Legal Tips For A Successful Startup Exit

By Ela Levy-Weinrib Globes, Tel Aviv, Israel.

The "Globes"-Bank Hapoalim (TASE: POLI) Smartup3 competition is over and the four winning startups will soon enjoy the promised prize: advice from high-tech and business experts in a range of pertinent subjects.

The advice will help the new companies survive the legal intricacies and the regulatory and other hurdles in the entrepreneurs' path, but the labor pains and teething problems from their babies -- the startups themselves -- are behind them.

They have already come up with an innovative idea, raised initial capital, sought protection through a patent or other method, and begun work on developing the technology that they hope will take them to the hoped-for exit -- and the big money.

How will they do this, and what are the legal obstacles they must -- really must -- overcome en route? The legal advisers of the incubators assisting the start-ups have responded to these questions for "Globes", offering legal tips that will facilitate the potential entrepreneurs' lives.

Adv. Lior Baruch, partner at Pearl Cohen Zedek Latzer Baratz, the legal adviser of 8200 EISP, which is assisting Paybox Ltd.

The founders agreement is your financing agreement

1. The founders: again and again, investors say that they invest in people, not in ideas, technologies, or market share. The most important and diverse resource is you and the other entrepreneurs on the team. Think about each of your strengths and weaknesses and the possible contribution now and down the road. Then sign the founders agreement for coordinating your expectations and relations in the first stage, until an external investor comes in. A good partnership between the founders is important, but the founders agreement is your financing agreement and insurance policy, and it must regulate all options for solving disputes, deciding disagreements, and returning shares to the company if a founder leaves sooner than expected.

2. The external advisers: the basic team, which ought to advise the founders until the company is founded, includes a law firm and CPA firm with experience in advising start-ups, and which can refer the company to another adviser, such as tax, intellectual property, employee options trusts, and regulatory experts. A good adviser is not cheap, but saving $1,000 when founding the company can easily cause $1 million in damage at a poorly planned exit.

3. Founding the company: to allow you diverse activities and avoid personal liability, you will want to found a limited company at an early stage. It is important to seek consultants for advice on where to incorporate, which will affect your options for raising capital from both government and private sources, and the applicable tax laws, which will ultimately determine how much money you will earn. Moving a company after it is founded will incur various payments.

4. Distributing the rewards: how many shares will each founder receive when the company is set up? This involves a delicate balance. In many cases, entrepreneurs distribute generous percentages, and are subsequently unpleasantly surprise to discover that they have lost control of the company. In other cases, entrepreneurs struggle to recruit partners because of unwillingness to allocate holdings. It is important to remember, a company will almost always need one or more outside investors, who will expect to receive a substantial stake in the company at the entrepreneurs' expense.

5. Call to order: anyone who has worked in the business has encountered examples of brilliant ideal which failed at a start-up because of improper conduct by the entrepreneurs. Work in an organized way. Document every act. Involve your expert consultants whenever there is doubt. Do not reveal your ideas to other without signing a confidentiality agreement. Do not cut corners, especially when hiring employees or with the tax authorities. If you do your work properly, you will discover that the chances that due diligence conducted by a future investor will not torpedo the deal. Adv. Maya Bar-On, legal consultant at Explore. Dream. Discover, which is advising TapReason Ltd.

Start the patent registration process as soon as possible

1. Where to register the company: whether you decided to incorporate in Israel or in another country, know that this fundamental decision will have consequences down the line, in terms of tax aspects of the company and the entrepreneurs, potential investors, the company's target market, and the ability to obtain support from Israeli government agencies, such as the Office of the Chief Scientist.

2. The proper distribution of the company's share capital: the company's share capital should reflect the distribution of company shares between the entrepreneurs. It is important to ensure that everyone important to the company's success will hold a respectable stake in the share capital. You will find it difficult to persuade an investor to invest in the company if the entrepreneurs who are supposed to be running it own only a fraction of its share capital from the outset. Take into account that the shares allocated at the outset will be taxed at the relatively low capital gains tax rate, but that subsequently allocated shares may be considered as labor income and be taxed at the higher income tax rate. In addition, do not forget to include in the table everyone who was promised a stake in the share capital at the outset: employees, subcontractors, consultants, investors, accelerators, finders, etc.

3. What is important to include in the founders agreement: on one hand, it is important to make sure that all the founders agree on the partnership and to anchor the agreements in a formal document. On the other hand, it is necessary to take into account that, upon the entry of the first investor, the founders agreement is liable to be amended and rendered obsolete. If you decided to draw up a founders agreement, give thought to the structure of the company's board of directors, what each entrepreneurs should contribute to the company, will happen if one of the entrepreneurs fails to deliver the goods or decides to leave, a commitment by all the entrepreneurs not to compete against the company, how to finance the company until the first investment, ensure that every entrepreneur transfers his intellectual property to the company, and dispute settlement. It is advisable to include dispute settlement and separation mechanisms in the agreement, as well as right of first refusal mechanism, preemptive rights, tag-along rights in the event of a sale of shares, etc.

4. Protecting company assets: ensure that the company's intellectual property rights are clear and that no external party, such as former employees of the entrepreneurs or research institutes, has any rights therein. Check with a patent attorney whether it is possible to patent the technology; if so, it is worthwhile to initiate the patent registration process as soon as possible. If not, check other ways to protect the concept, such as copyright.

5. Picking the right investor: pick an investor who can give you added value beyond the money he is injecting -- an investor with a track record of helping create relations with customers or strategic partners, helping the business side, and raising follow-on capital. Picking the wrong investor is liable to result in a disproportionate holding structure in which a small investor owns a large stake in the company at the expense of the entrepreneurs. Such a distortion will drive away other investors.

Adv. Stephen Barak Rozen, partner at Amit Pollack Matalon, the legal advisor of Nielsen Innovate, which is assisting The Grid

Adopt an options plan as quickly as possible

1. Plan the start well: if there is more than one venture and it has not yet been decided whether to found a limited company, draw up a founders agreement. The agreement will anchor, inter alia, decision-making, what happens to an entrepreneur's shares if he leaves, how much time the entrepreneurs must commit to the project, and whether or not a founder should return shares to the other founders if he leaves.

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