Part I - Cracking The Contract Code: Essential Startup Contracts Explained

In the fast-paced world of startups, innovative ideas drive entrepreneurial ventures, making startup contracts essential for protecting the interests of all parties involved. These contracts establish the foundation for business relationships by clearly defining the roles, responsibilities, and protections for founders, partners, investors, and stakeholders. Understanding these contracts is key for navigating the competitive startup environment, fostering partnerships built on trust and mutual benefit.

In this series, we will explore various types of startup contracts and highlight key clauses that require careful attention. We will cover agreements ranging from those between founders to employment contracts, investor term sheets to intellectual property licenses. Each type of contract has specific implications for the success and sustainability of a startup, making it essential for all stakeholders to understand these documents.

Defining Startups Under the Nigeria Start-Up Act, 2022

Startups in Nigeria are classified under the Nigeria Start Up Act as limited liability companies that have been operational for no more than 10 years. These companies focus on creating, innovating, producing, developing, or adopting distinctive digital technology products, services, or processes. 1 To be officially recognized as a startup, a company must meet specific criteria outlined by the Act and receive a label issued by the Coordinator of the Startup Support and Engagement Portal, appointed by the National Information Technology Development Agency (NITDA). 2 Notably, NITDA serves as the Secretariat for the National Council for Digital Innovation and Entrepreneurship. 3

To earn this startup label, the founders or co-founders must be Nigerian nationals and hold at least a one-third share of the company. Once these conditions are met, the startup is awarded a conclusive certificate of labelling, which is valid for up to ten years from the date of issuance. 4

Key Contracts Essential for Startups (Part I)

Startup contracts are foundational documents that define roles, responsibilities, and obligations within a startup. These contracts are vital for setting clear expectations, protecting legal rights, mitigating risks, and facilitating the smooth operation and growth of the startup. There are five primary types of agreements that are crucial for the seamless functioning and expansion of a startup:

1. Founders Agreements
2. Intellectual Property Agreements
3. Employment Agreements
4. Investment/Funding Agreements
5. Shareholders Agreements

While these five types of agreements form the backbone of legal frameworks for startups, it is common for startups to engage in additional agreements tailored to their specific business needs. However, the core agreements mentioned provide a foundation for protecting the interests of all parties involved and ensuring the stability and growth of the startup.

Founders Agreements

A founder's agreement or co-founder agreement is an essential document that defines the roles, responsibilities, rights, and obligations of each founder. Key clauses in founder agreements include:

1. Roles and Responsibilities: Defines the specific roles and responsibilities of each founder. It ensures that each founder knows their areas of oversight and responsibility, promoting a unified understanding and efficient collaboration within the team.
2. Equity Distribution: Details the initial shareholding percentage held by each founder, often reflecting their respective contributions, whether in terms of time, capital, intellectual property, or other resources.
3. Capital Contributions: Outlines the amount and schedule of financial contributions each founder is expected to make to the startup. It also covers future funding needs and the methods for securing additional capital to support the startup's growth.
4. Decision-Making Processes: Defines the process for making significant decisions, including those related to funding, product direction, and key personnel hires. It aims to ensure that major decisions are made collaboratively and with full agreement from all founders.
5. Exit Clauses: Exit clauses outline the processes and terms for a founder's potential departure from the startup, ensuring that transitions can occur smoothly without harming the business
6. Confidentiality and Non-Compete: These clauses prevent departing founders from using sensitive information to compete against the startup or sharing trade secrets with competitors.
7. Dispute Resolution: This establishes agreed-upon mechanisms for resolving disputes between founders, such as mediation or arbitration, ensuring that disagreements are handled constructively and efficiently.

Intellectual Property Agreements

Intellectual Property (IP) Agreements are vital for startups as they launch and scale their operations. These agreements ensure that the intangible assets, which are often the core drivers of a startup's value—such as ideas, innovations, branding, and confidential information—are properly managed and protected. Key clauses in intellectual property agreements include:

1. Confidentiality and Non-Disclosure Safeguards: This clause is essential for protecting the startup's sensitive and competitive business information. It restricts the unauthorized disclosure or use of this information by employees, contractors, investors, or any external parties and sets clear limitations on how proprietary knowledge can be used.
2. IP Ownership and Transfer Clause: It is crucial to define who owns the IP—whether it is the individual creators or the startup itself. This clause outlines the conditions under which IP rights are transferred to the startup, specifying whether the transfer is complete or partial. This clarity is essential for avoiding disputes over IP ownership and ensuring that all IP assets are legally accounted for within the startup.
3. Licensing Provision: This clause details the terms under which the startup's IP can be used by others. It includes the scope of the license, any fees or royalties that might apply, and the procedures for resolving disputes related to IP usage.
4. Infringement and Enforcement Provision: This establishes how the startup will monitor, detect, and enforce its IP rights. It includes mechanisms for addressing potential violations, reducing the risks of litigation by specifying the legal jurisdictions, indemnification terms, and alternative dispute resolution methods to be used in case of IP infringements.

Employment Agreements

Employment agreements are essential for clarifying the roles and responsibilities of each member within a startup, ensuring that both the interests of the employees and the employer are protected. These agreements cover a range of crucial aspects, from compensation to the handling of confidential information and the conditions of employment termination. Key clauses in employment agreements include:

1. Job Duties: This clause provides a clear description of the employee's roles and responsibilities. It defines their position within the organizational structure, including the performance standards expected of them.
2. Compensation and Benefits: This clause outlines salary or wages, bonuses, as well as additional benefits such as health insurance, retirement plans, leave entitlements, and potential share options.
3. Confidentiality and Non-Compete Provisions: These clauses protect the startup's sensitive information by preventing employees from disclosing company secrets both during and after their employment.
4. Termination Conditions: This clause specifies the conditions under which an employment relationship can be terminated, including required notice periods and the procedures to be followed. It also outlines post-termination obligations such as the settlement of dues, the return of company property, and the continued protection of confidential information.
5. Dispute Resolution: This clause outlines the steps to be taken to resolve disputes internally and specifies when legal action may be necessary.
6. Ownership of Creations: This clause clarifies the ownership status of any inventions, designs, or other creative work produced by an employee during their time at the startup.

The Importance of Comprehensive Startup Contracts

In this first part of our article series, we have discussed the critical roles that startup contracts play in forming the foundation of businesses. These contracts are key in safeguarding business interests, preventing conflicts and misunderstandings, mitigating risks related to unauthorized use or disclosure, and clarifying the rights and obligations of all stakeholders. The absence or inadequacy of key startup contracts can jeopardize a startup's legal, financial, and operational stability. Such gaps may hinder a startup's growth potential and increase its exposure to risks and uncertainties.

Ensuring Legal Soundness in Startup Contracts

It is essential for startups to have comprehensive and well-negotiated contracts to protect their interests and prevent future legal complications. In Part II of our article series, we will explore Investment/Funding Agreements and Shareholder Agreements and discuss optimal strategies for negotiating and crafting these essential documents.

For further information on startup legal frameworks in the Nigerian context, please contact: John Ojelabi, Oluwadolapo Owoyokun and Onyinye Igweonu.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.