Whilst having an unencumbered right to sell shares is good news for the seller it is not necessarily good news for the entrepreneur or, for that matter, the company. It is very possible for the company to be saddled with annoying or disruptive new shareholders, potentially with significant influence because of the percentage of shares they now hold.

All of the difficulties referred to above can be dealt with in a Founder Agreement. For example, a provision can be included that if any shareholder wishes to sell their shares, they have to offer them to the other shareholders first or to the company for repurchase (which is also called a pre-emption right or a right of first refusal).

2  Insufficient protection of intellectual property

 The lifeblood of a startup is normally its idea. Subsequently, that business will develop a brand, based on that idea. Both (which are normally included under the umbrella term of “intellectual property”) are crucial to the success of the business.

The law offers various protections both of ideas (through concepts such as patents and copyrights) and brands (through concepts such as trademarks, design rights and domain names). It is incumbent on the entrepreneur to ensure that those protections are put in place and are put in place quickly. The entrepreneur must, if at all possible, become the “first mover”, in relation to the idea, and then secure the brand.

By putting in place these protections, they will be able to maximise their competitive position. Other businesses will not, legitimately, have access to the idea or brand. If, however, those protections are not put in place (as often occurs), then the idea is potentially likely to be exploited by another business, including through a similar brand, and sometimes more successfully than by the person who came up with the idea.

3  Employment matters disregarded

Many startups will begin with just an entrepreneur. However, almost all expand to include employees. In the excitement of such expansion, key issues with employees are sometimes forgotten, for example:

• It is crucial that any employment arrangement is recorded in a formal, full contract. There is an old adage of “hire slowly, fire quickly”, but hiring mistakes are not uncommon. Entrepreneurs should consider including a probation period in any employment contract, to allow for an assessment of performance in the first few months and a short termination period if that performance is unsatisfactory. Allied to that, the contract should include a comprehensive role description, so that there is something tangible against which to assess performance.
• Any arrangement should include adequate protections (known as restrictive covenants), such as preventing the employee exiting with any ideas or confidential information of the business, or being able to poach the business’ clients or his or her former colleagues.
• Employment law is different all over the world. As such, there is no “one size fits all” arrangement for employees. Entrepreneurs need to consider local laws and their effect on employee relations.
• If an employee’s role changes, so might their tax status. A part-time, flexible worker may become a full time employee, or vice versa, and this may affect the business’ responsibilities to the relevant tax authority. If a business fails to properly monitor the status of an employee, it could face an expensive investigation, which, if it is found to be in default, might lead to retrospective charges, interest and penalties. A word of warning – in a world of shrinking tax revenues, authorities are increasingly unafraid to pursue potential non-payment.

Employment issues are important and disputes can take-up valuable time and energy from a startup business. As with many areas in relation to fledgling businesses, the small cost of specialist advice at the outset may avoid significant costs further down the line.

We’ll return with part three later this month, when we’ll look at matters including share incentives and the importance of getting commercial contracts right.