1. Founders agreements

A Founders’ Agreement is essential when starting a business with co- founders. Many startups overlook formal agreements in the early stages, but a lack of clarity on roles, responsibilities, and equity can lead to major conflicts later, potentially threatening the survival of the startup.

One essential element of a Founders’ Agreement is equity allocation – how ownership is divided among founders. This can be based on contributions such as time, expertise, or financial input. A clear understanding is important, especially when a founder exits the company.

Reverse vesting protects the company when a founder leaves early by requiring them to "earn" their equity over time, rather than receiving it all upfront. Unlike typical vesting, where shares are awarded gradually, reverse vesting assumes founders initially own 100% of their shares but will lose some or all of them if they leave within a specific timeframe.

For example, if a founder holds 25% of the equity, reverse vesting ensures that the founder retains full ownership only after fulfilling certain milestones, such as staying with the company for four years. If the founder leaves after one year, only a quarter of their shares might be ‘vested’, and the remainder will be forfeited or bought back by the company.

This mechanism ensures that founders who leave within the first few years do not retain a disproportionate amount of equity, which could demotivate remaining founders and affect future investors' confidence. By implementing reverse vesting, the startup ensures continued commitment from all founders while preventing equity from being controlled by someone no longer involved in the company.

Further, other elements of a Founders’ Agreement may include clear definitions of each founder's role to help avoid future misalignment and conflict as well as provisions on how decisions will be made, whether through majority voting or specific veto rights, and the dispute resolution process.

2. Intellectual property rights

The moment an idea is conceived, intellectual property (IP) is created. For many startups, IP is one of their most valuable assets. Protecting your ideas, brand, or technology from the start is crucial to prevent competitors or even customers from exploiting your innovations.

IP rights cover a much wider array of creations than trademarks and designs, and can extend to software and code or creations. A further subsection of IP rights even includes protections for the makers of databases if a substantial investment was made in obtaining, verifying, or presenting the content of the database.

You may choose to engage contractors or other third parties on a project-by-project basis to set up particular software or databases before engaging full time employees. One area you must make sure you take into consideration is – who owns the IP?

The law in the UK is designed to protect the creator. Generally, the person who creates the work or design will be the beneficial owner of the creation. The main exception to this is if the piece of work in question is created by an individual in their capacity as your employee, then you as the employing company will own the IP rights to the work.

What is not exempt is if you were to engage a contractor, consultant, or another third party, they will own the rights to their work. For this reason, when preparing agreements to engage an independent contractor you will have to ensure you have a specific clause under which the individual agrees to assign all IP rights in the works, inventions, and all other materials to you.

3. Financial promotions

For most startups, raising investment is a critical step in their growth ladder. However, when approaching potential investors, it’s essential to understand the rules around financial promotions to avoid any

penalties. In simple terms, a financial promotion is any communication, whether a pitch, prospectus, social media post, or even an email, that invites someone to invest in your business.

Sending out pitch emails to potential investors, posting an investment opportunity on your website, and presenting your startup to investors in a meeting or networking event, can all be considered a financial promotion if they are encouraging someone to invest. While this may be an exciting step in growing your startup, there are strict rules around how you can approach potential investors:

• Using approved platforms: one way many startups ensure compliance is by raising funds through authorised crowdfunding platforms or investment platforms. These platforms often handle the regulatory requirements for you, allowing you to focus on pitching your business effectively
• Targeting the right investors: not all investors fall under the same category. There are sophisticated investors and high-net-worth individuals who have more experience in making investment decisions and are exempt from financial promotion restrictions. This type of investor will have to certify their income or assets, and acknowledge that they may lose significant rights by completing and signing a statement in the form prescribed by the financial promotion regulation
• Disclaimers: every pitch deck, prospectus, or investment-related communication should include clear disclaimers. These disclaimers should outline that the investment carries risk, past performance is not indicative of future results, and potential investors should seek independent advice. This protects your business from claims of misleading information and sets the right expectations with investors.

Conclusion

Founders invest a lot of time and capital into the growth and success of their business, it is important to be aware of the abovementioned legal pitfalls to ensure the business you have built is protected. By taking these legal steps early on, you’ll protect your company from disputes and regulatory issues, allowing you to focus on growth and innovation.

This article originally appeared in the November/December 2024 issue of Startups Magazine. Click here to subscribe