Lifecycle of a tech startup series: Preparing to raise investment
We will help you to take the necessary steps to establish your business in the UK, whether you wish to set up a new venture or expand an overseas operation. We know that funds may be tight for you, so we’ll provide you with competitive quotes and give our view on what you should prioritise and what can wait.
In setting up your new business, you will be faced with a number of key choices with regard to structuring, funding and taxation. We will explain the differences between operating as a sole trader or partnership, or incorporating as a company or limited liability partnership (LLP). As tax and accounting considerations are often the primary drivers behind this decision, our lawyers work closely with our other practice areas and other advisers to ensure that you get the right advice at the very beginning.
Once you have chosen a business structure, we will advise on the best means of regulating relationships between a company, its directors and its shareholders, and between an LLP and its members. We will draft bespoke documents to reflect your priorities and to best protect your interests, including your shareholders agreement, articles of association, LLP agreement and all ancillary agreements and resolutions.
Our lawyers regularly advise companies on corporate governance issues, and advise directors, shareholders and LLP members on their ongoing obligations, duties, and potential liabilities.
In conjunction with our employment department, we can also advise you on the options for incentivising your employees and on the drafting and implementation of an appropriate scheme. We regularly draft bespoke HMRC approved employment management incentive (EMI) scheme rules and option agreements.
As well as providing technical legal advice, our lawyers will give you their commercial view (and will not provide you with lots of options and sit on the fence). Our aim is to be the corporate/commercial legal team for all your current and future business interests.
Before you decide to set up a company, it is important to consider what legal structure is right for your business. The time and cost required to set up a company will depend on the degree of customisation required. A simple ‘one size fits all’ company can be set up for under £100, and in some cases on the same day. However, this approach can lead to costly issues in the future. We would recommend that you take careful advice at an early stage on the capital structure of the company (ie on the rights which are associated with each share class, the denomination of the shares in each such class and the parties to whom shares will initially be issued) and on the nature of the articles of association (a public document which is filed at Companies House) which are adopted.
Once your company is up and running, there will be administrative costs and obligations which will vary with the size and nature of the business. These will include tasks such as keeping accurate records, submitting annual accounts and other returns to Companies House, registering for VAT and completing a tax return.
Operating as a sole trader or in partnership may be the right choice for many businesses, particularly when they start trading. However, operating in this way may give rise to significant personal financial risk. For sole traders and partners, there is no distinction between the assets and liabilities of the business and personal assets. The owner or owners of a business may have unlimited liability if anything should go wrong.
For example, if a contract with a third party is breached and damages are awarded in favour of the third party by a Court but the business has no means of paying these out, then the third party may well pursue the partners for the debt. It is therefore important to ensure that all contracts include appropriate limitations of liability, and also that insurance is put into place to cover all areas of potential risk. Even if such measures are taken, there can be no guarantee that they will be effective in shielding the partners from all personal liability.
In partnerships, a further risk can be the death of a partner. In the absence of a suitably drafted Partnership Agreement, the partnership is automatically dissolved. Further, a beneficiary of the deceased’s estate may demand the sale of business assets or force the business to adopt an unwanted approach.
The key differences between a limited company and an LLP include how they are taxed, how they allocate profits and how they can obtain capital.
Unlike a company, an LLP is tax transparent. This means that the members of the LLP will be taxed on the profits and gains of the entity as if they were self-employed. On the other hand, a company will be subject to corporation tax on its profits and shareholders pay income tax on any dividends. Choosing the most tax efficient structure will depend on the nature of the business and its owners.
An LLP can offer greater flexibility in how it allocates profits, losses and rights over capital to its members. Members can agree on how the income and capital profits and losses are distributed in an LLP agreement, and what happens to capital on a sale or liquidation, the terms of which which can easily be varied if required. Conversely, companies must declare the same dividend for each share of the same class and varying the rights relating to different share classes will require shareholder approval.
Companies are able to raise capital by offering external investors the opportunity to subscribe for shares. An LLP can also offer investors rights over its capital, but the executive board of the LLP often has discretion to vary such rights, and they are less easily transferred between members and third parties.
A company’s articles of association and a complementary shareholders’ agreement set out how a company is run and the means by which directors and shareholders may make decisions. The documents may deal with similar issues, and it is important to understand how they relate to one another.
Articles of association are required by law for a company formed in the UK. They are filed with Companies House, and are therefore a public document, and are relevant to any person who may be a shareholder or director of the company, whether now or in the future. The articles include the procedural requirements for board and shareholder meetings, removing or appointing members of the board and issuing or transferring shares.
Unlike the articles, a shareholders’ agreement is a private contract between those signing it which is not required by law. As well as being confidential, a shareholders’ agreement offers the ability to treat individual shareholders of the same class differently. Common provisions include enhanced rights for minority shareholders, a right for certain shareholders to remain as directors, a mechanism for resolving disputes and safeguards against the sale of shares. A shareholders’ agreement may also impose restrictive covenants on shareholders which may well run for a period after they have sold their shares. New shareholders may be required to sign a deed of adherence, whereby they agree to be subject to the terms of the shareholders’ agreement.
To find out more, read our blog 'Articles of Association, Shareholders' Agreements and Investors' Agreements - what's the difference?'.
A share will be issued once the directors of the company make a valid decision to take such action, and the statutory registers of the company (known as the “company books”) have been written up to show the new issue. The individual to whom the share has been issued will then be a registered shareholder of the company. They will therefore have an ownership stake in the company.
However, when a company grants a share option, the holder of the option merely has the right to acquire shares at a specified price at some point in the future, provided other criteria (such as the performance of the company) have been satisfied. Therefore, the holder of the option does not become a shareholder unless and until they are able to exercise the option, and choose to do so.
A share option scheme can be used to incentivise key employees and to encourage them to remain involved with a company. Further, they are highly flexible, easy to implement and avoid some of the complications which may arise if shares are held by employees directly. Importantly, share option schemes can also bring significant tax advantages for both the employer and the employee.
There is no ‘right time’ to set up a share option scheme and every company is different. A scheme can be a useful tool for all businesses, large and small. For example, startup businesses can use an option scheme to provide a means of attracting talent by granting rights to subscribe for shares when the company valuation is low, and as an alternative to paying high salaries and bonuses. Nonetheless, careful consideration should be given to the rules of the scheme and how these fit with the future of your business.
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