Venture capital start up – “ground up” legal structure

by | May 24, 2010 | Business Law

Many new businesses are founded on great ideas.  Often, they find an “edge” or niche in the market that others have not thought of yet.  This is the role of entrepreneurs.  They invariably need help creating a “ground up” legal structure.  The structure will vary depending on the size and sophistication of the business.  A few key components are:

  • Company or limited partnership? – You will need to set up a legal vehicle for the business.  Companies are frequently used, usually because of limited liability.  More recently, limited partnerships have become an option. This is a favourable structure if the investor wants to take advantage of loses which may be generated.  A constitution or partnership deed provides the rules for the entity.
  • Shareholders’ agreement – Often a venture capital business will involve the coming together of individuals who each contribute something special.  There may two people, three or even more.  Experience shows that fewer shareholders can make life simpler and less stressful!  However, this is not always the case.  Regardless, it is important to have an agreement between all shareholders governing their respective rights, especially in relation to exit.  When the business starts up, everyone usually gets along and it feels like an agreement is unnecessary.  However, we have seen many situations, especially over the last couple of years, where relationships have broken down.  It helps everyone if the important rights and obligations of all shareholders are clearly documented at the outset.
  • Protection of intellectual property – Startup businesses often involve a novel idea.  For technology businesses, new and exciting software is frequently in development.  This valuable intellectual property is a key asset of the business and should be protected.  An idea or formula is capable of being patented.  In most cases, it pays to apply for a patent early as a preventative measure to stop others exploiting the idea.  Software is usually protected by copyright law.  Perhaps more importantly, the licence for use by customers needs to be carefully drafted to ensure that ownership is protected, permitted uses defined and infringement avoided.
  • Capital raising – Venture capital businesses always require money.  Funding can be obtained in the form of a loan.  However, in most cases, the high risk/return nature of the investment means that equity funding is required.  Sometimes, this is done through a prospectus offering, directly to the public or through financial advisors.  More frequently, and usually due to the special nature of venture capital investments, private capital is sought from “angel” or other sophisticated investors.  Care needs to be taken that this funding is raised in accordance with the exceptions and exemptions provided under the Securities Act.  If not, there is the risk of void securities – meaning an obligation to refund the money and pay interest at 10% per annum.  Something to be avoided!
  • Marketing and advertising – A product or service needs to be sold and revenue generated.  This exercise will usually involve advertisements and other promotional material.  Care needs to be taken to ensure that promotional material does not breach the Fair Trading Act or other relevant consumer legislation.  Sometimes, the laws of other countries also need to be considered.  Especially when the internet is being used to target a wide audience.

In our experience, setting up a well thought out and carefully documented structure at the outset will avoid problems later on.  While entrepreneurs can focus on the key objectives of managing their business and making money, we can offer a valued service in providing the right structure.