Written by Team Farallon
When founders decide to develop their ideas and turn them into a commercial venture, the first step would be to incorporate a new company. The incorporation of a new company (the “startup”) creates a separate entity from the founders. This enables the company to own property, such as intellectual property rights which would arguably be the most important asset of a startup.
More importantly for founders, the principle of limited liability flows from separate legal entity. The principle of limited liability is that members will not be held liable for the company’s debts unlimitedly. The idea of limited liability is that when a company goes into insolvent liquidation, its members are not required to contribute to the assets of the company provided that they have paid for their shares in the company in full. In that regard, the founder’s liability is capped.
As the company is separate from its members, a creditor of the company cannot sue the members for any unpaid debt incurred by the company. This in turn allows the founders to develop and conceptualise their ideas without the fear of being personally liable.
There are several documents that have to be prepared when a startup is formed.
Formerly known as the Memorandum of Association and the Articles of Association of the company, these two documents have since merged to form the company’s Constitution. A company’s constitution is a formal legal document that sets out the rules that govern the company and also defines the relationships between the company, shareholders, and directors.
Pursuant to section 19 of the Companies Act (the “Act”), anyone incorporating a company must also submit the constitution of the proposed company. Section 22(1) of the Act also provides that the constitution shall state the following:
The company could opt to adopt the Model Constitution as provided in the Companies (Model Constitutions) Regulations 2015. Other clauses could be included in the Constitution, such as a clause prohibiting the alteration of the Constitution or clauses limiting the number of members or detailing share transfer restrictions. The clauses of the constitution should be precise and unambiguous so as to prevent potential disputes that could impede a company’s operation. In that regard, it would be prudent to engage a competent lawyer to tailor the company’s constitution to its needs.
The Shareholders’ Agreement or SHA is a contract entered into between shareholders of the company. A well drafted SHA should at the very least cover the following:
A SHA binds all shareholders of the company and incoming shareholders are typically required to enter into the same SHA. As mentioned earlier, if a company adopts the model constitution, shareholders could supplement the constitution by including additional terms into the SHA.
Having a well drafted SHA means that any disputes could be resolved expediently through the provided dispute resolution mechanisms, thereby minimising disruptions to the company’s operation and growth. There would be no ambiguity as to how the company should run, how important decisions should be made and agreed upon, minority shareholders are well protected, and there would also be no unwelcomed surprises as to the transfer and sale of shares when a shareholder decides to leave the company.
In that regard, while a SHA is not compulsory when incorporating a new company, it is highly recommended (unless the company only has one shareholder) that shareholders drafts and enter into a SHA.
When the company is incorporated, the first directors’ resolution will have to be passed. It would include important details such as:
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