandum of association, relevant side agreements, board and shareholder resolutions and duly obtained business permits and commercial licenses allowing the venture to operate lawfully in the respective business sector. This does not only prevent that the start-up runs into substantial regulatory penalties predominantly in highly regulated sectors such as financial, telecommunication, digital and technology related services or even be forced to close its operations down due to non-licensed activities but also addresses the risk of IP theft and unfair competition. The ability of a venture to demonstrate sound legal structures, documentation and registrations often decides whether a potential investor shies away from an otherwise promising investment opportunity or is interested in pursuing further an investment.

B. Tax Considerations when starting your business

Often entrepreneurs are occupied with their daily business operations, scaling their business or refining their value offering and R&D leaving less capacity and time to focus on significant administrative aspects such as Tax compliance. Most of the jurisdictions globally require start-ups, with varying regulations for sole establishments or proprietorships, to register for mandatory corporate income tax and VAT/GST registration with the competent tax authorities and to obtain valid tax registrations which need to be mentioned in a visible manner on tax compliant invoices. Reoccurring tax filings and submissions to the revenue authorities, often times on a yearly, quarterly or monthly basis depending on the type of levy, are usually burdensome and can absorb substantial company resources which are already limited from the outset. However, non-compliance with tax obligations can have grave consequences ranging from hurting fiscal penalties to jail terms, in severe cases. A lot of times, businesses tend to oversee the concept of permanent establishment ("PE") in domestic tax legislation triggering corporate income tax upon meeting certain criteria even though the undertaking is not formally incorporated in the respective country. The OECD defines PE as a fixed place of business in which a person or business entity carries on business for at least six months. This definition is often adopted by local tax laws. Mandatory and voluntary VAT or valued added tax registrations depend in many tax schemes on certain estimated or forecasted turnover thresholds which need to be observed while evaluating registration. Appointing an experienced tax advisor or accountant for mandatory minimum tax compliance in the very beginning of starting up a venture can be crucial to avoid tax non-compliance pitfalls.

C. Are your IP Rights sufficiently protected?

For many start-ups particularly for those active in the technology sector, their intellectual property such as knowhow, software, innovative processes, etc. is at the core of their business model and value proposition often combined with a cleverly designed logo respectively trademark building the base of their growing brand equity. IP rights can be sold or licensed, providing an important revenue stream, offer customers something new and different and form an essential part of the start-ups' marketing strategy and can be used for example as collateral for loans and debt. While focused on the daily operations and growth of the business, entrepreneurs might miss to protect appropriately their created intellectual property rights or even not be aware of their qualification as IP rights. Most of the IP rights such as patents, copyrights and trademarks can be registered with competent governmental intellectual property offices that will assess registration applications in respective classes. Once IP rights are duly registered, they grant the creator an exclusive right over the use of his/her creation for a certain period of time which can be extended accordingly. Something different applies to trade secrets; they refer to specific, private information that is important to a business because it gives the business a competitive advantage in its marketplace such recipes for certain foods and beverages, new inventions, software, processes, and even different marketing strategies. Trade secrets often cannot be registered and must be protected by non-disclosure agreements, non-competition arrangements or simply by restricting sharing whole or parts of the secrets. Additionally, many startups aiming to pursue franchise (growth) models need to consider that expanding incrementally into new markets necessitates entrepreneurs to register timely their IP-rights such as trademarks in target markets to safeguard the execution of their growth strategies.

D. Conclusion

Spending on professional service providers, regulatory and compliance requirements and registration fees can be burdensome for start-ups in the beginning and drain crucial resources needed for other areas of the business to boost growth. However, it is essential for ventures from their early stage to conform with mandatory regulations and to obtain professional advise to specific areas to prevent risk and challenges later on. Mostly during due diligence procedures, legal loopholes and non-compliance concerns might surface and be detected while ventures looking for investors and raising funds. Such discovered "red flags" might often lead investors and strategic partners to pull out of transactions and shy away from investments. This can be prevented by prudent management of certain risk factors and key aspects.

E. How can we help your organization?

We help start-ups and ventures to avoid legal pitfalls and boost their Investor readiness significantly during the initial and later stages of growth. We would be delighted to discuss your start-up or investor needs.

Disclaimer – The views expressed in this article are the personal views of the author and are purely informative in nature.