Startup Legal Agreements: Key Steps for Success - Atty. Mahmoud Turabi
- Mahmoud Turabi
- Jul 8, 2024
- 5 min read
Updated: Mar 8
Establishing a startup involves challenges and critical decisions, such as defining vision, strategy, roles, and safeguarding founders' rights. Clear startup legal agreements among founders are essential for stability, covering relationships and roles. This article reviews key agreements: Letter of Intent/Memorandum of Understanding, Shareholders' Agreement, and selecting the appropriate legal structure.
Startup Legal Agreements and Founders' Contracts
First: Letter of Intent / Memorandum of Understanding
We generally do not recommend registering a startup in its early stages. Some ideas may seem great at first, only to lose their appeal after further research and testing of their value and feasibility, or after assessing the market and identifying various obstacles. At the same time, some ideas may flourish and achieve real success. Therefore, drafting an initial Letter of Intent (LOI) or Memorandum of Understanding (MoU) between founders is crucial before diving deep into the process of establishment, preparation, and product or service development.
In the preliminary stages of developing an idea, several key questions may arise, such as: What is the company's vision and strategy for the future? How will it be managed? What are the roles of the partners? These and other questions must be addressed before officially launching the business and should be well documented in any of the legal instruments mentioned above or something alike.
However, based on practical experience, founders often do not pay sufficient attention to these questions. They rarely plan for the future or consider contingencies in case of potential challenges or obstacles. Instead, they tend to focus enthusiastically on product development, neglecting critical legal and contractual considerations.
Why Is such a legal instrument Important in the Beginning?
During the preparation and idea testing phase —before officially registering the company—several preliminary actions may take place, such as purchasing and reserving a domain name, registering a trademark, or opening a bank account. At this stage, a Letter of Intent (LOI) or Memorandum of Understanding (MoU) can help ensure that founders agree to register such assets in their names personally, with a commitment to transfer ownership—whether tangible or intangible—to the startup once it is formally established.
Having such a legal instrument from the outset significantly contributes to the continuity of the company and aligns the founders’ vision and objectives.
Second: Shareholders' Agreement
Before officially registering the startup, after testing its idea and business model, and once the shareholders have ensured alignment in vision and harmony among them, the commitments outlined in the LOI or MoU and any subsequent obligations should be formalized in another fully binding agreement between the founders—known as the Shareholders' Agreement. This agreement details the rights and obligations associated with their ownership of the company.
Additionally, the agreement outlines key operational procedures within the company and specifies how to handle significant events such as acquisitions, securing financial grants, participating in investment rounds, or company closure.
Is a Shareholders' Agreement necessary if the company's Memorandum of Association (MoA), Articles of Association (AoA) / Bylaws can already include key terms, obligations, and commitments?
It is essential to understand the key differences between the Shareholders' Agreement and the Company’s MoA, AoA / Bylaws (or Management Agreement). The latter are an official document required for registering the company with the Companies Registrar or relevant authorities. Therefore, including all rights and obligations solely within such documents is both legally challenging and impractical for several reasons.
Firstly, it is difficult to outline all necessary details in these documents. Additionally, adding too many conditions to these documents can complicate business operations and create obstacles for future shareholders or investors. Moreover, in many countries, these documents are considered public information, meaning anyone can access them. In contrast, many terms in a Shareholders' Agreement are intended to remain confidential among the founders.
Overall, having a Shareholders' Agreement simplifies processes, protects privacy, and provides the necessary flexibility to manage relationships between the founders effectively. For these reasons and more, a separate and independent Shareholders' Agreement is crucial.
A final note on this topic: It is important to emphasize that the Shareholders' Agreement does not replace the Articles of Association and Bylaws, as both play a crucial role in the company's formation and ongoing governance
Third: The Legal Structure for Startups
Choosing the right legal structure for a startup is a critical decision. Under corporate laws in Arab countries, several business structures are recognized, but two types are particularly suitable for startups: Limited Liability Company (LLC) and Private Joint Stock Company (PJSC).
It is essential to select the appropriate structure from the outset based on the founders’ vision and future aspirations for the company. For example, an LLC is often the best choice for startups aiming for long-term growth through self-financing (bootstrapping), those relying on grants and financial awards, or startups planning an exit strategy in the future.
On the other hand, a Private Joint Stock Company (PJSC) is more suitable for startups seeking crowdfunding from family and friends in exchange for granting them preferred shares, or for startups aiming to participate in investment rounds and attract new investors and partners. This is because PJSCs allow shares to be divided into common shares and preferred shares, where preferred shareholders do not have voting rights or management authority. This structure is often preferable for startup founders who want to retain control over decision-making while raising external capital.
It is important to note that certain business activities may require a different legal structure based on regulatory authorities or licensing bodies in each country. For instance, some activities may necessitate establishing a General Partnership (a type of partnership company).
Overall, the most suitable legal structure for a startup varies depending on the industry, financial and expansion plans of the founders, and the legal framework of the country. As a result, selecting the optimal legal entity depends on the specific circumstances of each case. Therefore, it is highly recommended to seek specialized legal advice from a lawyer with expertise in startups.
Conclusion
Starting a Startup requires more than just a great idea; it demands a strong legal and organizational framework to protect the interests of all parties involved. By establishing the right foundational agreements, founders can ensure a fair distribution of roles and rights, contributing to the long-term stability and growth of the company.
If you are in the process of launching a startup or currently working on developing your idea, consulting a startup-focused lawyer can be a crucial step to ensure that all agreements are properly structured and comprehensive.
Wishing you a successful and rewarding startup journey!
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Disclaimer: The information in this article does not constitute professional legal advice; it is merely a general overview and a starting point. If you would like to learn more, feel free to reach out to me.
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