John Morrison, a partner in Shepherd & Wedderburn's Corporate team emphasises the importance of new entrepreneurs preparing a founders' agreement to avoid issues later 

HeraldScotland:

Imagine you, and three friends, have discovered a unicorn of an idea. An idea so big that it will disrupt, and change, the market.

You don’t have time to waste on papering your arrangement so, together, you form your company online, split up the shares between you and get to grips with starting out in your new venture. 

The idea starts to come together and you are making great progress towards your first investment round when… one of your co-founders departs and heads off to set up a business with a very similar offering to the one you have developed, in more or less the same market and, for the kicker, your first (and key) team member is going to resign and join them. 

A little time taken at the outset to put in place a founders’ agreement could have future proofed the company, and the founders, against the risks that this situation presents. 
The old phrase ‘it’s all good until its not’ couldn’t be more apt. In this article we will cover the main questions we are asked when discussing founders’ agreements with entrepreneurs.

So, what is a founders’ agreement?

A founders’ agreement is typically entered into by founders when a company is formed, and generally lasts until the company receives its first real equity funding, when it will be replaced by a more fulsome investment (or shareholders’) agreement.

A typical founders’ agreement will not only deal with the day-to-day operation and management of the company (including allocation of roles and responsibilities), but also helps protect the value of the business for eventualities such as those above. 
How does the company get the benefit of the idea we formed before the company existed? 

A well draft founders’ agreement will ensure that founders transfer to the company any rights (including intellectual property rights) they may have in respect of the idea or the business itself. 

The last thing the company, the founders or an investor down the line will want to uncover is that critical rights have been left outside of the company and sitting with a founder. Such a situation has the potential to derail the entire business… an unwelcome outcome for years of hard work as a founder.

HeraldScotland:

How will the company be managed? 

Typically, founders will be both shareholders and directors of the new company. A founders’ agreement usually sets out who will be appointed as directors and how matters arising at board meetings will be decided. It is crucial to strike the right balance on decision making. It is important to protect the interests of the founders, but it is equally important to ensure the company remains ‘fleet of foot’ in order to take advantage of market opportunities.

So, what will happen to the shares of a founder who leaves the company?

It is not generally in the interests of the remaining founders for a departing founder to continue to hold shares – the remaining founders won’t want to share the value growth that their hard work could generate with the departing founder. Nor is it generally in the interest of the company for a potentially offside departing founder to have a say in decision making through retaining shares.

A founders’ agreement will usually contain leaver provisions allowing for the shares held by the departing founder to be acquired for a specified price, which will generally depend on whether the departing founder is deemed to be a good or bad leaver. Leaver provisions give all parties a clean break if a founder wishes to leave and, depending on the terms of the agreement, the shares could be recycled to a new employee joining the company and therefore act as an incentive for new staff.

Should founders be ‘locked-in’ to the company?
Founders do often agree to be ‘locked-in’ to the company for a period of time before they can transfer their shares. The rationale behind this is that the founders will be incentivised, by continuing to hold shares in the company, to work together to ensure that the business is a success. This is usually viewed positively by potential investors too. 

There will however be a degree of flexibility in relation to any lock-in arrangements – for example, a founder can usually transfer some shares to another family member (this is known as a permitted transfer) or the other founders could consent to a transfer of shares during this time.

What if a founder wants to dispose of shares without leaving the company?

If a founder is not leaving the business but wants to sell shares in the company then usually the remaining founders will want to have the first opportunity to buy those shares before they are offered to a third party. This is usually referred to as a ‘pre-emption right’ or a ‘right of first refusal’. 

Often, the remaining founders can only buy the shares in proportion to their existing shareholdings to prevent one founder acquiring a significantly larger proportion of shares in the company following the share transfers.

Will a departing founder be prevented from competing with the company? 

A founders’ agreement will usually, in the UK, contain restrictive covenants which, as the name suggests, restricts the ability of a founder who has left the company from starting a business in competition with the company, or from targeting the same customers or market, for an agreed period of time. 

Typically, the restrictive covenants will also prevent a founder from offering employment to existing employees of the company (again, for an agreed period of time). It is important that the restrictive covenants go no further than is necessary to protect the legitimate interests of the company. Stray too far from that and they could be held to be unenforceable; framed correctly, they protect the value of the business.

How can I put a founders’ agreement in place?
Speak to us. While it is true that a suitable founders’ agreement will be invaluable if things do not go to plan, it is not the case that a founders’ agreement is simply an insurance against worst-case scenarios. Instead, a founders’ agreement will help you to grow your business, knowing that there is an agreement underpinning the routine day to day operation of the business.

It is inevitable that situations evolve over time. 
Perhaps a founder may need to transfer their shares, or a significant decision will need to be made in relation to the business. In these instances, a founders’ agreement will ensure that there is an agreed method of handling those matters, and how to proceed if they cannot be resolved. It also gives parties peace of mind that the business has the right foundations to allow for investment.

Visit shepwed.com/start-to-scale for more information, or contact John Morrison, Partner in Shepherd and Wedderburn’s corporate team, at john.morrison@shepwedd.com

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Scale up and swim in a bigger pond

Q & A with Ross McLennan, Enterprise Executive, Edinburgh Innovations, The University of Edinburgh

HeraldScotland:

What is the top tip you would you give to founders?
Validation is key! The difference between a nice project and a strong business is customers. So engage early with potential customers, listen to the problems they have and develop a deep understanding of the issues that are important to them.

How important is it to have the right foundations in place for scaling?
The wise man built his house upon a rock. Scaling a company is difficult, but you are making things much more difficult for yourself if you don’t have clear evidence that you are solving problems for your customers and a strong team in place to develop and deliver your solution. 

With these strong foundations in place, I have seen many companies make much faster progress.

What more could the business community do to help our scale-ups?
This is a difficult question! They do say it takes a village to raise a child and there are many parallels when building scale-ups. 

We carried out some research which showed that our most likely entrepreneurs know more than five other entrepreneurs, so I feel that the more we can see and learn from others’ scale-up journeys, the better the chance of other founders understanding what is required and believing they can do it.

HeraldScotland:

What support do Edinburgh Innovations offer to start-ups?
As the University’s commercialisation service, we have a pipeline of support that can take people through their entrepreneurial journey from idea to impact – from basics, to builder, to support, financial and otherwise, as the company grows. 

For instance, our Data Driven Entrepreneurship programme provides funding, education, incubation space, venture building and acceleration support. We run competitions such as the Summer Accelerator and Power Her Up for female founders. 

The University’s in-house investment team has its own venture capital fund, Old College Capital, to provide seed funding, and manages the University’s portfolio as it grows, leveraging investment and sometimes reinvesting at a later stage.

Entrepreneurship can be lonely, so we have an online community students can access at all times. Now that we’re back in person, we have a physical enterprise hub too, and lots of networking events.

How can advisors play their part in supporting our entrepreneurs?
The entrepreneurs we support at the University of Edinburgh are bright, enthusiastic and capable fast learners. But the majority of them have never started a company before. Advisors have a key role to play helping founders navigate as smoothly as possible through the many pitfalls they may face.

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Trust in the titans of technology

Q&A with Ed Prior, Vice President, GP Bullhound, a leading technology and advisory firm

HeraldScotland:

How attractive is the UK tech sector to international investors?

In recent years, we have seen an increased amount of international funding being invested in the UK Tech sector. 

GP Bullhound’s Titans of Tech report released in 2022 highlighted that UK tech companies raised over $25bn in 2021 and the first two quarters of 2022 – which is the highest of any European country – and the amount of funding coming from foreign investors is increasing each year.  

Many of the top US growth funds now have dedicated offices and teams based in the UK and are actively looking to deploy capital, which highlights the quality of the companies which are being created and built in the UK. 

How is GP Bullhound finding the market for tech deals currently?

Coming off the back of record high activity in 2021, the market has slowed slightly in the past 6 months as the turbulence in the public markets has filtered through to the private markets. 

Therefore we expect the total number of deals completed in 2022 to be lower than 2021, but as VC & PE firms have all-time high levels of dry powder in need of deployment the deals market certainly won’t grind to a halt. 

It has been well documented that valuations have contracted recently, however for high quality assets valuation levels are stable – and in some cases they are increasing due to increased competition amongst investors to secure best in class companies. 

What more could we do to support our tech scale-ups?

In the past few years there has been a vast improvement in support available to scale-ups, ranging from governmental support (such as the tech visa scheme) to mentorship programmes, however these resources are not always clearly signposted to all founders – therefore we need to find a way to signpost the support available to those who need it. 

How important are market square events (such as the GP Bullhound Titans of Tech) events to the tech ecosystem?

Vital, entrepreneurship can be a lonely journey and therefore networking with other entrepreneurs at events can be extremely helpful. 

There are many challenges faced by entrepreneurs which are the same regardless of sector – such as dealing with difficult shareholders, raising investment, or entering new markets. Therefore, events provide the opportunity to learn from others who have already faced these challenges. 

The Titans of Tech brings together the entire ecosystem, it offers the chance for entrepreneurs to meet investors (and vice versa) and also for entrepreneurs from earlier stage companies to gain inspiration from those who have already scaled businesses successfully.

What bit of advice would you give to first-time entrepreneurs?

Identify your weaknesses and surround yourself with a core 
group of people who are experienced in those areas who you trust to give you honest feedback and guidance – not just yes men and woman who will tell you what you want to hear. 

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Secure your bright ideas at home and abroad

Joanna Boag-Thomson, a partner in Shepherd & Wedderburn's Media & Technology Team has some key advice for protecting your vital intellectual property in all circumstances

HeraldScotland:

How can I protect my intellectual property?

All businesses own intellectual property rights and, for many, this will be the  most valuable asset class. Understanding the different types of intellectual property rights, and how to protect them, is essential for founders of a business to develop, protect and exploit these valuable assets.

Fail to prepare and you might not own anything.

Do you know precisely what intellectual property you currently own and are likely to create in the course of your business?

Both individuals and companies can own intellectual property rights so you should take care to identify what rights the various individuals within your organisation may own and to ensure that ownership of these rights are legally transferred to the correct owner.

For example, rights need to be formally transferred from an entrepreneur or business founder to the new company being incorporated. Investors carrying out due diligence exercises often refer to this set of transfers as the ‘chain of title’. 

Who owns what?

Founders will likely own intellectual property rights they created before incorporating their company, however, these can often be jointly owned if more than one person was involved in their creation. If you have used contractors or other third parties in creating intellectual property rights then you will not own these rights unless you have an agreement that transfers those rights to you.

This is a common pitfall for new (and many experienced) businesses. For example, did your website designer actually transfer the intellectual property rights in the website design to you? Unfortunately, payment alone is not enough to transfer ownership. 

Get your paperwork in order
It is never too early to organise your paperwork, but it can often be too late! When you ask another party to create intellectual property rights for use in your business, you should have a clear agreement that transfers ownership of those rights to your company.

In some cases, the owner of those rights might only be willing to grant a licence to use those rights. This can be OK in some circumstances, however, not all licences are created equal and you should clearly understand if your business will need to use those rights in future before agreeing to a licence.

Types of intellectual property rights
Trade marks Often referred to as a ‘brand’, a trade mark is a name or a sign that distinguishes your goods or services from those of other providers. Registered trade marks can be used to prevent others from using your mark or benefiting from the goodwill attached to it.

There are rules that need to be followed and there may also be pre-existing rights holders who could challenge your application, so research your proposed name or sign carefully from the start. All businesses own intellectual property rights and, for many, this will be the most valuable asset class.

Patents Inventors can patent their inventions to stop others from using them without permission. The invention must be novel and protection usually lasts for a limited time (20 years) and must be periodically renewed.

There are strict rules about what can be registered as a patent but examples include mechanical devices, chemical compounds and methods or processes. If you have a new invention, it’s important to remember that before you reveal any details (for example, when seeking investment or a licence to sell to a manufacturer) you should always get written agreement from the other party that information will be kept confidential.

If you are an academic and you are considering a spin-out, remember to apply for your patent before you publish any details. 

Copyright Copyright exists in many media forms and, importantly, also protects software to stop others from copying your work. Copyright arises automatically in the UK without the need for any registration (although some countries, such as the USA, also allow formal registration). There is an overlap between copyright and other intellectual property rights, for example there will be copyright in a logo that may also be registered as a trade mark. You can indicate that copyright exists in your work by using the symbol ©, your company name and the year. 

Designs You can gain registered protection for the look of a product you’ve designed, including the appearance, physical shape, configuration (or how different parts of a design are arranged together) and decoration. A registered design is much cheaper than a patent, however it is not a substitute for a patent as it only protects against others copying the appearance of your product, not the way it works. To be eligible, your design must be new, and must not be a protected emblem (such as a flag).

Registered design protection initially lasts for 5 years but needs to be renewed after each subsequent 5 year period and can last for up to 25 years.

Know-how and confidential information Practical skills, knowledge and expertise are just as valuable as any other form of intellectual property rights. Trade secrets (like recipes or a manufacturing process) give your business a competitive advantage. There is no specific register for this type of sensitive information.

In the UK, these rights are protected under the common law of confidence as well as trade secrets legislation, and you need to actively manage your rights through keeping the information secret and only disclosing it to parties that have signed confidentiality agreements. 

Domain names While not strictly a category of intellectual property, securing the right to use a domain name can be critical to the success of your business. You should ensure you become the registrant of your chosen domain name, renew your domain name regularly through your domain name registrar and carefully align your online strategy with your trade mark protection. 

Uses of intellectual property The main use of your rights will be to protect your business by denying competitors the ability to copy your products or processes, however intellectual property can also generate income through being sold or, more usually, licensed in return for royalties. If you own a patent to a product, you could manufacture and sell those products, or you could create revenue from other manufacturers by licensing your patent. Alternatively, you could sell that patent and associated technology to an established manufacturing company, if you can show the product has commercial potential. 

Expand your horizons
Protection of intellectual property rights can vary from country to country and securing a registration in one country does not give you the ability to enjoy protection of that intellectual property elsewhere. Think carefully about where you want to operate your business and design your intellectual property protection strategy around your expansion.

Seek professional advice The need to protect and enforce your intellectual property rights never ends. Early preparation and ongoing management can make building your intellectual property portfolio more manageable and help to avoid early pitfalls or budgeting pinch points. 

Shepherd and Wedderburn’s Media & Technology Team combines industry knowledge and extensive experience with technical expertise, and is on hand to assist businesses at all stages of their growth journey.

The team’s Start to Scale initiative, comprising written guides, video content and in-person events, addresses some of the specific challenges affecting start-ups and scale-ups throughout their lifecycle to give entrepreneurs the insight they need to scale. 

Visit shepwedd.com/start-to-scale for more information, or contact Joanna Boag-Thomson, Partner in 
Shepherd and Wedderburn’s Media & 
Technology, at joanna.bt@shepwedd.com.