How not to lose in price: 10 legal tips for startup founders
What is “legal due diligence” and where does 25% come from
Legal due diligence — checking the legal documentation of a company to assess its risks before a takeover (purchase).
Practice shows that startups in the early stages are not worried about legal issues due to a number of well-founded reasons: the slowness of lawyers, the high cost of their services and, often, the inability to understand the technological component of a startup in order to properly execute it.
Because of this, in the process of conducting legal due diligence before a takeover transaction, serious legal problems arise. The most typical of them:
Unregistered intellectual property rights, unregistered trademark (potential problems with licensing developments in the future, risks for the brand, domains).
Lack of contracts and policies for working with personal data of clients (potential fines for violation of legislation on the protection of personal data).
Unregistered relations with the team (potential fines for violation of labor laws, as well as potential losses in case of leaving key employees).
Gaps in financial statements (potential fines from tax).
The buyer summarizes all potential fines / risks before the takeover transaction, and “discounts” the cost of the exit for the resulting amount. Often, the discount is 15% - 25% of the purchase amount, which was discussed before undergoing due diligence. A very unpleasant surprise for the founders.
To avoid this, already at an early stage you need to think about basic, but important legal points.
1. Registration of startup intellectual property.
Recommendation: sign agreements on the transfer of intellectual property rights with each freelancer / contractor / employee who creates something for your product (code, logo, design, texts, etc.). Do not hesitate, the buyer’s lawyer will ask about each intellectual property that the product consists of.
2. Registration of a trademark.
Recommendation: register a trademark for your brand. This will protect you from unscrupulous competitors who may register your name earlier, and then, on this basis, pick up all similar domains.
Recommendation: do not copy ToU from other people's sites. First, they may not comply with the laws of the countries in which you work. Secondly, they are likely to be missing the necessary disclaimers that should protect you from unreasonable user complaints. It is better to order a custom edition from a lawyer.
Recommendation: consult with a lawyer regarding specific requirements for working with personal data of citizens of individual countries / regions in which your product works. In some of them, authorization is required, in some - additional procedures that must be displayed in the policy.
5. Development and implementation of internal company policies for working with personal data.
The presence of contracts with third parties with whom the startup exchanges personal data;
implementation of internal policies for employees in case of personal data leakage or receiving requests from users to delete their personal data.
6. Audit of open source licenses that were used during product development.
Recommendation: make sure that the developers of your product record every “open license” when they use open source code in development. If your business model provides for the distribution of software, and the “open license” for open source code that was used during development does not allow this, you will need to either change the business model or the source code of the product itself.
7. The signing of the agreement between the founders of the startup.
Recommendation: record all the agreements reached before the start-up was created in the Founders Agreement. This is the “constitution” for the co-founders, in which the shares, the functions of everyone in the startup, the conditions for the entry of new partners, the exit of old ones, etc. are described. The more detailed this document is prepared, the more guarantees that the cooperation of the founders will be long and productive.
8. The issuance of options for employees.
Recommendation: fill out all motivation systems, conditions for promotions and the issuance of options for the team in the relevant documents. In most cases, a startup buyer is interested not only in your product, but also in the team that created this product and is able to develop it further. Therefore, in the process of due diligence before buying, he will want to make sure that the team is well motivated.
9. Registration of corporate documents for a startup company.
Recommendation: before the exit, make sure that you:
Distributed the shares of the company between the co-founders in accordance with the contract;
duly executed all the necessary protocols on the fees of the founders / directors;
made the necessary changes to state registries.
10. Disclosure of all “material arrangements” with third parties.
Recommendation: be careful when you promise your counterparties exclusive terms of cooperation, issue exclusive product licenses or agree on something else that somehow limits your opportunities for market expansion. The startup buyer will ask about this in great detail, and non-disclosure of this information in the future may entail great sanctions for the founders who made the exit.
Every startup founder thinks of exit as a reward for superhuman efforts to work on a technological solution. To get the discount of the amount of exit in a step from the seven-digit transaction amount is a big chagrin.
But if, in the process of developing a startup, the founders follow several simple rules described above, when passing through due diligence they can easily provide all the necessary information. This will help to quickly close the deal and get the full amount from a successful startup sale.