(Originally published on VIR) Startups require special assistance when it comes to making it big in any field, even after a sharp influx of funds. Pham Duy Khuong, managing director of ASL LAW, writes about the legal framework for a startup and recommendations relating to basic legalities, which clarify how founders avoid risks after mobilising investment from funds.
In general, the presence of investment funds not only help startups with the finances to maintain operations and implement new projects, but also creates opportunity for them to learn from investment funds about the management method, enterprise culture, and other support.
The factors creating success for co-operation between the two parties are the harmony and the understanding of the general targets of each side.
However, in numerous cases, startups have been dying even after receiving investment from giants. A part of the reason is that after receiving investment, owners rush to expand store volume but forget to train staff and maintain service quality. One other main reason is the conflict between the shareholders and the investor, which come from the misunderstanding on legalities from the owners.
There are three basic types of investments: equity, loans, and convertible debt. Each investment method has advantages and disadvantages, and each is better suited for some situations than others. Therefore, startups need to analyse their own capabilities prior to choosing the right investment type. This includes their size and industry; ideal time; the amount they are looking to scale up and how they plan to use it; and their goals for their company, both short-term and long-term.
When receiving investment capital, it is also necessary to appraise capital sources and investment plans, especially for foreign investors. Numerous funds set the target to withdraw from the startup in the short-term, and polish the company’s image in the short-term in order to divest this holding in a startup to other investors. Thus, startups need to study partners carefully in order to avoid unnecessary risk. Besides that, startups should verify and record the legal origin of the received capital, ensuring that investors are entitled to invest and disburse according to their competence and regulations.
In fact, many founders calling for capital do not have a team of intensive advisors and do not have much experience in receiving major investment, which means the co-operation process between startups and investors face many unexpected obstacles.
In addition, owners do not provide plans to use or allocate capital because of lack of financial knowledge. No investor accepts this because they always want to control the allocation of capital appropriately in each stage of the startup.
In reality, many businesses do not understand the investment procedures and terms as well as legal risks but still agree with the proposals. This usually comes from the need to raise capital for breakthrough growth. Many funds take advantage of the loopholes of businesses to set up articles in the contract to achieve their special goals. This includes increasing ownership if the business plan fails to meet the commitment, or even changing the management team to control management. This can become a burden on business owners in each stage of development, which often puts businesses in a difficult position at the negotiating table. That in turn easily leads to conflicts and future disputes.
Owners need to register intellectual property protection rights for their unique and different ideas of their products and services after establishing a company. Furthermore, startups need to anticipate legal notes based on the characteristics of the business. For example, if a company has a creative and inventive product, it is important to note how to control intellectual property, patent rights, trademarks, and confidential information.
In general, before receiving investment capital, due diligence is not taken into consideration seriously. However, the step of due diligence is very important for both investors and companies to understand the actual situation of the business, the opportunities as well as the risks for the business. This step needs to be conducted comprehensively.
In addition, startups should determine the position in relation to investors to ensure their business plan is on schedule and avoid losing control resulting in acquisition. Specifically, startups need to know the ownership rate before and after receiving capital. Furthermore, startups also need to understand the issues related to self-determination and veto.
They should be concerned about the relationship between scale-up and quality management issues. The problem of scaling up always comes with quality management issues. For example, in the food and beverage field, the growth rate is usually calculated by the number of stores or chain development. The fact shows that the pressure to expand scale from investors often leads to the situation where management ability cannot keep pace with development. This is a typical feature when developing the chain, whether in the form of self-development or through franchising.
Last but not least, a mechanism for dispute resolution should be prepared. Disputes can come at any time during the investment process, so it is necessary to set up a dispute resolution mechanism, and jurisdiction selection. Currently, in addition to the mechanism of dispute resolution by court, the settlement solution by arbitration and conciliation is often chosen to save time between the parties and above all, to ensure the confidentiality of information.