Legal aspects of launching a startup: how to properly formalize partnership relations

Adilbek Kamiyev, Head of the Venture Division at EA Ventures, Instagram, LinkedIn

In the early stages of their journey, startup founders often work in perfect harmony and do not think about legally formalizing the nuances of their partnership. And they can be understood: a great idea has emerged, and it is necessary to start implementing it as soon as possible to be first! After all, while there is only an idea, there is nothing to divide. But as the business develops, conflicts and controversial issues will arise, and some team members may decide to leave. Even at the moment of receiving the first profit, problems may surface, especially if one partner expected, for example, 70%, while the other was sure that everyone would receive an equal share.

Furthermore, properly drafted legal documents positively influence investors' decision-making. In short, for a project to survive and develop, it needs a legal foundation.

The Kazakh startup ecosystem is currently in a development stage and has significant potential. According to the Association of Fintech and Innovative Technologies of Kazakhstan, in the first half of 2024, 357 new startups emerged — a 28% increase compared to the same period last year. 

Let's figure out what needs to be addressed from a legal perspective to avoid disagreements and have crisis management solutions ready.

What is important to agree on

Not all potential problems can be predicted in advance, but it is important to hold a meeting with partners to discuss the main working conditions and algorithms. It would not be superfluous to invite lawyers and other specialists who can point out what the team is overlooking and suggest optimal solutions.

There are several topics that partners need to discuss at the start:

1. Depending on the contribution and share of participation in the startup, the distribution of profits among partners should be agreed upon. The plan may include an amount that will be directed toward business development.
2. All conditions for the redistribution of shares, including transfer and sale, must be formulated. The procedure for cases where partners' relatives may come into ownership should be defined. It is also necessary to immediately determine the conditions under which a partner can exit the business and what consequences this decision will entail for the company.
3. It is important to agree on property — real estate, equipment, or financial assets. For example, whether it will be in joint shared ownership or in joint use while retaining ownership rights with the partner-owner.
4. Discuss how expenses and losses will be covered.
5. Founders must document the company's management structure and each partner's contribution to the project. This may include not only money but also skills or networking. In the future, this should be reflected in writing in the clearest possible terms. 
6. Roles must also be delineated: it is important to determine who will be responsible for financial planning, strategy, and the production process. 
7. Determine how voting for decision-making takes place, what the quorum conditions are, whether management is delegated to one person or shared by the entire leadership team. Additionally, a person responsible for negotiations with investors may be designated.
8. A conflict resolution scheme must be agreed upon. For example, the involvement of mediators can be discussed in advance, and it can be decided who will take on this role.
9. Formulate an exit strategy in advance — a business development plan aimed at withdrawing investments from the project at the moment of its maximum capitalization. In IT, trends change quickly, and if you have a clear plan for crisis situations, it can greatly help when making decisions. Moreover, having a plan for returning invested funds can significantly increase your chances of securing funding, and developing a business with an understanding of exit options enhances its manageability in the moment.

Finally, separate attention should be paid to protecting intellectual property. To avoid disagreements regarding who receives rights to the development, partners can agree to transfer all created products to the company's balance sheet, as well as for each of them to receive a free license for the startup's developments.

When discussing this topic, it is important to consider the concept of mutual exclusion. For example, a provision may be adopted stating that no team member can work for or collaborate with competitors.

Types of Agreements

There are different formats of documents with their own specifics that can be used to formalize agreements with partners. 

1. Founders' Agreement. Signed when creating a legal entity. It establishes the obligations of the founders, the distribution of shares, profits, and losses, the size of the authorized capital, and options for partners to exit the business.
   In most cases, this is the very beginning — immediately after entrepreneurs decide to create a startup and register a legal entity.
   
2. Shareholders' Agreement. This is a more extensive document, similar to a "prenuptial agreement" for business partners. The content of this document is determined by the project creators; its key task is to establish methods for resolving complex situations. This document is not synonymous with the charter: the latter is mandatory for the company and applies to all employees. The shareholders' agreement is concluded voluntarily and applies only to the people who signed it.
   It is advisable to sign it before attracting investments, when you are certain that you will be communicating with investors. Or immediately after attracting investments, when the first funds have already been received.
   
3. Partnership Agreement. In terms of content, this document is similar to a shareholders' agreement. The difference is that a partnership agreement can be concluded, for example, within the framework of a sole proprietorship or between individuals, rather than within a company.
   It is good if, at the time of launching the MVP, you and your partner already have an agreement signed.
   
4. Option Programs. These can become one of the components of agreements on share distribution. Under these programs, company employees are offered the opportunity to purchase shares from a specially allocated pool at a pre-fixed price.
   In most cases, option programs are launched when expanding the team and preparing for scaling.

What is important to consider

The main points of the agreement between partners:

— goals and objectives of the company
— distribution of shares in the company
— roles and responsibilities of partners
— management of property
— decision-making procedure
— funding sources and investment attraction procedure
— crisis measures in case of conflicts
— conditions for exiting the project
— protection of intellectual property.

To ensure that the text of the agreement does not become a time bomb, it is important to choose the clearest formulations that do not allow for ambiguous interpretation. It is also important to evenly distribute areas of responsibility. 

It is unacceptable to leave questions of profit distribution for later, until the project starts generating money: this is a guarantee of partner conflict and a major risk to the survival of the business. Furthermore, for investors, how founders agree on money and in what proportion becomes an important signal about the state of the company. 

At the same time, absolutely equal shares are not an optimal option; the specific contribution of each individual must be taken into account. Otherwise, there is potential for deadlock — when partners cannot agree, leading to the blocking of business processes.

Involvement of a Lawyer

For preparing and formalizing agreements between partners, it is best to involve a lawyer. Here is what his tasks consist of:

1. At the document preparation stage, the lawyer speaks with each partner.
2. During partner meetings to discuss the future document, the lawyer asks questions that participants may be reluctant to voice. He also provides legal advice and offers lawful options for resolving complex issues.
3. After discussing all issues, the lawyer records all partner agreements and drafts the document.

Often, startup founders invest their personal resources into development and place the startup idea above legal nuances. But even if you and your partner are currently on good terms — this does not mean it will always be so. And it certainly does not mean that your partner cannot leave the startup and, taking advantage of your developments, create a new one.

Practice shows that not only in Kazakhstan but also abroad, if several people invest in a business, all expectations, obligations, and agreements must be documented. And this must be done correctly, with the involvement of lawyers.

Conclusion

Legal formalization of business partners' relationships is the key to the project's survival. The more nuances and pitfalls the team considers and discusses, the higher the likelihood that partners will be able to take the business beyond the first profit. However, documents must be well-thought-out with the involvement of a lawyer so that they do not hinder development.

And the best time to discuss all potential nuances and conflict points is at the beginning of the journey, when the startup is just taking its first steps.