Hong Kong – Startup Law 101: 6 Key Things To Know

13 June, 2017

 

There are a number of reasons why founders sometimes put off addressing legal issues. Founders often have limited resources to deal with all that it takes to start a company so it’s easy to understand how legal issues fall to the bottom of the list.

 

However, for your startup to succeed, you need to be able to monetize your ideas and hard work while also complying with the law. In reality, most founders are first time entrepreneurs who often do not appreciate all of the potential legal pitfalls (and potential liability) in connection with launching a startup business.  Similarly, founders may be aware of some but not all ways they can proactively use the law to protect their venture.

 

In the early stages of launching a startup, most founders struggle to grasp which legal issues need to be dealt with and in what order. No two startups are alike, but as you prepare to launch you should at least be aware of the following legal issues:

 

1. Starting Up: Business Formation & Founder Arrangements

 

There are many reasons why forming a business entity for your startup, rather than operating informally, should be a priority. For starters, doing so will protect the founders from liability, allow the startup to own property and open bank accounts, have different classes of shareholders (holding common and preferred shares) and carry on business both in and outside of Hong Kong.

 

Consider this: all issues related to ownership of the business, as well as intellectual property, will be settled in accordance with the law unless the founders have already taken affirmative steps to address them. For example, where two or more people are involved with developing a business concept, it is possible that they will be considered partners if there is no agreement otherwise, even if that was not their intention.

 

To avoid potentially unpleasant outcomes, you and your co-founder(s) should form your company early and ensure that arrangements among you are properly documented, making sure to cover at least the following:

 

overall goal and vision for the business

 

• what cash or other assets will each founder be contributing to the business?
• who gets what percentage of the company? Is the percentage ownership subject to vesting based on continued participation in the business?
• roles and responsibilities of the founders? What time commitment to the business is expected of each founder?
• if one founder leaves, does the company or the other founder have the right to buy back that founder’s shares and if so, at what price?
• how will key decisions and day-to-day decisions of the business be made?
• what circumstances would result in removal of a founder as an employee of the business?
• how will a sale of the business be dealt with?

 

2. Intellectual Property & Confidentiality

 

Your business’s most valuable asset will likely be its intellectual property (“IP”). Trademarks protect its name and branding, trade secrets protect certain kinds of confidential business information, and patents protect any inventions your startup will use. In Hong Kong, all of these require registration to enjoy protection from outsiders. Copyrights protect creative works such as songs, literary works and computer code, but they are automatically protected and normally do not need to be registered.

 

If you are like most startups, you will also need to design a website and register a domain name for it. Like all other IP created for the startup, steps will need to be taken to transfer ownership of your domain name to the startup itself. While there is no one-size-fits-all solution for registering IP, as a rule, you should arrange for a trademark search and companies search to be carried out to ensure that no one else is already using the name you want to use for your startup.  

 

To avoid disputes and ensure everyone knows what their role and responsibilities are, you will need suitable written agreements in place with all of your co-founders, employees, and contractors to ensure that the startup – not the individual creator – owns all IP created in connection with services performed for the startup.   In addition, you should have a standard non-disclosure agreement (“NDA”) for third parties to sign that prohibits them from disclosing and/or using your confidential information. Failure to put these protections in place can prove utterly disastrous.

 

3. Fundraising/Securities Issues

 

This is an area that is littered with potential legal pitfalls but might not be a concern if you are bootstrapping your business. However, if you are like many startups in Hong Kong, you will be looking to tap into the burgeoning local and international angel investor scene, and so caution is warranted. 

 

Hong Kong’s longstanding legal restrictions on raising capital from “members of the public” complicate the process of approaching potential investors, but it is possible to raise the capital you need without breaking the law whether you are intending to issue convertible bonds or shares. The most popular and useful exceptions require you to only raise money on a private placement basis or from “professional investors”. 

 

You should always speak to an experienced startup lawyer before undertaking any fundraising activities, even if you are just raising money from family and friends. Aside from ensuring that your fundraising complies with the law, getting advice before striking a deal can avoid unrealistic expectations on the part of investors and unwittingly tying a below-market valuation to the business. 

 

4. Employment Issues

 

You are probably already aware that employees and contractors are treated differently under the law, with employees given greater protection.

 

Before hiring employees or engaging contractors to perform services for your company (e.g., app development), you need to speak to a startup lawyer about what each will be doing, who is responsible for what, how they will be remunerated and, most importantly, who will own any IP they might create in the process. To protect your business, contracts governing these relationships should contain non-competes, NDAs and “work for hire” provisions.

 

In addition, startups usually incentivize early-stage and key employees with some form of equity participation such as share options. When structuring these arrangements, it is useful to have a lawyer’s input on what strikes the right balance between the company’s interests and making sure the terms are both fair and likely to incentivize these key people.  

 

5. Contractual Issues

 

Wherever possible, you should use written contracts when dealing with third parties. Oral agreements are normally enforceable in Hong Kong, but proving what was agreed upon can be complicated (read: expensive).

If limited time or resources prevent you from preparing standard written contracts, you should send out a binding letter of intent or, at the very least, a follow-up email to everyone concerned to document the key terms of your agreement. That way, if a dispute arises, you will have some evidence of what was agreed.

 

6. Who’s got your back?

 

Lastly, although not a legal issue per se, every entrepreneur needs an experienced lawyer that he/she can turn to from time to time. Good startup lawyers are not deal killers.  In fact, he/she will be able to identify and help you brainstorm a way through all of the significant legal risks you encounter and press you to negotiate reasonable protections in every deal you do.  If you don’t have much deal-making experience, your lawyer’s got your back in negotiations to help you get the best deal possible. Be sure to have a good enforcer on your team!

 

The above list only constitutes the basics of what you should know when launching a startup. For any given business, a dozen or more legal issues may surface within weeks of launching. However, failure to obtain sound legal advice on the key issues at the outset could lead you down the wrong track and be very expensive to get right. Our team is here to ensure you are always on the right track with the right tools to move forward.