A startup is not any newly established business. According to the startup guru Steve Blank, a startup is a “temporary organization designed to search for a repeatable and scalable business model.”
- more on the difference between startups and newly established businesses here.
A startup by definition is not geared to breakeven or become profitable initially: the first aim is to develop a product and take market share. Hence, startups are constantly raising capital. On the other hand, professional investors looking at startups have a statistical approach to investment on top of other criteria. Accelerators such as Zeroth.ai, focusing on early-stage AI startups in Asia and Brinc Global IoT Accelerator, supporting early-stage startups from concept to sustainable commercialisation, will select cohorts of startups to join their program and provide them with funding.
- more on accelerator and incubator programs in Hong Kong here.
Other investors focus on more mature businesses, for instance companies having developed a product which has reached market or which have reached a minimum turnover.
Through our partnership with Zegal, we started receiving weekly enquiries from Hong Kong based startups at the beginning of 2019. The flow has continued with other referral sources and we have developed services and pricing specifically addressing the needs of the buoyant community of Hong Kong startups.
Our offer for capital raising addresses the specific needs of startups. Our team has extensive experience providing timely and comprehensive legal input at key stages of business upscale.
Equity investments present the highest level of risk: investors may lose 100% of the amount invested. By investing in companies with limited liability, instead of partnerships, the risk for shareholders is limited to the amount invested.
Due diligence is not an insurance against this risk. But adequately targeted due diligence should enable you to identify financial, operational or legal issues before investing. We help our clients redress the most pressing matters and anticipate discussions with investors regarding conditions precedent, in order to avoid losing investment opportunities.
In practice, the level of scrutiny for due diligence is often inversely proportional to the closeness between founders and prospective investors. Friends or family may satisfy themselves with the founders’ words while private equity funds will involve their teams or trusted advisors to review the company’s books (essentially from a financial, tax and operations point of view).
Startups in Hong Kong benefit from a very liberal tax and legal environment, which does not mean they don’t need any processes to ensure general compliance (check General tax and compliance). Lack of housekeeping rules to ensure compliance may (rightly) hinder investment decisions and/or potential growth.
Our team provides practical resources and solutions to founders facing challenges regarding the regulatory, data management and intellectual property compliance of their business (check Corporate governance for information on our legal due diligence services).
SEEDS AND SERIES A-C LEGAL DOCUMENTATION
We have developed a streamlined set of legal documentation for investing in startups to maximise efficiency. Our team members have a deep understanding of the need of founders and entrepreneurs for quick and clear guidance within the context of negotiations with potential investors.
A good term sheet (TS), like a good letter of intent (LOI) for mergers and acquisitions or a good memorandum of understanding for a joint venture (JV), is a road map. A poorly drafted term sheet may lead to the delay or the loss of fresh funding.
Key terms include the nature and amount of the investment, conditions precedent, due diligence to be conducted, main provisions of the shareholders’ agreement, confidentiality and timeline. We help our clients navigate issues at stake and advise them on the potential impact of binding vs non binding terms for the future of the transaction.
Investment agreements used to be a necessary step for equity investment. It is a step between the Term Sheet and the investment, after the due diligence has been conducted. Early stage startups tend to dispense with this step if investors do not specifically request it, especially in case of “light” due diligence.
CONVERTIBLE NOTES AND SAFE
Convertible notes and Simple Agreements for Future Equity (SAFE) are common instruments for early-stage startups. Convertible notes are interest-bearing debt instruments that convert into equity in the future, upon the occurrence of a qualified financing, a liquidity event or at the maturity date.
SAFE are different as they do not comprise interest nor maturity date. The idea behind SAFE is to raise money first with friends and family or business angels and to issue shares later when a valuation is agreed with a professional investor for a Serie A round of capital raising. The legal documentation for SAFE was first released by the California-based seed accelerator Y Combinator in 2013. We partner with Zegal which has developed a tailor-made SAFE for Hong Kong startups.
We regularly assist founders contemplating to raise capital in their seeds financing rounds. Our team provides legal advice regarding the consequences of the options negotiated (purchase amount, discount and valuation cap) and their impact on the capitalisation table.
Once the decision to invest is made and the investment received, founders should not underestimate the paperwork needed to finalise the round. Signing the agreements is not the end: some back-office work is required from the company secretary to issue the shares and/or the person in charge of bookkeeping to ensure the investment is properly reflected in the balance sheet. Our team has considerable experience assisting companies throughout the post-completion formalities and the commencement of a new chapter for growth.
We offer fixed fee packages for reviewing documents drafted via Zegal platform and for the drafting of term sheets, investment agreements and convertible notes instruments. The same is possible for an in-depth review of SAFE and capitalisation table.