Legal Structure for Forming
Startups in Pakistan
The term “Startup” is in usage for describing a new business venture wherein, entrepreneurs and/or companies harmoniously combine their skills, ideas and financial resources to generate new business activity with higher returns. In fact, it could be apt to place the “Start up” phenomenon at the epicenter of a vibrant entrepreneurial cultural.
In Pakistan the ‘Startup’ trend is gaining momentum as entrepreneurs with creative ideas are seeking funding solutions to generate economic activity and new revenue streams. Devising a legal structure for a ‘Startup’ is essential, if it is to be made viable and functional. The objective of such a legal structure is twofold. First and foremost is to clearly layout the rights and obligations of the parties working under ‘Startup’ umbrella. Secondly, the aim is to safeguard their business interests. Thus ensuring a stable business platform wherein disputes can be prevented, the liabilities are defined and the risks can be mitigated.
The legal structure of a Startup venture mainly depends on the long term vision of the parties entering into such venture and the kind of venture in itself which is being entered into. A Startup in Pakistan may be structured in the following ways:
A registered partnership is the simplest way of entering into a Startup venture. However, the liabilities of the partners in a partnership concern are joint and several which may expose any one or more partner(s) to third party liabilities because of the acts or omission of other partner(s). Specially in the cases where one partner is an investor and not interfering in day to day affairs of the venture.
Another issue which might erupt in a partnership structure is the entitlement of any Intellectual Property (“IP”) created in the course of business. The IP is owned by its creator unless there is an agreement to the contrary.In cases of Startups it is usually agreed to vest the title of an IP in the name of the legal entity. However, the property of a partnership vest in the partners jointly and severally.
Therefore, in case of any dispute or dissolution of partnership the dispute as to title of IP becomes questionable and the interest of the investor (depending on the sort and extent of the investment) is jeopardized. Another issue which may erupt in the eventuality of dissolution of partnership is divisibility of the IP title, specifically in a scenario where IP is not fully mature or cannot be sold out in the market and it becomes really difficult to get it valued. This anomaly can be covered by giving a right to vest the title of IP in investor which, in most circumstances might not be acceptable between the parties.
The most ideal way of establishing a Startup is to form a limited liability company. A limited liability company is an independent juristic person, therefore, the title of the newly developed IP can be easily vested in the company without any hassle albeit subject to necessary agreements between the shareholders and/or employees (as the case may be).
Nevertheless, a lot of people are reluctant to form a limited liability company due to its registration requirements and subsequent filing requirements with the regulator which may incur certain additional overheads. The overheads for a limited liability company might include a chartered accountant to conduct audit of its accounts and a retainer lawyer as a mandatory statutory requirement.
Another advantage of a limited liability company is the equity injection by having variation in rights and privileges of subsequent investors in an organization. A company limited by share may have more than one kind of share capital and may have different classes of share under each kind. The variation in the rights and privileges of the shareholders in a kind of share capital or calss or classes therein may include the difference in voting rights, voting rights disproportionate to the paid-up value of the shares held, voting rights for specific purposes only, no voting rights at all, different rights for entitlement of dividend or such other rights as the member may determine through special resolution.
The Startups are never recommended to make a special purpose vehicle for one particular venture with a particular set of people. However, if a startup intends to form multiple ventures with the same set of people it is always recommended to make a venture capital company.
An efficient way of forming a startup (for one specific venture) is to enter into a joint venture or collaboration. The joint venture or collaboration are partly interchangeable terms and have basically thin distinguishing line depending on the terms and conditions to be settled between the parties. It is always advisable to form a collaboration or joint venture which shall end up in a limited liability company at a specific point in time or triggering of a specific event.
A joint venture or collaboration agreement can be comprehensive enough to incorporate the internal systems of an organization and the issues related to vesting of IP rights. In the joint venture/collaboration agreement the rights of IP can be vested in the name of the Joint Venture and/or Collaboration respectively and once such IP or final product (e.g. software etc.) comes into existence the same would be owned by the joint venture/collaboration or the subsequent entity i.e a limited liability company.
