introduction

Starting a new tech business is a big deal. It is not just a case of coming up with a great idea and everything else will fall into place – in most cases, the good idea is the easy part.

There are so many big issues to think about and resolve. How will I build my product/service? How will I prove it works? How will I prove customer demand? If there is customer demand, how will I take the product to market? How on earth will I fund all this?

Let’s face it, with all these big issues to address, it is not surprising that many tech startups struggle to find the time to sort out the legal stuff that goes with setting up a new business. So to help with this, we have written this guide to help new businesses get the legal basics sorted.

when should I form a company?

There is no legal requirement to incorporate a company in order to run a business in New Zealand. However, there are some practical benefits that come with incorporation, including limiting your liability for the trading activity of your business and enabling you to divide the ownership of the business through the issue of shares.

We generally recommend that entrepreneurs incorporate a company once they:

  • start to incur non-trivial costs that will need be accounted for by the new business
  • are ready to hire your first employee or contractor
  • are ready to start trading.

Some online commentaries on this topic recommend incorporating as soon as you have more than one person involved in starting a business. This is good advice if the contributions that each party will bring to the startup are clear and unlikely to change in the short term.

However, in the early stages of developing a business idea, the perceptions amongst a group of co-founders about the value that each of them will bring, and the roles that each of them will play once the business starts to solidify, often turn out to be inaccurate. Since incorporation fixes the ownership percentages of the co-founders as at the date of incorporation, it may be handy to delay setting up a company until the roles and value of each of the co-founders have become more settled. Changing ownership percentages post incorporation can cause tax and legal difficulties, not to mention the potential for disputes between co-founders.

how to form a company

Incorporating a New Zealand company is a cheap and easy process that you can complete online. You don’t need a lawyer or accountant to do this for you, although either should be able to do the job for a modest cost if you are in a hurry.

To complete the incorporation process online, you will need the following information/documentation handy:

  • company information, including name and physical address and total number of shares on incorporation. You will need to reserve the company name first, before you can proceed to incorporation (a name reservation generally wouldn’t take more than about 20 minutes to be processed through the Companies Office website)
  • director information, including full name, residential address, date and place of birth, residency status (i.e. whether s/he is a NZ resident) and IRD number. At least one of the company’s directors must live in NZ or live in an enforcement country identified under the Companies Act and be a director of a company that is registered in that country
  • shareholder information, including full name, address, number of shares held by each shareholder, and IRD number
  • a constitution – it will make it easier to run your company if you adopt a constitution which, to the maximum extent permitted by the Companies Act, allows the board to do things like issue shares and take out D&O insurance without the need for shareholder approvals (the Simmonds Stewart template constitution takes this approach)
  • a decision on whether you’re registering the company with the IRD, as an employer and/or for GST at the same time. There are several pieces of information required if you are, which the Companies Office explains on its website.  It’s simpler from an administrative point of view to take care of IRD, employer and GST registration upfront on incorporation, but registering for GST isn’t necessary, or advisable, for every company.  Before making the call, it’s worth reading the guidance available from the IRD website, and discussing it with a professional.  As a general rule, the IRD encourages you to register for GST if you know your turnover will be more than $60,000 in the next 12 months.

You can always save your progress during the online incorporation process and return to it later, if you don’t have all the information available upfront.

record keeping

Good record keeping is a necessary (if boring) discipline that will save you time, money and aggravation down the line. Bad record keeping will do the opposite – and will make you look disorganised and unprofessional when talking to potential investors.

There are a bunch of records that the Companies Act requires companies to keep, including:

  • a share register (a physical share register is required to be kept in addition to recording details of share issues and transfers on the Companies Office website), minutes of meetings of directors and shareholders, directors’ interests register, and a number of similar administrative records. Our template company registers contain versions of the necessary registers and details of the records that need to be kept in them
  • accounting records that correctly record and explain the transactions of the company, and that enable the financial position of the company to be determined with reasonable accuracy (s194 of the Companies Act). Virtually all of the NZ startups that we deal with use Xero, and down the track this is appreciated by NZ investors who are usually very familiar with the Xero accounting platform.

To find out more, the Companies Office has a lot of information on company record keeping obligations.

Most startups will need to engage an accountant to assist with tax and annual accounting compliance. Many will also need help with the initial setup of their accounts in Xero and with ongoing bookkeeping. We think trying to do this yourself, unless you have an accounting background, is usually a false economy. Many accounting firms are interested in developing their portfolio of companies with high growth potential, so it is usually possible to find an adviser that is able to provide high quality assistance for a reasonable cost. There are also specialist Xero bookkeepers, such as GoFi8ure, who can look help you to set up your accounts in Xero and with day to day book keeping on a very cost effective basis (although you will probably also need an accountant on board to help with annual accounts an tax compliance).

The Companies Act also imposes an obligation to file a range of information and documents on the Companies Office website. The common filing requirements for startup companies are:

  • updates to company fundamentals, including company addresses, director details, changes to the total number of shares, and the company’s constitution. These must be done within minimum timeframes after the event occurs (generally 10 working days)
  • annual returns (which aren’t necessary in the first calendar year of a company’s incorporation)
  • director certificates each time you issue new shares (s47 of the Companies Act) or options or convertible notes (s49 of the Companies Act).

To find out more, the Companies Office has a lot of information on these filing obligations.

Record keeping and filing requirements can also arise under a range of other legislation, depending on the type of business being conducted. We briefly discuss tax record keeping requirements later in this Guide. You will need to become familiar with these requirements, and any others applicable to your business.

In addition to statutory record keeping, we recommend that startups companies keep:

  • an up to date cap table spreadsheet, that records current share, option and convertible note holders and allows modelling of the effect of further capital raising. This will be key tool when planning and negotiating capital raisings, as it will help you to model outcomes for both current shareholders and incoming investors. Our template cap tables are a great starting point, as they allow you to model the main variables of your raise (being the size of the raise and the pre-money valuation)
  • an electronic due diligence file, containing indexed copies of company documents that potential investors (and potential acquirers) will to want to see as part of their investment processes. We suggest that companies maintain their due diligence file as a series of folders matching the topics that investors commonly address in a due diligence questionnaire, using a template questionnaire as an index for the documents in your file. See our template due diligence checklist. This is a typical set up of a due diligence file:

founder arrangements

Documenting arrangements between you as founders and your company is an important step in establishing your company as a standalone entity. Incoming investors will want to confirm that the arrangements with founders have been properly documented, and this paperwork will also be important if/when one or more founders come to leave the company.

The basics that need to be covered by most companies and their founders are:

  • IP assignment deeds, transferring all relevant intellectual property from founders to the company. It is important to do this as early as possible, as there are potentially adverse tax consequences if left until material value has been built in the IP. Our template IP assignment deed will do the job in most cases
  • contractor or employment agreements for each founder. As well as dealing with what each founder will be paid, these documents deal with IP ownership (vesting any IP created on the job in the company), confidentiality and non-competition/restraint of trade. Our template independent contractor agreement covers these basics
  • the terms on which any founder funding is provided e.g. to meet establishment costs, including whether initial funding is to be provided as debt (shareholder loans) or equity (shares). Shareholder loans are the most common approach early on in a company’s life. However, keep in mind that future investors will probably be reluctant to allow their investment funds to be used to pay off shareholder loans, and will often require some or all of the loans to be converted to equity as a condition of their investment. So using shareholder loans to avoid arguments about valuation may simply be deferring that problem to a later date.

Some startups will want to implement founder vesting arrangements, under which a founder who leaves the company within a set period (commonly 3 years) surrenders a portion of their shares back to the company. This type of vesting arrangement is common in Silicon Valley, and is becoming more common in New Zealand.

We provide short form and long form template founder vesting agreements on our website. The long form agreement is intended to address the fact in Silicon Valley, if a company is dissatisfied with the performance of a founder, it is possible for a company to trigger founder vesting by terminating the founder’s employment under at will employment provisions, whereas in New Zealand it is much more difficult to dismiss an employee so an alternative means is needed to trigger founder vesting in these circumstances.

Founder vesting is most likely to be useful for founders that have come together through an accelerator programme or for a competition like a startup weekend. As the founders in these situations have usually not contributed much time or money to the startup, it is appropriate that the founders be required to work in the startup for a minimum period in order for their equity allocation to fully vest. Also, because the founders in these situations may not know each other well beforehand, there is a reasonable likelihood that some will drop by the wayside in the first year or so of the startup’s life, and it is easier to address what happens to a departing shareholders’ equity in advance rather than once that event has arisen.

governance documents

We recommend that startup companies with two or more shareholders adopt a constitution that:

  • streamlines the administration of the company (the default provisions of the Companies Act require shareholder approvals for a range of matters that, with a constitution, can be decided by the board without shareholder approval)
  • contains tag and drag provisions, so that a minority does not end up stranded when a majority of shareholders sell to a third party (tag along) and so that a minority cannot block a sale of the company since acquirers usually wish to purchase 100% of the target company (drag along).

Simmonds Stewart’s template constitution is drafted for use by startups and addresses both of these areas. In addition, the template includes pre-emptive rights on share transfers, so that a shareholder wishing to sell some or all of their shares must first offer them to existing shareholders.

We generally suggest that startups planning to raise external capital hold off entering into shareholders’ agreements. Most incoming investors will want the company to adopt a new shareholders agreement that is designed to protect their interests as investors. Therefore entering into a shareholders’ agreement between company founders is often a wasted effort. It is still worth thinking about whether founder vesting agreements are needed though – since you will want to be covered if a founder bails out before you complete a capital raise (and founder vesting arrangements will usually remain in place post investment).

For startups that do not expect to raise external capital, a shareholders’ agreement is likely to be a good idea, whether or not founder vesting agreements are used. In this case, our template shareholders’ agreement for product companies provides a good starting point.

founder, friends and family seed funding

Most startups need to raise some initial funding to meet operating costs. Even startups operating from a founder’s apartment or garage need to spend some money on things like website hosting and cloud subscriptions. These costs increase when the startup needs to hire contractors/employees and/or to pay its founders.

The most common sources of initial seed funding are founders themselves, followed by friends and family. It is pretty common for this type of funding to be provided by way loans, often with little or no formal documentation.

This can cause problems down the track as a company moves to secure third party investment. New investors will generally be reluctant to see their funds used to repay loans from founders, friends and family. But they equally will not want the loans to remain in place, since this will affect the return to investors on exit (and will be a drag on the company’s solvency in the meantime). Therefore new investors generally require the conversion of these loans to equity before their investment is made.

Conversion of loans to equity can cause a number of problems:

  • some lenders may not want to convert to equity, as it will put a strain on them financially. This most commonly occurs when founders have resorted to short term borrowing (e.g. credit cards) to fund the company, or where older parents have lent their adult children money
  • for those that are willing to convert, it can be difficult to agree a valuation for conversion purposes, particularly where some founders have provided loan funding and others haven’t. There is an unavoidable conflict between the interests of lenders and non-lender founders, particularly if the loans are large and stand to significantly dilute one or more founders.

Two ways to avoid these problems are:

  • for founders to fund the company by pro-rata shareholders loans. Provided the founders can afford to convert the loans to equity when seeking external funding, the valuation for conversion is irrelevant because the founders’ shareholding percentages will not change
  • to bite the bullet and issue shares to your backers at the outset. This does require you to decide on valuation for your company, but you will probably be able to do this by weighing up a % shareholding that you are prepared to give up for the provision of this seed funding. If everyone understands that the funding is provided in return for shares at the outset, there should be no dramas about repayment or conversion when you raise your first external funding round.

No special documentation should be needed if you are funding the company by pro-rata shareholder loans. It is usually sufficient to record the debt in shareholder loan accounts within your company’s accounts.

For share issues, as a minimum board and/or shareholder resolutions will be need to be completed (share issue resolutions are discussed in the company administration section below). To provide a measure of formality, and to provide your funders with some basic protections, a document like our simple seed investment subscription agreement can be used.

A convertible note agreement could be used for this early fund raising. However, convertible notes are harder to explain to friends and family. Plus subsequent external investors may still want these prior notes to be converted to equity before they invest, even if the new investors are investing via a KISS or similar instrument. For this reason, we tend to steer clients away from use of convertible notes in the friends and family phase.

As with more formal capital raising rounds, founders need to comply with the Financial Markets Conduct Act 2013 (FMCA) when raising money from friends and family. More specifically, they need to ensure that one of the exemptions from the information disclosure requirements of the FMCA, contained in Schedule 1 to the FMCA, applies to each investor. Founders involved in capital raising need to become experts on these exemptions – a good starting point is our guide to the FMCA exemptions.

The parts of Schedule 1 which are most likely to be relevant to friends and family investments are the exemptions for offers to:

  • relatives of the directors of your company
  • close business associates of those directors.

There is no explicit exemption for offers to friends. While a founder’s extended family are fair game under the FMCA, their friends are protected unless they are close business associates or one of the other exemption categories applies. The most likely candidates will be the small offers exemption, or the exemption for offers to wholesale investors.

employees and contractors

There are lots of reasons to complete formal employment agreements with all of your employees, and contractor agreements with all of your contractors.

With employees, these include:

  • the Employment Relations Act requiring you to have a written employment agreement (that complies with the requirements of that Act) in place with all employees
  • if you want to use the 90 day trial system, you must have this in a written employment agreement that must be signed before the employee enters your premises to start work; and
  • ensuring your employees are bound by decent intellectual property and confidentiality provisions (this is important when you come to raise capital and/or exit)
  • where appropriate, to apply restraints of trade.

You can find other useful resources on employment agreements and your responsibilities as an employer at: http://employment.govt.nz.

Reasons for completing an independent contractor agreement with your contractors include ensuring:

  • each contractor is covered by intellectual property and confidentiality provisions (this is important when you come to raise capital and/or exit)
  • your contractors are contractually responsible for tax due on the payments that you make to them
  • if applicable, you have reasonable non-competition provisions in place
  • you can terminate the relationship on short notice.

Although it may be appealing to hire team members as contractors (it is much more flexible, and you avoid liabilities such as holiday pay, KiwiSaver and ACC contributions), the decision is not entirely up to you. If a team member works substantially or entirely for your company and works under your direction and control, they are likely to be treated as your employee for both employment law and tax purposes, despite the fact that you signed them up as an independent contractor. This could leave you with a big tax liability if your contractor fails to pay their tax to the IRD, as well as other legal headaches.

There is a lot of information online about the difference between employees and contractors, including these useful Department of Labour tools.

Finally, an important topic for all business owners is health and safety. You can find detailed information on your obligations under the Health and Safety at Work Act on the Work Safe website.

sweat equity

From a New Zealand tax perspective, the best time to allocate equity to team members is on the incorporation of your startup. There should be no tax payable on those shares (assuming there was no intention to sell the shares at the time of issue). If desired, you can use founder vesting agreements, discussed above, to reclaim shares from a team member who doesn’t last the distance.

The common practice in New Zealand is to issue shares on incorporation of a company for nil consideration (which is the default position under the Companies Act 1993). Since share issues for nil consideration are exempt from the disclosure requirements of the FMCA, there are usually no securities law issues arising on establishment of a new company.

Issuing shares to team members post incorporation is more complicated.

If you issue shares to employees or contractors in payment for work performed (sweat equity), that payment will be taxable (PAYE for employees, GST and income tax for contractors). Closing your eyes and leaving your team members to sort out the tax is a risky strategy – since your company is likely to carry the risk for some or all of the tax due, plus penalties if they fail to take care of the tax themselves.

The FMCA is also relevant to sweat equity arrangements since the work performed by your employee or contractor is consideration for the issue of shares. There is no single exemption that applies in these circumstances – we think the employee share schemes exemption probably does not apply to sweat equity arrangements since raising funds via opex reduction is, in effect, the primary purpose of the arrangement. As a consequence, entrepreneurs using sweat equity to remunerate staff will need to undertake the usual pick and mix process to match exemptions to individual employees/contractors.

employee share schemes

Employee share schemes are more or less the norm for New Zealand startups.

You can also learn more about this topic by reading the following template documents for simple employee share option schemes:

company administration

In addition to the general filing requirements described in the record-keeping section above, annual housekeeping obligations apply to each NZ company by default. The annual housekeeping obligations break down to holding an annual general meeting for shareholders (AGM) and end-of-year financial reporting. The clock starts ticking on the deadlines for these obligations from the company’s balance date, which is 31 March for all NZ companies unless they have made special alternative arrangements.

shareholders’ AGM

A company must hold its first AGM within 18 months after its incorporation. From the second year of incorporation onwards, the AGM must be held within:

  • 6 months after the balance date of the company. For most companies, this deadline is 30 September
  • 15 months after the previous year’s AGM.

The AGM is an opportunity for the shareholders to vote on matters relating to the company, including the company’s annual financial reporting obligations discussed below. There are likely to be few, if any, matters that the company has to address at that meeting if the company is either small enough to fly under the radar of the annual financial reporting obligations or the shareholders of the company have previously voted to opt out of those obligations (see the discussion below). If nothing else though, an AGM is a good chance for a company to touch base with its shareholders.

If holding an AGM in person (including via skype, etc.) is unnecessary or unworkable, the obligation to hold an actual meeting can be bypassed by circulating a written resolution for your shareholders to sign.

annual financial reporting

Under the default annual financial reporting obligations, a company must:

  • arrange for financial statements to be prepared and audited within 5 months after the company’s balance date. For most companies, this deadline is 31 August
  • prepare and circulate to shareholders an annual report containing the annual financial statements and other details required under section 211 of the Companies Act at least 20 working days before the date of the AGM.

Companies with fewer than 10 shareholders are generally subject to a lighter mandatory admin load. So a startup with fewer than 10 shareholders will not have to prepare financial statements or an annual report unless its shareholders require it to do so using the opt in provisions of the Companies Act.

Companies with 10 or more shareholders are subject to the full annual financial reporting obligations by default, but can in some cases opt out of these obligations if their shareholders allow them to do so using the opt out provisions of the Companies Act.

intellectual property

If you’re not familiar with intellectual property (IP) rights, it’s helpful to think of them as rights in your ideas and other hard to define things that you can exploit to become a commercial success.

Each country has its own sets of IP laws, so don’t assume that protection in New Zealand means protection anywhere else.  On top of this, certain registrable rights (patents, trade marks, and registered designs) have finite windows of opportunity to get registration.  So, if you rely heavily on IP and are seeking to be an international business, you should think about a global IP strategy for your target markets sooner rather than later.

Here are the key IP rights most technology businesses deal with.

trade marks

These are the names, logos and brands that you use to identify to others that your products and services have come from you.  Getting your trade mark registered makes enforcing your rights in these easier.  At the most basic level, and common to all countries, a trade mark needs to be distinctive (e.g. SOAP for soap products is not an option) and sufficiently different from marks already on the register.

Applications to register trade marks in New Zealand are made through the Intellectual Property Office of New Zealand (IPONZ).

international trade marks

If you want to register the same trade mark in a number of countries, it’s worth thinking about an international trade mark.  This is a collection of registrations in the countries you have selected from those that have signed up to the Madrid treaty (being the treaty on international trade mark registrations).  The process has a one-for-all approach for each of the key steps (e.g. application, payment of fees, examination, and renewals).

You can apply for an international registration through IPONZ.  You’ll need:

  • an existing trade mark registration in New Zealand, which will need to remain valid for 5 years
  • to be based in a Madrid treaty country.

Check out the World Intellectual Property Office (WIPO) website for more information.

copyright

Copyright protects your original works, including written works (e.g. software source code and object code) and artworks (e.g. website graphics) from being copied without your permission.

Most countries are members of the Berne Convention, which means that pretty much everywhere you go, copyright in your work:

  • attaches automatically on creation (once recorded) if it is sufficiently original and creative
  • doesn’t need to be formally registered
  • doesn’t need to have a © notice on it, although we suggest that you always put this on to notify others of your rights.  How you should style it is:  © [company name] [year of first publication]
  • is protected for the life of the author plus at least 50 years.

patents

Patents are exclusive rights granted by a government over inventions (usually for 20 years).  An invention covers pretty much any product or method which is new, inventive, useful and doesn’t fall within an excluded category.  Patents are hard to get and:

  • different countries have different excluded categories. In particular, methods of medical treatment, computer programs, business methods, diagnostic tests, genetic material, and animals and plant varieties vary widely in patentability from place to place
  • obtaining a patent is lengthy (from application to grant will take years), usually requires specialist legal input, and is expensive
  • by definition, your invention needs to be new (i.e. novel). This means it hasn’t been made available to the public (not even as a one-off) before, anywhere in the world, by you or anyone else.  This is obviously a tall order.  There are some exceptions – e.g. disclosure in confidence is sometimes ok, but this exception is very narrow in scope.

So why would you consider a patent?  The beauty is in the word monopoly.  If you have a patent, no-one else in that territory can use the patent (e.g. sell the product, or perform the method, that you have patented) without your permission.  IPONZ has a useful guide on patents too.

There is also an international system for seeking patent protection in multiple countries (known as a Patent Cooperation Treaty (PCT) patent).  You can submit a PCT application through IPONZ, who then passes it directly to WIPO for processing.

registered designs

Registered designs protect new aesthetic design features of mass-produced articles (e.g. the design features of a new look tablet).  Rights in New Zealand must be formally registered and can extend for up to 15 years.  IPONZ has some good information on this.

how do you avoid stepping on someone else’s toes?

Not only may you have IP rights that you can wield against others, others may have IP rights that they can wield against you.

Often businesses get their IP lawyers to conduct a freedom-to-operate (FTO) search to help identify early whether anyone else has existing rights (particularly patents) that might be infringed.  However, FTOs can be expensive and no search will be 100% accurate (e.g. patent applications usually aren’t published until 18 months after the application is filed).

With the advent on online registers and other tools, there is a lot searching that you can do yourself.  E.g.:

  • finding out how your target territories deal the relevant IP rights
  • carrying out your own online searches (e.g. checking domain name registers)
  • if certain registrable rights look relevant, looking up the time lines and processes for getting those registered so you can be sure to get advice and action in good time.

contracts

Every startup is different (or so founders tell us), and startup contracts are similarly diverse (or at least lawyers like to think so).

Unfortunately, re-imagining the contract is a costly business. If funds are tight, and particularly while you are only at the alpha and beta trial stage, we think most startups can make do with relatively generic templates that cover off common use cases in an 80/20 fashion.

We provide basic contract templates on our website that will help many startups, particularly those operating in the software, web, digital and services fields:

You can get your lawyers to help you customise any of these documents to suit your particular needs.

tax and compliance

It is important for startups to get on top of their tax compliance obligations right from the outset. Getting behind on PAYE, GST or provisional tax obligations will cause ongoing problems until you can get up to date again, and the distraction is not something you need when you are trying to get your business off the ground.

Tax compliance problems are also off-putting to potential investors. Problems of this nature suggest a lack of attention to detail or a cavalier attitude on the part of founders, neither of which are investible qualities.

Implementing Xero or a similar accounting package, getting a good accounting firm on board, and following your accountant’s advice on tax set-up and compliance, are the most important steps you can take to avoid tax problems. It is also good to learn as much as you can about your obligations. The IRD’s Tool for Business has a lot of information, and most of the bigger accounting firms also offer plenty of information online.