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Asean Centre of Entrepreneurship

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Legal Consultation

Overview

In Malaysia and the Asia region, especially among developing countries, legal practices and consequences are not taken as highly by startups and new entrepreneurs, most of which claim their ignorance over the importance of at least knowing the legal pitfalls for running their business operations. Many have caused them money and lawsuits in the future, hence we have taken our entrepreneurs a step into the legal Know-Hows for entrepreneurs.

Attention to a few legal details as you are building your business can make the difference between falling into a legal mess and realising all that is due you.

Most common mistake is a tendency to think, “Once I get my funding, once I’m up and running, then I’ve got time to hire the lawyers; right now, I’m running as fast as I can to get my business plan done and raising money.” This is shortsighted logic. But does that mean that one should devote all of their time, effort, and money to the legal issues? No. That’s a good reason to hire a competent lawyer. Excellent legal talent can be retained for relatively little money up front at the early stages. It will cost much less to get it right at the beginning than to try to sort it all out later and correct it.

Service Providers

Glossary of Legal Terms for Startup

Glossary of Legal Terms for Startup – What an Entrepreneur Must Know By Heart

ARTICLES OF ASSOCIATION: This is the document that sets out amongst others, the startup’s internal management rules, authority or powers of the company directors and members and the rights of its members in particular to be notified of, attend and vote at meetings and to receive dividends on their shares if declared. In Malaysia, the startup may adopt a readily available format of the Articles of Association in Table A of Schedule 4 of the Companies Act 1965.

AUTHORISED SHARE CAPITAL – Authorised share is the maximum amount of share capital that a startup can issue to its shareholders. The amount and type of authorised shares is set forth in the MEMORANDUM OF ASSOCIATION, the wordings as follows:

“The capital of the Company is RM100,000 divided into 100,000 ordinary shares of RM1.00 each”.
The startup can change the amount and type of authorised share capital with the shareholders’ consent.

CALL OPTION – the holder of a call option (buyer) (“A”) has the right to require the other party or parties (“B”) to sell their shares to the buyer at a price based on a predetermined formula or fair value. To illustrate this, please see the following:

The Call Option Holder must not necessarily buy the shares – it is not an obligation, it is a merely a right that he can invoke.

CONDITION PRECEDENT – In the DEFINITIVE AGREEMENTS, the investor sets certain conditions that must first be met by the startup and the founders before the funding is released to the startup. Some examples of conditions precedent are, completion of DUE DILIGENCE and that the investor is satisfied with the same, signing of DEFINITIVE AGREEMENTS and capitalisation of advances by shareholders.

CONVERSION RIGHT – rights by which preference shares convert into ordinary shares based on a pre-agreed conversion rate. This right can usually be exercised by a holder of preference shares at any time.

DEFINITIVE AGREEMENTS – This refers to the set of agreements that the investor requires the startup to sign before the funding is disbursed. Definitive Agreements normally comprise the Subscription Agreement, the Shareholders’ Agreement, Call Option Agreement and / or Put Option Agreement (this depends on the terms of the deal structured), the Employment Agreement and the Intellectual Property Assignment Agreement (if applicable). The signing of the Definitive Agreements is one of the conditions precedent to the investment by investor.

DIVIDENDS – distribution of a portion of a company’s available profit to its shareholders, decided by the board of directors (subject to any legal restrictions).

DRAG ALONG RIGHTS – This is the right of a majority shareholder, where if it wishes to sell its / his shares in the company to a third party, it can ‘drag along’ (in other words, force) the minority shareholders to sell out to such third party.

DUE DILIGENCE – A due diligence on the startup is the most critical component of the conditions precedent in investment. Due diligence means the process where the investor conducts investigation into the startup and looks into the company’s business, management, technology, financial, taxation and legal. The startup is to provide all documents and information / confirmation to the investor and warrants that such documents and information / confirmation are true and accurate. Once the due diligence is completed, the investor will form an assessment as to the viability of the investing into the startup.

EQUITY – the value of an ownership interest in a company, usually in the form of shares.

INTELLECTUAL PROPERTY – right that is presumed to represent an advantage to the company’s position in the marketplace, including patents, trademarks, trade secrets, copyrights and licences.

INITIAL PUBLIC OFFERING (IPO) – the process where the private company offers its shares to the public. The process is highly regulated by the Securities Commission and Bursa Malaysia Securities Berhad and corporate advisors will advise on the IPO.

ISSUED SHARE CAPITAL – Issued share capital is the number of authorised shares that the startup has issued to the shareholders. The shares to be issued cannot exceed the number of AUTHORISED SHARE CAPITAL.

ALLOTED CAPITAL – An allotted capital is that part of the AUTHORISED SHARE CAPITAL which has been allotted to shareholders.

MEMORANDUM OF ASSOCIATION: This document is a legal document and is to be lodged with the Companies Commission of Malaysia during the incorporation of the startup. It sets out the main objects of the startup’s business.

MEMORANDUM & ARTICLES OF ASSOCIATION – For the incorporation of the startup, the startup must file the MEMORANDUM OF ASSOCIATION and the ARTICLES OF ASSOCIATION with the Companies Commission of Malaysia. The MEMORANDUM OF ASSOCIATION and the ARTICLES OF ASSOCIATION are legal document that bind the shareholders and they can be amended provided that the shareholders agree to such changes.

ORDINARY SHARES – Ordinary shares represent equity ownership in a limited company and is also known as ‘non-preference shares’. A holder of ordinary share can exercise one vote per share on a poll on any resolution put to a meeting. If the company is wound up, the holder of ordinary share is entitled to participate in the proceeds of the company’s assets after all the debts have been paid.

PREFERENCE SHARES – shares in a company which give the holders an entitlement to a fixed dividend but which do not usually carry voting rights. If a company is wound up, preference shares are usually repayable at par value and rank above the claims ordinary shareholders.

RIGHT OF FIRST REFUSAL – This is the right of existing shareholder against other shareholders, in the event (i) any other shareholder sells its shares (in which case, such existing shareholder has the right to acquire those shares before an outside party can); (ii) the company allots further shares (in which case, such existing shareholder has the right to be allotted with the new shares, before the company makes the offer to outside parties). This right of first refusal is exercised in proportionate to the shareholders’ stake / shareholding in the company.

PRE-EMPTION RIGHTS – a private company may have its Articles of Association (and they may be repeated in a shareholders’ agreement) a provision that any issue of shares may not be made without the shares first being offered to existing shareholders.

PUT OPTION – the holder of the put option (seller) (“A”) is given the right to require the other party or parties (“B”) to purchase the seller’s shares based on a specified and predetermined formula or at a fair value and within a specified period. An illustration is as follows:

REDEMPTION RIGHTS – the investor’s right to force the company to purchase shares.

SHAREHOLDERS’ AGREEMENT – a contract between the shareholders of a private limited company, defining their mutual obligations, privileges, protections, rights and usually comprising the company’s Articles of Association.

TAG-ALONG RIGHTS (Co-Sale Agreement) – obligation on the majority shareholder to include the minority’s interest in any sale it makes to a third party. The minority shareholder has the right to join the transaction and sell his or her shares in the company.

TERM SHEET – Term Sheet is a document outlining the terms of the offer of the funding from the investor. Once the terms of the term sheet are agreed by the startup and investor, the investor will carry out the DUE DILIGENCE on the startup. If the conditions to the investment are fulfilled to the investor’s satisfaction, the DEFINITIVE AGREEMENTS are then signed and funding is subsequently disbursed.

WARRANTIES – specific statements in relation to the company given by the directors of the company (or in the case of share sale, the sellers) to investors purchasing shares or acquiring shares in the company, as an assurance to the worthiness and state of the company.

Key Legal Documents for Startups

  1. Non – disclosure agreementThis is the document that the startup should first sign with any party who is interested to value or invest in its business. It protects the confidentiality of the information and documents disclosed by the startup company to the prospective investors and vice versa.
  2. Subscription AgreementThe document that governs the process, price and number of the new shares to be subscribed by the investor.
  3. Shareholders’ AgreementThis document that governs the relationship between the shareholders in a company. It is a binding contract between shareholders and where there is dispute between shareholders, the terms of this agreement will govern the manner in which the dispute is to be resolved. The dispute may include operational matters or shareholders’ matters. It is worth noting that it is a common practice that founders in a startup do not sign a shareholders’ agreement and this may give rise to issues later. Professional investors will however make this mandatory to be signed between all founders and the investors.
  4. An Employment AgreementFrom the investor’s point of view, it is crucial that the founders and key personnel sign a binding employment contract with the company. In the employment agreement, matters such as exclusivity of employment and the business that the founders are in, as well as transfer of intellectual property rights from the founders to the company, are duly addressed.
  5. An intellectual property assignment agreementThe founder or the developer (of the software / website) assigns the intellectual property rights in the software / website to the company.
  6. A put-option agreementThis gives the shareholder the right to sell its shares at a specified price within a specified period.
  7. A call-option agreementThis gives the shareholder the right, to buy the shares at a specified price within a specific time period.

Sample Key Legal Documents

You can download some sample key legal documents here.

Call Option Agreement
Put Option Agreement
Subscription Agreement
Shareholders’ Agreement between Founders of Startup

Exit Strategies

Investors take up a stake in the startup with a view to grow their investment and subsequently exit the startup. As such, it is important that a startup considers the exit strategies for the investors right from the start.

When to Exit?

  1. Would you rather sell your startup for RM15 million where you are the majority shareholder, OR, sell your startup for RM50 million but you are the minority shareholder? How much time should you spend on your startup until you decide to dispose your stake?
  2. Start-ups want to sell for as much money as possible (investors as well) and investors want to maximize their returns and spend as little as possible. As such, founders need to carefully analyse when is the growth rate high instead of when the startup is very profitable.

Types of Exits:

  1. Put Option AgreementA put-option agreement gives the shareholder the right (though not obligated) to sell the shares at a specified price within a specified period.
  2. Call Option AgreementA call-option agreement gives an investor the right (but not obligated) to require the other party to purchase such investor’s shares based on a specified and predetermined formula or at a fair value and within a specified period.
  3. Merger & Acquisition (M&A)This normally means merging with a similar company, or the company that is smaller in size is being bought by a larger company. M&A is an efficient strategy for companies to increase its product line or services. M&A may be a preferred route for investors if the market conditions are not conducive for an IPO exercise to be undertaken.
  4. Initial Public OfferingIPO brings about many benefits to the company, amongst which, are (i) the huge amount of capital raised and this facilitates expansion, corporate marketing and development, and/or acquisition capital, (ii) as an exit strategy for the founders, (iii) provides a ‘publicity campaign’ to the company where the IPO can attract potential partners, customers, and most importantly, strategic investors, (iv) enabling a higher valuation to the founders ,where studies have shown that founders in public companies sell at an average that is much higher than the founders in a private company, (v)providing stock options to employees; and (vi) greater transparency and corporate governance – this boost shareholders’ confidence and investors.
  5. Trade SalesThe founders of the startup sells the company to another company. It is quite common to founders to dispose its startup and move on to other ventures or projects. An example of this is no other than Reclip.It (co-founded by CEO of MaGIC, Cheryl Yeoh) that was acquired by Walmart Labs.