The Startup Documents Your Business Cannot Live Without: A Complete Legal Toolkit
09/07/2019 — by Alvin Yu
Ensure your startup is legally compliant, so you can focus on the tasks that matter
You have taken the monumental step of your startup journey by incorporating your company. While the thrill of starting a new business is intoxicating, it could overshadow the minutiae of operating it. Neglecting the legal documents for your new company can result in compliance issues or legal disputes, which get in the way of perfecting your idea and scaling up operations.
Here is an overview of the common documents that are vital to a startup in Hong Kong:
After incorporating a limited company for the purposes of a startup, there are a number of documents that can provide legal protection to the stakeholders involved.
According to the Companies Ordinance, the Articles of Association acts as the company’s constitution, functioning as a contract that binds the company and its members.
The Articles list out fundamental information of the company, such as:
The scope of a company’s business;
The founders and their initial shareholding;
The classes of shares available; and
Standard procedures for holding general meetings.
It is imperative that the Articles are unambiguous and detailed, so as to avoid confusion in the startup’s operation down the line.
To save time, startups can consider adopting the Model Articles authorised by the Companies Registry, editing its contents as they see fit instead of starting from scratch.
A Shareholder Agreement is a contract between a company’s shareholders, and is useful in consolidating the equity proportions for founding shareholders and angel investors, as well as listing out their rights and obligations, such as when and how they can issue new shares or transfer ownership of their own shares.
Proprietary assets are the most valuable property of startups. When the ownership rights to these assets are transferred, they are also the most prone to ambiguities and confusion. This can be prevented by delineating each party’s rights in easy-to-read documents. An Assignment of Intellectual Property Rights, as its name suggests, allows founders who hold intellectual property rights (patents, registered trademarks, designs etc.) to vest them in the startup. In the event that the founder leaves the startup, the company can continue to make use of the intellectual property.
Startups can also license out their software and trademarks to outside parties without compromising their ownership of the assets by way of Software License Agreements and Trademark License Agreements.
All initial investors and founders should also consider signing a Confidentiality Agreement to prevent parties to the startup from divulging confidential information crucial to the company’s development.
To facilitate the day-to-day operations of the business, the startup’s shareholders may appoint a director via a Shareholders’ Resolution to Appoint Directors. The director is a statutory officer of the startup, instead of an employee, but they can be recognised as such via a Directors’ Service Agreement, under which they can enjoy employment benefits guaranteed by the Employment Ordinance. Startups that wish to engage a mentor or advisor instead can make use of a FAST (Founder Advisor Standard Template) Agreement, where a person assumes an advisory role in the startup not for monetary compensation, but for the right to receive company shares in the future.
As for other employees, startups can save time during the hiring process by making use of Zegal’s Employment Contract template, which ensures that employers do not miss out on any crucial provisions such as statutory benefits, restrictions on financial interests in other companies, or non-disclosure clauses. To incentivise employees, startups can consider offering them shares with the Share Option Plan, where employees are granted the option to purchase shares, subject to the Directors’ Resolution and Shareholders’ Resolution to Adopt Share Option Plan. The Share Vesting Agreement can also be adopted to directly vest employees with shares, with the startup reserving the right to buy them back.
Workplace policies, such as the Health and Safety Policy or the Data Protection Policy which lists out guidelines on safeguarding workers’ personal data, are conducive to establishing a safe and congenial working environment, which enhances the reputation of the startup and attracts talent. Laying down clear ground rules with a Disciplinary Policy and Procedure document is the first step in establishing common ground and trust between the employer and employee, and lowers the possibility of future labour disputes.
One integral aspect of startups is to secure funding and scaling up. The most common method of funding is by issuing shares. Startups, for example, can enter into a Simple Agreement for Future Equity (SAFE) with investors – in which the investor makes a cash investment in return for the right to subscribe for shares in the future – when the company has no current intention of issuing new shares, or to alleviate immediate cash flow considerations. If both the shareholders and directors of a startup agree to directly issue new shares (which must be respectively evidenced by a Shareholders’ Resolution and Director’s Resolution to Issue Shares), Zegal offers Term Sheet templates, on which negotiations with investors can be recorded, as well as Investment Agreement templates to finalise the transaction. In accordance with s.144 of the Companies Ordinance, a Share Certificate must be issued to the investor within two months as proof of their shareholding in the startup.
Alternatively, startups can enter into Loan Agreements on commercial terms, or obtain loans from directors or shareholders. Another option is to raise capital via a hybrid of borrowing and issuing shares: Convertible Note Instruments, debt instruments that can be converted into equity for the creditor when certain financing events are fulfilled. Although the interest payable to creditors is lower, the startup risks equity dilution in the long run.
If the startup has reached a certain stage of development and scaling up, such as reaching Series C or D funding, venture capitalists may request the rights to manage the startup to a certain degree. In this case, a Management Rights Letter lists out the management rights and restrictions of these investors.
If the shareholders of the startup decide to transfer the ownership of their shares as part of an exit or buyout, they can do so via an Instrument of Transfer and a Contract Note. The former transfers legal ownership, while the latter transfers beneficial ownership. Please note that if the Model Articles of Association in Hong Kong are adopted without any alterations, according to Article 2(2) of the Model Articles, the directors of a company are entitled to refuse the transfer. According to s.151(2) of the Companies Ordinance, a Notice of Refusal must be sent to both the shareholder and buyer within two months after the application to transfer the shares is lodged with the startup. If the shareholder/buyer asks for reasons for refusing the transfer, the director can either explain their decision, or approve of the transfer within 28 days, per s.151(4) of the Companies Ordinance.
If the transfer is approved, a Deed of Adherence is needed to replace the original shareholder in the founding Shareholder Agreement with the buyer of the shares, such that the buyer becomes a party to the Agreement. If the transfer is part of a buyout, the outgoing shareholder(s) should sign a Deed of Novation with the new owner(s), in order for the former to transfer the contractual rights and obligations owed to a third party to the latter. This ensures a smooth transition of ownership, and minimises the risk of contractual disputes.
Having ready-made templates of the essential legal documents for a startup can streamline the daily operations of the company, and ensures that founders are not distracted from their innovative priorities.
This article does not constitute legal advice.
The opinions expressed in the column above represent the author’s own.