This guide is for founders who have recently started their own business and are preparing for their first round of funding. The guide sets out six things you should consider:
- founder vesting
- remuneration arrangements
- intellectual property
- cap table
- corporate secretary
- due diligence folder
Our suggestions in this guide assume that you want to raise money from a professional investor such as a VC firm, angel group, or incubator, i.e. investors that are likely to carry out some form of due diligence and will want formal legal documents put in place as part of the funding round.
In contrast, friends and family type investors are often willing to invest without going through a formal due diligence process, meaning you may not need to do as much legal housekeeping to secure their investment.
1 founder vesting
Where you have two or more founders in your startup, it is worth having a conversation about how much time and for how long each founder will contribute to the business. Typically, founders intend to work full time for the foreseeable future. However, it is possible that personal circumstances like a family illness or career opportunity might make a founder wish to move on earlier than anticipated.
Because of this, it is common for founders to sign a founder vesting agreement. These agreements state that a founder only unconditionally owns of all his or her shares after having contributed to the business for a certain agreed period. If a founder leaves during the vesting period, a proportion of the shares can be bought back and cancelled by the company for nil (you can read more in our comprehensive guide to founder vesting).
It is better to set these expectations on all founders earlier rather than later, when relationships are good and before you get into the fundraising process.
Founder vesting agreements are different to shareholders’ agreements, another common legal document. Shareholders’ agreements are more comprehensive, and set out most of the rules which govern how a company is to operate.
We generally suggest holding off putting your first shareholders’ agreement in place until you meet an investor who requires you to have one. Almost all of the provisions of a typical shareholders’ agreement are relevant only after you bring in a material outside investor. Putting such an agreement in place too early tends to be a bit of a waste as you will almost always have to terminate and replace it at the time of your first investment.
(Click here to download our founder vesting agreement template)
2 remuneration arrangements
employees and contractors
Broadly speaking, you can remunerate those who provide services to your startup through cash or equity (or a combination). Every person that you hire as an employee or contractor should have an employee agreement (the Ministry of Manpower’s template is available here) or independent contractor agreement.
(Click to download our independent contractor template.)
For early stage startups, it is common to engage a third-party advisor (or advisors) who the founders can glean industry insight or other expertise from when trying to work out how to take their idea to market, scale-up, and so forth. The advisors will sometimes be granted shares or options in return for their advisory services (typically set out in an advisor agreement) if they are providing material value to the company.
Whether you should pay such an advisor using shares or options is often driven by the cash resources at the time, but founders and advisors should note that the advisor may have tax consequences of receiving equity for services.
(Click to download our basic advisor share agreement template.)
employee share option plans (ESOPs)
We are often asked whether an early stage company needs to put an employee share option plan in place. Most investors ask startups to establish an ESOP as part of the first funding round. They will not expect the company to already have an ESOP in place and so we normally advise founders to hold off on their ESOP until this time (unless they have an urgent need to grant options to employees for retention or hiring purposes).
3 intellectual property (IP)
Tech investors will usually want to be certain that the company owns all of the IP necessary to run its business, or at least, holds valid licenses to use that IP.
different types of IP in a business
Intellectual property can be loosely divided into two types: IP that can be registered (e.g. patents, trade marks and registered designs), and IP that cannot (e.g. most software). Most startups only have unregistered IP.
Patents are difficult to obtain but may be worth applying for in some circumstances.
Although investors are usually less concerned about this, it is always worth considering registering your business trade mark, as a means of safeguarding and commercialising your company’s brand.
how to document your IP
Whatever the form of your IP, it is important to document the ownership of that IP by your company.
The most common way of doing this is by having each founder, employee and contractor sign an employment or contractor agreement. Those agreements should include a clause that states that the company owns all IP created by the founder, employee, or advisor during the term of the agreement.
If IP was created before a founder, employee, or contractor entered into a services contract, this pre-existing IP can be transferred to the company using a deed of assignment of IP.
4 cap table
Most investors will ask you to send them a cap table that sets out your existing shareholders and the number (and class) of shares held. The cap table might need to set out any other rights to subscribe for shares in the company (e.g. convertible notes, SAFEs, or outstanding options).
If you have a share option plan your cap table will not usually be exactly the same as the electronic register of members (EROM) on ACRA. This is because a cap table typically shows the fully diluted position (which assuming all options have been allocated) whereas the EROM only shows the shares in issue.
(Click to download our template cap table.)
5 corporate / company secretary
All companies are required to have a company secretary from incorporation. We suggest making sure that your company secretary is one that knows how to handle the sort of directors’ and shareholders’ resolutions and approvals you will need to establish an ESOP, issue shares on the conversion of investments made under convertible notes, issue shares with preferential rights and so on.
6 due diligence folder
We suggest keeping a Google drive, Dropbox or similar folder that keeps copies of your key company documents in one place. For starters, it should include:
- your ACRA Bizfile
- your constitution
- the other documents mentioned in this article that you have in place (i.e. any founders agreements, employment agreements, advisor agreements, etc)
Having this folder will allow you to quickly and easily provide potential investors with access to these key documents. This will make the company look well organised to potential investors when they are making an initial investment decision and will speed up the process when they are undertaking due diligence.
Most startups do not need to have complicated paperwork in place prior to seeking investment. Your key focus should be on developing the business and creating a compelling product and/or service.
Nevertheless, it is good practice to have some or all of these arrangement in place in advance. Fundraising is a high friction activity at the best of times, but having your ducks in a row at the start of the process should make it as smooth as possible and save you a few headaches along the way!
Kindrik Partners has a library of 30+ templates and guides for startups, including guides on capital raising. Read our guide on seed rounds or if you have any questions, get in touch with one of our venture capital lawyers.