A lawyer’s advice to start-ups: before approaching investors with your pitch, ensure your house is in order

31. August 2022

A lawyer’s advice to start-ups: before approaching investors with your pitch, ensure your house is in order

Even though Estonia is a great place for start-ups, businesses can later fail due to contracts not having been concluded. Ajujaht mentor and attorney-at-law from TRINITI law firm Peeter P. Mõtsküla highlights the three most common issues to consider:

“Everybody knows that starting a company in Estonia has been made extremely easy. However, new companies often struggle with finalising proper legal agreements. This is due to a lack of related knowledge or people simply thinking that they’ll deal with the issue of contracts after x, y and z have been done. Unfortunately, by that time it may be too late and they may end up facing complicated and expensive legal disputes.”

A founders’ agreement is as important as a company’s articles of association.

Mõtsküla stresses that a company’s articles of association and founders’ agreement are two different documents, both of which are equally important. The former is a compulsory framework document for the formation of a company and for it to pursue its business activities, whereas the latter is a voluntary agreement that sets out the division of roles between the founders, as well as mutual dispute settlement procedures. Both documents hold an important place in business and they have to be mutually compatible.

“Every now and then, we are approached by someone from a start-up who is dealing with a dispute between owners. If it is not possible to rely on written agreements in a situation like this, the result often tends to be a huge mess that can cost a considerable amount of money,” Mõtsküla pointed out.

The founders’ agreement becomes particularly important when one of the founders fails to meet his or her commitments to the other founders and the company. If there is no agreement that sets out procedures in the event that the partnership ends, it is not possible to simply exclude the person from the list of owners, and the process of buying him or her out may become expensive and complicated.

Also, don’t forget to protect intellectual property

In parallel with the founders’ agreement, legal experts recommend finalising an intellectual property agreement, which stipulates that any rights for intellectual property – copyrights, inventions, design solutions, etc. – that the founders or employees may have, are automatically transferred from these individuals to the company.

“The first thing that investors consider before making investments in a start-up is whether the company exercises control over what they are building. In other words, they want to make sure that intellectual property related to the activities of the company belongs to the business and not to one of the founders or a code office,” explained Mõtsküla.

To illustrate the point, Mõtsküla said that he was once involved in advising a start-up where one of the three key founders had retained part of intellectual property.

“Once the company was ready to raise capital, this specific founder wasn’t willing to relinquish his part to the company unless they paid him a sizable sum of money. In the end, the company didn’t pay and investors walked out because the case posed too many risks,” said Mõtsküla.

In addition, relationships between shareholders must be legally enforced.

When investors (i.e., new shareholders) enter the scene, a shareholders’ agreement needs to be drawn up in addition to the founders’ agreement. This agreement proves helpful in situations where one of the shareholders can no longer contribute to the development of the company due to their health, or wants to leave the company altogether for some other reason.

“From our experience, I can say that a shareholders’ agreement really helps to avoid conflict. It is very common for start-ups to have some shareholders leave and others join the company. If the roles are not regulated enough, it can easily result in a dispute,” concluded Mõtsküla.

Initiated by

The Ajujaht accelerator programme and TV competition is a collaboration between the public and private sectors and is created by Enterprise Estonia.

Initiated by: EAS