Startup Success: Cracking the Legal Code – getting the right advice from the start
- Written by Jonathan Harris, Harris & Company
There is an excitement and challenge which comes with starting any new business, and start up founders know all too well how much time and energy is put into establishing and growing a new company. With tight budgets, limited working capital, and pressure to generate a return, the importance of obtaining initial structuring advice and getting the right legal documentation in place can be overlooked.
Having the proper structure and legal documentation in place is essential to allow for the business to grow and onboard new customers. In addition to having a soundly based structure and proper legal documents in place to operate the business, it is also important for founders to consider their exit strategy early so that they may plan for the future. Having a well planned corporate structure and clearly documented agreements with key clients and suppliers is an important part of growing a business, and by getting the right plan in place early it will inevitably be beneficial in the future when new investors or prospective purchasers look to undertake due diligence.
Documenting key client/supplier relationships, shareholder relationships and other obligations from the outset.
Coming up with a new business venture is only half of the problem. The next step, and arguably the bigger issue, is getting the idea off the ground. Often when advising clients, we start with asking them to think about issues such as:
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How will you manage your relationships with customers and what form of services agreement/terms and conditions do you require?
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What are your privacy obligations and should you implement a privacy policy?
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Do you intend to raise capital in the future? What happens if you bring on investors?
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How will you manage the relationships between shareholders and what sort of provisions do you need in a shareholders agreement? Who should have the right to acquire shares in the company? What happens if you bring on future investors? What happens if one or more founders want to sell?
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What goodwill and IP will be generated in the business and how are you going to protect that moving forward?
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Do you require contracts with third parties and suppliers for licenses/approvals to operate and are those capable of continuing follow a change of control?
The involvement of trusted advisers early in the start up process is key in ensuring that you obtain the right advice and get the right documents in place early. There are plenty of pro-forma templates which are available, however not all will be fit for purpose and often more tailored documents and advice can mitigate costly issues in the future.
What about getting the right advice on structure?
Like anything, there is no one size fits all approach to corporate structuring. The structure that is suitable for founders will differ depending upon factors such as whether they plan to bring on private equity investors, whether they intend on undertaking their own M&A strategy to grow and expand and whether they intend to go public in the future or undergo a private sale. Its crucial to obtain the right legal and tax advice about that structure when its being set up as once the business is underway, clients have been onboarded and revenue and goodwill are being generated, it will be harder to retrospectively restructure without a variety of legal and tax implications of doing so.
The corporate structure adopted needs to be flexible enough to meet the changing needs of the business and the ability to raise future capital, while also balancing risk and asset protection. With any level of complexity, comes additional establishment costs and ongoing compliance costs. There is also the risk of unintended consequences from a tax perspective when it comes to restructuring or a sale.
If a company intends on undertaking its own series of acquisitions as it grows, it needs to give some forethought to how any acquired business is going to fit into its own corporate structure. Will the start up acquire the assets and goodwill of the other businesses or does it plan to expand the corporate group by ‘bolting-on’ other companies. If the founder plans on selling in the future, will it be possible to separate out various assets or corporate entities for a sale and are there any unforeseen tax consequences from the sale due to the way the original purchase was structured.
Future Benefits from getting the right structure and documents in place early
While there is obvious value in having well drafted agreements to avoid disputes and to manage risk in the operations of a business, there is also benefit in having proper documentation in place when it comes to planning an exit. The focus when setting up a business is naturally on getting the business up and running, but when viewed through that lens it can be easy to forget the impact of early decisions on exit opportunities in the future.
In most service businesses, significant value lies in the goodwill and contracts held with key clients. Amongst other things, a purchaser or investor wants assurance that key contracts are on foot and will continue after a change of control in the business. They also want to be comfortable that contracts are on acceptable terms and that the goodwill and IP acquired will be protected and maintained post completion.
While exit opportunities might seem like a distant reality, it is essential that start up founders turn their mind to the types of legal matters which will be scrutinised in the future and plan ahead. Having the necessary documents well drafted, well organised, and readily available from the outset not only speeds up any due diligence process, but can maximise the price a purchaser is willing to pay.
There is a risk in failing to properly document the company’s relationships both externally (customers and suppliers) and internally (such as between co-founders, shareholders or other entities in the corporate group). When it comes time to go through a sale process, if certain arrangements haven’t been properly documented, it can be difficult for a purchaser to make an informed decision as to whether to proceed. Often when companies are getting ready for a due diligence exercise, it can be quite a costly task to go back and locate historic records or otherwise try to retrospectively document existing arrangements with external and internal stakeholders.
Likewise, having unfavourable or poorly planned corporate structures in place can cause headaches in the future. Often very little thought goes into the reasoning behind a specific structure, and a corporate structure which seemed appropriate when setting up a business, may no longer serve its purpose or have unfavourable tax consequences for founders when trying to exit the business. It is therefore important that founders have the right advice upfront on the different structures that may be utilised.
About Jonathan Harris
Jonathan is a Senior Associate at Harris & Company. He practices in the areas of: Corporate and Commercial; Property; Banking and Finance; Trusts; Business Succession and Estate Planning.
Jonathan advises clients in a wide range of commercial and business law matters with a focus on commercial transactions, mergers and acquisitions, share buy-backs, business structuring, joint ventures and trusts. He regularly advises companies, and their directors and shareholders, in relation to compliance issues and their rights and duties under the Corporations Act.
Jonathan is also experienced in finance transactions and has assisted both lenders and borrowers with the structuring and documentation of loans, mortgages and other securities (including registration of security interests on the PPSR under the Personal Property Security Act (Cth) 2009), and negotiation of debt restructuring and workout arrangements between lenders and borrowers in distress.
He provides assistance to clients in relation to property acquisition and disposals, development projects and a wide range of general property matters (including rural, residential and commercial conveyancing) along with various other incidental issues arising from those transactions such as advising on duties and land tax issues. Connect with Jonathan here: https://www.linkedin.com/in/jonathan-harris-76637016a/
About Harris & Company
Harris & Company is a long established Sydney city law firm which provides advice and expertise in a broad range of legal disciplines with a strong emphasis on corporate/commercial advisory and property transactions. Harris & Company also has a long history of acting in respect of commercial dispute resolution and intellectual property protection. Harris & Company is the valued advisor and the trusted confidant of many clients to whom the firm provides a personalised, efficient service across their business and personal needs. They tailor expertise to facilitate clients continued growth and success. http://www.harrisco.com.au/
