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Corporate structuring for raising investments

Monday, February 1, 2021

Startup Jedi

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Sooner or later, any startup has to think about raising investment to grow and develop. One of the most important questions when preparing for the round is the correct corporate structuring of the startup. Vitaly Tvardovskiy, attorney at SBH Law Offices, shares how to get started preparing structuring, what documents should be drawn up, what to look for when choosing a jurisdiction and registering a company, as well as how and when to start the restructuring process.

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Getting started

Corporate structuring for raising investment

This is where a startup usually is in the very start. There are several founders who join their efforts working on a product. In order to start preparing for structuring, you need to register a legal entity:

  1. that will unite the founders and allow to formalize e initial agreements;

  2. where IP and financial flows will be focused.

Such a legal entity will represent the “core value” for raising investment.

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Basic documents

As part of corporate structuring, it is necessary to draw up several documents that are important for a startup. They define the main agreements of the founders and ensure the further work of the startup:

  1. Shareholder agreement (SHA).

  2. IP assignment agreement (for example, exclusive rights assignment agreements).

When registering a company abroad, it is often necessary to prepare and conclude contracts with local service providers that will ensure the operation of the company in the country of registration at the first stage (you need to provide legal address, audit and accounting services, services of nominee directors and secretaries).

SHA

Shareholder agreement allows founders to define basic agreements at the early stages, namely the size of the shares and the conditions for making decisions on certain issues. It can also include the option pool for employees, changes in the shares of founders depending on participation in the further work of the startup, vesting, conditions for raising investments, selling the company, etc.

IP

Based on the results of the startup’s work before registration patents, domain names, trademarks, etc. can be transferred. Appropriate contracts for software development must be concluded with the developers, taking into account all the requirements of applicable law.

Startup founders may see no changes once the process is complete. In certain cases they are not even required to relocate to the place where the company is officially registered. Meanwhile, the startup will be all ready to raise the first investments.

Corporate structuring for raising investment

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Choosing jurisdiction

There are several general criteria when choosing a jurisdiction:

  • The possibility of carrying out activities (the need to obtain a license for the implementation of the project), legal restrictions;

  • Taxation;

  • Investment attractiveness;

  • Rase of opening a company and account;

  • Associated costs (including the maintenance of the office, directors, the cost of registrar services, etc.).

Based on these criteria, the countries for registration can be roughly divided into:

  • Countries that are convenient and understandable for investors (USA, Cyprus);

  • Countries that can be used to work with clients in the region (Estonia for the EU, Hong Kong / Singapore for Asia, Russia / Belarus for the CIS);

  • Countries with a special tax regime for startups (USA (Delaware), Cyprus, Malta, Estonia, Latvia, Russia (Skolkovo), Belarus (HTP).

The decision to register a legal entity can also be made on the basis of a specific investor / startup accelerator, with whom there is a preliminary agreement on cooperation.

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What’s next

After registering a legal entity and as part of startup development, it may be necessary to register a company in another jurisdiction (for example, to make it easier to conclude contracts with clients, accept payments, reduce operating costs, etc.). At the same time, with the simultaneous operation of a large number of companies, albeit one united into a group through founders, it is rather difficult to determine a target company for raising investments and therefore to structure a deal.

Corporate structuring for raising investment

At this stage, it is advisable to restructure the group of companies and create a special holding company for further growth and raising investment.

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Restructuring using a holding company

In this case, the most common restructuring option is the transfer of ownership of all the companies of the group to one company, which will be the center of the company’s value and distribution of cash flows.

Corporate structuring for raising investment

A holding company can conduct operational activities if it is effective based on the legislation and applicable tax rates. For example, when organizing a holding company in Belarus (HTP), such a company can also carry out development. However, taking into account the need to control the working capital of companies, as well as the need to diversify risks, this is not the most common option.

As a rule, the holding company owns all the key assets of a startup directly, without distributing them to other companies — this allows companies to structure financial flows effectively.

When choosing the jurisdiction for a holding company, besides the criteria discussed above, it is necessary to consider whether you plan to sell the company in the near future, and whether a dividend incentive model for founders / investors will be used. For example, if dividends are not paid, and all profits are used in turnover to increase the value of the company (it is assumed that the founders and investors will receive more benefits from the sale in this case), it is advisable to use jurisdictions with low income tax excluding dividend tax (for example, in Estonia, as a general rule, only distributable profits are taxable). If you don’t plan to sell the company and part of the profit can be distributed among shareholders, you need to choose a jurisdiction with low or no tax on dividends (for example, Hong Kong or Singapore).

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Corporate structuring for raising investment

Taking into account the interests of previous investors / shareholders

Any investment transaction needs to define the legal status of past investors and shareholders, including employees. When restructuring before the transaction, it is important to consider the interests of all shareholders of the company, as well as to comply with the agreements reached in previous rounds.

As a rule, restructuring issues are carried out with the consent of investors and are subject to the incorporation of all agreements into the documents of the new company. The decision on the new structure, as well as the approval of new documents defining the relations of shareholders and the conditions for the return on investment, is made jointly with the investors.

In practice, there are cases when an employee or a minority shareholder retains a stake in an operating company (for example, they work in this company and are interested in making a profit from such a company, while not receiving a stake in the holding company). However, this approach entails difficulties with the sale of the group of companies, and may also lead to additional questions about the ownership structure in new investment rounds.

Correct corporate structuring will allow you to show the investor the value of the target company without significant problems, as well as ensure compliance with agreements. Also, corporate structuring can help with the distribution of startup financial flows and cost optimization and, as a result, increase the value of the company.

1 Feb 2021

 

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