Common Legal Mistakes of Startups (part I)
As a lawyer and founder of Donkin & Partners Law Firm, focused primarily on startups companies and entrepreneurs, I have had the opportunity to observe the progress of many startups.
Thus, I have managed to identify recurring legal mistakes that many startups make, and with this article I would like to point them out and give you advice on how to avoid them.
Mistake № 1. Not knowing the different types of legal entities for conducting a business
One of the first decisions, that founders have to make, is to choose the type of legal entity that best suits their business. They often start without consulting a lawyer, or at least exploring the different types of organizational forms and opportunities that each type of legal entity provides. However,this decision is crucial for the future business’ success, it is often underestimated by the founders.
The Bulgarian Commerce Act defines the different types of merchants, so I will briefly introduce you to each of them:
Natural person merchant (NPM) Any legally capable person carrying on by occupation commercial transactions, whose domicile is in the country and is registered in the Commercial register of Bulgaria, is to be considered a natural person merchant. However, a natural person merchant is not a new legal entity, as one company is, for example. All rights and obligations with regards to the commercial activity are united by the personality of the person, recognised as a merchant and in this sense the NPM is simultaneously а holder of commercial and civil rights and obligations. With the same property he will be liable for the obligations acquired as a result of pursuing his business activity and for any other property relations, in which he enters in his private life – in this regard also Decision№ 855-2003-II c.c.
The situation would be different if the merchant establishes a single owned company – EOOD or EAD. In this case, the merchant legally splits, i.e. he separates the business activity from the private life. The separation of the business activity as an independent legal entity leads to risk mitigation, which is inconceivable with the NPM figure.
Another disadvantage of NPM is that it does not provide an opportunity for partnership.
The legislative classification of the merchants- trade companies is numerus clausus, which means that the types of companies are exhaustively listed by the legislator – there are five in total:
- general partnership;
- limited partnership;
- limited liability company;
- joint stock company;
- limited stock partnership.
General partnership (SD – “Sabiratelno druzhestvo”) When establishing a General partnership, the founders, who must be at least two legally capable persons– natural or legal, conclude а constituent contract, which should be drawn up in writing with notarized signatures of the founders. The founders are then obliged to register the company in order for it to incorporate – this is done by registering it in the Commercial registerof Bulgaria
The partners shall be jointly liable and their liability shall be unlimited for the obligations of the company. This means that each partner is responsible for the debts of the business with his personal property and thus risks his personal assets for the obligations to the creditors of the business.
Limited partnership (KD – “Komanditno druzhestvo”) The incorporation of a Limited partnership, as for the general partnership, requires a constituent contract to be drawn up with notarized signatures of the founders and a registration in the Commercial register of Bulgaria, as the founders should again be at least two legally capable persons – natural or legal. The difference here is that one or more of the partners shall be liable jointly and their liability shall be unlimited, and the remaining partners’ liability shall not exceed the amount of the agreed contribution. So, the limited partnership has two types of partners – with unlimited liability and with limited liability.
Limited liability company (OOD – “Druzhestvo s ogranichena otgovornost”) It is the most common and preferred form of partnership, creation of the German legal doctrine.
This form of partnership overcomes the inconveniences and disadvantages of the General partnership (SD) and the Limited partnership (KD) – the partners in the Limited liability company are not obliged to make personal efforts and work for the company, and their responsibility is limited up to the extent of their share contributions to the company’s capital. This means that, unlike the General partnership and the Limited partnership, in case of a Limited liability company (OOD) – the company is responsible for its activity and the responsibility of the partners is limited to the amount of theirs hare, which has already been paid into the capital of the company.This makes the company’s finances separate from the partners’ personal finances.
A limited liability company may be formed by one or more persons who shall be liable for the company’s obligations to the extent of their share contributions to the company’s capital. Unlike the General partnership and the Limited partnership, the Limited liability company forms a capital whose minimum amount is BGN 2.
In view of the mentioned advantages of the Limited liability company (OOD) and in accordance with the experience of developed countries, this legal form is the most commonly used and most suitable for starting a business.
Joint stock company (AD – “Akcionerno druzhestvo”) The Joint stock company was born from the need to accumulate large financial resources for the achievement of significant business goals. AD is the company of the large capital.
The Joint stock company may be formed by one or more natural or legal persons. The founders adopt a statute in a written form. The company must form capital, the minimal amount of which should, according to the Bulgarian legislation, be BGN 50 000.
The Joint stock organs shall be: the general meeting of the stockholders; the board of directors (one-tier system), or the supervisory board and the managing board (two-tier system).
Limited stock partnership (KDA – “Komanditno druzhestvo s akcii”) The Limited stock partnership is an intermediate form of KD and AD. KDA has two types of partners- with unlimited liability and with limited liability. The Limited stock partnership is incorporated with a contract between the unlimited liability partners, as there is no requirement for minimum number of partners with unlimited liability- there can be only one. After the implementation of the procedure laid down by the law and the adoption of the necessary acts, the partners with unlimited liability shall attract shareholders- the partners with limited liability, whose number shall not be below 3.
*Establishment of all companies under the Bulgarian legislation arises after their registration in the Commercial register of Bulgaria.
Mistake № 2. Ambiguity in relationships with co-founders
Whatever legal form you choose for your business, you should sign a contract with your partners. It is with this contract that you should settle your relationships with them, while taking into account your personal interests, common interests and vision for the growth of the company, the political and economic situation, etc. These essential steps are often ignored by entrepreneurs, as they conclude blank contracts, without taking into account all the above factors.
A good example in this direction is the partnership between Steve Jobs and Steve Wozniak. Despite Apple‘s success, Wozniak felt that Apple hinders his personal development as an engineer, and, moreover, he did not share the vision of his partner for the future of the company. This is the reason why he leaves Apple, saying that the company “has gone in the wrong direction”.
To avoid such a course in the relationships with partners, you should consider the following key moments when engaging in a written agreement with them.
- Who gets what?
- What are the roles and responsibilities of the founders?
- What is the overall purpose and vision for the business?
- How are key business decisions made (*in scenarios where law gives you freedom to negotiate) – simple majority, absolute majority, qualified majority, unanimity?
- and other important questions, which should be complied with the chosen legal form and the freedom to negotiate, provided by the legislator.
Mistake № 3. Lack of draft contracts (model contract)
In their business activities most of the companies often conclude multiple contracts with identical or similar content. It would be inefficient and time-consuming every individual contract to be a result of a lengthy negotiation process.Even more inefficient and risky would be to conclude contracts with content you don’t understand or don’t regulate your relationships in an advantageous and fair way. Thisis the reason why every company, especially startups, shall have general terms, which should be included in the contracts they conclude. These are the so-called model contracts or draft contracts. They are pre-drafted text, which is proposed as a basis for negotiation in the negotiation process. These contracts save time, simplify the negotiation process, standardize the rights and obligations of the counterparties, provide for full settlement of the relationship between the parties and the fullest possible protection in the event of disputes (if competently written, of course).
If you are unable to consult a lawyer to draft the right contract for your business and protect your interests to the fullest, here are some tips/steps on how to get a standard contract:
- Get to know more sample contracts, signed in your industry – you can get a general idea of the necessary content of your contract, as well as get ideas for various clauses, which may be included;
- Describe as clearly and fully as possible its subject, goods/services, remuneration, rights and obligations of the parties; term of the contract and/or termination condition;
- You may include “Privacy” and “Force Majeure” clauses;
- Include protection clauses in case of a non-fulfilment;
- Include dispute resolution clause;
- If you are concluding a contract with a company from another country, arrange the applicable law and which court will have jurisdiction to resolve any disputes;
* The above points do not claim to be exhaustive, so we advise you to consult a lawyer when drafting contracts and negotiating their content.
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