Having a chatur idea and actually starting your business are two different things. Starting up a venture is not a cakewalk and not all entrepreneurs understand the implications surrounding various legalities involved in starting a business. Right from starting a company to raising your first round of funding, an entrepreneur should have a clear understanding about the legal formalities to avoid costly mistakes that could crash your startup before it takes off.
Before getting into certain important legalities every entrepreneur should understand about which type of form of business he wants to start. Choosing the right form of business directly impacts on the growth and profits of your business. An entrepreneur can choose to register his venture as a company, an LLP, or a partnership, etc. Forming a 'Company' is the most preferred way for startups, considering the fact that many of them want venture capital funding later as their source of growth capital.
There are few crucial legal documents that every entrepreneur should know about and they are…
- Memorandum of Association,
- Articles of Association, and
- Founders’ Agreement (in case of multiple co-founders)
- Term Sheet (Key legal document during fund raising)
- Shareholders Agreement
The memorandum of association sets out the main objects and activities of a company. An entrepreneur/founder should identify the core business of the company and ensure that the same is reflected in the ‘main objects clause’ of the memorandum of association.
On the other hand, Articles of Association acts as the rule-book or bylaws of the company. It contains provisions pertaining to transfer of shares, further allotments, board and management procedures, etc.
Founders’ Agreement is reflective of the intended relationship among the founders. A founder discusses various aspects of how the multiple founders propose to own and operate the company. Accordingly, the agreement is prepared. Typically a founder’s agreement will have provisions relating to shareholding and percentage splits, dilution mechanisms (especially in the context of a fundraising in future), share transfer restrictions and board seat/ management rights, etc.
As per many industry experts, 'Clarity is the key' when it comes to documents like Founders' Agreement or Term Sheet. Various aspects of business are involved in a Founders' Agreement which can affect the organisation as whole, like delegation of decision making, valuation norms for investments by partners, exit valuation between partners, settlement of accounts on liquidation or exit, etc. Not only this but with clarity, an entrepreneur should also ensure necessary registrations or licences are obtained, labour compliances are adhered, formalisation of these important documents is crucial for any business.
The term sheet is basically a non-binding document. Once you have an interested investor on board, both you and investor or a group of investors enter into a letter of intent or a term sheet. The term sheet essentially sets out the basic framework of the transaction. It's an extremely important document as this determines how a transaction unfolds. Apart from two or three clauses - like those relating to exclusivity, confidentiality and governing law - the other provisions in the term sheet do not constitute a binding contract. This document also allows the parties to gain exclusivity, and that's why it's one of the important legal document when you are raising funds for your startup.
A term sheet in nature codifies the discussions between the involved parties. As many in the industry say that it is just the beginning of the funding process. There is a due diligence done post the term sheet is signed, accounts get audited, tax filings is looked upon, partner agreements and patent filings are checked. Assuming the outcome being satisfactory, an investor then proceeds with negotiating definitive agreements like Shareholders' agreement or Share subscription agreement.
Having a legal counsel to assist on various issues helps address all these problems before they snowball into something ugly and your startup pays the price for it. And of course, you can always contact the Chaturs if you need any help.