START-UP: Save the complex legal issues for later

Synch’s Katrine Madsen, who is advisor for start-up companies, gives some advice on which legal issues start-up companies should consider on an early stage.

As a new start-up it can be challenging to navigate the immense amount of legal issues you need to consider. For sure, down the road, you have to deal with these legal issues that well-meaning people around you keep reminding you of, but as a new start-up, this is not the time to come up with complex company structures or highly advanced GDPR compliant IT systems. In my opinion, this is the time to keep it lean and simple – also when it comes to the legal part. As a new start-up, one of your most valuable resources is your time. Don’t spend it on redundant legal stuff. Spend it on developing the business and chasing product/market fit. I have the privilege of providing legal counsel to a lot of young and upcoming start-ups, and I am often puzzled by their prioritisation.

Preliminary research of whether there is a demand in the market for what you are planning to sell needs to be conducted before you even start worrying about company structure, tax registrations and other similar legal issues. If there are no buyers to what you are planning to sell, it’s better to know as early as possible in the start-up process. As a new start-up, you need to move quickly and “Do things that don’t scale” to attain valuable intel on the profitability of your business. You also need to embrace failure, all of them, as a way to improve your business and try again.

Even after you have passed this threshold and you are moving on to building a production of and administration around your product the time is not for taking on complex legal issues. Your focus should still be to reach product/market fit. Product/market fit is when your product is verified in the market in such a way that it secures the future turnover and significant growth of your business. However, on your journey towards reaching your product/market fit, some legal issues necessarily need to be considered – but keep it simple, stupid (“KISS”).

Here are some of the legal issues that I typically discuss with new, upcoming start-ups because it makes sense to consider on an early stage.

1. Establish the company before you enter into your first agreement

Avoid postponing the foundation of your company until after you have entered into your first agreement. Establishing your company before you enter into your first agreement allows you to make the company party to the agreement instead of you personally. Agreements typically put obligations and liabilities on you. When your company is party to the agreement, those obligations and liabilities are attached to your company and not you personally, which means that – as the main rule – you cannot be held personally liable for the performance of the agreement.

2. Choose a company form with limited liability

There is a variety of options when it comes to choosing your company form. However, on an overall basis, the Danish company forms can be divided into the following two categories:

Companies with personal liability (e.g. I/S and K/S),

Companies with limited liability (e.g. ApS, IVS and A/S).

In a company with personal liability you are jointly and severally liable together with the company for any debts and liabilities arising. In a company with limited liability your liability cannot exceed your investment in the company. In other words, your assets, like bank accounts and real estate, are protected the best if you choose a company with limited liability.

3. Etablish a holding company only if it is necessary

A holding company is a company with the purpose to own shares in other companies. A holding company is not an independent company form – it can have any company form you want. In a typical simple holding structure, you are the sole owner of the holding company and the holding company owns all (or some) of the shares in the start-up.

There are many advantages to owning your start-up through a holding company. Most of them are tax-related. For instance, the transfer of profit distributed as dividends from your start-up to your holding company does not trigger dividend tax. Not until you choose to distribute the money from the holding company to yourself do you pay dividend tax. The holding company works as a safe – so to speak – where you decide the timing of dividend taxation. However, if you are the only person in the start-up, you already have the luxury of solely deciding on the timing of distribution of dividends, and therefore – especially if you are only planning on being you – establishing a holding company might just be unnecessary paperwork for a new start-up that has a lot of other more urgent things to think about. Keep it as lean and simple as possible.

4. Enter into a shareholders’ agreement if you are more than one shareholder

A shareholders’ agreement is a crucial document that must not be deprioritised in your company if you are more than one shareholder. The purpose of a shareholders’ agreement is to protect the shareholders’ investment in the company by establishing a fair relationship between the shareholders and regulate how to run the company. Among other important things, the shareholders’ agreement typically states the procedure for solving disagreements between the shareholders.

Typically, in a start-up, all (or some) of the shareholders play an essential part in the success of the start-up. Therefore, it might be worth considering including an obligation in the shareholders’ agreement to not sell the shares for a specific period – until certain goals are reached in the company. Bottom line is: Don’t forget to have a shareholders’ agreement, if you are more than one shareholder.

5. Make sure that essential agreements are not just handshake deals

Even though oral agreements (handshake deals) are just as binding as written agreements, you should make sure that all the essential agreements in the company are made in writing. When you have a written agreement, some things are inarguable, while if you have an oral agreement, everything is potentially up for debate, which is risky if the agreement is fundamental to the success of the company.

OVERVIEW:

  • Establish the company before you enter into your first agreement
  • Choose a company form with limited liability
  • Etablish a holding company only if it is necessary
  • Enter into a shareholders’ agreement if you are more than one shareholder
  • Make sure that fundamental agreements to the company are not just handshake deals

For more information, please contact Katrine Hedensted Madsenkatrine.madsen@synchlaw.dk, +45 3135 5781.

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