Before You Build: 10 Legal Documents Every Founder Needs

Starting a business can be an exciting moment, but young entrepreneurs often become overwhelmed when they encounter the legal or financial jargon associated with running a new enterprise. Whether you're participating in a business accelerator program, bootstrapping, or have just read Elon Musk’s biography, it's time to assess your legal situation and register your startup. This post will provide you with information about the top ten legal documents that every business founder should be familiar with.

When you decide to create a business, whether it's a tech startup or a brick-and-mortar store, you will have to deal with legal concerns; if you don't pay enough attention to these details, you risk losing the business due to silly blunders.

Start-ups often spend their initial energies developing their product, raising money, securing clients, and forming their business. While concentrating on turning their idea into a successful venture, they often overlook legal structuring and governance. But the absence of a sound legal framework at an early stage may cause major problems as the start-up evolves. Ownership uncertainty, unrecorded agreements between founders, inadequate intellectual property protection, and vague business documentation could all lead to disputes, regulatory issues, and fundraising challenges. By having the correct legal structure in place from day one, founders can establish clear definitions of rights and duties, safeguard their assets, maintain regulatory compliance, and create a solid foundation for their future success.

LEGAL DOCUMENTS AND THEIR ROLE IN STARTUP GOVERNANCE

The legal framework for a startup is made up of important documents that help establish ownership, create linkages, protect vital assets, and ensure compliance. While a Founders' Agreement outlines the rights and duties of the founders, incorporation documents form the legal framework for the company. Board resolutions and statutory registers help in company governance and compliance. An IP Assignment Agreement helps protect the startup's intellectual property, while a Non-Disclosure Agreement protects confidential information. ESOP Policy ensures equity of the employees, and a cap table helps in managing ownership and dilution of shares. These documents help avoid conflict, protect intellectual property, and establish ownership.

• FOUNDERS’AGREEMENT/ CO-FOUNDER’S AGREEMENT

A founder's agreement ("Agreement") is a contract signed by all of a company's co-founders. The Agreement establishes ownership, rights, obligations, dispute resolution, and other terms to be followed by the founders and the company.

Key Terms of the Agreement- 

• Equity ownership- One of the most essential provisions of the Agreement is defining how much equity each of the company's co-founders owns. The equity ownership of the company's co-founders is determined using a variety of criteria, including monetary investment, expertise, existing intellectual property, know-how, and industry network. Equity ownership also determines the voting rights that a co-founder may exercise.

•  Vesting- One of the most crucial aspects to keep in mind while developing the Agreement is to include a mechanism for dealing with the circumstance in which one or more of the co-founders leaves or is removed from the organisation. For this purpose, the Agreement shall include a vesting structure that details how the founders will acquire the shares. The shares may vest in the following manner:

1. Time-Based Vesting- Under time-based vesting, the founder's shares are vested in proportion to the amount of time spent with the company. If the founder decides to leave the company before the end of their tenure, the remaining shares will be returned to the company.

2. Milestone Vesting- The corporation achieves the objectives outlined in the Agreement, and shares vest accordingly. This type of vesting rewards the overall performance of the organisation. If a founder departs the company before the milestones are met, the shares designated for that founder do not vest.

• Demarcation of the roles and responsibilities- The Agreement should clearly define the roles and obligations of each of the company's co-founders. The co-founders' duties and responsibilities are broadly separated into four categories: operations, marketing, administration, and finance.

• Restriction on share transfers- Another key topic to address in the Agreement is the founders' rights and restrictions on transferring their shares in the company. The Agreement may include a lock-in clause that specifies the number of years before the expiration date during which the co-founder is not entitled to transfer his shares in the company. It is important to determine the valuation method used for the shares, as well as the anti-dilution rights attached to them. The High Court of Judicature at Bombay in Bajaj Auto Ltd v. Western Maharashtra Development Corporation Limited (CDJ2015 BHC 1305) held that in the event there is an agreement inter se the shareholders containing restrictions on transfer of shares of the company, then even if such a company is a public company, the restrictions on transfer of shares will be enforceable.

• Intellectual property assignment - In typical business practice, a person's ideas, inventions, and other intellectual property remain their own. While drafting the Agreement, ensure that the co-founders' intellectual property rights are allocated to the company and do not remain the property of an individual. It is not commonplace for corporations to first obtain trademarks, patents, and domain names in the names of one or more co-founders, which can then be transferred to the company's name. The company's valuation is determined by its intellectual property.

• Founders' Value additions - Co-founders may provide value to the company by adding intellectual property rights, technical know-how, marketing rights, or other comparable value enhancements. It is critical that the co-founders have a clear understanding of the nature of such value additions, their monetary value, the time periods during which such value additions will be made, and the compensation to be paid to the co-founders for bringing in such value additions. The Agreement should clearly state the number of shares to be issued, percentage shareholding, and method of valuation of such shares, so that there is no question about it.

• Non-competence - The company's co-founders are expected to keep the company's business activities strictly confidential and to refrain from engaging in any business that is in contradiction with the company's business. There should be a clear agreement between the co-founders barring them from engaging in activities that are contrary to the company's aims throughout their association and for a period of a set number of years following the termination of the Agreement. In Gujarat Bottling Company Ltd and Ors. v. Coca Cola Co. and Ors. [1995 (5) SCC 545 it has been held that “There is a growing trend to regulate the distribution of goods and services through franchise agreements providing for the grant of franchise by the franchiser on certain terms and conditions to the franchisee. Such agreements often incorporate a condition that the franchisee shall not deal with competing goods. Such a condition restricting the right of the franchisee to deal with competing goods is for facilitating the distribution of the goods of the franchiser, and it cannot be regarded as in restraint of trade.”

• Confidentiality - Because of their close involvement with the company, the founders are privy to a wealth of confidential information about the company, some of which may be trade secrets. The founders should be contractually prohibited from releasing any sensitive information gained by such co-founder during his or her involvement with the company, as doing so could cause irreparable harm to the company's business.

• Employment - In most cases, co-founders must work full-time for the company. The co-founders must have a clear understanding of their respective job terms, designations, salary, and benefits.

• Future finance - The Agreement should include detailed provisions for the co-founders' contribution of additional funds for the company's growth, such as whether the additional funds will be contributed as equity or debt, the method of valuation of equity in the case of equity financing, and the rate of interest to be paid by the company in the case of debt financing.

• Termination and Dispute Resolution - The Agreement shall specify the rights of the company and the co-founders to cancel the Agreement. The Agreement may be ended following the occurrence of a certain event, i.e., for or without cause, by any party or by mutual consent of the parties. Furthermore, the Agreement shall include a clear procedure for resolving disputes between the company and the co-founders regarding any topic included in the Agreement, such as mediation, conciliation, and arbitration. The parties shall agree on the Agreement's governing law and the exclusive jurisdiction of the courts to which any disputes under the Agreement may be directed.

• INCORPORATION DOCUMENTS

Company incorporation documents are the official records needed to officially register your company, establish its structure, and set its operating procedures. The specific documentation varies by your business kind (e.g., Private Limited, LLP, Proprietorship) and jurisdiction.

Transitioning from the Companies Act 1956 to the Companies Act 2013 is akin to relocating from your previous residence to an altogether new one. The provisions have been updated in the 2013 Act.

• Analogous Law:

This section corresponds to Section 33 (Registration of memorandum and articles) of the 1956 Act.

• Applicable Section:

Section 7 and 12 of the Companies Act, 2013.

• Applicable Rule(s)

Rule 8 to 18, 24, 25 and 38 of the Companies (Incorporation) Rules, 2014.

What Are the Documents Required for Company Formation in India?

1. Identity and Address Proof for Directors and Shareholders.- PAN Card, Passport. Required documents include Aadhaar, voter ID, driver's license, bank statement, and utility bill.

2. Registered Office Proof- Recent utility bill (electricity, water, gas, and telephone), Rent or lease deed (if the premises are rented), No Objection Certificate (NOC) from the property owner

3. Other Mandatory Documents: Digital Signature Certificate (DSC) for all directors. Director Identification Numbers (DIN), Memorandum of Association (MoA), Articles of Association (AOA), INC-9 Declaration (filed via SPICe+ and aligned with MCA Form INC-9).

How do I submit these documents?

* Step-by-Step Company Incorporation Process:
* Choose a business structure: Pvt Ltd, LLP, OPC, or subsidiary.
* Apply for DSC - required for a secure digital signature.
* Apply for DIN - through SPICe+ during registration.
* Reserve the company name by filing SPICe+ Part A online.
* Draft the Memorandum of Agreement and Articles of Association to describe objectives and internal governance.
* File SPICe+ Part B, which includes ID, address proofs, office proof, MOA, AOA, INC-9, and so on.
* Pay MCA fees and stamp duty, which vary by state and share capital.
* Get a Certificate of Incorporation - your legal registration is complete.

• SHAREHOLDER’S AGREEMENT {SHA}

A Shareholders’ Agreement (SHA) is a legal contract that regulates the interactions between shareholders and their connection with the company. It outlines the governance structure and defines the roles, responsibilities, and rights of primary founding shareholders, including their expected participation, incentives, and the vesting of founder shares. It might also outline the firm's goals, limit competing business activities, and detail actions that need shareholder consent. Moreover, an SHA governs issues like transferring shares, issuing future shares or options, employee incentive schemes, upcoming funding rounds, and debt financing.

A shareholders’ agreement can effectively ensure that the provisions are highlighted to shareholders, who may otherwise overlook the details specified in the Articles. Additionally, from a legal standpoint, certain terms might be added to the shareholders' agreement that could be disallowed in the Articles or under the Companies Act 2006. If founders choose to establish a “founder shareholders' agreement,” they must be cautious not to harm themselves by accepting overly limiting clauses or relinquishing excessive rights within a “founder shareholders” agreement" or any initial shareholders' agreement. Therefore, we suggest obtaining legal advice at the earliest opportunity to ensure a suitable approach is adopted.

• BOARD RESOLUTIONS

Board resolutions are essential for efficient corporate governance since they officially record and formalise significant decisions taken by a company's board of directors. They guarantee that choices are made openly, lawfully, and in alignment with the company's foundational documents. Resolutions also make directors responsible by explicitly stating who supported or rejected particular actions.

Essentially, board resolutions are crucial for the efficient and lawful functioning of a company. They provide a structure for decision-making, ensure accountability, and safeguard the interests of the company and its board members.

• STATUTORY REGISTERS

Every company must keep statutory registers, which should be maintained at the company's registered office in either paper or electronic format, in compliance with the Companies Act, 2013, and the associated rules. Not keeping a statutory register can result in a penalty of no less than Rs. 1 lakh and as high as Rs. 10 lakhs. Moreover, the company's officers could face a penalty of up to one lakh rupees or a prison sentence that must be no less than 25 thousand rupees. Thus, it is essential for every private limited business, limited company, or single-person corporation established in India to keep a statutory register.

Significance of Legal Registers-

• Legal Adherence: Failure to comply may lead to substantial consequences, such as large fines for both the company and its executives.

• Corporate Governance: Reliable records enhance transparency and accountability, building trust among stakeholders.
  Operational 

• Efficiency: Properly managed registers enable seamless corporate activities such as audits, mergers, acquisitions, and share transfers.
  
  

• Risk Reduction: Adequate documentation aids in avoiding legal conflicts and possible harm to reputation.

Effects of Non-Compliance and Legal Actions

• Sanctions and Legal Measures

Monetary Sanctions: Penalties for the organisation and its executives, which can be significant.
Legal Responsibility: Directors might encounter individual liability.
Reputational Harm: Failure to comply can damage the firm's public perception and reduce investor trust.

• Correction of Mistakes

Prompt Response: Rectify any mistakes promptly upon their identification.
Voluntary Disclosure: Notify authorities in advance to reduce penalties.
Expert Help: Seek advice from legal professionals to manage the correction procedure.

• IP ASSIGNMENTS

An Intellectual Property (IP) Assignment Agreement is a legally binding document that ensures a smooth transition of ownership of intellectual property, which can be patents, trademarks, copyright material, software, or any other technological and innovative asset created, from the owner or creator of IP to another party, typically the startup. Unlike a license, which involves only the use of the IP, assignment transfers ownership rights to another party. It is commonly used in employment and consultancy contracts and is very important for ensuring the startup's ownership of IP.

The agreement should be written down and clearly specify the IP being assigned. The founders must ensure that all IP created by employees, consultants, and independent contractors is assigned to the business, as ownership may not be transferred automatically to the startup. If needed, the assignments of registered IP should be filed with the right agency.

• NON- DISCLOSURE AGREEMENT

A Non-Disclosure Agreement (NDA) is a legal document that safeguards confidential information between two or more entities. It limits access to this information and dictates how it may be used. NDAs can encompass a broad spectrum of sensitive information, including trade secrets, business strategies, customer databases, marketing plans, and unpublished inventions. In essence, it establishes a confidential relationship among the involved parties. NDAs can be either mutual, where both parties agree to keep information private, or unilateral, where only one party is obligated by the confidentiality terms.

Key Components of an NDA 

For an NDA to adequately safeguard your business interests, it should include several vital elements that clearly define what information is being protected and the responsibilities of each party involved. 

Here are the crucial components of an NDA: 

Definition of Confidential Information- This section specifies which particular information is deemed confidential and safeguarded by the agreement, eliminating any uncertainty regarding what the recipient is permitted to disclose and what is not.

 Obligations of Receiving Party- This outlines precisely what the recipient is required to do to safeguard the confidential information, including security protocols, restricted sharing within their organisation, and appropriate handling procedures. 

Exclusions from Confidentiality- These are conditions under which information is not protected, such as instances when it is already publicly available or was lawfully received from third parties. 

Duration of the NDA- This details the time period during which the confidentiality commitments remain applicable, which can vary from several months to indefinitely based on the type of information and industry norms. 

Consequences of Breach- This describes the legal and financial penalties that may arise if the agreement is breached, frequently encompassing monetary compensation, injunctive relief, and the possible end of the associated business relationship.

• EMPLOYEE STOCK OPTION PLAN (ESOP) POLICY

ESOPs are wealth-creation plans that give an employee or a grantee (an employee or any other person who has been granted options) the option to buy a certain number of company shares at a future date, either at market value or at a discounted price fixed on the date the option is granted.

Why should employees have an ESOP? 

1. Reward early-stage workers for taking risks: Employees at early-stage startups provide years of experience, take a chance by joining the firm before it has established product-market fit, and help it achieve its short-term objectives and long-term vision. 

2. Use "deferred profit sharing" or ESOPs to match typical market compensation: Early-stage companies offer "deferred profit-sharing" in place of ESOPs since they are unable to match regular market compensation, although growth-stage companies may still be able to do so. Depending on how important the employee is to the expansion of the company, these equity shares may be given out at the time of hire or over the duration of employment.

3. Align employees with the organisation's mission to support the interests of shareholders: Founders use ESOPs to align employees with the organisation's vision and foster a sense of trust and ownership throughout the ranks. 

4. As employees' share options vest, let them participate in the success. 

5. Draw in and keep talented individuals from management and lower-level staff .

6. Encourage long-term thinking by incorporating the organisation's long-term objectives into LTIP design.

• CAP TABLE

The capitalisation table of a firm is a comprehensive document which shows the firm's ownership interests. The document reflects not only who currently owns the company and their interest percentage but also how the ownership will evolve in the future. A capitalisation table usually includes the equity owned by the founders and the investors, the pool of ESOP and any convertible instruments (convertible debt).

Having the capitalisation table up to date is crucial for determining the ownership, diluting the ownership during the fundraising process and making the decision on the equity distribution. Moreover, the capitalisation table makes the information about ownership transparent for the founders and the investors and prevents potential issues related to ownership disputes. Some common errors in this area include not updating the cap table in case of shares or options issuance, incorrect calculation of ownership percentage, failure to take into account any convertible instruments and forgetting about the ESOP pool.

A PRACTICAL TIMELINE: WHEN SHOULD FOUNDERS PUT THESE DOCUMENTS IN PLACE?

CONCLUSION

Legal documents are not only a formality but rather serve as the basis for everything else concerning the structure and operation of a start-up company, such as its ownership, control, intellectual property rights, investments, and management. The right documents can help founders determine their position, prevent misunderstandings, protect the company's valuable resources, stay compliant with all laws and regulations, and clarify ownership and decision-making. The legal documents should be revised and adjusted as the start-up progresses.