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5 Common Legal Mistakes Hong Kong Startup Founders Should Avoid

Starting a new business adventure means managing multiple exciting activities simultaneously: product development, marketing, sales, etc. With so many things to get done, legal aspects usually tend to take a back seat. Many founders consider legal advice a luxury, assuming that their bootstrapped startups cannot afford it. Unfortunately, this leads to all sorts of legal problems that can undermine the foundation of their startup and even become company killers.

The following are some of the common mistakes made by Hong Kong startups:

1. Not protecting their intellectual property (IP)

Intellectual property refers to any intangible assets, such as patents, trademarks, copyright, logo, design, and anything else that differentiates a business’ offering. If a founder has a brilliant idea, there will always be those who will try to duplicate it and get a bit of the brand’s success, with a risk of undermining or even destroying the brand’s value. Intellectual property is one of the most valuable asset for a startup, as it provides commercial value to and differentiates a startup from the others. Therefore, it’s really important to identify the strategic intellectual property at the very beginning and to enlist legal support to protect it properly. Most, if not all, of the investors would love to see startups with a well-developed intellectual property protection strategy.

Also, there is no such thing as “global IP protection” – if the intellectual property is protected in Hong Kong this does not necessarily mean that it is automatically protected in any other country. The rule of thumb is to register IP rights in each jurisdiction the startup works with.

Some excellent resources about intellectual property protection in Hong Kong include:

Hong Kong – IP Trading Hub
Intellectual Property Department
Online Search for Trademark, Patents & Designs

2. Sealing the business with a verbal agreement and a handshake

When friends or family members come together to form a company, more often than not, they will not consider the need for a written shareholders’ agreement as they tend to rely on mutual trust, respect and confidence. Of course, this generally works perfectly when the business is doing well and profitable, and while the shareholders are receiving their expected return on investment. But what if things turn sour? Whether the business is not doing well or trust and confidence morph into distrust and suspicion, what can shareholders do? In circumstances like these, the shareholders’ agreement comes into play. A well-drafted shareholders’ agreement should be able to offer a solution to the parties in most cases. As with any other agreement such as those for sale and purchase, and loan transactions, the importance of a shareholders’ agreement is to safeguard interests of the shareholders and if disputes arise between the parties, there is an agreement they can fall back on setting out clearly what the parties can or cannot do, and shall or shall not do.

Here are some of the terms the written shareholders’ agreement should address:

1. How the shares will be split between co-founders
2. The management of the company – the roles and responsibilities of the co-founders
3. The right of founders to nominate directors
4. Frequency, procedures for convening and holding board meetings and shareholders’ meetings
5. Matters which require simple majority, super majority or unanimous votes
6. Dividend policy
7. Issue of new shares and admission of new shareholders
8. Transfer of shares
9. Anti-dilution mechanism
10.  Deadlock
11.  Minority shareholder protection
12.  Further financing needs of the company
13.  Non-competition undertaking by shareholders
14.  Term and termination of the shareholders’ agreement
15.  Dispute resolutions

3. Poor management of accounting

One more common mistake made by startups is the poor management of their expenses throughout the year. Founders usually rush to collect all receipts only when they need to file tax returns. Some business expenses may be deductable from the income to reduce the amount of payable tax, so good accounting practices not just help make informed business decisions, but also save costs.

4. Not registering the right business entity

There are many reasons startups should form a business entity rather than operate as a sole proprietorship. In Hong Kong, in most instances, that will mean a limited company. Limited companies can protect the founders and investors from corporate liability, own property, open bank accounts, have different types of shareholders (holding common and preferred shares), sue and be sued, and carry on business both in and outside Hong Kong.

It is essential to form the company early and to document the formation, the ownership, and the agreed arrangements among the shareholders. All of this can be done cheaply by professional corporate service providers, but to make sure that it is done properly, taking into account the current and future needs of the startup, as well as the preferences of the founders (and investors), it is advisable to speak to a startup lawyer first.

5. Not engaging legal council

Smart business owners know that it is better to involve a professional legal counsel earlier than later and that fixing legal mistakes is more expensive than preventing them. Downloading free document templates on the internet can save money in the short term, but can lead to all sorts of problems in the future: the documents may not be suitable for industry or jurisdiction, may be outdated, etc. Though legal advice is not cheap, it is possible to find it all over the price spectrum. Moreover, lawyers often provide pro bono and free brief legal clinics and can even make special arrangements for startups.

Online subscription to customizable legal templates with ad-hoc legal advice, such as OLN Online, is also an easy-to-budget and easy-to-use solution.

If you need more hands-on assistance with your legal issues, we recommend that you contact one of us at OLN. We have decades of experience advising founders and investors about emerging businesses and can provide the advice you need for your contracts and other arrangements.

If you have any questions regarding your contract needs or other legal issues, feel free to contact us for advice.