Partnering with a partner in a mutually beneficial strategic partnership can be valuable to any startup to charge their growth. It is important to structure these partnerships to safeguard the interest of both sides, especially when it is a deeper partnership where more there might be more confidential information being exchanged. At the same time, internal partnership can be invaluable.
Lawyers Chia Yong Yong (Lawyer, Chia Yong Yong Law Corporation), Farhana Siddiqui (Partner, WhittersKhattarWong) and Faith Sing (Director, Corporate & Commercial Lawyer, FSLAW LLC) shared the different views on internal and external partnerships and agreements in an event jointly organised by Asia Law Network and LadyBoss Asia and moderated by Samson Leo (Co-Founder, Xfers).
#1 Internal Partnerships
How to go forth from an idea
So, you are an aspiring entrepreneur and have a brilliant idea. What do you do next or how do you move the idea forward?
All three lawyers agreed that it is, first and foremost, important to build a strong foundation for the business before thinking about the legal structure. Lawyers will be there to help with the legal structure, but they can only do so if you have something concrete. Points to consider could include the following:
- Vision & objectives – why and what do you want to do?
- People – who do you want to bring on board
- Time & goals – where do you see yourself or the business in 5 years and 10 years
- Intellectual property – what do you want to preserve and/or protect
Writing down the above details will help to articulate not just the structure, but also, the people you need to talk to.
Working with another party – in what capacity and the need for formalisation
At the start, you could be working with another party to develop your business with an informal agreement. Is there a need to formalise this partnership?
As there are many ways to structure a relationship, Faith suggested for anyone going through this to think about the role of the person. Is this person going to be a partner or is he/she going to be an employee or consultant? What are their expectations and the true value of their contributions? Are they providing a specific type of service or are they truly a business partner?
Farhana added that it is also useful to have some figures such as capital/ inputs you need to grow the business as it will determine who and when you approach. For example, perhaps you only need $50,000 to start the business and it could be your relatives or friends who loan you the money. However, if you are looking to develop an application and you need an IT person but you can’t pay him a salary, how are you going to incentivise the person?
Founders’ and Shareholder Agreements – a necessary step?
Faith shared that such agreements will assist in providing clarity on the roles of each party.
Yong Yong added that founders are people who started the business. They may or may not be shareholders but they usually are. Shareholders, on the other hand, may not be founders or may not be all founders. So many times, we would have a shareholders’ agreements with founders’ rights and responsibilities. The differentiation of roles, once again, is important. Also, founders typically carry a particular value to the business and the shareholder/investor will need to acknowledge and safeguard it.
It would be beneficial to think objectively about potential problems that could arise, how it should be resolved and also, to have a talk about it when everything is still going well. This will help refine the strategies and focus.
The founders’ agreement differentiates the roles of each founder hence, there is less room for overstepping on each other’s boundaries. It also indicates how each founder share risks, opportunities or profits. Take, for example, if you enter in additional rounds of investing, you will need to consider if there is a dilution of shares or no dilution of shares.
Farhana added that you could also have a founders’ agreement before the legal structure is formed, which in legal terms, is an unincorporated partnership.
Intellectual property (IP) and patents
On the note on Intellectual Property (IP), you could potentially face a problem where you want to build an application but have no IT knowledge, hence engaging another party to build it for you. In this case, what happens to the IP of the application?
Yong Yong shared that there needs to be clarity on who is owning and who is developing the application. Since there is another party involved, what capacity is the person coming in as? If it’s an employee, then it is likely for the company to own the application. If you are engaging a consultant or third-party developer, then you need to properly document this relationship and may need a power of attorney for the company to act as well. All these considerations will affect the structure of the company. She added that the IP strategy must support your business strategy – it works hand in hand with the business strategy and your growth will be more coordinated.
Also, the decision to patent the product is dependent on your strategy and nature of your intention. The reason being once you patented it, it is public information but there could be parts of the product or machine that you want to keep secret. But the involvement of another party could also mean it is not as secret. These are considerations you need to have so as to come up with different strategies for different parts of the products – basically, how you protect the bundle of IP that surrounds or underlies the product. You may need a good patent attorney as they will draft the clauses on claims and how much claims you can make is dependent on their drafting of your clauses!
Farhana added that an idea cannot be protected, at least, not in Singapore. If you have an idea and openly discussed it in a public setting and someone else takes and run with it, there is nothing much you can do. The type of property you can protect could be things like your company’s name or logo as it is your reputation. IP is not just about a trademark. A trade name, which is an unregistered trademark, is value. Proper research needs to be done before incorporation to prevents cases of infringements etc.
Considerations for not-for-profit start-ups – does it differ from normal businesses?
Yong Yong shared that one must have the right mentality for such businesses. You may be running a not-for-profit/ social purpose/ social impact startups, but you still need to make profits in order to contribute to social causes.
The main difference between such businesses and regular businesses is the articulation of the vision.
Oral Contracts – Is it enforceable?
Faith shared it is enforceable but it is unlikely you will recite an entire agreement over the phone. A well-drafted shareholders’ agreement covers many complex issues and it may be that you want to set this out in writing.
Farhana added that while it is enforceable, it is difficult to prove and it will need a lot of evidence, which is why lawyers always advocate you put it down in writing.
#2 External partnerships
External investors – what do they look and ask for?
In a nutshell, Faith explained that it depends on the sophistication of the external investors and their experience. Essentially, investors want to protect their investments. They want to make sure they can profit and exit. They might have an investment committee to report to or a general counsel who has seen many deals and therefore, have strong views on the way certain things are drafted. If you are the founder of the company and driving the company forward, the shareholders’ agreement might have a few clauses designed to make it more difficult for the founder to leave without the shareholders exiting too.
Types of business structure
Farhana shared that in Singapore’s context, private limited companies (PLC) are the only corporatised structure whereas a limited liability partnership (LLP) is relatively recent and not as familiar to many.
The advantages for a PLC is limited liability. A PLC has separate legal status from its shareholders and directors, who have limited liabilities for the debts and losses of the company. An investor could be just investing the money and is not interested to sit on the board, hence they want to keep their liabilities limited to how much they invested in the business.
An LLP is a blend of a partnership and a private limited company. An LLP gives owners the flexibility of operating as a partnership while having a separate legal identity like a private limited company, with limited liabilities. It can govern the choice of structure, how to take out monies as you don’t have to make a profit to declare a dividend, unlike in a PLC setting.
Managing strategic partnerships or opportunity-based partnerships
Yong Yong shared that it is up to each party to decide the mode of collaboration. It could be an exclusive distribution or a manufacturing agreement or one that you want to grow and reap benefits together or a joint venture. The usual considerations for risk and profit sharing should also be thought through.
Faith suggested for the founders to read through the agreements and highlight any “showstopper” clauses and negotiate for it first. Subsequently, you may send it to a lawyer who can catch other clauses that you may have missed. Farhana added that the founder must also know what is important to him/her, for example, branding. Write down the points and make sure it is covered in the contract
For an overseas partnership, Farhana highlighted that unlike in Singapore context, it is best if you engage a lawyer early on rather than later, as there are different requirements in different countries. For example, Taiwan is very restrictive and as a foreigner, there is only certain business you can do, or in Indonesia, where you need a local partner because of shareholdings rules. It would be detrimental if you have signed an agreement to do business without fully comprehending the legal requirements of the different countries.
Managing an overseas partner in the event of disputes
Well, in case of a dispute, it is first and foremost, important to have a well-drafted contract!
Faith shared that a well-drafted contract will contain a governing law clause and a dispute resolution clause which will indicate where the dispute will be settled. For cross-border deals, there tends to be a compromise. For example, a London-based party and a Sydney-based counterparty may choose Singapore as the seat of arbitration.
Yong Yong’s advice is not to leave such clauses open as there could be different systems in different countries and it could get very complex. You will be focusing on the law rather than the dispute on hand. She added that they will help clients to negotiate for Singapore laws to apply as we follow the common law so most common law countries will have some semblance. Singapore also has one of the best arbitration centre in the world, a Singapore international commercial court and a reputation for being cheap and efficient.
“Tag along” or “drag along”?
Samson explained that he had seen “tag along” or “drag along” clauses at seed stage. What exactly are these clauses?
Tag along clause – Faith provided an example where if someone sells their shares, the other shareholders get to tag along and sell it too. You cannot sell your share unless you procure an order from the purchaser to buy the other shares too. Investors may prefer this clause as, during a startup’s initial years, a founder is the one driving the business and hence If the founder wants to exit, naturally, the investors will want to exit too.
Drag along clause – For this, Yong Yong explained it’s a case where one person wants to sell and the others don’t have a choice. This will help exiting shareholders manage small investors, where they do not get worse off than what the founder receives.
Also, note that you do not have to agree to all the terms in the contract. There is a need to understand why the clause is there and work out your positioning and what would protect you and be satisfactory to both sides.
Employee Share Option (ESOP)
Yong Yong shared that it is important to understand the rationale behind giving the ESOP – is it for incentives? Points to consider include:
- Do you want the employee to hold on to the shares if they leave the company?
- Do they get voting rights?
- What exactly do you want to give?
From the above, lawyers will then advise you on the structure and types of shares or maybe even a call option. She also advised consulting a tax advisor before making a decision.
Faith made additional points for consideration which includes ensuring that your ESOP doesn’t stop you from making decisions during unforeseen circumstances, such as in a restructuring.
What happens if things go south and KPIs are not met?
Yong Yong shared that it is important to establish trust and respect for each party to do their part of the work. Be prudent when drafting KPIs to ensure they are sufficiently realistic and think about the downside and negative factors that could impact your ability to perform, for example, during economic downturns.
Faith shared that if an investor has a put option to get all their money back, you might be better off with a loan as your only KPI is interest repayment and gearing ratio.
Exit strategies and type of clauses
There should be a clear exit strategy in place, according to Faith. Both sides need to think clearly what each other is getting out from the business. A well-drafted contract will have clear termination clauses to prevent a messy divorce as well as a process for remedy. She also added that some parties enter into an agreement with a mutual right to terminate on a three months’ notice period, but essentially, they are entering into a three months contract so do think holistically, in a bigger picture too.
Farhana shared that common practices boil down to the type of partnerships. For termination clause, you would see how long is the notice period? Or if it’s monetary investments, how did you invest – through loan and if so, can you call back your loan or if it’s equity, do you have transfer rights or can you redeem the shares?
Yong Yong mentioned that the exit clause could be dependent on the capacity you are in. If you are a founder, you would be thinking differently from an investor or contractor. Especially if you are a founder, think what you can bring in, what you can lose, how to move forward and how to be compensated.
Succession planning in the event of the unfortunate passing of a founder
Faith shared that if the business is heavily reliant on the founder, then provisions should be made in the contract, for example, part of shares could be earmarked for potential future contributions. Yong Yong suggested that in this case, the business should be at a certain level of maturity as it can depend on how much the founder can pull in and not just what he invested in. The founder could have a small monetary contribution but brings in the business.
Yong Yong further shared that the keyman insurance could be easier to apply in a business, which the purpose of the policy is to insure the business against loss of profits arising from the death or disability of a “keyman”. As with all insurance, there will be a need to review as the business expands and grows.
Faith added that a creative way could perhaps be an ESOP for the founders and that you stop receiving share options if you stop contributing.
We have talked about both internal partnership (between founders) and external partnerships (between investors, strategic or opportunities-based partnerships). As agreed by all three lawyers, do take a step back and write down your thoughts and process before approaching a lawyer – have a concrete plan and then the lawyers can advise you on best structures. The lawyers are here to help and protect your interests.
Get in touch with the lawyers
You are ready to take off with your business idea and want a formalised structure in place. With Asia Law Network’s Quick Contracts, you can now get all your legal documents for your startup and SME quickly and conveniently, without hassle and uncertainty. You may choose to engage Chia Yong Yong Law Corporation or FSLAW LLC or any of our legal partners. Alternatively, you may also wish to request a quotation from Farhana for your legal needs.
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This article does not constitute legal advice or a legal opinion on any matter discussed and, accordingly, it should not be relied upon. It should not be regarded as a comprehensive statement of the law and practice in this area. If you require any advice or information, please speak to practicing lawyer in your jurisdiction. No individual who is a member, partner, shareholder or consultant of, in or to any constituent part of Interstellar Group Pte. Ltd. accepts or assumes responsibility, or has any liability, to any person in respect of this article.