Best Practices For Establishing Effective Corporate Governance Structures In Tech Startups

Majority of startup founders rarely give shareholder concerns, board composition, or corporate governance any thought. As a result, corporate governance is frequently neglected and put off until later. Startups frequently prioritize staffing, fundraising, and determining the product-market fit.

The weakness in these startups' corporate governance frameworks is exposed when they require investment from venture capital firms and angel investors. But when businesses establish a strong platform for success through sound corporate governance, they almost always attract even more interest from wealthy investors.

DEFINITION OF CORPORATE GOVERNANCE

Corporate Governance is simply put, the system of rules, practices and processes by which a firm is directed and controlled. It is the framework that allows a company to thrive by balancing and addressing the vested interests of various stakeholders including shareholders, employees, and customers

The primary goal of corporate governance is to ensure that an organization operates in a fair, transparent, and responsible manner, with a focus on maximizing value for shareholders while taking into account the interests of other stakeholders and adhering to legal and ethical standards. Corporate governance practices are firmly anchored in core principles, notably accountability, transparency, and equity.

PRACTICES FOR ESTABLISHING CORPORATE GOVERNANCE STRUCTURES IN TECH START-UP

The lifecycle of a startup consists of different stages from evolution to eventual scale-up. Each stage requires different priorities and characteristics, which means that the governance structure and consideration required in each stage differ. There are four stages in the life cycle of a startup.

1. IDEATION STAGE

The corporate governance focus should be on the following throughout a startup's conception phase, when alliances are made, concepts are conceived, market study is completed, and the product map is developed:

a. Registration and setting of business structure: A lawyer can help you choose the best legal structure for your business, such as sole proprietorship, partnership, LLC, or corporation. A lawyer can also help you register your business with the city, county, state, or federal authorities and obtain any licenses or permits that you may need. It could be either be

b. Sole Proprietorship: For tiny startups, this is the most straightforward and typical structure: one person owns and runs the company. All business debts and legal duties are the owner's personal responsibility.

c. Partnership: In a partnership, two or more individuals share ownership and responsibilities. Partnerhips can be general (where all partners have equal rights and responsibilities) or limited (with a mix of general and limited partners).

d. Limited Liability Company: An LLC provides limited liability protection for its owners (members) while allowing flexibility in management and taxation. It's a popular choice for startups seeking a balance between liability protection and simplicity.¹

e. defining founders' expectations, roles, responsibilities, and contributions (monetary or intellectual);

f. determining equity interests and vesting schedule for founders' shares;

g. establishing the rules for joining and exiting the company;

h. clarifying ownership of intellectual property: This should focus on establishing that all products created by the partners belong to the company. Also, the duty of confidentiality among partners should be established, to avoid misuse of trade secrets.

i. management and Board composition.

j. Drafting of the contracts and agreements: It is essential to have carefully drafted agreements that protect your interests and clearly define the rights and responsibilities of all parties involved. One of the major agreements in this stage is the Co-founders agreement.²

The Co-founder Agreements outlines the roles, responsibilities, and ownership stakes of each founder, ensuring clarity and avoiding potential disputes in the future. It is a legally binding document, which aims to safeguard the interests of each founder while forestalling any possible conflict that may arise.

2. THE EARLY STAGE: The early stage is referred to as the 'validation stage'. At this phase, the idea is left to evolve until it becomes a Minimum Viable Product (MVP). Governance at this stage should focus on:

a. Company set-up and organizing rules regarding the rights and duties of the partners

b. Financing and Funding: A lawyer can help you raise capital from angel investors or venture capitalists by preparing term sheets, offering documents, stock purchase agreements, convertible notes, etc. A lawyer can also advise you on compliance with securities laws and regulations.³

• New Partners and Investors: As stated earlier, at this stage the company can receive its first round of investments. It is pertinent that founders map out how these new partners and investors would come into the company. Usually, investors require an equity stake in the company, and where proper care, attention, and structure are not put in place, founders risk losing most of their interest just to accommodate a new round of investors. It is advised that the negotiation be conducted carefully

As the founders need to take into account that this situation will repeat itself in each round of investment. If, for every fundraising, founders extend new rights to investors in the current round and those from previous rounds, they will end up giving up some of their own rights or equity interests on a continuous and cumulative basis.⁴

• Means of resolving disputes: At this stage, it is important that the startup decides on the dispute resolution mechanism to employ in the event of a conflict. Where the startup decides to opt for arbitration or mediation, this must be expressly provided for in the articles of association and/or the partnership agreement

• Intellectual Property Protection: At this stage, ensuring confidentiality and protection of trade secrets is of utmost importance. The startup is to focus on registration of intellectual property, and to ensure ownership of brand names, domains, software, patents, and trademarks to protect the company's value. To safeguard IP, the following steps should be considered:
• Conduct thorough research: Before launching your startup, conduct comprehensive research to ensure that your intellectual property does not infringe on existing trademarks, patents, or copyrights.
• File for trademark and patent: If your startup has unique products or services, consider filing for trademarks and patents to secure legal protection.
• Implement strong confidentiality measures: Protecting your trade secrets is equally important. Implement strict confidentiality measures, including non-disclosure agreements (NDAs) with employees, contractors, and partners

• Investment Agreement: When seeking external funding, it is important that there is a clear and well-drafted investment agreements in place. These agreements define the terms of the investment, including equity stakes, rights, and obligations of both parties.

• Compliance with securities laws: Nigerian Startups seeking investment must comply with Securities and Exchange Commission (SEC) guidelines.

• Due diligence: Conduct thorough due diligence on potential investors before accepting their funding. Verify their credibility, reputation, and previous investments to minimize the risk of fraud or legal complications.⁵

3. GROWTH/TRACTION STAGE: This is the stage where the product being tested at the previous stage has been validated. Thus, the focus of the startup is on getting new customers, getting new employees, and revenue generation. Profitability at this stage is paramount as this stage has the highest failure rate. Governance at this stage should focus on:

• Establishing a Board Structure: At this growth stage, establishing a board structure for strategic support and deliberation is of the utmost importance. This could be an advisory board or a board of directors.

• Defining hierarchical levels for decision-making: In this regard, a company structure/organogram should be drafted to highlight roles, responsibilities, and hierarchy in the company. This clear attribution of competencies will avoid an instance of overlapping issues, confusion, and conflicts

• Evolving business and control practices: Here the startup should focus on scaling company culture and mapping out the resources available, goals to be met, and responsibilities of each partner and employee. This is to have a structured system where all employees are aware of the company's goals and what needs to be done to meet or exceed them.

• Employment contracts: As you hire employees to support your scaling startup, it is necessary to have employment contracts that outline the terms of employment, including compensation, benefits, and intellectual property rights. This also extends to Health and Safety Regulations for employees to prevent workplace accidents and potential liabilities

• Tax and Regulatory Compliance: Complying with tax laws and regulations is not only a legal requirement but also contributes to the overall financial health of the company. Consider the following:

• Register with the appropriate tax authorities: Ensure that your startup is registered with the Federal Inland Revenue Service (FIRS) and obtains a Tax Identification Number (TIN).
• Understand tax obligations: Familiarize yourself with the various taxes applicable to your startup, such as corporate income tax, value-added tax (VAT), and withholding tax.
• Regulatory compliance: Nigerian startups are subject to various regulatory requirements depending on their industry⁶

EXPANSION STAGE

This is the growth/scale-up stage which marks the distinct phase of a company's growth.¹¹ At this stage, the company is already well established and ready to move at a faster pace, hire more staff, put out more products in the market, and expand to other locations.

ROLE OF LAWYER IN THE EXPANSION STAGE

1. Implementing Policies – policies that regulate transactions with related parties, practices of donations, communication, prevention, and detection of acts of an illegal nature should also be implemented.

• Ethics and Codes – this is setting down principles that promote the integrity of the company. Ethical decisions are those in which the decision made involves, at all stages, not only the identity of the organization, but also the analysis of the impacts of each decision on all stakeholders, society in general, and the environment. Codes of Conduct represent the formalization of expectations regarding the behavior and conduct of partners, administrators, employees, suppliers, and other stakeholders.

• Succession Plan – as most companies at the expansion stage are concerned about longevity, a succession plan then becomes necessary.

• Improvement of shareholder and investor relations – at this stage, formalizing and optimizing the relationship and communications with shareholders and investors is of priority. Such communication is to reflect accountability, transparency, and inclusivity. Improvement of internal control and management – this can be achieved when the board creates committees to address the growing complexities of the company. These committees will take on a check and balancing structure and examples of such committees include the audit committee, risk management committee, strategy committee, governance committee, and the like. These committees are created tailor-specific to the needs of the company.⁷

CONCLUSION

For every organization, including startups, to be sustainable, corporate governance is essential. A startup may use it as a tool to safeguard the interests of its stakeholders. Early-stage startups do not have to follow the same corporate governance requirements as publicly traded companies; instead, their corporate governance framework should develop over the course of their existence.

As a startup develops and grows, the fundamental and straightforward corporate governance policies and procedures that are implemented in its early stages can be transformed into a more complex and sophisticated corporate governance framework.

Footnotes

1. Esegi Maureen, "Navigating Legal Considerations for Startup Success", (https://www.mondaq.com/nigeria/corporate-governance/1397414/navigating-legal-considerations-for-startup-success), accessed on May 13, 2024

2. Marcus Okoko, "Adopting Corporate Governance Practices by Startups", (https://www.mondaq.com/nigeria/shareholders/1172746/adopting-corporate-governance-practices-by-startups), accessed on May 13, 2024

3. Supra, No(1), accessed on May 13, 2024

4. Supra No(2), accessed on May 13, 2024

5. Supra No(3) accessed on May 13, 2024

6. Norebase, "Tax Compliance for Startups, All you need to Know", (https://blog.norebase.com/tax-compliance-for-startups-all-you-need-to-know/), accessed on May 13, 2024

7. Supra, No (2), accessed May 13, 2024

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.