So you have an innovative idea and you are very confident that your idea is of a revolutionary nature that will change the world and become the next big thing. You think it is about time to turn that idea into reality. So you quit your job and start a company.
Launching a startup requires far more than just a good idea.
You need to come up with a business model, write a business plan, design your sales and marketing strategies, hire people, make good use of your assets as well as look for funding to finance your startup. All of these require your careful analysis and attention since they all bring along different types of risks, including legal risk.
Many entrepreneurs do not realise the importance of having a strong legal foundation for their startup until it is too late. They fail to appreciate that launching a startup is as much about the structure as it is the product or service. Entrepreneurs who seek legal advice at the early stage of their business enjoy the benefit of avoiding any unnecessary legal pitfalls.
Duties to Previous Employers
Many entrepreneurs were once employees of another company before launching their own startups.
It is very important for the entrepreneurs to make sure that they do not breach their duties to their previous employers when starting their own companies. Such post-employment duties are usually found in the form of assignment of intellectual property (IP), confidentiality obligation, non-compete and non-solicitation covenants.
- Assignment of IP – Many companies (particularly technology-based companies) require employees to sign IP assignment agreements which provide that the employee agrees that any inventions, ideas, work product or other development conceived or developed during the course of the employee’s employment will belong to the employer. Even in the absence of a written agreement, the Copyright Act 1987 and the Patents Act 1983 state that, unless otherwise agreed by the parties, the employer is deemed to be the first owner of the work made in the course of the employee’s employment. In other words, if you had invented an invention or written a source code as part of your job, you cannot bring along with you and use it when you leave the company.
- Confidentiality Obligation – Under the common law, an employee owes a duty to maintain the secrets and confidential information of an employer, whether or not there is a written agreement to that effect, and such obligation continues even after the employee has left employment. Certain things like trade secrets and customer lists are considered confidential information. The employee must refrain from disclosing or using such information for the purpose of operating a new startup.
- Non-compete and non-solicitation covenants – Depending on the position of the employee, certain employment agreements also include covenants from the employee not to compete with the business, or to solicit employees, customers or suppliers of the former employer for a period of time after the employee has left employment. Generally, non-solicitation covenants are enforceable if properly drafted. As for non-compete covenants, usually, such covenants are void to the extent of the restraint unless such covenants are drafted in such a way as to include an element of the use of confidential information belonging to the former employer. There is generally no restriction on stopping an ex-employee from making any use of experiences or skills that he had acquired in the course of his employment or starting a business to compete with his former employer’s business.
Legal structure, licenses, permits
Startups may run their business through different legal structures, such as sole proprietorships, partnerships or companies.
Sole proprietorships/conventional partnerships enjoy flexibility in administration as in there is no issuance of shares, no formal requirement to submit financial statements to the Companies Commission of Malaysia (CCM) and no need to hold Annual General Meetings.
However, sole proprietorships/conventional partnerships do not enjoy the benefit of limited liability like what a private limited company would enjoy. The owners of a private limited company will only be liable for the company’s debts up to the amount of their shareholder investments, except in cases where they are found to be personally liable by law, such as fraud or breach of directors’ fiduciary duties.
In light of this, startups should consider setting up their business through a limited liability partnership (LLP).
The LLP is a hybrid between conventional partnership and company whereby the partners enjoy both flexibilities in terms of administration and the limited liability status. However, if you hope to attract investors, a private limited company might be a better structure.
Depending on the location and nature of your startup, there may be federal, state and/or local licensing and permit requirements that you must follow before launching your startup.
Co-founders agreement, shareholders agreement
If you have one or more than one co-founders, it would be good to put a co-founders/shareholders agreement (depending on the legal structure) in place.
The agreement should address each party’s role, duties and obligations in the startup, how profit and equity will be divided, the voting process, board composition, how the shares will be broken down and at what price the shares will be sold if a founder leaves, how the startup can be dissolved, etc.
Whether you are bringing in an investment or hiring an employee or developer, it is important to have a written agreement in place at the outset to avoid disputes in the future (Remember the movie “The Social Network”)? Some startups issue shares to key personnel under a share option scheme to incentivize them to work towards the success of the business. This should also be properly documented.
What’s in a name?
Names are always important. The power of words should never be underestimated.
The company name must contain the word “Sendirian” or “Sdn.” and “Berhad” or “Bhd.” For LLP, the name must end with the words “Perkongsian Liabiliti Terhad” or “PLT”. The company/partnership name must not be the same as any other company/partnership in Malaysia. The law prohibits or regulates the use of certain terms in company/partnership names. Please refer to the “Guidelines for Naming a Company” issued by the CCM for more details.
As for brand name (trademark) and domain name, you should carry out screening searches to make sure the brand name and domain name are registrable and are not identical or closely similar to another brand name and domain name that belong to another party.
Website ownership and hosting
A website development contract should be put in place to govern your relationship as a client and your web developer.
Make sure that you own the copyright on the website (including the source code) and retain full control and freedom over the website. You should also make sure that you get a warranty from your developer that their work product does not infringe other’s intellectual property rights and an indemnity to compensate you for any costs and liabilities resulting from the breach of this warranty.
Most of the startups usually have some form of an online presence. Make sure that any images, texts or other content placed on your website belong to you or you have obtained a licence to use them. Website terms of use and privacy policy should always be prominently displayed on your website.
Your contract with the web hosting company that hosts your website must also address several key issues such as available bandwidth, service level guarantees, security, handover in the event you switch to another web hosting company, price and payment, renewal before the contract ends, etc.
Developing and launching a startup can be both exciting and overwhelming. While it might seem like a daunting task, getting the legal foundation right in the beginning stages will save you from unnecessary headaches and allow you to focus on the more important things in your startup.
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About the author:
This article was written by Edwin Lee Yong Cieh, Partner of LPP Law – law firm in Kuala Lumpur, Malaysia
This article was first published in CHIP Magazine Malaysia.
The view expressed in this article is intended to provide a general guide to the subject matter and does not constitute professional legal advice. You are advised to seek proper legal advice for your specific situation.
Edwin is a corporate and technology lawyer. He is also the founder and deputy managing partner of Lee & Poh Partnership (LPP Law). Edwin has advised a range of companies from technology startups to multinational corporations on a range of matters. In 2020, Edwin was named as a Malaysian Rising Star by Asian Legal Business, a finalist for the Young Lawyer of the Year at the ALB Malaysia Law Awards as well as a lawyer in the annual ALB publication of Asia 40 under 40.
View his full profile here.
