Chapter 9: Legal Aspects
Authors: Xinyue SU
Estimated reading time: 7 min
Legal aspects when creating a startup
Startups are becoming increasingly essential in the European business landscape and the subject is constantly developing from a financial, commercial and also legislative point of view.
Legal advice is a key factor in creating the conditions for the launch of a company.
Protection of patents and registered trademarks, data collection, privacy compliance and intellectual property management are just some of the aspects that make legal advice fundamental when creating a startup.
Why startups need legal support
The regulatory body is constantly evolving; It is complicated for entrepreneurs to keep up with this changing legal ecosystem, therefore startup legal advice plays an essential role in the development process of a startup concept. The lawyer must be seen as a partner who knows how to guide the development path of entrepreneurial action in the most correct way, with a watchful eye on current legislation.
When entrepreneurs decide to transform an innovative idea into a business, they have to face a series of bureaucratic steps. That’s why they need to rely on a legal team able to define the best solution for their needs. Timely advice on legal matters can avoid financial, economic and fiscal issues for the company.
Legal support doesn’t limit itself to administrative tasks, it is the lawyers’ duty also to advise the entrepreneur on the right legal entity to use in the formation of the startup.
The first choice faced by entrepreneurs is between for-profit companies (the majority) and non-profit ones, which do not distribute earnings to the shareholders. Nowadays, many innovative ideas are born with the aim of having a social impact, of improving the world, of bringing social innovation, and this can lead us to believe that such companies are non-profit, but this is a misconception: in fact, most of these enterprises pursue Social Development Goals (SDGs) and also generate financial profits.
We will analyse these two types of organizations better in the following paragraphs.
Non-profit organizations are private entities which in their statute or deed of incorporation declare to carry out charitable, cultural or research activities with the aim of social solidarity; such organizations, as mentioned, do not distribute profits and if they have operating surpluses they are obliged to reinvest them in other activities.
Every country has its own regulations concerning non-profit organizations and, usually, these entities are designated differently, according to their objectives: they can be social advocacy groups, charitable organizations, social welfare organizations, fund associations, cooperative organizations et cetera.
Non-profit organizations have a series of advantages and disadvantages related to their formation:
Separate entity: the company is recognized as a person and it is responsible for its contractual and other obligations
Existence: a non-profit organization has a statutory right to exist in perpetuity;
Limited liability: directors and other members are not legally responsible for their company’s debt and liabilities;
Tax exemption: non-profit organizations can apply for tax-exempt status.
Access to financing: some forms of non-profit organizations have the right to access public and private grants to finance the working capital.
Regardless of their social benefit, non-profit organizations must still follow precise guidelines to operate. They need to comply with the provisions of the statute under which they were formed and they still need to pay a filing fee to be registered in the state directory. They also need to follow precise guidelines concerning management definition and oversight.
A for-profit organization usually operates in the private sector and is oriented towards the realization of earnings, that are later on distributed as dividends. For-profit companies can still be characterized by a vision of creating long term positive externalities. All the corporations that are established as for-profit ones, are considered active for corporate tax purposes.
For-profit organizations can be subdivided into two groups accounting for different liability policies: Non-limited liability companies and limited liability companies.
Non-limited liability companies
In this type of company, the personal element prevails over the patrimonial one, as the shareholders are personally responsible for the obligations assumed by the company, indefinitely, jointly and subsidiary.
The legal entity is therefore represented by the individual shareholders, holders of rights and obligations deriving from the business activity. We will not dwell on them as they are types that are practically never used by those whose aim is to found a startup.
Limited liability companies
In limited liability companies, the patrimonial element prevails over the personal one, in the sense that it is the company with its assets that responds to the obligations of the company itself and not the individual shareholders with their personal assets.
According to our legal system, these are organizations of people and means for the joint exercise of productive activity, endowed with full financial autonomy.
The shareholder has limited liability to the capital conferred: if the business goes wrong his/her losses may correspond to all that he had invested, but, even in the event of bankruptcy, it will not be possible to draw on his/her personal assets to heal anything.
It is very important in limited liability companies to correctly prepare the following documents:
Deed of Incorporation – which contains issued shares, the payment on the securities issued, details on the founders, directors and other managerial profiles, the articles of association, and the first financial period of the company.
The company statute – which contains the corporate name, the company’s purpose, the address of its office, the amount of capital invested, persons and/or institutions that will constitute the company.
A shareholders’ agreement is defined as the contract between several subjects (usually two or more shareholders, but also between shareholders and third parties), aimed at regulating the future behaviour that must be observed during the life of the company or, in any case, on the occasion of the exercise of certain rights deriving from the equity investments held.
The deed of incorporation must be made by the notary who provides it for filing in the Business Register: only after registration with the competent Business Register the limited liability company can be said to have actually come into existence.
Legal Steps for Startups
In this section, we are going to summarize the main aspects a new company has to consider, starting from its launch phase.
When running a certain type of business in a determined location, you may need specific business licenses and permits from your country, state or city.
Among them, we can mention the local business licenses, the permits to build, the health and safety-related permits, the fire permits, the industry-related permits et cetera.
Another crucial aspect to be considered when running a business is taxation: in fact, potential taxes are also part of any legal checklist for startups.
Taxation depends on the legal entity you choose, the type of business you are running and where you are located.
During the year, you need to register and file for a wide range of taxes, which includes the annual corporate income tax, your personal income tax and the VAT/sales taxes.
If you run an international business, you might also need to take care of tax obligations in your foreign customers’ locations, like filing foreign corporate income tax or VAT/sales tax related returns.
When you have employees, you may need to obtain an identification number and fulfil all types of wage withholding tax obligations.
When hiring an employee, you should know not only the related implications and laws, but also your tax obligations. You should therefore know:
- How to create standard employee contracts
- How to meet the minimum wage, hour requirements and industry-related regulations
- How to eventually take care of the implications of firing an employee.
Depending on what type of business you have, protecting your IP assumes crucial importance for the future development of the company.
To protect your intellectual property you need to register the name, the brand and the logo. Every invention and innovation you make should be also registered, through patents and copyrights.
It is important to know that simply registering and/or claiming ownership of your IP is not enough. Generally, the IP’s owners have to monitor and proactively enforce their rights.
Last but not least, you should also be aware of the current anti-discrimination laws and apply them to your company.
Common startups’ mistakes
Legal concepts are either able to make or break a company and they are usually overseen or not considered, due to the sometimes high consulting costs.
Usually, companies make mistakes in the following areas:
Structuring their business: A lot of companies end up operating as proprietorships or partnerships and this exposes the owners to multiple risks as well as heavier taxation treatments on some occasions.
Company name: It is common that the first name people think for their company is already taken by someone else. Ergo, it is cardinal to check the availability, trademarks and domain availability at first
Compliance with security issues: Whenever a company issues securities to angels or investors, it needs to comply with disclosure, filing and form criteria. It can happen that the company loses precious resources since lack of compliance results usually in a financial penalty for the entrepreneurs.
Taxation: Usually, startups in their early stage don’t have the resources to invest in accountants or tax advisors which can turn into a big problem. Taxation requires skills and capabilities to not only incur in unanticipated tax amounts, but also to be able to foresee the tax quota and plan companies activity efficiently.
Permits & Licenses: According to the nature of the startup, it may need licenses or qualifications such as Industry-specific permits, state qualification to do business, sales tax license or similar. Startups could end up with the wrong documentation when they decide to save costs by hiring inexperienced legal counsel, friends or relatives.
How will GründerAtelier help?
GründerAtelier is a creative space where high-potential startups find knowledge, funding and guidance for a successful launch and expansion. We strive to partner with ambitious entrepreneurs and bright minds to create a prosperous environment where the most innovative ideas can thrive.
The professional team of GründerAtelier has offered many successful sessions to guide young startups through their capital raising, operational development, marketing, sales, talent acquisition and scaling endeavours.
We’ve launched an accelerator program that will guide you through all the steps you need to take in order to scale.
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