Enthralled by the idea and the desire to bring their startup to life, founders often overlook legal matters. Focused on product development, they may miss important aspects of legal regulation that can have consequences in the future. Non-compliance with these requirements can lead to disputes and conflicts with partners, investors, or clients. How should startups choose a legal structure? How should ownership shares be allocated? And what documents are needed to attract funding? Petro Bilyk, Chief Innovation Officer at Juscutum law firm, shared insights on these and many other topics at the recent IT Ukraine Legal Conference 2023. Mind took note of the most interesting points from his presentation.
To attract investment, it is necessary to create an appropriate legal structure. Many startups choose the Delaware structure, but it is not always suitable. It may also entail certain obligations, especially in the European market. However, if you create an LLC (Limited Liability Company), particularly in the United States, no investor will provide funding because LLCs are generally not suitable for investment in that country.
When it comes to investments in Ukraine, despite the existence of the Diya.City regime, Ukraine is currently not an attractive jurisdiction for startups. Issues related to law enforcement agencies and courts have not been resolved. Investors do not see sufficient protection. However, it can be a good option for establishing an R&D centre within the startup structure.
When building the structure, it is worth considering the following:
In Ukraine, investors often prefer to immediately acquire a stake in the company, whereas abroad, the majority of deals at early stages are done through convertible loans. Therefore, it is important to determine which mechanism is better suited for your startup. If we are talking about raising investment through the sale of equity or shares, two mechanisms can be applied:
Another process of fundraising occurs at the pre-seed and seed stages. Here, instruments such as convertible loans or safes are typically used.
Although these instruments are similar, they have their differences. Convertible loans involve a specified date by which the loan must be repaid or converted into shares, whereas safes involve conversion during the occurrence of a certain event.
Approximately 70% of funding in the market is raised through convertible loans, regardless of jurisdiction. Large and promising startups often utilise safes. In other words, convertible loans are typically more advantageous for investors, while safes are beneficial for founders as they do not require a specific date for investment repayment or conversion into a certain share.
However, safe is a rather specific instrument that may not be available in all jurisdictions and may not be suitable for all purposes.
At the pre-seed and seed stages, the main goal of a startup is to quickly obtain funds without the need for extensive legal work or complex legal processes. Such agreements allow for rapid funding and agreement on key terms without the need to alter ownership stakes or enter into corporate contracts.
It is important to note that the due diligence of a startup largely depends on the investors. For example, some startups that received funding from major funds in Silicon Valley did not undergo detailed due diligence at early stages. A presentation was sufficient for them. They made their initial investment based on a safe agreement.
However, in Europe, certain forms of due diligence are more commonly practised to ensure that the startup's presentation meets the investor's requirements. In such cases, it is necessary to consider:
These questions may arise during due diligence in one way or another. It is better to have everything prepared in advance.