There are a number of things you need to get done before potential investors do due diligence on your start-up
Seek advice from others, ensure any legal advice is professional, and do due diligence on your investor as well
Bread & Kaya by Foong Cheng Leong
WHEN I was in high school, I invested a few thousand ringgit on a web-hosting company operated by a ‘friend.’ Unfortunately, the web-hosting company didn't materialize and I never saw my money again, nor the ‘friend.’ In fact, there was no such web-hosting company!
That was my first failed investment. Looking back, I realized that the investment was purely done by trust. I did not do any background check on the company or even the ‘friend.’
But years later, I was approached by a stranger (at that time) to help his start-up by providing my services to him, in return for shares in his company. I did not invest a single ringgit. I am glad to report that the start-up is doing well, with offices around South-East Asia and other parts of the world.
Today’s column sets out some tips before opening your start-up for funding.
Before you think about attracting investors, you need to get your house in order. Prudent investors would usually do an in-depth due diligence of your company to see, among others, what assets and liabilities you have.
They will check your background, hence you need to make sure it’s squeaky clean. They will obtain a company search report from the Companies Commission of Malaysia to verify the details of your directors and shareholders, shareholding structure and financial reports – so make sure you file your reports on time.
They will also go through your memorandum of association and articles of association (documents that are required before incorporating a ‘Sdn Bhd’). Take some time to read them and amend if necessary. Board and shareholders minutes will also be part of due diligence exercise.
Investors usually come with high expectations. Thus, educate your investors of the nature of your business and industry, business plans, goal, competitors and obviously, monetizing strategy. Over-promising will create legal trouble for you.
When meeting your investors, appoint someone presentable who speaks well to deal with them. This raises investor confidence.
Other than your financial records and information, here are some common matters that should be addressed before the due diligence stage.
1) Intellectual property rights
Intellectual property rights generally refer to your trademarks, copyright, industrial designs, confidential information and patents.
Start-ups generally file their trademarks first as it is affordable. If you have a physical product and the design is new, do consider filing an industrial design to protect the design.
Patents are usually not filed due to budget constraints. A patent application (with the assistance of a patent attorney) costs at least RM5,000 and above. However, if the invention is novel and you think it’s worth protecting, do file it within one year otherwise it will not be afforded protection.
You can file for protection with the Intellectual Property Corporation of Malaysia (MyIPO), or if your business or operation extends to other countries (e.g. Singapore), you should register your rights there too.
A registered intellectual property right gives you the exclusivity over your product, thus you may stop others from using them. Also, the Income Tax (Deduction for Expenditure on Registration of Patent and Trade Mark) Rules 2009 provides tax deduction for the registration of trademarks and patents in Malaysia for certain start-ups.
2) Proper contracts
All terms and conditions between the founders, with merchants, customers, vendors and employers must be properly spelled out. For existing contracts, review them to see whether they are still applicable or have to be changed or terminated.
Here are a few tips:
In your agreements with customers, investors will look on how revenue is generated and to find any unfavorable terms, etc. Do make sure your contracts (or invoice or receipt) with service providers (e.g. graphic designer, website, software) do not state that intellectual property rights (in particular, copyright) belong to them (by default, intellectual property rights belong to the person who commissioned the work, unless stated otherwise). Such contracts should describe the subject matter in detail and that the rights to the intellectual property are properly assigned to your company.
3) Non-disclosure agreement
Before opening your door to investors, do get them to sign a non-disclosure agreement (commonly known as an NDA). This agreement is crucial in making sure that they do not misuse the information they gathered from the due diligence. Such information may include your finance information, source codes and customer data.
Your investors may also want to look into the source codes of your proprietary software. Although an NDA may be signed to protect it, you may want to take an extra step to request that the software due diligence is done by an independent third party.
Also, when dealing with your vendors or employees, get them to sign a NDA. Your information is your asset.
4) Employee matters
If you have employees, make sure that there are employment contracts. If you have promised the employees something (e.g. equity), make sure you state it in writing. Ensure that you have been contributing to statutory contributions such as the Employee Provident Fund (EPF) and Social Security Organization (Socso).
This guide is a non-exhaustive basic guide and merely an idea on what you need to do before attracting investors. Do seek out advisers or mentors for help and advice. Get an experienced lawyer when dealing with terms and conditions. Speak to other fellow entrepreneurs who have done it before for advice.
Most importantly, do due diligence on your investor as well!
Foong Cheng Leong is a blogger pretending to be a lawyer, and a lawyer pretending to be a blogger. He blogs at xes.cx and foongchengleong.com, and tweets at @xescx and @FCLCo.
Previous Bread & Kaya:
Bread & Kaya: Looks can be deceiving!
Attention e-commerce businesses: Fraud, the law and you
PDPA: Businesses have responsibilities and burdens
Start-ups and deals, Malaysian style
Raising money IS supposed to be hard!
Angels with pitchforks, VCs who don't venture
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