Simon Wallwork, head of the Corporate and Commercial team at leading Manchester law firm Slater Heelis LLP, outlines some of the most common pitfalls start-ups face and how to avoid them.
Start-ups face many challenges in their formative years. Perhaps the hardest challenge is raising the necessary finance from the small number of venture capital, business angel and specialist funds that are prepared to invest in early stage companies.
There are a number of things a start-up business can do to, not only ease the funding process, but provide an impression that the company is well run, creating trust and building a strong platform for further growth.
Over the course of a company’s life the share structure of a company will change with the allotment of new shares, transfer of existing shares, the granting of options and the investment by funders. It is important that the share structure is planned with as much foresight as is possible. Failure to plan the share structure can lead to issues which may cause unforeseen tax consequences and the need to correct the share structure. This will involve additional costs and be problematic. It is important to factor potential share option pools into the share structure so future dilutions arising from funding rounds don’t hit the founder’s shareholding in ways not anticipated.
It is also important that any share changes have the correct pre-emption procedures applied and are properly recorded so that there is a paper trail of the necessary board approvals, shareholder approvals and filings at Companies House.
Intellectual Property Rights
Intellectual property is something unique that a business physically creates and intellectual property rights are the fundamental assets of most start-ups. The company has to have the right to own or use the intellectual property rights either outright or by having the necessary licences. There is a common held misconception that where a company has commissioned a third party to undertake research and development that the company therefore owns the created intellectual property rights. In fact, it is only where employees carry out research and development themselves, that a company will own the intellectual property rights. As such, where contractors have undertaken work or where development work was undertaken prior to the company being incorporated, the appropriate assignments or licences of intellectual property must be put in place dealing with the ownership of the rights arising.
It is often tempting for companies to save time and costs by agreeing contracts either verbally or by way of email or other correspondence rather than having contracts drafted or scrutinised by lawyers. The value of a company is based upon its assets and turnover, or potential turnover, and the security of its trading relationships and, therefore, a company should have its material contracts properly drafted and in place. Uncertainty in the wording of contracts or in what has been agreed, leads to uncertainty and creates potential for dispute.
Clearly, all companies should comply with applicable employment legislation. It is important that all employees have written terms and conditions and the appropriate employee handbook, grievance and disciplinary procedures are put in place. Where employees are undertaking work that will create intellectual property rights their employment contracts need to make it clear, even though it is implied by law, that all intellectual property rights and confidential information created by the employee are owned by the company and that following termination of any employment contract, the appropriate provisions and restrictive covenants to protect intellectual property rights, confidential information and the company’s customer base, are enforceable.
Make use of Tax Reliefs
There are many tax reliefs available to start ups and a thorough understanding of their availability and application is a must. R&D tax credits can be a significant benefit to companies and their availability is often misunderstood. The share structure of the company should be set up so that the founders obtain Entrepreneurs Relief and, as highlighted above, the start-up should ensure that any forward planning in respect of share structure and operations gives regard to maintaining qualification status for both seed Enterprise Investment Scheme tax relief and Enterprise Investment Scheme tax relief. Patent box tax relief can also be very beneficial to companies.
Starting a business can be a complicated and confusing time. By attending to the issues above, and seeking expert advice as much as possible, business founders can give themselves the best chance of success.