The following chapter is an introduction to issues that should be analysed jointly and deeply by every business manager whose business activity is at an early stage of development (start-up) and who, when taking decisions, intends to deal with legal risk management in order to limit or eliminate risk.
The issues have been divided into three regulation categories, on the basis of their frequency of occurrence, as observed by the author during his work as a lawyer, that is:
regulations that will relate to a given start-up in any case, irrespective of its scope of activity;
regulations that apply to most start-ups that carry out their activity in the virtual environment;
regulations that apply only to a limited number of start-ups that carry out their activity in the virtual environment.
Regulations that will relate to a given start-up in any case, irrespective of its scope of activity
Firstly, it is necessary to distinguish the regulations that will apply to a given start-up in any case and irrespective of its scope of
activity. They shall include:
regulations governing the form and manner of running a business (e.g. a limited liability company, a joint-stock company, a limited partnership or a limited joint-stock company), including regulations relating to the distribution of profit in a company and to investing in the company’s development by third parties (e.g. business angels, seed funds, venture capital funds);
and tax regulations. In the Republic of Poland, examples of such regulations are, inter alia, The Commercial Companies Code, The Freedom of Economic Activity Act and a series of other tax laws (e.g. The Goods and Services Tax Act, The Corporate Income Tax Act).
Distribution of profit/ Equity splits
Founders A, B and C decided to launch a start-up X. At the very beginning of their activity, they should decide whether to establish a profit distribution plan already at this stage (e.g. founder A - 33%, founder B - 33%, founder C - 34%) or to postpone this decision to another moment (e.g. the moment of acquiring the first external investor).
As observed in the literature referring to business aspects of the issue being discussed (e.g. Noam Wasserman in “The Founder’s Dilemmas. Anticipating and Avoiding the Pitfalls That Can Sink a Start-up”), in the case of choosing the first possibility, there is a risk of underestimating some of the founders (e.g. due to their age, little experience, small share capital), but, on the other hand, the knowledge about the future share can function as an incentive.
By contrast, in the case of choosing the second option, it is possible to establish, at the very beginning of the activity, at least the way in which the above plan will be determined, including factors that will be taken into consideration and the moment when it should be done. However, in my opinion, what should be assessed is especially the legal admissibility of this solution, which depends on the chosen legal form of the activity (e.g. a limited liability company, a joint-stock company) and tax implications of this choice.
The above decisions are all the more important because they also determine which founder and to what extent will havethe casting vote in the key decision-making process concerning the company’s development (the number of shareholders usually translates into the number of voting rights); they can also influence the way in which the founders will exercise their tasks (for example, a profit distribution plan established by the founders at the very beginning, that takes into account especially the results of actions of each of the founders during a certain period of functioning of the company, can be motivating, but it should be kept in mind that its beneficiary will not be the founder who seems the most experienced at the beginning, but the one with the best results obtained within the designated time).
Moreover, the founders can consider the admissibility of adopting the so-called dynamic split plan, according to which the distribution changes depending on the period (e.g. month, quarter, year) in which the profit was produced. The above issues, irrespective of which option is chosen by the founders, should be settled timely and in accordance with the rules of applicable law, which will allow the founders to avoid any expensive legal disputes in the future.
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Choice of legal form
Irrespective of where the founders have decided to launch their start-up X, they should consider all benefits and limitations resulting from the choice of a given legal form for their business. For example, if the founders choose a limited liability company (within the meaning of the Polish legislation) as their organizational form, it is necessary to remember that the company’s income can be paid to the shareholders only in the form of a dividend, which is subject to so-called “double taxation”. In fact, at first the whole income of the company is subject to the corporate income tax (CIT) and then the income of a given shareholder is subject to the personal income tax (PIT).
What is important, however, is that the shareholders being natural persons have the right to serve on the company’s board of directors and be remunerated for this. In addition, when choosing this legal form of business activity, it should be kept in mind that the shareholders, in principle, are not personally liable for the company’s obligations (i.e. the company has unlimited liability).
Start-up X has found its first external investor. However, before starting to negotiate an investment agreement, the owners of the company should examine a whole series of solutions aimed at protecting their interest and the interest of investors, as well as the advantages and disadvantages of each of these solutions, and only then should they make key decisions regarding the company’s development. Furthermore, the following questions are worth answering:
the planned goals?
What is the purpose of the planned cooperation
with the investor and what is the planned
allocation of the funds obtained from the
the investor’s role going to be?
Will the investor engage in the activity of the
company and does he have the professional
knowledge necessary to run a start-up together
(if he is going to)? Is he going to have an
influence on the management of the start-up?
If yes, to what extent?
Type of the planned contribution
Will the investor’s contribution be a capital
injection or will it be a contribution in-kind
(e.g. premises, machineries) or another type
of non-monetary contribution (know-how,
provision of work or services)?
the planned investment
Is the cooperation with the investor going to have
a permanent nature or do the parties envisage
that the investor will withdraw from the joint
undertaking after a predetermined period of
What are the goals of the parties regarding
obtaining and sharing the profits from the joint
undertaking? Is the profit going to be used for
further development of the activity or does the
investor have a determined annual rate of return
that he wants to obtain? How often is the profit
going to be distributed?
As part of the investment process itself, the investor will execute a legal/tax audit of the company, a financial audit, and perhaps a technological audit (whose subjects are, for example, the applied IT solutions and the ICT structure). On the other hand, the owners of the start-up should ensure that the investor does not acquire the company exclusively in order to service the internal or/and external debt of one of its subsidiaries (so-called “debt push-down”).
Moreover, the parties can negotiate such documents as:
Term Sheet (a document describing the main assumptions of the planned transaction),
Investment Agreement (a document outlining the rights and responsibilities of the parties and the schedule of investments),
The Articles of Association,
The Shareholders’ Agreement (a document constituting the agreement between the company’s shareholders),
The Share Sale Agreement.
Therefore, it should be underlined that the owners of the start-up should examine the many solutions applied in the above-mentioned agreements, including the following notions and methods of quitting the company after an investment of a third party:
the right of one of the parties, granted in certain
circumstances, to require the other party to sell
some or all of its shares at a previously agreed
the right of one of the parties, granted in certain
circumstances, to require the other party to
purchase some or all of its shares at a previously
the right, usually conferred on the investor,
to drag along other stockholders in a sale
transaction; that is, the right to require the other
party to sell its shares to the indicated third party
for the same price as the dragging party;
if one of the parties sells its shares to a third party,
the other party has the right to join the deal;
a priority right to purchase and to participate
in any possible increase of the share capital;
preference of stock in case of the liquidation
of the company (preference in obtaining a part of
the residual value).
Summing up: it is always necessary to consider the limitations and possibilities resulting from the legal form that has been chosen for a given business activity (including regulations related to, for example, distribution of profits and investing in the company’s development by third parties), as well as tax regulations.
Regulations that apply to most start-ups that carry out their activity in the virtual environment
Secondly, it is necessary to indicate regulations that apply in most cases to start-ups that carry out their activity in the virtual environment, namely:
The regulation governing the ownership and transfer of determined intellectual assets and other intangible goods
I.e. economic copyrights e.g. to software, exclusive rights to trademarks, inventions, industrial designs and utility models, know-how and business secrets, related/neighbouring rights, integrated circuits layout designs - in the Republic of Poland, examples of such regulations are the Copyright and Neighbouring Rights Act, the Industrial Property Law, the Suppression of Unfair Competition Act and the Database Protection Act
The necessity of creating an intellectual property management system
Start-up X creates intangible goods, subjects of intellectual property, that is, among other things: software, utility schemes, electronics schemes, inventions, designs of products, integrated circuits layout designs, audiovisual works (e.g. publicity videos), graphics and any other designations used in order to identify an entrepreneur or products and services produced/distributed by them. A summary categorization of subjects of individual intellectual property rights (“IPR”), according to the applicable legislation of Poland, is presented below:
Subjects of copyright
Subjects of related rights
Subjects of industrial property right
Know-how and business secrets
Creative work (including software and development of works).
Videogram; phonogram; artistic performance; broadcasting rights; first edition rights; rights to scientific and critical editions.
Data of a technical, technological, organizational, economic, financial, commercial, marketing nature and any other economically valuable data.
Significantly, in this case, start-up X should ensure that the employees or other contractors/counterparties, who created the above-specified goods at its request or on its behalf, transfer their above-specified rights to start-up X, in writing and to the extent applicable. It is equally important to ensure that the relevant entities (e.g. special purpose entities or counterparties) have - if it is necessary for the performance of business activity - precisely defined rights to use the given goods (i.e. exclusive and non exclusive licensing agreements, for a limited or unlimited period of time, precisely indicating the way in which the entity can make use of a given good).
Start-up X should also introduce an internal policy related to, inter alia, informing about the intention of employees/counterparties to use the subjects of intellectual property rights of third parties, and about the way of their use within the framework of the final results being developed by start-up X.
The main purpose is to avoid the “infection” of products of start-up X (e.g. software) by the rights of third parties. The start-up should also implement defined operating procedures towards those of third parties that violate the start-up’s intellectual property rights; such procedures would include actions like the monitoring of the use of the property rights, as well as the enforcement of an appropriate remuneration by legal means.
Moreover, in the case of development of inventions, individualizing marks or schemes, it is also advisable to consult the proper office (OHIM, EPO, Polish Patent Office, United States Patent and Trademark Office or any other office that is competent on the basis of the area of operation of start-up X) in order to register - in an appropriate manner and if it is legally possible:
utility models (i.e. new and useful solutions of a technical nature, related to the shape, construction or arrangement of a durable object) and industrial designs (i.e. a new and individual form of a creation or its part, obtained mostly through characteristics of lines, boundaries, shapes, colouring, structure of the material, and through its ornamentation),
geographical designations (within the meaning of the Polish legislation, geographical designations are word marks referring directly or indirectly to the name of a place, town, region or country (area) that identify the product as originating from that area, when a certain quality, good opinion or other characteristics are assigned to the product mostly due to its geographical origin),
integrated circuit layout designs (i.e. a solution consisting in a spatial and expressed in any manner layout of elements - of which at least one is an active element - and of all or some connections of the integrated circuit).
The main elements of IPR management system in a company are indicated below:
Business secrets and Confidentiality agreements
Start-up X also generates determined technical, technological, organizational or economic data; such data is important to the start-up’s business and covered by know-how. In case the data has not been publicly disclosed yet and, at the same time, it is economically valuable and the entrepreneur has taken necessary actions in order to keep it secret, then this data is also a part of the legally protected business secret.
As a consequence, any disclosure of such information to a third party (e.g. a counterparty, a contractor, a subcontractor, an investor) should be made only after signing a written confidentiality agreement that expressively indicates, inter alia:
how the receiving entity should handle the received data (e.g. disclose it to its employees and counterparties exclusively on a “need to know” basis, secure it in an appropriate manner, destroy data carriers in case of the termination of the agreement);
how the receiving entity can use the confidential data (e.g. exclusively for the purposes defined
in the agreement, that is, within the framework of collaboration with start-up X);
in what circumstances the receiving party is entitled to disclose the information (e.g. in case of information that can be treated as confidential information, but became publicly available otherwise than by means of violation of any confidentiality obligation or provisions of law, or information that the receiving party is forced to transfer or disclose by virtue of a legal obligation resulting from the legislation in force, a final judgement of a court or a final administrative decision, provided that each time, before taking these actions, the receiving party notifies the disclosing party in writing, providing the scope of the confidential data to be transferred or disclosed, the reason and the form of their transfer or disclosure and the precise legal basis, unless such notification is forbidden by the legislation in force).
Question of forgotten founders
At the early stage of the start-up-creation process, one of its founders (the one who developed the majority of assumptions of the future product) decided to withdraw from the project. His part of the rights to the above-mentioned assumptions should have been transferred to the company, but the founders had not settled these issues at the beginning.
As a consequence, after start-up X has received significant financial support and initiated the commercial sale of the product, the former founder made a financial claim against the company, stating that the company has unlawfully benefited from his economic copyrights to the above-mentioned product assumptions. The company, in order to acquire full rights to the product and ensure the possibility of receiving further financial support, was forced to negotiate with the former founder and to reimburse him with a sum of money that was many times higher than the remuneration that he would have taken on the day he withdrew from the project.
This problem may concern, for example, software, inventions, parts of inventions or trademarks, as well as utility models and industrial designs.
The law on personal data protection that can be applied
For example, in the case of entrepreneurs who gather and process the data of their clients (e.g. users of a service they offer) - in the Republic of Poland, an example of such regulation is the Personal Data Protection Act, implementing the Directive 95/46/EC.
Registration of the personal data filing system or appointment of an Information Security Administrator
Within the framework of its activity, start-up X uses the personal data of the clients (the term personal data covers any information related to an identified or identifiable natural person, e.g. the IP number, the email address). If the company is established in Poland, the entrepreneur must either register the personal data filing system at the office of the Inspector General for the Protection of Personal Data(GIODO) or appoint an Information Security Administrator(ABI) within his organization. The decision of which solution to choose should be made after an analysis of all the possibilities and limitations resulting from both of them.
For example, in the case of the appointment of an ABI, the GIODO can ask the ABI, appointed by the company and registered in the public ABI register, to verify the compliance of data processing by the company with the personal data protection provisions. At the same time, the GIODO indicates the scope and date of such verification (the so-called “simplified control”, “internal control”). After the control, the ABI submits a report to the GIODO via the company.
The following table shows the advantages and disadvantages of both solutions:
Appointment and registration of the ABI by the company
No appointment or registration of the ABI by the company
No obligation of the company to register the personal data filing system (unless the company processes “sensitive data”).
No obligation provided that the ABI has been registered in the GIODO register (point 6 of the Table below).
Obligation of the company to register the personal data filing system (if no statutory exemptions are applied).
The GIODO can ask the ABI appointed by the company and registered in the public ABI register to verily the compliance of data processing by the company with the personal data protection provisions.
At the same time, the GIODO indicates the scope and date of such verification (the so-called “simplified control”, “internal control”).
The GIODO has no possibility to ask any employee of the company to verify the compliance of data processing by the company with the personal data protection provisions.
The control is carried out by the employees of the GIODO’s office (“external control”).
After the above-specified control, the ABI submits a report to the GIODO via the company.
No employee of the company has a possibility to prepare a report for the GIODO.
The responsibilities laid down in the law fall on the ABI.
The ABI shall be bound by the Regulation as regards the means of fulfilling the above-mentioned responsibilities.
Lower risk of criminal liability of the board members of the company on account of the infringement of the Personal Data Protection Act.
The responsibilities laid down in the law fall on the company.
The company is free to choose the means of fulfilling these
The member of the board of the company, who was responsible
for the supervision of the fulfilment of responsibilities, shall be held criminally liable for their non- fulfilment.
Company’s responsibility for providing the ABI with conditions compliant with the Personal Data Protection Act.
The company has no responsibility referred to on the left.
Obligation to register the ABI in the register kept by the GIODO (within 30 days from the appointment).
No obligation referred
to on the left.
In case of dismissal of the ABI by the
company, the company shall be obliged
to provide the GIODO with the reason for
No obligation referred
to on the left.
At the same time, it is important to remember that there are some exceptions where the above choice does not apply (provided that these exceptions are the only ones that concern the given company), since there is no obligation to register the personal data filing system (selected cases resulting from the Polish Personal Data Protection Act are indicated below):
Selected exemptions from the obligation to register the personal data filing system.
Data processed in relation to the employment in the service of
the controller, the provision of services on the basis of civil-law
contracts and concerning persons who are members of
the controller‘s association or students.
Data processed exclusively in order to issue invoices and bills,
or for the purpose of financial statements.
Publicly available data.
Data processed in relation to current minor affairs of everyday life.
Data processed in filing systems that are not kept with the use of
computer systems, with the exception of filing systems containing
Composed by Adrian Branny
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