Startup: legal aspects

Every startup company needs to consider and plan a number of things in its activities to plan the future of the company and reduce the headache for its founders.

Below is a list of the most important aspects to consider when building a startup.

1. Agreement between partners

As of 2019, the legislation provides for the possibility of entering into collective bargaining agreements. A collective bargaining agreement is an agreement between the members of a company that establishes the procedure for exercising their corporate rights and powers as well as the conditions and procedure for selling corporate rights (for example, tag along right (the right of a member to sell his share together with the share of another member), drag along right (the right to demand that minority members sell their share when selling their share).

This includes the distribution of shares in the company in the future, roles and functions in the company, incidents affecting the increase or decrease of shares, the creation of special funds for company development, etc.

Why is this important? When raising an investment, prospective investors also evaluate the structure of the agreements between the current shareholders of the company regarding their shares, as well as the changes in the shares after the entry of the new shareholders into the company.

2. Options

An option is an agreement between the company and the employee, according to which the employee receives the right to buy a certain number of shares in the company upon achievement of the agreed performance indicators in the company.

The option is the best example of win-win for the parties: the company receives a motivated employee, who is interested in the development of the company, and the employee understands his value and the prospects of his work in the company.

Especially useful is the use of options for start-ups, when there is not enough investment, and qualified workers are needed.

The conditions for an employee to receive the right to use an option are:

– achievement of a KPI in the activity;

– Duration of employment with the company (for example, after 2 years of employment the employee is entitled to acquire 50% of the option, after 5 years – 100%).

However, maintenance of the option system requires additional administrative expenses both for the company and the employee (reporting, conducting changes in information, processing sales, etc.). A simpler form is an agreement under which the company pays the employee a bonus (it can have a expressed explicit amount or a percentage of monthly income, or the equivalent of the value of the company at the time the KPI is met) when the employee achieves the KPI.

3. Personal information

The best way to avoid problems is to take care of them early. In Ukraine, because of weak legislation and minimal liability, companies are not used to thinking about the procedures for collecting, processing and storing personal data. But if a company plans to operate in developed markets, in order to avoid heavy fines, it is necessary to create personal data policies.

Attention should be paid to GDPR (personal data regulations in EU countries) and CCPA (California state personal data regulations).

When developing the policy paper, you need to understand 1) which rules apply in the case of your company; 2) which data is processed and what its nature is; 3) what is the purpose of the data; 4) how long is the data stored; 5) whether personal data is transferred to third countries; whether users are properly informed about the collection of their data; 7) whether data protection officers are required, 8) whether a risk assessment needs to be coordinated with the European Data Protection Board (EDPB).

4. Protection of confidential information

After the development of products/programs, algorithms of work, formation of the client base, it is necessary to properly protect confidential information. If this information is disclosed – the value of the company will be reduced.

Another side of the need to implement – to guarantee the contractors that the information they pass to your company does not fall into the hands of third parties.

Non-Disclosure of Confidential Information (NDA) agreement. This type of contract serves to define confidential information, the boundaries of the use of this information, the responsibility for breach of confidentiality. The contract is signed with employees, contractors. Also, relevant confidentiality clauses may be specified in the section in the main contracts.

Confidential information protection clause. While the NDA regulates the bilateral relationship between the company and the employee, the Regulation regulates the system of confidential data protection in the company as a whole. In particular, regarding information with limited access, defining the means of control over the circulation of confidential data, establishing restrictions and rules for the transfer of information.

5. Intellectual property

Intellectual property rights are a major asset for startups, so protecting these rights needs to be taken care of especially carefully.

Actions to protect intellectual property rights can be divided into two parts, depending on the origin of the intellectual property:

1. Intellectual property for trademarks (name, image).

To increase the valuation of the company, this category of rights should be registered to the company, because few people will want to buy/invest in a startup that does not own the trademark it uses. If the startup plans to scale in other markets – it is necessary to register the trademark in those countries in advance, or register the international trademark.

2. Intellectual property rights on developments, products, software codes.

Ownership of this category of rights is fixed in contracts with employees (employment contracts, gig-contracts, contracts with FLPs), and/or outsourcing and out staff companies. What you need to pay attention to in these contracts:

  • the moment of acquiring intellectual property rights by the company;
  • the moment of transfer-acceptance of the services provided;
  • clearly define the scope and content of confidential information.

In addition, the trademark registration of the name/image of the startup to the legal entity, the product/software/game developed, will help to increase the startup’s valuation.

6. Forms of relations with employees

There are two main ways of cooperation with employees: concluding contracts with employees as an FLP and hiring them as employees of the company (employment contract). Both have advantages and disadvantages. The advantages of cooperation with employees as sole proprietors are usually lower taxation (sole proprietors of group 3 pay only 5% of income and unified social tax in the amount of 22% of the minimum wage), simpler mechanisms of termination of cooperation with employees. The disadvantages are the possibility of obtaining a fine for hidden labor relations (more than 100 thousand UAH) and reduction of the value of the company when evaluating it. The advantage of employment contracts is the sense of security when the State Labor Inspectorate checks the existence of hidden employment relationships, the possibility of holding the employee liable for the material damage caused. The disadvantages of employment contracts are the significant difficulty of terminating the employment relationship with the employee and the higher tax rate compared to FLPs.

Since 2022 companies which are residents of the legal regime Diia.City may use the third type of contractual relations with employees in their activities — gig-contracts. This is a mix between contracts with sole proprietors and labor contracts. Thus, the taxation rate of gig-contracts is similar to that of FLPs + 1.5% of the military fee, employees are enrolled in the staff of the company, it is easier to terminate contractual relations with them, there is an opportunity to use additional guarantees for non-competitive actions of the employee.

Svyatoslav Lindyuk, an attorney with Patriot.Legal’s Litigation Representation and Corporate Law practice

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18 August 2022
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