How to avoid the legal pitfalls of early stage investment

By Stephens Scown - 13th July 2020

For start ups and early stage companies seeking seed funding, the challenge is not just finding the right investors, it is important to navigate several key legal issues too. Giles Dunning, partner in Stephens Scown LLP’s corporate team has helped many start up businesses avoid the legal pitfalls. Here are the areas he recommends entrepreneurs think about.

 

Wait until you have advance assurance of qualification from HMRC
An increasingly popular way to secure seed funding is through the Government-backed SEIS and EIS schemes. These schemes offer significant tax advantages to investors. However, an important point with these schemes is to seek advance assurance of qualification from HMRC before sourcing funding.

 

Don’t fall foul of the financial regulations
There are strict rules around seeking investment and breaching them is a criminal offence. The financial protection laws set out in the Financial Services & Markets Act 2000 mean that you are unable to advertise shares in your company to just anyone. You must only approach sophisticated investors or angel investors.

You must also ensure that your investor deck and the information you provide to potential investors is factual with appropriate disclaimers in place. Inflating the potential return on investment for example, is a breach of the regulations. It is important to take legal advice early on in the process to guide you through.

 

Ensure you own all of your assets
A common trap to fall into is finding out when a potential investor is undertaking due diligence that you do not own all of your assets – particularly your intellectual property.  All businesses will interact with and create IP, from customer lists, to brand, to the design of products or software.

An important step is to ensure that you have identified and registered any IP, including trade marks. This is a powerful protection for your business and your brand and in the future can also become an asset that creates revenue.   Many businesses do not engage with the IP system until it is too late.  As well as protecting your IP, you should ensure you are not infringing anyone else’s.

Consider also what, if any, interest the investor is looking to take in your IP.

It is also crucial to ensure that ownership rights are assigned to you if you use third parties to create any content, such as your website, etc. Many people are surprised to learn that the ownership of these rest with the party who created them, unless you have the paperwork to assign them to you.  When it comes to software assets, picking apart the IP{ and examining the use of any open-source code are really important steps.  Having early conversations around these issues will save problems later.

These may seem like unnecessary steps to take early on in your business, but I have known investors to walk away if they find out that assets are owned by third parties.

 

Protect yourself with a shareholders’ agreement
When you are securing funding it is important to have a well drafted shareholders’ agreement to protect you and your business. It is important to look beyond the funding goal and consider the future of your business. A good corporate lawyer will help to guide you through this process to ensure that you are not agreeing to terms which could cause you difficulties at a later stage.

Giles Dunning Stephen Scown

Giles is head of the corporate team in Exeter dealing predominantly with M&A work with a particular focus on buying and selling IFA firms. 

Giles has over 9 years’ experience in advising business owners throughout the lifecycle of their business including start up, funding, share incentives, acquisitions and exit.

Woman on a tablet illustration